The Obama administration has endorsed these policies. Secretary of Transportation Ray LaHood and Secretary of Housing and Urban Development Shaun Donovan have agreed to require metropolitan areas to adopt compact-development policies or risk losing federal transportation and housing funds. LaHood has admitted that the goal of this program is to "coerce people out of their cars."

As such, compact-development policies represent a huge intrusion on private property rights, personal freedom, and mobility. They are also fraught with risks. Urban planners and economists are far from unanimous about whether such policies will reduce greenhouse gas emissions. Some even raise the possibility that compact city policies could increase emissions by increasing roadway congestion.

Such reductions are insignificant compared with the huge costs that compact development would impose on the nation. These costs include reduced worker productivity, less affordable housing, increased traffic congestion, higher taxes or reduced urban services, and higher consumer costs. Those who believe we must reduce carbon emissions should reject compact development as expensive, risky, and distracting from tools, such as carbon taxes, that can have greater, more immediate, and more easily monitored effects on greenhouse gas emissions.

In three of the four general categories of innovation examined in this paper — basic science, diagnostics, and therapeutics — the United States has contributed more than any other country, and in some cases, more than all other countries combined. In the last category, business models, we lack the data to say whether the United States has been more or less innovative than other nations; innovation in this area appears weak across nations.

In general, Americans tend to receive more new treatments and pay more for them — a fact that is usually regarded as a fault of the American system. That interpretation, if not entirely wrong, is at least incomplete. Rapid adoption and extensive use of new treatments and technologies create an incentive to develop those techniques in the first place. When the United States subsidizes medical innovation, the whole world benefits. That is a virtue of the American system that is not reflected in comparative life expectancy and mortality statistics.

Policymakers should consider the impact of reform proposals on innovation. For example, proposals that increase spending on diagnostics and therapeutics could encourage such innovation. Expanding price controls, government health care programs, and health insurance regulation, on the other hand, could hinder America's ability to innovate.

Being a smart, informed, and aggressive consumer is each person’s responsibility if a free market is to operate well. The alternative is a negative feedback loop in which government authorities protect us, we rely on that protection and stop policing retailers. Thereby we abandon the field of consumer protection to government authorities, who—try as they might—can never do as good a job for us as we can for ourselves.

The Senate Commerce Committee is having a hearing today on “Aggressive Sales Tactics on the Internet and Their Impact on American Consumers.”

Smart-growth planners believe that Americans live the wrong way, and they use land-use regulation to impose on others what they believe is the right way to live. Surveys consistently show that all but 15 percent to 25 percent of Americans want to live in single-family homes with a yard, but planners think we would be better off if a much higher percentage lived in high-density apartments or condos.

Consider my former hometown of Portland, Ore., which many consider the nation's leader in smart-growth planning. To increase urban densities, planners are turning dozens of neighborhoods of single-family homes into apartments and condos. While past land-use rules set maximum densities, Portland's rules set minimum densities.

This means if your neighbors own a vacant lot, they cannot build a single-family house on it; they must build a rowhouse or apartment. In some cases, regulation is so strict that, if your house burns down, you cannot rebuild it; you must replace it with an apartment.

Portland planners soon decided that rowhouses and low-rise apartments were not dense enough, so they increased height limits to 50 feet or 60 feet to allow four- and five-story mid-rise apartments. Even that isn't dense enough, so now they are beginning to encourage high-rises.

After the first high-density developments saturated the demand, planners supplemented land-use mandates with tax breaks, below-market land sales and other subsidies to developers who built high-density housing. This means Portland neighborhoods continue to be invaded by mid-rise and high-rise developments, even though there is no more demand for dense housing.

Many of these developments are in transit corridors. Yet independent studies reveal that the people living in them don't ride transit significantly more than residents of single-family neighborhoods.

Portlanders did not welcome densification. Almost all of the targeted neighborhoods fought it; almost all of them lost. Planners followed a divide-and-conquer strategy, taking one neighborhood at a time so opponents could not build up enough momentum to stop the process.

Increased densities destroyed the small-town atmosphere that once made Portland attractive. Congestion is worse, housing and consumer costs are high, and urban services such as fire, police and schools have declined as the city took money from these programs to subsidize high-density developers.

Despite these problems, scores of cities from Missoula, Mont., to San Diego, Calif., have passed similar smart-growth regulations. Planners want to use smart growth everywhere they can, including Houston.

To get out of Portland, I moved to an exurban neighborhood 150 miles away. Like many Houston neighborhoods, we have a homeowners association and deed restrictions, so we will never have to worry about outside planners imposing some unwanted development on us.

Unlike most other cities, Houston makes it easy to create homeowners associations in neighborhoods that do not have them. Houston's system of deed restrictions puts you and your neighbors in charge of your neighborhood's future.

By contrast, smart-growth planning puts your neighborhood's future in the hands of people who may know little about you or your neighbors and whose ideas about how you should live may be very different from yours. If you want to protect your neighborhood from high-rises and other unwanted developments, then smart-growth planning is the last thing you need.

For those observations, economist Brad DeLong called me an “utter fool.”

Let me draw your attention to an article in the Washington Post today entitled “Corporate giants sit on piles of cash.” Nucor Steel is sitting on piles of cash that it is unwilling to invest. Nucor’s chief executive Daniel Dimicco explains:

Everything is still on hold because we don’t have a lot of confidence that the right things are being done in Washington to reinvigorate the economy.

To story goes on:

Nucor isn’t alone. The balance sheets of large U.S. corporations are for the most part in good shape. Many big companies have piles of cash on hand and credit markets have thawed so that they can raise new funds… But most U.S. executives lack enough confidence in the economy to expand their businesses.

The article explains how big businesses are “jittery” for various reasons, such as memories of last year’s credit crunch. It doesn’t mention President Obama’s policies, but at this point in the economic cycle when world growth is returning, the lack of excitement by U.S. businesses regarding domestic investment is very curious.

Unfortunately, the Obama administration is giving them nothing to get excited about. The President is promising them higher health care costs, higher corporate taxes, more labor regulations, higher energy costs with cap-and-trade, and a lack of interest in further trade agreements.

The Post article says that some U.S. multinationals are using their hoards of cash to invest abroad, allowing them to avoid punitive treatment under the high-rate U.S. corporate income tax.

How do we get U.S. multinationals to start investing their “piles of cash” in the United States? Cut the U.S. corporate rate permanently to 15 percent, as I’ve described in Global Tax Revolution. With just about every other advanced economy having slashed their corporate rate in recent years, we are “utter fools” for not following suit, especially with the unemployment rate now topping 10 percent.

In the blame game, the Obama administration isn't about to stop with Fox News. Instead, it's moving on to lowly scientists.

Last month, President Obama gave a somewhat chilling, if somewhat ignored, speech on climate change at the Massachusetts Institute of Technology. He stated that any scientific debate about the magnitude of global warming is unscrupulous, decrying "those who . . . make cynical claims that contradict the overwhelming scientific evidence when it comes to climate change, whose only purpose is to defeat or delay the change that we know is necessary."

