Winning a case against the federal government is difficult. Most federal agencies are well represented by an army of skilled attorneys. The Department of Justice via the Office of the Solicitor General represents the federal government before the US Supreme Court, winning most of its cases each year. 

What’s less clear is why these agencies enjoy an even greater rate of success within their own court systems. Most people are unaware of America’s submerged judiciary known as administrative law courts (ALCs) and their estimated 3,000+ administrative law judges (ALJs).  

These are in-house quasi-judicial tribunals within approximately 40 federal agencies that adjudicate legal disputes involving regulations and public benefits. ALCs allow agencies to resolve many of their problems in-house without needing to go before an impartial federal court. While Congress intended for ALCs to be statutorily and functionally independent from the agencies they adjudicate for, many agencies circumvent this separation.

Below, I offer a quick glimpse into my ongoing research on the home court advantage in agency adjudication, weighing an agency’s rate of success before its own ALC vs. its success before the Supreme Court.

Administrative Law Courts are Unfair  

Federal ALCs stack the deck against private litigants in adjudication, primarily by adhering to the agency’s internal set of legal procedures.  

This includes reversing the burden of proof, denying access to a jury trial, and delaying public hearings. The Securities and Exchange Commission (SEC) was even caught secretly sharing information between its ALJs and prosecutorial staff. Rather than provide new hearings or outsource these cases to federal court, the SEC dismissed them as a “controlled deficiency.” 

Some ALCs, like in the National Labor Relations Board, enable the Board’s clerk to revise draft ALJ opinions if directed to do so. This enables the Board to manipulate case decisions before they receive administrative appeals, while undermining their ALJs’ decisional independence under the law.  

Other agencies, like the Federal Trade Commission (FTC), have reduced their ALJs’ powers to exert greater control over case outcomes. This came after a rare set of losses for the agency in the Illumina Grail and Juul Labs antitrust rulings. The FTC had typically won 100 percent of its adjudicated cases. It took steps to avoid being foiled again.

Breaking New Ground 

Until now, no one has attempted to uncover the true extent of agency advantages in adjudication and in-house success rates. My research seeks to uncover if institutional factors contribute to an agency’s high rate of success before its ALC.

I researched every adversary adjudicatory decision by an ALC from 2012-2022. My preliminary results cover annual ALJ orders from 20 of the 42 known federal ALCs (mean = 31,927), much of which is attributed to the Social Security Administration’s annual benefits cases.

My early findings suggest that agencies win 92 percent of their cases against a private party in-house (Table 1). By comparison, the federal government won only 55 percent of its cases before the Supreme Court during the same period (Table 2). The scales are clearly tipped in cases heard by ALCs.

My research explores certain institutional factors that may contribute to an agency’s heightened rate of success before its ALC. So far, this includes independent variables representing: the number of ALJs at each agency, the agency’s annual number of adjudicatory orders, and the size of the agency’s legal staff. I also control for the government category (subagency, independent, etc.) and the agency’s final adjudicator model (specifying the agency official/s adjudicating appeals).

I ran a multiple linear regression to test the effect of each variable on the agency’s rate of success before its ALC. The results of my regression point to a statistically significant model as at the <.001 level. No single variable proved to be statistically significant from this early test. Nonetheless, by incorporating the remaining 22 agencies and additional variables, we may uncover a factor that predicts agency success.

What does this mean for the average American?

The preliminary results of my analysis suggest that there are likely multiple institutional factors that contribute to an agency’s heightened success before its ALC. With this in mind, Americans should be deeply worried about agency adjudication.

Many ALCs impose cost-barriers that only wealthy litigants can scale. There are often compounding costs for litigants stuck in protracted adjudication. This burden is exacerbated for those appealing their cases to federal courts. In the face of such high costs and unlikely odds for success, most people are forced to back down and settle with the agency.  

Some litigants have seized rare victories against ALCs in federal court. Last year, the Supreme Court’s decision in SEC v. Jarkesy liberated George Jarkesy from a $300K monetary penalty and nearly 14-year legal ordeal within the SEC’s tribunal. Similarly, Michelle Cochran struggled for seven years against the SEC’s court before receiving proper justice in the Supreme Court’s Axon v. FTC (2023) ruling. 

From the above research, we learn that agencies win 92 percent of their cases before ALJs compared to 55 percent when represented before Supreme Court Justices. This suggests that an agency’s in-house advantage far exceeds the federal government’s ability to win before an impartial court.  

This early research points to an alarming area of bureaucratic dominance. We deserve to know more about these shadowy ALCs and what factors contribute to an agency’s ability to win virtually all its cases in-house. This research suggests that the scales of justice need serious rebalancing.

 More about Administrative Law Court Reform

The New York Times recently reported that NPR and PBS are bracing for a funding battle under the new administration.

While there’s been talk about defunding NPR and PBS for years — who can forget Mitt Romney being accused of wanting to “fire Big Bird” during his 2012 presidential bid — there’s reason to believe it could actually happen. 

One reason is pretty obvious. “Elon Musk is gunning for public media,” reports the Times. 

It’s no secret that Musk has a beef with NPR, which he labeled “state-affiliated media” in 2023, prompting NPR to quit Twitter. (It’s also clear that NPR has a beef with Musk, whom they cover with a barely concealed hostility, the most recent example being the 1,000-word treatment they devoted to Musk giving a “Nazi salute” when he extended his arm to thank those in attendance at a celebration for President Donald Trump in Washington, DC.)

Musk will find plenty of allies in his quest to defund NPR and PBS. 

For years, conservatives have bristled at NPR’s slanted political coverage and cultural commentary, which promoted books teaching parents how to make toddlers “woke.” Calls to defund grew more intense during the pandemic, a period that saw much of NPR’s journalism turn into polemic and obscurantism, including an article that directly compared Americans who believed COVID-19 may have come from the Wuhan Institute of Virology to QAnon conspiracy theorists. (The CIA now agrees that COVID-19 most likely originated from a lab leak, but NPR has yet to label the Agency QAnon kooks, to my knowledge.) 

The complaints go beyond conservatives and libertarians, however. 

In 2024, one editor who described himself as a Sarah Lawrence-educated, Berkeley-minded, Subaru driver “raised by a lesbian peace activist mother” resigned from NPR in protest. He went on to publicly scold NPR for abandoning “straightforward coverage of a belligerent, truth-impaired president” for journalism that “veered toward efforts to damage or topple Trump’s presidency.” 

Media can take sides in presidential elections. Taxpayer-funded media may not. 

Still, there are plenty of arguments (good and bad) to continue funding NPR and PBS. 

Both media outlets do some pretty good journalism at a time when good journalism is in decline. Additionally, anyone who does a quick Google search will find an abundance of evidence showing NPR and PBS receive only a small percentage of their revenues directly from the federal government. 