Then, the president talked tough, saying, "We'll just have to deal with those people," language familiar to anyone who knows the vagaries of Chicago politics.

This surely isn't the first time in world history that some president, premier, or pope has attempted to define science and threaten those who disagree. But the truth of the matter is that disagreement, one way or another, is a given. One can selectively cite recent climate data in support of pretty much any point of view, from the rejection of any influence by humankind at all to the wild notion that the world is about to come to an end.

The ease with which anyone can construct just about any climate argument he wants has to do with the inconstant nature of climate itself. The sun warms the earth, but the amount of energy it radiates changes (right now it's pretty cold). The earth's surface is dominated by two very different substances — uneven rocks and large, smooth oceans — so internal climate oscillations and accidents happen as well.

Temperatures seesaw up and down depending upon ever-changing currents of air in the tropical atmosphere and oceans, including El Niño in the Pacific and other weather features elsewhere. They can be either cold or warm. When the warm ones are absent or weak for a decade or so — a common occurrence — temperatures may stay the same or even fall. When there's a huge warm phase in El Niño, global temperatures rise, as they did in 1998, setting records that have yet to be broken.

Finally, there's carbon dioxide itself. We put it in the air whenever we burn pretty much anything, be it in a power plant or in an automobile. Everything else being equal, that will warm temperatures at the surface and in the lower atmosphere. Just how much is the subject of a great scientific debate that has yet to be resolved.

And everything else is never equal. Cold portions of El Niño and a cold sun can completely halt carbon-dioxide–induced warming (and clearly have for more than ten years now). And this behavior creates a fertile environment for criticism of the projections of computer models for this century.

What you can say is happening to the climate depends on the period you choose to study. Using the surface-temperature record that scientists cite the most, you will find a significant cooling trend after 2000. You'll find no significant trend whatsoever if you start in any year between 1996 and 2000. Beginning your trend before 1996 will yield you significant warming. And so forth.

It's therefore not surprising that anyone can see anything on the climate Ouija board.

In fact, though, there's only one thing that is clear: For the last decade and a half, our climate has not behaved in accordance with the predictions of most climate models. They just don't predict such a long hiatus in warming even as carbon-dioxide emissions from human activity continue to climb.

Note to the president: I do not say that to "defeat or delay" your policies on climate change. The fact is that the U.S. Senate is likely to do that anyway, with or without this information. Early on Election Day, the GOP boycotted a session of the Environment and Public Works Committee in protest of a climate-change bill's costs, and Democrats were split on the legislation as well. Tuesday's election results are likely to give Blue Dog Democrats further pause.

If the Senate does not pass a climate bill that is acceptable to the president, Obama is almost certain to ask the Environmental Protection Agency to issue regulations on carbon-dioxide emissions that he can take to the Copenhagen climate conference next month as evidence of America's efforts. These will then be used to extract some vague concessions on the part of the world's largest emitter of greenhouse gases, China, and the Copenhagen Protocol will be hailed as a major victory over global warming.

Of course, it will be no such thing. If the EPA does issue global-warming regulations, it will have to defend the science that it uses to raise the price of virtually everything. And it is true, Mr. President, that people will use the inconvenient facts of recent climate behavior to defeat or delay the "change" the EPA commands. The administration may respond by "working on" the global-warming people it doesn't like, but it can't "work on" the obvious and growing disconnect between what was forecast and what is happening.

The administration did a great job of increasing the ratings of Fox News. Maybe it can do the same for dissident scientists.

The "Greenspan doctrine" on monetary policy says that the Fed should not attempt to check asset price surges ahead of time but just manage the aftermath if they turn out to be bubbles and eventually burst. Such bubbles are difficult to detect before they actually burst, and a consistent policy intended to check presumed bubbles would reduce the economy's long-term growth potential. The job of regulating asset prices rests with market participants whose interests motivate self-regulation against undue market-risk exposures.

But in a speech last week, Fed governor Don Kohn said that "central banks are being encouraged to 'lean against the wind' in the face of asset price bubbles. We need to be honest about our very limited ability to assess the 'fundamental value' of an asset or to predict its price. Research should help to identify risks and inform decisions about the costs and benefits from a possible regulatory or monetary policy decision attempting to deal with a potential asset price bubble."

This suggests a re-thinking of the Greenspan doctrine within the Fed. The recession that began in 2007 has been enormously costly in terms of output and job losses. It is not surprising that Fed economists are examining whether monetary policy could prevent such episodes in the future instead of simply "mopping up" after the fact.

It's well known that the Fed successfully averted economic meltdowns after Wall Street swooned on several occasions: the stock market crash of 1987, its intervention to resolve the LTCM failure during 1998 and the even sharper bursting of the stock price bubble in 2001.

However, memories of those "successful" Fed interventions may have spurred even larger subsequent surges in asset prices because of their moral hazard effects on investor attitudes toward risk. Although other factors such as ratings errors and improper SEC regulations were important contributing factors, the recent financial collapse would not have been as severe without prior Fed-induced moral hazard among investors. So should the Fed now be formally vested with the responsibility of containing asset price bubbles pre-emptively and regulating financial firms?

Economists have long lamented problems in assessing whether asset price increases constitute bubbles and in predicting the timing of asset price bubble bursts. Setting capital standards and ancillary regulatory frameworks for financial institutions is more art than science. Given economists' poor predictive ability in evaluating macroeconomic risks and setting appropriate capital buffers for financial institutions, the Fed is bound to eventually (and spectacularly) fail at preventing asset price bubble bursts followed by severe financial disruptions. Then calls for congressional investigations and oversight on monetary policy would threaten the Fed's independence.

Indeed, making the Fed a financial super regulator would only provide formal sanction to policies that have increased moral hazard effects in the first place. Once the current recession is over and the Fed has withdrawn its extra-normal initiatives to restore credit markets, the correct policy approach may be to do the exact opposite — to signal that there will be no super regulator for financial institutions and to formally prohibit the Fed from engaging in bailouts of non-bank financial firms. Such a formal stance by Congress on financial regulatory policy is the best bet for developing mechanisms for sustained and effective self-regulation by market participants.

Fed officials are probably well aware of the dangers of accepting responsibility for setting financial regulatory standards and using monetary policy to prick asset price bubbles. The dangers are in setting anti-bubble policies that are so draconian they reduce the economy's long-term growth potential and eventually fail to protect financial institutions and the economy from a large macroeconomic shock. Such failures could permanently compromise the Fed's independence in monetary policymaking.

Although Fed analysts will doubtless continue research on the causes of asset price bubbles, they would be foolish to accept formal responsibilities for pre-emptively containing asset price surges and becoming financial super-regulators.

None of this was supposed to happen, of course. During the recent UK debate over banning tobacco displays, the government repeatedly assured parliamentarians that not only would such a ban not increase the already large UK illicit market (HMRC estimates that 26 percent of all cigarettes consumed in the UK are non-duty paid and some 70 percent of seized cigarettes are counterfeit), but it would result in a significant decline in smoking, particularly among young people.

But the evidence from across the Irish Sea shows that both of these claims are simply false.