Howard Husock, a senior fellow in Domestic Policy Studies at the American Enterprise Institute, last year wrote a piece for Fox News in which he described efforts to defund NPR as “quixotic” and misguided. Husock didn’t defend NPR, which he described as “an echo chamber…with a liberal spin.” But he argued that in the unlikely event that such a defunding effort succeeded, it would likely make NPR’s bias worse. 

“A defunded NPR would almost surely become a culture war martyr,” Husock wrote. “We should expect major left-liberal big philanthropy — including the Ford, MacArthur and (George Soros’) Open Society Foundations  — to rush to fill the gap, followed by Carnegie, Hewlett and a host of others,” many of which already sponsor NPR programming.

When even conservatives like Husock defend these public expenditures, it stands to reason that NPR and PBS could dodge the executioner’s axe once again. This would be most unfortunate. 

Yes, NPR and PBS do some good work. But the idea that taxpayers are funding media at a time when the world is drowning in media — podcasts, movies, radio, Twitter, YouTube, cable news, movies, and more — is nonsensical. This is doubly true when one considers the US government is $36 trillion in debt.

People who say defunding NPR and PBS isn’t going to balance the budget have a point, of course. We’re talking about relatively small revenue streams here (though everything looks small when you’re talking about a $2 trillion annual deficit). 

Still, that one-to-two-percent figure comes with caveats. While it’s true that NPR typically receives around two percent of its budget directly from the federal government, federal dollars account for an enormous percentage of NPR’s overall revenue. 

Paul Farhi explained more than a decade ago how the game is played. 

“Washington plays a critical role in public radio’s finances,” Farhi explains in the Washington Post. “Congress passes millions of tax dollars through the federally chartered Corporation for Public Broadcasting to NPR’s member stations, which in turn use some of those funds to buy programs from NPR.”

Through this complicated, bureaucratic payment system, NPR receives station fees that typically account for 40 percent of its annual budget (perhaps a bit less in recent years). Considering that NPR has an operating budget of about $300 million, we’re talking about more than $100 million a year. 

Again, this may not make a massive dent in the federal deficit, but few would deny there’s something unseemly about taxpayers ponying up their hard-earned dollars so NPR can pay hosts $500,000 salaries. 

Also, we shouldn’t lose sight of the fact that there’s a purpose to all this spending. 

As the saying goes, “He who pays the piper calls the tune.” Those who control these tax dollars are in a sense purchasing the allegiance of those who shape the ideas, opinions, and thoughts of the American public. They are in a very real sense the political allies of the DC bureaucracy and political establishment. 

This is what makes government-funded media so sinister. It undermines the independence of media organs. Americans instinctively recognize this. We laugh at the crude propaganda machines of other nations and can tell you about the propaganda efforts of Goebbels; many of us even can remember the ridiculous messaging of Baghdad Bob. Yet far fewer Americans seem able to recall the US government’s long history of using propaganda, which grew more sophisticated over the years and involved planting disinformation at news outlets.

The bottom line is this: the government has no business funding media (though it clearly has a desire to not just fund media but control it).

I don’t want to go into the whole social contract thing, and start quoting Hobbes and Locke, but the raison d’etre for government is that it’s supposed to fund “essential services” that markets can’t provide. 

To accept the premise that the government should be funding media outlets destroys the whole idea that government should be limited. You might as well argue that the government should be funding the Dallas Cowboys.

Put aside Husock’s arguments of utility, and his belief that congressional hearings can help bring NPR to heel and make it a less-partisan media organ. Look instead to first principles. The Founding Fathers had a clear philosophy on the proper role of government, and funding media operations isn’t something you’ll find enumerated anywhere in the Constitution.

Defunding NPR and PBS and all government-sponsored media isn’t just about saving taxpayers money, and it’s certainly not about placating Elon Musk. 

It’s about restoring the federal government to its proper role.

Nvidia became the world’s most valuable company out of the blue — almost. 

Adding trillions to its market capitalization within just a few months in the spring of 2024, its stock price almost tripling that year, by itself it contributed almost one-quarter to the return of the S&P500 index. (Today, Apple is once again top dog, but stock prices shift fast.)

That’s not to say this rallying was a fluke: It was long in the making.

All of us ’90s kids with a penchant for gaming have heard of Nvidia — excellent graphics chips for high-end, performance video games. But what truly propelled Nvidia from a large company successful in this original niche was the AI revolution. 

To most of us, the deep-learning/neural network software that we often sloppily call artificial intelligence arrived on the world scene a few years ago. While at first it had some mania tendencies of a typical Garter hype-cycle variety, it now seems here to stay, promising almost daily to overhaul this or that industry. What’s so incredible about the Nvidia-AI story is that Nvidia’s long-time CEO, Jen-Hsun “Jensen” Huang, saw this coming a mile away — well before anyone but nerdy computer scientists and chess engine builders knew what neural nets were. 

Tae Kim, senior tech writer for Barron’s, spent 2023 delving deep into the history of wonderchild Nvidia, which had just celebrated 30 years as a business. The result, The Nvidia Way: Jensen Huang and the Making of a Tech Giant is an excellent feat of journalism. It’s based on hundreds of interviews that Kim made  —  at a breakneck pace no doubt  —  in the 19 months from when the publisher approached him to the finished product hit the shelves late last year. 

Like a good, intricate novel there is a dizzying array of characters and more abbreviations than anyone ought to endure. (Welcome to computing history.) The writing is easy-going; the author managed to be both relatable and minimally personal. It’s not completely detached from voice  —  Kim makes personal remarks now and again  —  but readers are mostly turned into a fly on the wall in Nvidia’s various offices. 

The story Kim weaves together is one of hard work and Jensen’s eccentric personality. Per the title, the Nvidia “way” is Kim’s attempt to characterize what makes Nvidia different from other companies. He identifies three components: a strive for excellence (and pretty astonishing work ethics, with workweeks in the 70-80 hours, and record-low employee turnover); hiring practices, where Nvidia goes out of its way to attract and maintain the best people; and generous and widespread stock programs, especially directly connected to achievements rather than as a vague, broad-brush end-of-year bonus. Encouraging for the revival of American corporate culture is that all the people Kim talked to “reported that the company was largely free from the internal politics and indecisiveness typical in large organizations.”

Many chapters read like they could have been long-form essays, the early ones of Nvidia’s history sometimes approaching a Wikipedia entry. The result is something between a comprehensive business history — and a puff piece of its leader. It’s obvious that Jensen comprises a big portion of Kim’s book and that his peculiar leadership style (nimble organization, flat hierarchy, open dialogue, direct communication with hundreds of employees) has been a crucial factor in Nvidia’s success. 

Nvidia began out of the dejected experience of Nvidia cofounders Curtis Priem and Chris Malachowsky at Sun Microsystems in the early ’90s. In a telling explanation, symbolic for the ethos that came to dominate Nvidia, Priem “just wanted to make good graphics chips and had no interest in corporate infighting.” Both Priem and Malachowsky, both having been at Sun for a few years, quit in protest over what they saw as the wrong technical approach to building the computational graphics for a workstation. 

The pair picked up a discarded project of their former employer and approached Jensen, who in 1992 managed a division of the microchip company LSI Logic and whom the pair had worked with on a Sun project. They wanted to make a demonstration chip for Samsung; in the blunt way characteristic for Jensen’s future leadership, the latter one day stopped and say, “Why are we doing this for them?”

Meddled through the pages describing the events and personalities that made Nvidia is a meta-conversation Kim is having with the reader about the relative virtues and luck and hard work:

“To those outside of the company, Nvidia’s meteoric rise seems like a miracle. Those inside it, however, consider it a natural evolution […] Nvidia wasn’t lucky; it was able to perceive the wave of demand on the horizon years in advance and had prepared for this very moment.”

“Luck has a lot to do with success,” Jensen reminisces,” and my luck was having met [Chris and Curtis].” 

The company, too, was lucky to overcome the constant financing problems of the early years; lucky to recover from the failure of the NV1 and NV2 chips and production problems surrounding RIVA 128: “Nvidia barely survived its first ten years,” writes Kim summarizing part II of the book. It takes him to the second-to-last page to spell out the themes on my mind reading most of the book: “In writing the history of Nvidia, I was struck by the times it verged on failure and outright destruction. If things had gone just a little bit differently in a few instances, computing would have taken another course.” 

If either of the founders had decided to take offers from established firms instead of venturing out on their own; if financing hadn’t come through in the critical summer of 1993; if rival firm 3dfx had been more aggressive in trying to acquire Nvidia when the latter was financially struggling, or when the planned IPO (and infusion of cash) was delayed; if the large order for RIVA 128s hadn’t come in when it did.

Like legendary investor Benjamin Graham exemplifies, you need to work yourself into a good enough position where luck can alter your destiny. Success, while obvious in hindsight, is delicate and vulnerable. “In a sense,” writes Kim, “Nvidia was doing what it had always done: spotting a big opportunity and racing to get its products to market before anyone else realized the potential was even there.” 

There are fascinating tidbits scattered across the book, too — like the origin of the company name (a tech spin on the latin word for envy) and how the commercial profits of every era of computing have followed a Pareto principle. The dominant player, from WinTel to Apple, Google to Nvidia, 80-90 percent of industry profits have accrued to the player “who can develop a market-leading platform.” Or the story of Jeff Smith of activist fund Starboard Value, who sold over 4 million shares of Nvidia in 2013 after a neat 20 percent gain, missing out on some 33 thousand further percent gain since (or, 27,300 percent, since Nvidia shares just fell 18 percent compared to the day I first typed this). “We should never have exited the position,” Smith tells Kim in a painfully dramatic chapter ending.

The story of Nvidia is about risk-taking and how a dedicated team, laser-focused on a company’s mission can result in extraordinary feats — especially when supplemented by hard work day in and day out.

For maximum symbolism, too, in November 2024 Nvidia replaced Intel on the Dow Jones index — Intel, which was alternatingly a stable Nvidia client and rival, and for whose products Nvidia was making chips in the late ‘90s and early ‘00s. Even in tech, fate, it seems, has a sense of irony.

Kim is proud to have rushed this business history to the shelves, and surprised that so little has been written on Nvidia (certainly compared to the myriad of Apple/Steve Jobs biographies). Scanning Amazon for new and upcoming books, that won’t stay true for long. 

For most of modern computing history, Nvidia has been there, powering the devices we use every day and repeatedly challenged that industry. That’s what made it, however briefly, the most valuable company in history.

The retreat from DEI has gone from a handful of companies to one of the primary objectives of the new Trump administration. While the pre-election season was marked by a cascade of major companies ranging from Meta to Tractor Supply axing diversity initiatives in response to pressure from activists like X journalist Robby Starbuck, the post-election world is quite different. Diversity, equity, and inclusion are in the crosshairs of the federal government, and now a movement that started with a souring on the racialism that crept into American boardrooms after the death of George Floyd has the potential to snowball into a massive trend across industries.

But as the media portrayal shifts from diversity as an integral part of a workforce to a rapidly burgeoning liability fraught with legal and reputational risk, one major misconception remains about the effects of ditching DEI initiatives: the idea that ditching DEI is a capitulation to far-right ideology.

Observe, in the case of Meta: journalists described the company’s ditching of diversity initiatives as a “further right-wing shift.” Or this stunning piece of analysis from Al Jazeera: ”The real end goal of the far-right war against affirmative action is… a state of quasi-legal racial segregation.” Or this piece at Yahoo News, similarly about the cascade of companies dumping DEI: “These 12 major companies caved to the far right.” You get the picture. Ditching discriminatory DEI initiatives, depending on your perspective, is anything from complicity in right-wing activist narratives to dog-whistling white supremacy. 

I oversee shareholder engagement at one of America’s leading ESG-skeptical corporate engagement firms. I’ve watched and covered many recent corporate DEI pivots and helped clients put proposals on the ballots of dozens of companies calling for rollbacks on similarly divisive policies. When people ask me why this pivot has been occurring, the answer is summed up in the following: for years, left-wing activists took their demands to investor relations departments and executive boards at America’s largest brands, while the center and right were asleep at the wheel of asserting their financial influence. As a result, brands shifted in the direction of the people they were overwhelmingly hearing from.

Spoiler alert, it wasn’t people trying to keep companies out of politics. A cursory glance at the growth of DEI, ESG, and the increasingly normalized practice of companies opining on hot-button cultural and political issues outside of their core business practices, proves this to be the case. Conservatives, and right-of-center consumers hemmed and hawed, and threatened boycotts as left-of-center activist groups talked to executives, used the pathways of shareholder engagement, and saw progress.

Against that backdrop, look to 2025: a majority of companies are reevaluating their complicity with activist groups, and changing up their strategy for the next four years where rampant progressivism is viewed as anything but progress by many influential corporate actors. Is the pendulum of corporate America shifting right?

The answer, at least as of early 2025, is a resounding no. Trump’s recent executive order prohibiting the use of discriminatory DEI in federal contexts, and the accompanying similar kiboshes in the private sector, is being painted as a newly culturally ascendant Right running wild with power. The reality? Ceasing DEI programs that rely on defacto quotas or otherwise encourage racial discrimination through corporate policies, is not a bid to make companies “right-wing.”