There are several reasons why banning tobacco displays drives the illicit tobacco market. First, by putting all tobacco products under the counter, a display ban undermines the belief that tobacco is a legal, regulated product and that selling and consuming counterfeit and smuggled tobacco products are crimes. Surveys in Canada have found, for example, that a majority of Canadians who buy illicit cigarettes do not believe that they are committing a crime.

Second, display bans fuel the illicit tobacco market by making it more difficult for customers to distinguish between legal and illegal products, since all tobacco is hidden from view. Third, display bans make it easier for dishonest store keepers to mix illicit and untaxed tobacco products and legitimate taxed cigarettes and thus to pass off illicit products.

Fourth, display bans make it more difficult for enforcement agencies, already overtaxed, to identify illicit tobacco products since all tobacco products are hidden from view. Fifth, through blurring the distinction between above and below the counter products, between legal cigarettes and illegal cigarettes, a display ban makes it more likely that smokers will increasingly get their tobacco from illegal as opposed to the legal and regulated tobacco market.

But banning tobacco displays not only drives the illicit cigarette market; it also does nothing to reduce smoking. To return to Ireland again, a just-released EU survey found that 33 percent of the Irish population smoked, which is the highest rate in the last eleven years. Since 2007, tobacco taxes have increased and tobacco displays banned, but smoking prevalence has increased from 29 percent to 33 percent. Even more alarming is the fact that the largest cohort of smokers is now aged 16-30.

The same lack of effectiveness for draconian smoking measures, such as a public smoking ban, is found in England. The NHS recently released a study, 'Statistics on Smoking', which found that the public smoking ban had not resulted in a statistically significant decline in smoking. Indeed, certain groups, such as young males, are in fact smoking more than before the ban.

Part of the reason for these increases in smoking, particularly in the young, is that many smokers find these heavy-handed measures unacceptable. They are what psychologists call 'reactant', that is, they push back against regulation and assert their freedom through engaging in the very activity that the state is trying to prevent.

Hence, far from preventing smoking, measures like a display ban actually encourage it in those young people already most susceptible to begin smoking.

Therefore, in a UK with a tobacco display ban, we can expect to see not only more smokers, particularly young smokers, but also an enormous increase in illegal, unregulated, and untaxed cigarettes. That's quite the public health 'success'.

This view is a pipe dream. Most new regulation will do nothing to limit crises because markets will innovate around it. Worse, some regulation being considered by Congress will guarantee bigger and more frequent crises.

Government-Induced Moral Hazard Caused the Crisis

The Financial Crisis of 2008 did not occur because of insufficient or ill-designed regulation. Rather, it resulted from two misguided government policies.

The first was the attempt to promote homeownership. Numerous policies have pursued this goal for decades, and over time they have focused mainly on homeownership for low-income households. These policies encouraged mortgage lending to borrowers with shaky credit characteristics, such as limited income or assets, and on terms that defied common sense, such as zero down payment.

The pressure to expand risky credit was especially problematic because of the second misguided policy, the long-standing practice of bailing out failures from private risk-taking. This practice meant that financial markets expected the government to cushion any losses from a crash in mortgage debt. Thus, the historical tendency to bail out creditors created an enormous moral hazard.

One crucial component of this moral hazard was the now infamous "Greenspan put," the Fed's practice under Chairman Alan Greenspan of lowering interest rates in response to financial disruptions that might otherwise cause a crash in asset prices. In the early to mid-2000s, in particular, the Fed made a conscious decision not to burst the housing bubble and instead to "fix things" if a crash occurred.

It was inevitable, however, that a crash would ensue; the expansion of mortgage credit made sense only so long as housing prices kept increasing, and at some point this had to stop. Once it did, the market had no option but to unwind the positions built on untenable assumptions about housing prices. Thus government pressure to take risk, combined with implicit insurance for this risk, were the crucial causes of the bubble and the crash. Inadequate financial regulation played no significant role.

New Regulation Must Avoid Moral Hazard

If government-induced moral hazard caused the crisis, then new regulation should avoid creating or exacerbating this perverse incentive. Yet two components of proposed regulation will increase, rather than decrease, the chances for moral hazard.

One proposed change in regulation would give the Federal Reserve increased power to supervise financial institutions, especially bank holding companies such as Citigroup or Bank of America. This approach is a triumph of hope over experience. Why should an expanded Fed role be beneficial when the Fed erred so badly in the previous instance?

Defenders of an expanded Fed role will claim that, in the lead up to the crisis, the Fed did not have explicit powers to supervise and monitor non-bank financial institutions, and that such powers could have avoided the crisis.

Yet during the years before the crisis, the Fed had more than ample power to recognize the unprecedented level of risk that was building in the economy and to issue stern warnings, whether or not it had explicit regulatory authority. In fact, far from cautioning the market to behave, the Fed promoted the notion that it could solve any problems that might result from a bursting of the housing bubble.

Regulators are fallible. Alan Greenspan, once thought to be the Maestro, got it fabulously wrong. Ben Bernanke, regardless of the merit's of his stewardship, will not be Fed chairman forever. Centralized and expanded power to make things better is also centralized and expanded power to make things worse. In particular, any mistakes made by a powerful, centralized authority have a magnified impact because they distort the behavior of the entire market.

Just as problematic as granting the Fed additional powers is the proposal to allow the FDIC to resolve bank holding companies using taxpayer funds. Under the proposed arrangement, the FDIC rather than bankruptcy courts would be responsible for bank holding companies, and the FDIC would be authorized to make loans to failed institutions, to purchase their debts and other assets, to assume or guarantee their obligations, and to acquire equity interests. The funds would be borrowed from Treasury.

This means that FDIC resolution of bank holding companies would put taxpayer skin in the game, a radical departure from standard bankruptcy and an approach that mimics the actions of the U.S. Treasury under TARP. Thus, the new approach would institutionalize TARP.

The result will be that under the proposed system, bank holding companies would forever more regard themselves as explicitly, not just implicitly, backstopped by the full faith and credit of the U.S. Treasury. That is moral hazard in the extreme, and it will create an unprecedented incentive for excessive risk-taking by these institutions.

The Bankruptcy Approach

The only way to limit financial panics is to eliminate government-induced moral hazard, and that means letting failed institutions fail. Whether resolution is carried out by the FDIC or a bankruptcy court is not the crucial question; rather, it is whether that resolution process forces all the losses on the institution's stakeholders rather than bailing them out with taxpayer funds.

The standard objection to allowing failures is that some financial institutions are allegedly so large or interconnected that their failure causes a breakdown of the credit mechanism, thereby harming the whole economy rather than just transmitting losses that have already occurred. According to this view, letting Lehman Brothers fail was a crucial mistake that initiated the meltdown, and bailing out other financial institutions was a necessary evil to prevent even further chaos. Nothing could be further from the truth.

Rather than being a cause, Lehman's failure was merely the signal that time had come for the U.S. economy to pay the price for all the distortions caused by the misguided policies toward housing and risk. Given those distortions, a massive unwinding and restructuring was necessary to make the economy healthy again.

This restructuring required lower residential investment, declines in stock and housing prices, and shrinkage of the financial sector. All of this implied a recession, even without any impact of financial institution failures on the credit mechanism, and the recession meant that lending would contract, even without a credit crunch.

The bailout itself, moreover, caused much of the financial market turmoil. The announcement that the Treasury was considering a bailout scared markets and froze credit because bankers did not want to realize their losses if government was going to bail them out. The bailout introduced uncertainty because no one knew what the bailout meant. The bailout did little to make balance sheets transparent, yet the market's inability to determine who was solvent was a key reason for the credit freeze.

Thus letting Lehman fail was the right decision; bailing out Bear Stearns, Fannie, and Freddie in advance of Lehman, and the rest of Wall Street afterwards, were the mistakes. For all its warts, bankruptcy rather than bailout is the right way to resolve non-bank financial institutions. Any regulation that formalizes bailouts creates an enormous moral hazard and a black hole for taxpayer funds.

The Future

To limit future financial crises, policy must first avoid the distortions inherent in the attempt to expand homeownership. This means eliminating the Federal Housing Administration, the Federal Home Loan Banks, Fannie Mae, Freddie Mac, the Community Reinvestment Act, the deductibility of mortgage interest, the homestead exclusion in the personal bankruptcy code, the tax-favored treatment of capital gains on housing, the HOPE for Homeowners Act, the Emergency Economic Stabilization Act (the bailout bill), and the Homeowners Affordability and Stability Plan. None of this is sensible policy.

In addition, policy must end its proclivity to bail out private risk-taking. This second task is difficult, since it requires policymakers to "tie their own hands." Specific changes in policies and institutions can nevertheless support this goal. The first is avoiding new regulation that makes bailouts more likely. A second is repealing all existing financial regulation, since this would signal markets that they, and only they, can truly protect themselves from risk.

The third and perhaps most important way to reduce moral hazard is to eliminate the Federal Reserve. As long as the Fed exists, it will regard itself as, and be regarded as, the economic insurer of last resort. In a world with perfect information, appropriately humble central bankers, and an absence of political influence on monetary policy, such a protector might enhance the economy's performance on average.

In the world we live in, none of these conditions will hold consistently, so the potential for policy-induced disasters is large. The U.S. economy prospered for its first 125 years without a central bank. It's time to try that approach again.

Total losses from the bailout of Fannie and Freddie are likely to exceed $250 billion — as much as the cost to the taxpayer of all bank failures in American history combined.

Fannie and Freddie infected capital markets and spread through every sector of the banking system. Before the bursting of the housing bubble, holdings of government-sponsored enterprise (GSE) securities — bonds and mortgage-backed securities as well as preferred stock — constituted more than 150% of core capital for insured banks.

It was not only the commercial banking system that was stuffed with toxic GSE holdings; it was also many of the investment banks. More than 50% of Maiden Lane One, the toxic assets that the Federal Reserve guaranteed in order to persuade JPMorgan to buy Bear Stearns, are GSE securities.

Additionally, more than 40% of money market mutual fund holdings were in the form of GSE securities.

The threats to the stability of the mutual fund industry were not simply a result of Lehman's failure. Had the government not bailed out Fannie and Freddie, many funds would have "broke the buck."

Save A Chinese Bank

Quite simply, Washington fostered an environment where if Fannie and Freddie caught a cold, the banking system would catch a fever.

Fannie and Freddie were the weak links in our domestic financial system. They were also the vehicles that carried excess world savings into America's housing market.

At the height of the bubble, almost 60% of newly issued GSE debt was purchased outside the U.S. One of the largest purchases of that debt was the Chinese Central Bank.

What did Fannie and Freddie do with their foreign borrowings? They invested in the subprime mortgage market.

At the height of the bubble, Fannie and Freddie purchased more than 40% of the private-label subprime mortgage-backed securities. Between the two of them, they were the largest single source of liquidity for the subprime market.

Interestingly enough, the very vintages of subprime loans that performed the worst — 2006 and 2007 — were the years in which Fannie and Freddie entered the market in force.

With their massive leverage, Fannie and Freddie were levered more than 100-to-1 — a disaster waiting to happen.

Why then were foreign investors so willing to trust their money to Fannie and Freddie? Quite simply, they were assured by U.S. Treasury officials that their losses would be covered.

Ultimately, Fannie and Freddie were not bailed out in order to save our housing market; they were bailed out in order to protect the Chinese Central Bank from taking losses. Without the implicit federal guarantee of Fannie and Freddie, trillions of dollars of global capital flow would not have been funneled into the U.S. subprime mortgage market.

Protect Taxpayers

Some might argue that the problem with Fannie and Freddie was fixed with last year's regulatory reform bill. That bill created a new regulator, one with increased supervisory powers, including the ability to wind down a GSE, and independence from the congressional appropriations process, letting the regulator raise additional funding.

Nothing could be further from the truth. As one of the drafters and negotiators for that bill while on the staff of the Senate Banking Committee, I can say that there was a shared awareness by all parties that the bill was insufficient to prevent the failure of Fannie and Freddie.

It was not the best bill that could be crafted. It was the best bill that could pass, given the continued strength of Fannie and Freddie apologists in Congress.

Nothing in the bill would have prevented the GSEs' massive accumulation of subprime mortgage-backed securities. Nor would the bill have deterred the GSEs from purchasing the many whole loans that have soured on them.

With their "strengthened" affordable-housing goals, the bill encourages GSEs to extend those purchases.

Had the reform bill that passed been signed into law years earlier, we would be in the same spot with Fannie and Freddie.

Most of the worst economic and financial crises in American history have involved real estate. Such is likely to be the case in the future. Reform of Fannie and Freddie is imperative so that American taxpayers will not be on the hook for hundreds of billions of dollars for the next real estate bubble.

As state treasurer, Mourdock is the person responsible for investment decisions concerning Indiana’s state employee pension funds, some of which owned a small share of Chrysler’s $6.9 billion in secured debt and some of which opposed the administration’s offer of $.29 on the dollar for that debt. Though these small secured holders were publicly castigated by President Obama as “unpatriotic” and unwilling to sacrifice for the greater good, Mourdock led the effort to stop the “sale” of Chrysler all the way to the U.S. Supreme Court.

Mourdock’s presentation gives a flavor for the tactics employed by the  Obama administration to “encourage” senior, priority creditors to back off their claims so that chosen parties could take priority—tactics that included backroom reminders that some of those creditors had received and might seek more TARP funding, threats of bringing the full weight and measure of the White House press office to bear down on dissenters, public condemnation, and other forms of arm-twisting most Americans would find unseemly for a U.S. presidential administration.

At the Cato event, Mr. Mourdock was joined by University of Pennsylvania Law School professor and corporate law expert David Skeel, who demonstrated quite clearly that the “sale” of Chrysler, as orchestrated by the Obama administration under cover of Chapter 11 bankruptcy reorganization, was indeed a sham sale. Skeel’s presentation begins at 20:15 of this video.