It’s a bid to achieve political neutrality – and insulate against the coming legal reckoning for biased corporate policies.

As someone who engages with companies about these biased corporate policies daily, a few notable examples come to mind of policies that, despite what DEI advocates would have you think, are not milquetoast endeavors to simply respect employees from diverse backgrounds. They’re recent, indefensible, examples of how a theoretical desire for diversity gets applied as unequal employee treatment.

• Internships only offered to applicants of a certain race (or that bar applicants from certain racial groups from applying), at IBM.
• Racial quotas for recruitment and promotion, which also has IBM currently under legal fire but many large firms also boasted about.
• Employee resource groups (ERGs) offered by companies based on race and gender but not other protected aspects like faith. (If a company’s black employees can have a special group but its Muslim employees can’t, that’s a conversation shareholders ought to be having, and one my firm has been discussing with many companies this year).
• Policies that create quotas based on race and gender for the suppliers a company works with, a policy that Walmart recently axed as part of its DEI rollbacks.
• Race a criterion determining eligibility for grant funding, as at Citi (this practice may have been discontinued).

Rolling back these politicized policies doesn’t make a company “take a different side.” It takes the company away from politics and away from side-taking in general. American shareholders do not need companies who previously had DEI programs to institute some “reverse DEI” for members of groups that previous DEI programs did not prioritize. Shareholders want race neutrality in hiring because of the underlying belief that corporate neutrality is better for productivity and profitability. Eschewing politics altogether is a better solution for companies looking to maintain long-term reputational stability than pendulum-swinging their policies every time the balance of power shifts in Washington. 

Why does this narrative of “ending DEI as a far-right capitulation” persist? The obvious explanation is that the current push against DEI in academia and the workplace is coming, in the majority of cases, from the political right. But that doesn’t mean that policies proposed by the right only serve the right. Policies like race-neutral recruitment and promotion serve everyone. Policies prohibiting the use of racial quotas serve everyone who doesn’t wish to see their corporate career as the product of how well they meet skin-deep quotas.

There’s one last explanation of why this false narrative about ending DEI persists. Much of DEI training discusses the dangers of unconscious bias. The fact is, many people (and some companies) see corporate neutrality as extreme because they’ve been taught the kind of unconscious bias that sees activist-driven, one-sided, corporate-ideological lockstep as normal. And that’s one area of unconscious bias that every business should be trying to unlearn.

On January 17, the Congressional Budget Office (CBO) released its latest Budget and Economic Outlook and Update. It attracted little attention in a media environment flooded with stories about then-incoming President Trump, but it should have been one of the big stories of the year. The CBO takes stock of the incoming administration’s fiscal inheritance, and it is a grim one.  

“[T]the federal budget deficit in fiscal year 2025 is $1.9 trillion,” the CBO notes, or “6.2 percent of gross domestic product (GDP).” This comes after a deficit of 6.6 percent of GDP for 2024 and is a staggering number for an economy which is, we are told, booming. 

If we go back to World War Two, the only years when the Federal budget deficit has been higher as a share of GDP are the recession and slow recovery years 2009-2012 and the pandemic years of 2020 and 2021. What is worse is that, despite all the “Building Back Better” of the last few years, the Federal budget deficit has actually risen from 5.3 percent of GDP in 2022. Perhaps this vast infusion of borrowed money is why the economy is supposedly “booming.” If so, this sugar rush is not sustainable.  

Looking ahead, the numbers do not improve. The deficit is forecast to hit 6.1 percent of GDP in 2035.  

The result of these large, persistent, and growing deficits is a large and rapid increase in Federal government debt. “From 2025 to 2035,” the CBO writes: 

…debt swells as increases in mandatory spending and interest costs outpace growth in revenues. Federal debt held by the public rises from 100 percent of GDP this year to 118 percent in 2035, surpassing its previous high of 106 percent of GDP in 1946. 

In 2035, in other words, the Federal government debt will be larger relative to national income than it was at the end of the Second World War, when we had just defeated Nazi Germany and Imperial Japan.  

The deficit arises from an imbalance between Federal spending and revenues. The CBO forecasts that “Revenues total $5.2 trillion, or 17.1 percent of GDP, in 2025” and reach “18.3 percent in 2035.” If revenues are forecast to climb as a share of GDP, the forecast deficit must arise from an even greater increase in spending. The CBO writes that “Federal outlays in 2025 total $7.0 trillion, or 23.3 percent of GDP…reaching 24.4 percent of GDP in 2035…” These deficits and higher debt are driven, then, not by deficient revenues – indeed, the CBO notes that “Revenues remain below their 50-year average in 2025 but rise above it thereafter” – but by excessive spending: “Measured as a percentage of GDP, federal outlays in CBO’s projections exceed their 50-year average every year from 2025 to 2035.” 

“The main reasons for that increase,” the CBO continues, “are growth in spending for Social Security and Medicare and rising net interest costs.” Mandatory spending, of which Social Security, Medicare, and Medicaid account for 79 percent in 2025 rising to 84 percent in 2035, is forecast to rise from 14.0 percent of GDP to 15.1 percent over the same period. And, with rising deficits and debt to finance with Treasury yields at levels not seen in 18 years, the CBO notes that: 

Net outlays for interest increase as debt mounts. Interest costs exceed outlays for defense from 2025 to 2035 and exceed outlays for nondefense discretionary programs from 2027 to 2035. From 2027 on, interest costs are greater in relation to GDP than at any point since at least 1940 (the first year for which the Office of Management and Budget reports such data).   

And this assumes that the rates on 3-month Treasury bills and 10-year Treasury notes decline from 3.8 percent to 3.1 percent and 4.1 percent to 3.8 percent, respectively, from 2025 to 2030-2035.  

As a result of this, discretionary spending — which includes defense spending as well as programs such as transportation, education, housing, and social service programs, as well as science and environmental organizations — falls from 6.1 percent of GDP in 2025 to 5.3 percent in 2035. Defense spending falls from 2.9 percent of GDP to 2.4 percent over the same period. 

Those who suggest that the budget can be balanced simply by cutting military spending are living in a fiscal fantasy, especially in a time of rising global tensions.  

This is President Trump’s fiscal inheritance. He cannot feel too aggrieved, however. His first administration saw an increase in the Federal budget deficit from 3.1 percent of GDP in 2016 to 4.6 percent in 2019, before COVID-19 hit.