If you want to have a better sense of what’s going on in Washington (or to affirm your worries), I recommend you watch Mourdock here, listen to Mourdock here, read the Indiana Pensioners’ petition for Writ of Certiorari (appeal to the Supreme Court), and read the Cato Institute’s amicus brief in support of the Indiana pensioners here.

The truth about second-hand smoking is finally out.

Thanks to some unusual candour on the part of the anti-tobacco brigade in New York City, we now have official confirmation that banning smoking in public has absolutely nothing to do with protecting the health of non-smokers from second-hand smoke, but everything to do with stigmatising both smoking and smokers. Closer to home, new evidence from the National Health Service (NHS) shows that the public smoking ban in England has made absolutely no positive difference in smoking rates, despite claims made by its champions that it would.

In September, Dr Thomas Farley, New York City's Health Commissioner, proposed banning smoking at all of the city's parks and beaches (1). Dr Farley's rationale for the ban has nothing to do with the risks that outdoor smoking pose to non-smokers, but rather with preventing people, particularly children, from having to see anyone smoking in public. Farley says, 'We don't think children should have to watch someone smoking'. Farley also defends the extension of the smoking ban to outdoor areas by arguing that it is 'part of a broader strategy to further curb smoking rates'. New York mayor, Michael Bloomberg, confirmed earlier this month that he would implement Farley's proposal, arguing that the public is 'overwhelmingly in favour' (2).

Why have the champions of banning smoking everywhere, even in private accommodation, suddenly come clean about the driving force behind their crusade? The answer is that they have essentially won the war over public smoking. But why is this the case? The answer, sadly, is that for the past 15 to 20 years, the public has been bombarded with a carefully orchestrated government-funded anti-tobacco campaign to convince them — in contradiction of the scientific evidence — that smokers pose a deadly health risk to non-smokers, particularly children.

The scientific evidence has never supported the case against public smoking. The US Environmental Protection Agency's seminal early 1990s report on second-hand smoke was severely flawed. Its critique of second-hand smoke was only sustained through a careful exclusion of non-confirming evidence and a non-traditional application of the statistical test known as confidence limits. The report was subjected to a scathing analysis by a US federal court, which rejected its scientific claims about the dangers of second-hand smoke, a finding that even on appeal was not reversed (3).

Moreover, a scientific study conducted by the World Health Organisation's International Agency for Research on Cancer found that there was no statistically significant association between smoking in the workplace and social settings and lung cancer in non-smokers. Indeed, the majority of studies about second-hand smoke and lung cancer in non-smokers have found non-statistically significant associations both in workplace and domestic settings.

Of course, none of this startling lack of scientific evidence has moved beyond the scientific journals and into the public domain, which means that the debate about public smoking is a non-scientific debate. And this means that it can proceed on virtually any grounds, unchecked by the need for careful and verifiable scientific evidence. The anti-smoking movement has always known that the evidence about the risks of public smoking, or private smoking for that matter, to non-smokers was marginal, at best, and nonexistent, at worst. But this was fundamentally unimportant.

Preventing people from smoking in public was never about real health risks - that is, it was never about protecting non-smokers so much as it was about stigmatising smoking and smokers and making it difficult for them to smoke. So with the science of second-hand smoke now never discussed, the anti-tobacco movement feels confident in moving the argument forward and revealing the starkness of its real agenda.

There is no compelling evidence that second-hand smoke poses a health risk to anyone in open spaces like public parks and beaches, but that is beside the point. The new push seeks, first, to demonise smoking and, second, to exert a brazen paternalism in which it is made virtually impossible for smokers — for their own good, of course — to light up in any public space.

There are profound difficulties with both of these objectives. For one thing, where is the justification for banning unhealthy behaviours from the public square simply on the grounds that someone might see them? Or, indeed, what is the justification for banning unhealthy behaviours from public viewing full stop? This opens up substantial room for prohibiting an enormous range of other behaviours which are neither immoral nor illegal, but simply unhealthy.

For example, by parity of reasoning it could be argued that children should never have to see anyone eating unhealthy foods in public, or indeed see anyone who is fat in public. Surely, there must be some evidence that seeing someone engaged in unhealthy behaviour puts others at risk. But where is this evidence?

For another thing, there is the issue of whether such measures actually work. For example, the NHS recently released a study on the effectiveness of the public smoking ban (4). The fact is that certain groups, such as young males, are smoking more after the smoking ban than before it. So, not only are such bans not supported by science, they are also not supported by the evidence on their practical effect in changing behaviour.

Finally, any policy by which the government engages in stigmatising the legal behaviour of its adult citizens is repugnant in a democratic society. Fundamental to democratic government is the respect that it owes to its adult citizens' choices about legal behaviour and, more fundamentally, how they choose to live their lives. Paternalistic interventions, whether through stigmatising or other means, can only be justified in the rarest of instances.

What the evolution of the debate over public smoking shows is how little science has to do with the anti-tobacco crusade, how disingenuous that crusade is about its real motives and goals, how easily the crusade on tobacco can be extended to other causes (most notably the war on obesity), and how fundamentally dangerous it is to a society both free and democratic.

(1) New York Eyes 'No Smoking' Outdoors, Too, New York Times, 15 September 2009 (2) Mayor Bloomberg vows to snuff out smoking in parks, beaches, New York Daily News, 1 October 2009 (3) For more on the EPA study, see An epidemic of epidemiology, by Rob Lyons (4) See Statistics on smoking, NHS, 29 September 2009 [pdf]

Executive pay has emerged, once again, as a major issue in Washington. This week Treasury and the Federal Reserve announced new regulations designed to oversee and limit executive pay at thousands of financial institutions. This is deeply ironic, because today's pay woes are the direct result of prior government intervention.

In 1993, Congress decided it would use the tax code to "improve" (i.e., reduce) executive compensation in publicly traded companies. Its vehicle was the Budget Reconciliation Act, a key provision of which became Section 162(m) of the Internal Revenue Code.

Noting that executive compensation levels had received negative "scrutiny and criticism" from the public, the new law targeted what it called "excessive employee remuneration." It did so by limiting the ability of public companies to deduct executive compensation for its top employees unless the compensation was paid out in a form that Congress found acceptable. Salary was bad. Stock options were tax favored.

Specifically, corporations were barred by law from deducting as a normal business expense any salary payments of over $1 million. Stock options, however, qualified for the corporate tax deduction without limitation. Much maligned today, stock options then were said to be "performance based" and therefore exempt from the new tax rules.

The new tax law immediately led to a tectonic shift in the way CEOs and other top U.S. executives were paid. Stock and stock options became the dominant feature of executive compensation packages.

The impetus for changing the executive compensation laws back then was exactly the same as it is today. Politicians wanted pay lower and wanted to change the executive compensation model to "fix" the risk-taking proclivities of top managers.

In 1992, the government thought that managers were too risk averse. Stock options were seen as the magic bullet for making managers act more aggressively in the shareholders' interests. Today, many in Congress are blaming U.S. executives for causing the financial crisis precisely by engaging in "excessive" risk-taking. What they fail to mention is that it was Congress's own tinkering with the tax code that led to the very compensation packages that incentivized the risk-taking.