The prospects that the second Trump administration will get Federal spending, deficits, and debt under control look a little brighter. President Trump’s choice for treasury secretary, Scott Bessent, has laid out an economic plan known as “3-3-3,” which involves reducing the federal budget deficit down to 3 percent of GDP, getting real GDP growth up to 3 percent, and producing an additional 3 million barrels of oil a day by 2028. The plan has drawn criticism for, among other things, requiring “enormous cuts to programs such as Medicaid,” but there is no path to Federal government solvency that doesn’t pass through major reforms to mandatory spending programs like Social Security, Medicare, and Medicaid, for which there appear to be next to no appetite anywhere on the political spectrum.

But we cannot place all the blame on the politicians. To some extent, they are simply giving the American voters what they want. During last year’s presidential campaign, the candidates for President and Vice President debated for a combined total of 270 minutes. At no point were they asked a direct question about the Federal government’s deficits and debt and what they would do about them. This ought to be the biggest issue in American politics and hardly anybody cares.  

There are those who tell you not to worry. “We owe it to ourselves,” they will say, ignoring that “we” and “ourselves” are different people so all it amounts to is that “we” owe it to the holders of Federal debt. Others will tell you that the Federal government can simply print whatever money it needs to pay its bills. The last few years have demonstrated once again what happens when we do that. 

Whether you’re one of those who believes that the United States should police the world or one of those who believes that it must attend to its own problems first, fixing the explosion of Federal government debt has to be a priority. Just as America grew strong because it had a strong economy, it will grow weak if its economy is allowed to grow weak under the growing weight of debt. Not for nothing did Thomas Jefferson urge Americans to “place economy among the first and most important of republican virtues, and [regard] public debt as the greatest of the dangers to be feared.” 

Introduction

Economics textbooks feature a coherent theory of how markets can allocate scarce resources in ways that achieve what is plausibly described as maximum possible human satisfaction. This theory is grounded on certain foundational assumptions, such that the existing ‘distribution’ of wealth is legitimate, that each adult is a rational actor who knows his or her preferences and circumstances better than does anyone else, and that no one person’s or group’s preferences count for more than do those of any other person or group.

It is then shown that when markets are “perfectly competitive,” and when each person bears in full the marginal costs, and reaps in full the marginal benefits, of his or her actions, the resulting allocation of resources will be one that, if altered, would worsen overall human satisfaction. This model is not intended to describe reality but to provide a widely predictive tool related to human motivation and the inescapability of resource scarcity.

All students of formal economics know that conditions for such an ideal outcome to prevail are strict—so strict that they are impossible to meet. This fact often generates this policy conclusion: “Therefore, government intervention is necessary.” But as all careful students of economics know, this conclusion is a non sequitur. The market certainly is imperfect, yet it doesn’t follow that the government should intervene.

Government intervention is plagued by its own deep imperfections, the most prominent of which are the knowledge problem and the incentive problem. The former refers to the obstacles faced by government officials to acquire (and to correctly process) all the knowledge they would need to improve market outcomes; the latter refers to incentives that often push political actors to pursue their own interests in ways that conflict with the public interest.

Recognition of either of these problems alone should create a presumption against government intervention. Taking cognizance of the simultaneous existence of these problems should make this presumption stronger. And this strong presumption should hold even when the existence of market imperfections is unambiguous.

By far, the market imperfection believed, at least by economists, to be most common is that of externalities. An externality, as defined by the Nobel-laureate economist George Stigler, “is an effect, whether beneficial or harmful, upon a person who was not a party to the decision.” Consult almost any economics textbook and you discover a similar definition of externality. Because harmful effects of this sort (“negative externalities”) generally get more attention than do beneficial effects (“positive externalities”), the discussion in this Explainer will be confined to negative externalities, although most of the points I make apply also to positive externalities.

A classic example of a negative externality is a railroad that builds a line next to farmland and, when it runs its trains, throws sparks onto the farmland, occasionally burning the farmer’s crops. The farmer suffers damage that he did not bargain for. If the railroad doesn’t pay for this damage, it does not cover all of its operating costs, which include doing damage to crops. Because incurring costs restrains the actions that generate the costs, not having to pay all of its costs leads the railroad to run too many trains. And when the railroad runs too many trains, the farmer winds up supplying too few crops.

To induce the railroad to produce the optimal amount of railroad services, it must somehow be obliged to pay not just for some of its costs of doing business—to pay not just wages to compensate its workers, and prices to compensate its suppliers of fuel—but to pay for all of its costs, including whatever damage it causes to farmers and other parties who suffer incidental losses as a result of the railroad’s operation.

A.C. Pigou and Ronald Coase

The government can “correct” this market imperfection by imposing on the railroad a tax equal to the value of the crops damaged by its trains. This tax—called by economists a “Pigouvian tax” (after the British economist A.C. Pigou)—“internalizes” on the railroad the cost that it once imposed on the farmer. A cost that was previously external to the railroad’s decision-making processes is now internal to it given that the railroad must pay the tax. With this cost “internalized” on the railroad, it will now produce the economically optimal amount of railroad services, and allow the farmer to supply the optimal amount of crops.

As Ronald Coase pointed out in one of the most influential economics papers ever written, such a tax isn’t the only, and likely not even the best, means of internalizing this externality. If the railroad and farmer can bargain with each other, all that needs to be done is for the property right to be clarified. With a clear understanding of prevailing property rights, the farmer and railroad will bargain with each other to reach an agreement that brings about the optimal amount of both railroad services and crop supply.

According to the famous “Coase Theorem,” if bargaining is possible it does not matter economically what the property-rights assignment is, only that it exists and is known and unequivocal. A simple example makes the Coase Theorem clear.

Suppose that each train that runs alongside the farm causes $10,000 of crop damage, and that by running each such train the railroad earns a profit of $16,000. Further suppose (for simplicity) that the only way to prevent the trains from causing crop damage is to stop running the trains alongside the farm. If a court declares that the railroad has no obligation to compensate the farmer—which is to say, if the court rules that the farmer has no right to be free of the crop damage caused by the railroad—the railroad obviously will continue to run its trains alongside the farm. But suppose instead that the court rules that the railroad has no right to damage the farmer’s crops. Legally, the farmer could then compel the railroad to stop running trains alongside his land. Prior to the publication of Coase’s article, this outcome is the one that was believed would prevail. But the Coase Theorem helps us understand that the railroad will keep running the trains and do so with the farmer’s consent.

The reason is that the railroad will offer to pay the farmer, for each train that it runs by the farmer’s land, some amount above $10,000 and up to $16,000 for the right to run that train. If, say, the railroad offers the farmer $12,000 for each train that it runs alongside his land, the farmer will accept; it’s better for the farmer to lose $10,000 of crops and receive in return a payment of $12,000 than to avoid losing $10,000 of crops and receive no payment from the railroad.

Now change the example to suppose that, while each train continues to cause $10,000 of crop damage, the profit that the railroad earns by running each train is only $8,000. It’s clear that if the court rules that the farmer has the right to be compensated for any damage that the railroad causes to his crops, the trains will stop running. The railroad won’t find it worthwhile to compensate the farmer for the crop losses.

Yet the trains will stop running even if the court rules that the railroad has no obligation to compensate the farmer. The farmer will pay the railroad some amount between $8,000 and $10,000 to stop running its trains alongside his land. If, say, the farmer offers the railroad $9,000 not to run a train that would cause $10,000 of crop damage, the railroad will accept. Better not to run the train and get $9,000 from the farmer than to earn $8,000 of profit by running the train and thereby lose the opportunity to get $9,000 from the farmer.

Oceans of ink and gazillions of pixels have been devoted to the debate over just how realistic such bargaining is in the real world, as well as to identifying how it might go awry. (In the last example, what prevents the railroad from telling the farmer that the number of trains it plans to run is greater than the actual number that it plans to run? Courts deciding on where to locate, and just how to define, property rights must be aware of potential unintended consequences of their rulings. The details matter.) Nevertheless, the Coase Theorem reveals an important economic reality: When allowed to operate, markets tend to allocate property rights to those persons or parties who value them most highly, and such allocations are done in ways that are mutually beneficial.

It Takes Two to Externality

For all of its apparent cleverness, the Coase Theorem is actually mundane (as Coase himself understood). This theorem simply shows that, as long as individuals can bargain with each other, legal rights no less than goods and services will be acquired by those persons who value them most highly. Nor is the Theorem the most important part of Coase’s paper (as Coase also understood). That distinction belongs to Coase’s insistence that all externalities are bilateral or multilateral. Jones cannot impose a loss on Smith if Smith is not in a position to be harmed by Jones. If there were no cropland adjacent to the railroad tracks, trains running along the tracks would cause no crop damage. The existence of the externality results from actions taken by both parties. In our example, the externality is caused no less by the farmer’s actions to plant his crops where he does than by the railroad’s action to situate its tracks where it does and run trains along them. Just as it takes two to tango, it takes at least two to “externality.”

This reality has this implication: Because each party took steps to make the externality possible, each party can take steps to prevent the externality. The following question is thus raised: Which party should take that step? Answering a “should” question involves value judgments, but economics can lend a hand by pointing out that resources are saved if externalities are dealt with in the least costly way possible. It’s not a terribly controversial normative stance to argue that the party who can eliminate the externality at lowest cost “should” be the party on whom responsibility for doing so is placed.

In the farmer-railroad example, most readers’ sympathies likely lie with the farmer. The railroad, after all, appears to be the cause of the externality. But appearances can deceive. Suppose the farmer bought the land adjacent to the railroad tracks long after those tracks were laid and in full knowledge of their existence as well as of the fact that trains continue to run along them and throw off hot sparks. If the farmer then nevertheless plants crops near the tracks, who’s responsible for the resulting crop damage? In this case, it’s no longer obvious that the culprit is the railroad. The farmer could have bought land elsewhere, or chosen not to plant crops so close to the tracks so as to be burned.

In our world of scarce resources, we want to impose the legal responsibility for dealing with externalities on those parties who can do so at the lowest cost—that is, who can deal with externalities using the fewest amount of resources. And so a ‘good’ system of property rights encourages those parties who can avoid externalities at lowest cost to be the ones who take the actions to do so. If the cost to the farmer of buying equally good cropland away from the existing railroad tracks is lower than the cost to the railroad of diverting its trains onto routes other than that which passes near the cropland, a ‘good’ system of private property rights encourages the farmer to do so. If under these circumstances the farmer nevertheless purchases the land adjacent to the tracks and plants crops on them, the courts ‘should’ therefore rule that he has no right to be compensated for the resulting damage to his crops. By so ruling, the courts oblige the farmer to bear the cost of his decision; he cannot offload this cost onto the railroad. This ruling will discourage farmers in the future from making a similar costly choice.

Costs Are Not Losses

Yet an even deeper point lurks in this example. It’s commonplace among scholars in law and economics to describe the farmer in the last version of this example as the “low-cost avoider of the externality.” But I argue that in the last version of this example there is no externality. If the farmer knows about the railroad tracks and the sparks that come from passing trains but still chooses to plant crops near the tracks, he cannot plausibly be said to suffer losses due to the railroad’s operation. Prior knowledge of the railroad and its sparks was sufficient to internalize on the farmer the consequences of his decision to plant crops near the railroad tracks. Indeed, the price the farmer paid for the land must be assumed to have been discounted to reflect the likelihood of damage to any crops planted alongside the tracks – meaning that the farmer paid for the land a lower price than he would have paid had the tracks not been there. This discount on the price of the land compensates the farmer for the expected value of the crops to be damaged by passing trains. The fact that this compensation is “paid” in advance, in the form of a discount on the price of the land, is economically irrelevant. Resources are allocated the same way. When the trains now pass and burn some of his crops, these are damages that the farmer anticipated and for which he has already been compensated.

It’s important to get the language straight. The value of the damaged crops, in this case, are not “losses.” They are costs, and costs differ from losses categorically. This distinction might at first come across as one without a difference, but it is real and relevant. Before returning to the farmer and railroad, let’s explore this difference.

By “losses,” I mean the value that a party is denied when he or she is stripped of some property interest in which he or she has a legitimate legal entitlement. If a thief steals your car, you suffer genuine loss. If Jones builds a tall fence that blocks a view to which Smith has good reason to believe he is legally entitled, Smith suffers a loss. If a freak earthquake destroys my home in northern Virginia, I suffer a loss. Using conventional language we might say that the theft “cost” you $25,000, that Jones’s fence “cost” Smith his lovely view, and that the earthquake “cost” me my home. But to get a clearer understanding of externalities, the decrements from your welfare, from Smith’s welfare, and from my welfare are better called “losses” and not “costs,” for it’s important that losses and costs be kept distinct from each other.

Unlike losses, costs are what choosers voluntarily sacrifice in exchange for benefits. Both losses and costs, each standing alone, are decrements from individuals’ welfare. But only losses spring from a series of human interactions (or Acts of God) that decrease that welfare on net. When someone suffers a loss, that person is made worse off. In contrast, when someone incurs a cost, that person is made better off.

This odd-sounding conclusion about costs follows from the fact that costs, unlike losses, are the flip-side of choices. I choose to pay $20 for a pizza because I expect that the satisfaction that I will get from the pizza exceeds the satisfaction that I would get if I were to spend that $20 some other way. Because I can get satisfaction from the pizza only by incurring the cost of sacrificing $20 to obtain it, the process of incurring this cost makes me better off.