Fed Chairman Ben Bernanke asserted this week that "compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability." Mr. Bernanke promised that the government "is working to ensure that compensation packages appropriately tie rewards to longer-term performance and do not create undue risk for the firm or the financial system."

Other government interference has made the executive compensation problem even worse. A provision in the 1992 tax law required that executives meet certain "objective" performance measures in order to qualify for incentive-based (tax deductible) pay. In the scramble to come up with objective metrics on which to base executive pay, cottage industry "executive compensation consultants" emerged as the most important architects of executive compensation plans.

The compensation consultants promised to design pay programs that did things like "drive the right behaviors" by corporate management, which meant assuming more risk to maximize shareholder value. Public companies hired droves of consultants to analyze pay schemes and design pay packages that created incentives to maximize share prices. Consultants came to be viewed as essential to boards of directors that wanted to implement appropriate—and tax qualified—performance measures.

The most successful consultants are those who can justify the biggest salary increases for the top executives of the companies that hired them. Researchers at the University of Southern California recently found that the median CEO compensation is $1.5 million in companies not using executive compensation consultants, $3 million in companies that purchase general survey data from such consultants but do not directly retain them, and $4.2 million in companies that retain consultants.

Some companies use multiple consultants. The USC study found that the more consultants a company hires, the more it pays its top executives. About one-quarter of Fortune 250 companies hire multiple compensation consultants.

Activist investor Carl Icahn summed the situation up well when he recently observed on his Web site that "the use of these compensation consultants, gives both boards and CEOs the appearance of legitimacy for their decisions to award massive pay packages to lackluster CEOs, making it appear that these decisions are objective and scientific, which they absolutely are not."

The government also has tried to regulate executive compensation by requiring greater disclosure of the details of compensation plans. Perversely, this too has contributed to an increase in executive pay.

How so? No self-respecting board of directors is willing to admit that their company's CEO is below average. So anytime the new disclosures indicate that an executive's pay is below average in any way, a pay increase is ordered.

Since the early 1990s, government regulation of executive compensation has encouraged greater share-price volatility and risk-taking by U.S. corporate executives and led directly to higher, rather than lower, levels of executive compensation. Nevertheless, the Obama administration is now seeking an even greater role in overseeing and regulating executive pay.

In June, Gene Sperling, a top aid to Treasury Secretary Tim Geithner, told the House Committee on Financial Services that "our goal is to help ensure that there is a much closer alignment between compensation, sound risk management and long-term value creation for firms and the economy as a whole."

This is just what the regulators told us back in 1992. Current proposals will no doubt result in even higher percentages of executive compensation coming from stock and option schemes rather than from salaries. History teaches that the most profound consequences of new compensation regulation will be unintended. It also teaches that as bad as private ordering may have worked in getting executive compensation right, the results of central planning have been even worse.

The conservative case for government intervention in energy markets is just as flimsy as the liberal case for government intervention in any other sector of the economy. Energy markets may not work as perfectly as in a textbook model, but they work — and government works even less perfectly.

Consider one of the premises underlying the present energy-policy debates: the fear that our reliance on foreign oil leaves us vulnerable to supply disruptions. Most conservatives seem to believe that a reduction in imports will insulate us from price shocks caused by developments overseas. That is nonsense. A supply disruption anywhere will increase the price of crude oil everywhere for the same reason that an early frost in Florida will increase the price of citrus produced in Florida and California by roughly the same amount. Energy independence provides no protection against supply disruptions abroad.

Others fear that reliance on imports requires us to undertake military commitments to ensure that oil continues to flow. But producers have even more reason to worry about the safety of their facilities than we do and, likewise, more reason to ensure the security of international oil-shipping lanes. Hence, they have every incentive to defend their oil infrastructure, whether we help foot the bill or not.

No less a conservative than Dick Cheney argues that producers and consumers make bad decisions in energy markets: They fail to appreciate the profit opportunities associated with certain investments, he says, be they renewable, nuclear, clean coal, ethanol — whatever. Consumers, the argument goes, are too risk-averse to make expensive bets on promising technology, while they discount the certainty of energy depletion and the dwindling of power supplies. And, Cheney says, producers' time horizons are too short to invest in energy technologies that offer long-term promise. But economists investigating the issue find little evidence for assertions like Cheney's, and little reason to believe that markets in energy are different from markets in other commodities.

Policy activists are on somewhat firmer ground, however, when they argue that energy prices do not fully reflect the environmental costs associated with energy consumption. But economists are wildly divergent in their estimates of the costs of these energy-consumption externalities. Some studies find that present prices for conventional fuels, such as natural gas, are too high rather than too low — owing to regulatory distortions in the market.

In the case of fuels for which the evidence about environmental externalities is clear, the solution is a tax that increases the price and allows producers and consumers complete freedom to adjust. But that would create visible costs and diffuse benefits, and politicians prefer the opposite: concentrated benefits for companies that collect subsidies and diffuse costs imposed on the taxpayers and the economy.

The strongest critique of a laissez-faire energy regime is that innovators in energy markets cannot capture the full benefits of their innovations. Hence, businessmen may underinvest in energy research and development. Notice that the complaint, however, is that industry will underinvest in R&D across the board — not that investors back the wrong technologies. If this is a serious problem, the solution is to make all R&D more attractive through preferences in the tax code. Targeted energy R&D subsidies and mandates simply substitute political judgments about investments for market judgments, even though politicians have no comparative advantage in sorting technological winners from losers.

Consider the current love affair of the Right with "clean coal" technology. Billions of federal tax dollars have been spent since the 1980s on various iterations of this concept — most recently via George W. Bush's "FutureGen" project and the "Clean Coal Power Initiative" — yet the marketplace has not been friendly to new coal plants. From 2001 through 2007, 179,382 megawatts of natural-gas-fired electric generators were added, but only 3,311 megawatts of coal-fired generation capacity came online.

It's not that we don't know how to make coal facilities cleaner — it's that we don't know how to make coal plants both cleaner and profitable. Throwing more tax money at this riddle will not necessarily produce an answer. Why are conservatives doubling down on the same ill-fated taxpayer adventure that Ronald Reagan labored so mightily to kill in the 1980s?

Nuclear power is another favored recipient of conservative largesse. Despite promises in the 1950s that nuclear power would soon become "too cheap to meter," 50 years of lavish federal subsidies and regulatory preferences have yet to produce an industry that can turn a profit without taxpayer help. That is an observation that even the nuclear-energy industry's trade association freely concedes, at least when it is time for politicians to reconsider the merits of existing subsidies such as the federal guarantee of private loans to the industry, federal protection against liabilities beyond a certain threshold, production tax credits, and the like. Tufts economist Gilbert Metcalf calculates that nuclear-power costs would increase by almost 50 percent if those subsidies were eliminated.

How is the conservative case for the above subsidies any different from the liberal case for subsidizing solar or wind energy, or high-mileage automobiles — or, for that matter, the case for government backing of financial institutions and automobile companies? It isn't, and conservatives should not check their skepticism about central planning and the bureaucratic ordering of markets at the door when they walk into the energy-policy funhouse. There is no BTU exception to The Wealth of Nations.