More precisely, my access to the opportunity to incur this cost makes me better off, for embedded in this opportunity is the prospect of my receiving a gain that is greater than the cost. This reality is not changed by the fact that the net increase in my welfare from taking advantage of this opportunity would be even greater were the restaurant owner to surprise me by giving me the pizza free of charge. The bottom line is that the $20 that I spend for the pizza is not a “loss,” and no one would describe it as such.

Consider another example. Suppose that, to buy a home, I borrow $250,000 from a lender and agree to repay the loan, in monthly installments, at a certain rate of interest over fifteen years. I move into the home today and commence living in it. A Martian, with no knowledge of earthly conventions, visits earth three years from now and observes me sending a check each month to the mortgage holder. After a few months of observation, the Martian reports to his leaders on the red planet that each month the mortgage company inflicts on me a loss in the amount of my mortgage payment. The Martian and his leaders conclude that I would be better off were I not obliged to suffer a loss each month in the form of these monthly payments.

But no knowledgeable earthling would describe me as each month suffering a loss. When asked to describe the meaning of my mortgage payments, the earthling would say that I’m paying the cost of having borrowed money to purchase a home. The earthling would be correct. Of course, I would be delighted if, after I obtain the borrowed funds, the mortgage holder then relieved me of my obligation to repay. My welfare would be raised by such relief.

However, I clearly would be made worse off if, as a result of the mistaken conclusion that the practice of mortgage lending imposes losses on borrowers, creditors were prohibited from demanding repayment from debtors. While in my ideal world the mortgage lender would simply give me the $250,000 with no strings attached, I’m nevertheless better off in a world in which mortgage lenders can lawfully demand repayment of loans than I would be in a world in which such demands are unlawful.

Back to the Farm

And so it is with the farmer who chooses to plant crops near land that he knows will occasionally be set ablaze by sparks from passing trains. This farmer values the expected benefit of cultivating that particular piece of land by more than his cost of doing so. This fact implies that the farmer judged all other available options for using the time and resources that he invests in cultivating that land as inferior. By cultivating that piece of land, despite the expectation that crops grown on it will occasionally be burned, the farmer maximizes his net worth (and, in turn, his net welfare).

So the fires, when they do happen, cause the farmer no losses; the crop damage was expected beforehand and so the farmer, when making his plans, took the likelihood of this damage into account. This damage was “internalized” on him from the start of his operations. The farmer thus suffers no unexpected reduction in his net worth or welfare when trains pass by and set fire to his crops. The farmer obviously would be pleasantly surprised if the actual amount of crop damage turns out to be less than he expected, but the crop damage that does occur as a result of the railroad’s normal operation is nevertheless no net reduction in his welfare. This crop damage is merely among the farmer’s costs of cultivating that land.

The situation would be entirely different if, when the farmer began cultivating his land, he had no good reason to believe that a railroad would be found to have the right to run spark-spewing trains near that land. In this case, the damage done to the farmer’s crops by the railroad would indeed be losses to the farmer.

The challenge facing courts when hearing cases in which party A accuses party B of violating party A’s property interest is to determine which party has the most legitimate expectation—that is, which party actually has the property interest. If the courts find that the farmer could not have legitimately expected to be free of crop-damage caused by the railroad, the courts will rule that the farmer suffered no losses that the railroad is legally liable to cover. In economic terms, the railroad imposed no externality on the farmer, for the expected crop damage was already “internalized” on the farmer when he, knowing of the fire risk, chose to plant crops near the railroad tracks. If instead the court finds that the farmer had a legitimate expectation to be free of such damage, then it will rule that the railroad is liable for any damage that it causes to the crops. In this case, unlike in the former, the railroad does indeed impose on the farmer a negative externality—that is, a loss.

Confining the Concept of ‘Externality’

The reader at this point might ask, “So what?” The answer is this: “plenty.” 

In society people constantly choose and act in ways that negatively affect other parties, including many parties distant from the initial choice or action. If the concept of negative externality is taken to mean any negative effect suffered by Party A as a result of actions taken by Party B, then society overflows with negative externalities. My decision to skip lunch today denies to a local restaurant or supermarket the sales that it would have enjoyed had I chosen to eat lunch today. Steve’s decision to ask Sarah to marry him—and Sarah’s decision to accept Steve’s proposal—makes it more difficult for Sam and Scott to get a date with Sarah. Americans’ decisions to have fewer children reduce the sales of firms that produce baby food, diapers, and strollers. Tony’s decision to open a pizzeria in town draws customers away from the local Pizza Hut, Domino’s, and Taco Bell. The cascade of effects is endless.

Because nearly every choice other than deciding in which position you sleep has some impact, positive or negative, on persons who have no say in that choice, the concept of externality, if it is to be useful, must be confined. Otherwise, the concept is so all-encompassing that it loses meaning. The appropriate way to confine the concept of negative externality is to use it as a label for those effects on third parties that are legitimately regarded as ones to be avoided. Negative externalities, thus, are effects on third parties that are considered so harmful or unacceptable, within a society’s existing legal and normative structure, that they should be discouraged or prevented altogether. The vast majority of effects on third parties commonly called “externalities” do not fall into this category.

Ultimately, distinguishing third-party effects that should be discouraged or prevented from those that should be ignored involves a value judgment. In our society, it’s widely regarded as inappropriate to appear unclothed in public, so someone who strolls naked down Fifth Avenue is appropriately described as imposing on others a negative externality. Even for the classical liberal and most libertarians, it’s thus no overreach by the government to enforce the wearing of clothing in public, and it’s no defense of the naked pedestrian to point out that his or her activity is peaceful. In a society in which public nudity is accepted, that same activity would not be a negative externality and, thus, would be permitted.

The essential point here is that determining if some effect is or is not a negative externality isn’t an exercise of pure, objective, universal science. What’s required is knowledge of the society’s prevailing norms —which, in turn, means knowledge of what are and what are not legitimate expectations in that society. People in modern America expect not to see adults strolling naked on public streets. When that expectation is violated, an externality exists.

Expectations are Key

The great majority of the effects that one person’s choices and actions have on third parties are so clearly in conformity with prevailing expectations that no one is tempted to think that negative externalities are afoot. You might dislike my hairstyle while I dislike your religion, and both of us dislike the fact that Larry, our beloved neighbor, has chosen to move to another state. Yet in modern America it doesn’t dawn on you that my wearing my hair as I do imposes on you some harm for which you deserve compensation, and it doesn’t occur to me to think that you’re violating some right of mine that entitles me to seek redress in the courts. And both you and I agree that, although he worsens our welfare by doing so, Larry’s decision to move to another state violates none of our rights. Larry owes us no compensation. In these cases neither you nor I are said to suffer losses as a result of the other’s or of our neighbor’s actions. None of these cases involves an externality.