So like every good dorm room bull session, we begin in the weeds of  policy and quickly find ourselves breathing the rarefied air of constitutional theory. Supposing for the moment that we thought it were a good idea on policy grounds, would it be within the power of Congress to set ground rules for online advertisers who gather personal data from Web browsers? Recall that there are two particular rules that I’ve said I’d be tentatively open to, but which Jim rejects: a requirement of notice when information is being collected (say via a small link from the adspace to a privacy policy) and a rule establishing that privacy policies are enforceable, so that individual users can sue for damages if a company knowingly  violates its stated policy (thus far, courts have not generally found these to be binding). Does this fall within the power to “regulate commerce … among the several states”? I think so. I’ll start with what I hope will be some uncontroversial arguments and go from there.

So first, let’s grant that there’s one type of “original intent” that everyone ought to care about, whatever their more general interpretive stance: what Ronald Dworkin calls the linguistic intent of the Framers. That is, if words like “commerce” and “regulate” had narrower meanings in 1787 than they do today, we must, of course, read them now in that light: “Commerce” means actual interstate traffic in goods and services, rather than economic activity more generally, and “regulation” is centrally about establishing uniform rules and procedures.  With these appropriately narrowed readings in mind, I think it’s still a slam-dunk that online ads are covered.

There are, in fact, at least three different senses in which behavioral ads might be classed as interstate commerce. First, the purchase of the ad space itself is obviously a commercial transaction—frequently though not necessarily between entities in different states—and there’s a reasonable question of whether a host site with posted privacy policy is implicitly committed to applying that policy as a condition on ad space sold to third parties. The ads themselves will typically propose a commercial transaction, and in a more direct way than other ads are, can plausibly be seen as the first step in the transaction itself, as clicking on the ad will often bring you directly to a page where you can complete the purchase it recommends. Finally, the personal and behavioral user data collected is itself a valuable commodity, and many sites function with a pretty explicit informational quid pro quo: You will receive access to our content in exchange for registering and providing us with certain data. Since the Internet is borderless, most sites will be getting most of their traffic from people located in different states or countries, and even narrowly state-focused sites are likely to have substantial border-crossing traffic. So on a pretty straight reading of the constitutional language, I find very little reason to doubt that Congress may set uniform default rules for these interstate transactions, rather than leaving it to a patchwork of state rules.

Now, Jim’s reason for questioning this seems to be that the primary concern of the Framers was to prevent states from creating trade barriers. That may be, but if we skip ahead to Article 1, Section 10, we find that Congress knew perfectly well how to enact general and purely prohibitory bans on such shenanigans  using more apt “no state shall” language. Instead, they used precisely the same language for interstate commerce as they did for international commerce, where history suggests that the Framers (many of them steeped in the mercantilist economic theories of the day) had been above all concerned to preserve the ability to erect protectionist trade barriers. So we’re left with a choice between ascribing to the Framers a frankly stunning level of linguistic incompetence or supposing that the Constitution actually does grant the affirmative power that a facial reading suggests.

Needless to say, this does not require us to adopt the post–New Deal reading that places anything with the least potential influence on economic activity under Congressional purview. But we’re pretty close to the core here. Indeed, one of the early cases I know Jim considers a lodestone for the “no trade barriers” reading, Gibbons v. Ogden, involves a congressional grant of a license to operate steamboats. The court found that this superseded the monopoly New York had sought to grant another steamboat operator, which fits Jim’s point to an extent, but it’s crystal clear from that (1824) ruling that the power of Congress here is a broad authority to grant or withhold a privilege to operate interstate vessels, and establish conditions on such vessels, including restrictions on ownership and personnel. It seems to me you’d have to get awfully creative to read the clause in a way that authorizes that kind of authority over an “instrumentality” of commerce (water navigation) but forbids Congress from specifying the kind of notice a merchant must provide when initiating an actual interstate commercial transaction.

A slightly more controversial suggestion: When the specific substantive intent of the Framers is not explicitly embedded in the Constitution’s language—by which I mean, the specific use they thought a wise Congress would make of enumerated powers in light of contemporary economic theories, whether liberal or mercantilist—I am not inclined to give it very great weight. Or more bluntly, when the legal language is abstract, I don’t think we’re bound by an original conception of how or where it applied in specific cases—to the extent such a consideration is even intelligible when we’re talking about Internet advertising. Manifestly, very few people at the time of the passage of the Fourteenth Amendment believed that the abstract guarantee of “equal protection” entailed a substantive right of black children to attend public schools the states restricted to whites. But insofar as what they wrote into law was the abstract guarantee, I don’t think we’re required to care what they believed. Our modern reading should be constrained by the original sense of the words used, and to some extent by the original structural purpose served (translated as necessary). But in specific application—whether privacy rules for online ads are encompassed within “regulation” of “commerce”—then even if you pulled out the Ouija board and got a personal verdict from James Madison, it would just be one more opinion.

Finally, and maybe most controversially: What kind of recommendations should we make in a world where our preferred interpretation of the Constitution lost the fight a long time ago? If the question is what we should recommend to judges, presumably we want to recommend that they start shifting back in the direction of a reading we regard as better justified. But what about when, as Jim imagines, we’re advising legislators? Should we only recommend what we believe to be authorized by what we hold to be the best reading of the Constitution, or will it sometimes make sense to endorse legislation that is plainly allowed by the current regnant interpretation, but that might be outside the scope of the interpretation we regard as superior? I think it will, partly for theoretical, and partly for pragmatic reasons.

At a practical level, both legislators and citizens widely believe Congress to have broader policy discretion than most of the authors here. So very generally speaking, I don’t think it serves limited government to refrain from weighing in on the relative merits of policy options that wouldn’t be on the table at all if our arguments had fared better at the meta-level. (Recall the old joke about the principled pacifist answer to how to respond to World War II: Don’t sign the Treaty of Versailles!) Now, on this particular question it’s not a sure thing that Congress or the FTC will act, and maybe “hands off” is the best advice to give. But there are plenty of areas where there’s no realistic chance that Congress is going to abstain altogether, even if we think that’s what the best interpretation of the Constitution requires. In those cases, I think it’s at least sometimes appropriate to flag the meta objection and then say something about the policy merits. Obviously there are limits—I don’t expect I’ll ever express a view on the “best” way to run a torture chamber—but there are plenty of issues where it seems perverse for the people most concerned with limited government to sit out the day-to-day debates and focus on getting Wickard v. Filburn overturned, glad as I am that there are folks hammering that.

That dovetails with the theoretical reason, which has to do with the broader question of why constitutional principles are binding on us at all. I assume it is not because the Founders, brilliant though they were, enjoyed some divine right of command that the inheritors of their institutions are compelled to obey. Partly it’s that the principles embedded in the Constitution are good ones, but a substantial piece of the answer, I think, is that they provide a stable framework within which we conduct our political and private lives. Judges give weight to stare decisis even when they think the case at the fountainhead of a line of precedent was poorly decided, in part because the legitimacy and authority of law are to a great extent a function of its predictability, of the way it allows us to take actions and make agreements and know pretty much what the legal consequences will be, however much else may remain unpredictable. Constitutional restraints do this one level up, establishing (albeit roughly) a domain of legal variation over the longer term. This is  not, for what it’s worth, wacky postmodern Critical Legal Studies stuff; it’s an extrapolation from Hayek. To imagine that you can remake a society’s institutions wholesale—even if your guide is the best interpretation of a founding document, and even if you’re pretty sure that interpretation held sway a couple centuries ago—is the fallacy of constructivist rationalists.

Now, I think the right account of why we should regard the Constitution as binding starts with considerations along these lines, but this has the (perhaps unfortunate) consequence that even if you had a super-awesome unanswerable argument for why the Constitution mandates libertopia, at least when read properly absent the accretions of precedent, you still wouldn’t have an argument that judges, legislators, and government officials must all start acting on this understanding as of tomorrow. What you’d have is a good starting point for a much more gradual process of paring government back down. Not, to be clear, because I think the Constitution “means whatever the Supreme Court says it does”—that would be incoherent, since the court’s practice is unintelligible, and its legitimacy illusory, unless we assume there’s an independent meaning for them to strive toward.  But an “independent” meaning can be located in a community of interpretation and practice that extends beyond the framing generation. By analogy: If I want to use language “correctly” to communicate, I don’t get to just assign whatever meanings I like to words. It’s even possible to make a strong argument that the majority of speakers at a particular historical moment are using a word—like “decimate” or “hopefully” or “brutalize”—improperly. But neither does it mean that the first person to coin the term gets to specify its legitimate uses forever. And, in fact, anyone who insisted on using “decimate” to mean only “reduce by ten percent” would probably find his attempts at communication misfiring badly. To say that meaning is necessarily public and independent—consult Hayek’s cousin Wittgenstein here—does not require a baptismal view of meaning. Or at any rate, whether it does or not depends on the function your interpretive practice serves.

So yeah, that’s all pretty far removed from our original discussion—and I’m hoping far enough below the fold that it doesn’t put me on the wrong end of another dozen arguments with colleagues. I’ll do another post later this week where I actually get to the policy question, and some potent objections that both Jim and Tim Lee have raised.

Williamson, a pioneering theorist of the incentives that shape business firms, is one of the world's most cited living economists. Until Monday, Ostrom — a 76-year-old professor of political science at the University of Indiana, and the first woman to win the economics Nobel — was rather less well-known. She is, however, abundantly deserving of both the prize and increased attention. Through an ingenious blend of formal game theory, laboratory experimentation, and down-and-dirty empirical fieldwork, Ostrom has shed light on the ways real people arrive at rules that allow them to live in harmony with each other and their natural environment.

Much of Ostrom's work can be seen as a comprehensive response to a famous paper by the ecologist Garrett Hardin on the so-called "tragedy of the commons."

Imagine a pond considered community property. There's only so many fish in the pond. Each fish taken from the common pool leaves one less for others and everyone knows it. Absent a set of rules governing fishing, the individual's best fish-getting strategy is to race to the pond and take as many fish as possible before the others have taken them all. In the myopic rush to get something now, individuals use up the commons, tragically depriving everyone of its fruits thereafter.

Hardin argued that tragedies of the commons may be avoided only if we turn either to privatization or, more likely, top-down government regulation. Ostrom has proved that this is a false choice. Her trailblazing fieldwork in rural areas of poor countries has shown the users of various common-pool resources can and do develop and enforce rules that make community use of shared natural assets sustainable. "Many policy analysts presume that without major external resources and top down planning by national officials, there can be no provision of public goods and sustainable common-pool resources," Ostrom has written. "This presumption is wrong."

Ostrom is quick to point out attempts to manage common-pool resources outside of formal markets and the regulatory state don't always work. But Ostrom's close inspection of the conditions attending both success and failure helps to clarify many of the challenges of human social life, from the sustainable management of forests to the maintenance of public order by municipal police departments.

If more of us saw the world like Elinor Ostrom, it would be a better world. To see the world more like Elinor Ostrom is to see humans and their communities as a natural part of the natural order, not as invading aliens essentially at odds with their environment or one another. Ostrom has emphasized none of us would be here today had our ancestors failed to work together to find ways to align individual interest with public interest.

Her field work and laboratory experiments both lend credence to the idea that creative, collective problem-solving is a part of human nature. We seem to be "designed" by evolution to negotiate mutually agreeable terms of association, to internalize norms, and to detect and sanction those who flout the rules. But successful solutions to the problems of ecologically embedded common life often depend crucially on the fine-grained details of the problem. That's why top-down, one-size-fits-all solutions so often fail.

According to Ostrom, the terrain of a meadow, shape of a pond, or population of a village can make all the difference. To see the world more like Elinor Ostrom is see the organic, delicately adaptive nature of local rules, and to see the folly of arrogantly assuming our textbooks have taught us a better way.

Where most modern political economy assumes a stark dichotomy between the market and the state, Ostrom makes space for a third sector of voluntary civil association. By insisting on a more realistic account of human behaviour, Ostrom's work not only helps to account for forms of social co-ordination most economists have missed, but it also helps us envision markets and governments as parts of a single tapestry of overlapping and interwoven institutions. Because the devil's in the details, it's hard to say in advance what mix of institutions will work best in a given place.

Ostrom's early work on municipal police departments (with her husband, the decorated political scientist Vincent Ostrom) illustrates the refreshingly pragmatic thrust of her worldview. During the 1960s and '70s the existence of multiple, relatively small police departments in larger metro regions was widely considered wastefully redundant. Many believed that the consolidation and centralization of police authority and administration would both save money and help fight rising crime rates. But the Ostroms found that the opposite was true; people living in small jurisdictions within large metropolitan regions got better policing for less money. Public order is best assured by what may look like a chaotic hodge-podge of overlapping institutions.

To see the world more like Elinor Ostrom is to see each public policy like a real-world experiment. Policies are implemented because they are predicted to have certain beneficial effects. But even experts are fallible. We make mistakes. Multiple, partially redundant jurisdictions make a virtue of inevitability. They allow for simultaneous policy experiments that help us grope toward effective solutions. Successful policy can be easily observed and adapted to other jurisdictions and the damage caused by failed policy is contained.

To see the world more like Elinor Ostrom is to be guided less by ideology and more by the contours of the situation — to use the right institutional tool for the job. "[N]ational governments," Ostrom tells us, "are too small to govern the global commons and too big to handle smaller scale problems." Size matters. We have to understand that we may not have a good tool for our biggest jobs.

But that's okay. To see the world more like Elinor Ostrom is to see that people are creative, that it is possible to get together and work things out. "It is ordinary persons and citizens," she says, "who craft and sustain the workability of the institutions of everyday life."

This is a message we need to hear. In a year that saw some of our central economic institutions collapse, it is good to be reminded that our institutions are our creations, our tools. It's good to be reminded that there is profound social intelligence even in the most modest rural village. It's good to be reminded that even the best and brightest are limited, that failure is inevitable. That we can, and must, learn from our mistakes.