At the opposite end of the spectrum are clear-cut cases of losses for which the victims unambiguously deserve compensation. If Joe murders Jack, Jack obviously suffers a loss, as does Jack’s family. But even if Joe kills Jack accidentally, say, by negligently running a red light while driving, Joe and his family suffer losses for which, in our society, they deserve compensation. And the state is justified in taking steps both to punish Joe and to attempt to diminish the chances of similar killings taking place in the future. Rape, assault, battery, arson, theft, and fraudulent conveyance are likewise clear-cut cases of one party inflicting genuine losses on other parties. Each of these cases involves an externality.

Of course, using ordinary language we call none of these disapproved actions “negative externalities.” Nor do economists use such language. These offenses are simply called “crimes.” But each of these actions is a source of negative externalities. Each of these actions violates a legitimate property interest—an interest that exists not chiefly because it was declared to exist by the government but, rather, because the expectation is widely shared in society that individuals are to be free of these kinds of damages.

The kinds of actions that generally fall within the category of actions that the economics term “negative externality” is meant to embrace are, in legal lingo, torts. For example, Bob’s tuba playing prevents his next-door neighbor Betty from sleeping soundly. Negative externality or not? It depends on the prevailing expectations. In modern American society, if Bob toots his tuba at 1:30am, a court will find that he violates a property interest held by Betty. Americans expect to be able to sleep at night without being disturbed by noise from their neighbors. If instead Bob practices his tuba playing at 1:30pm, a court will likely find that he has a right to do so – meaning that Betty has no property interest in being able to sleep without neighborhood noise in the middle of the day. This court ruling will not change even if Betty proves to the court that she is nocturnal and sleeps during the day. The court will reason that the typical person sleeps at night and that people have more rights to make noises in their homes during daytime hours than during nighttime hours.

The economist who keeps the concept of externality properly confined will say that Bob’s wee-hours tuba playing unleashes a negative externality, but his daytime tuba playing does not. The fact that Betty might happen to be discomfited by the latter more than by the former is immaterial because prevailing norms—prevailing expectations—allow more household noises during the day than during the night. Betty, living in modern America, should expect that she’ll hear noise from her neighbors during the day. Because Betty should expect to hear noise from her neighbors during the day, Betty suffers no externality when she hears Bob’s daytime tuba playing.

Put differently, Bob’s daytime tuba tooting imposes no losses on Betty. Her hearing these noises during the day are among the costs that she must be presumed to have agreed to incur by choosing to live in a house in close proximity to other residences. If Bob were taxed for playing his tuba during the day, he would effectively be compelled to pay a cost that by right ought to be paid by Betty. The imposition of such a tax in this case would itself be a negative externality imposed by the government on Bob, for this tax would violate a right that prevailing social expectations give to him.

As this example shows, “externality” does not properly refer to any and all third-party effects. For the concept to make any sense at all—for it to be of use analytically as well as for guiding public policy—it must be confined to effects that violate rights or property interests. If Smith’s actions violate no right or property interest held by Jones, Smith’s actions are not properly regarded as sources of negative externalities suffered by Jones regardless of how much Smith’s actions might in fact reduce Jones’s welfare.

Economic Competition Is Not an Externality

Insistence on properly confining the concept of externality is especially important when discussing economic competition. Suppose a new Burger King restaurant opens up near a long-standing McDonald’s restaurant. Further suppose that this new Burger King so reduces the sales of this McDonald’s franchise that the owner suffers a reduction in her net worth of $1 million. Alternatively, suppose that a neighborhood vandal inflicts on that McDonald’s restaurant $1 million in property damage. In both cases the McDonald’s franchisee is made $1 million poorer, and in both cases she is equally distraught. Yet only in the latter case has this franchisee suffered a genuine loss.

Because the franchisee had no reason to expect that her property would be vandalized, the vandal inflicts on the franchisee a negative externality. But in the case of the new competition coming from Burger King, the McDonald’s franchisee had no legitimate expectation of being protected from competition. This franchisee knew—or reasonably should have known—that other restaurants can compete with hers. The necessity of competing for customers, and the possibility of being out-competed, are among the costs of operating businesses in a market-oriented economy. This cost is one that the franchisee knew – or reasonably should have known—she would have to pay. When this cost becomes a reality, it’s just that: a cost. It is not a loss of the sort that the concept of externality identifies as a problem that must be solved.

The same logic applies to international trade. Consider an American steel worker who loses a job because fellow Americans start buying more steel from Brazil and, hence, less steel from Ohio. This worker suffers no loss. Instead, this worker pays a cost of participating in the modern commercial global economy. It is indisputable that this worker would prefer not to have to pay this cost, just as, in the example of me taking out a mortgage, it is indisputable that I would prefer not to have to repay my mortgage lender. But this reality does not transform the worker’s (or my) cost into a loss.

Each worker in a modern commercial economy is very much like a mortgage holder or the McDonald’s franchisee. Each such worker voluntarily participates in this economy because of the benefits he or she reaps from doing so. But these benefits are possible only because producers must compete for consumers’ dollars—only because consumers are generally free to spend their incomes as they choose and are not regarded as contractually binding themselves, with their purchases, indefinitely to each producer that he or she patronizes.

These benefits are possible, in other words, because the law protects the physical uses and integrity of property and not properties’ market values. In brief, neither competition in general, nor free trade specifically, create losers who in justice must be compensated for whatever costs they bear as a result of participating in the market economy.

Conclusion

This attempt to usefully define and confine the concept of negative externality does not answer all practical questions. Reality is complex, and it often offers up interpersonal conflicts for which it is not obvious which party’s expectations are the ones that better align with those that are prevalent in society. Nor is it clear if global-level consequences such as those generated by carbon emissions are appropriately treated as negative externalities or, instead, as some other sort of potential problem that demands a collective response.

This paper will have served its purpose if it makes clear, first, that not all third-party effects are properly classified as “externalities;” second, that “costs” are not synonymous with “losses;” and third, that the existence or not of a negative externality depends on whether or not the actions that cause the third-party effect are ones that are approved by social norms and expectations and are in harmony with the larger body of rules that govern that society.

* Professor of Economics at George Mason and Senior Fellow at the Mercatus Center.

For helpful feedback on an earlier version of this paper I thank Veronique de Rugy, Roger Meiners, Andy Morriss, and Bruce Yandle. Astute readers will detect in this Explainer the strong influence of the economist Terry Anderson (who, I hope, will forgive me for using the “e” word).

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References

1.  See for example Tyler Cowen and Alex Tabarrok, Modern Principles: Microeconomics, 6th ed. (New York: Worth Publishers, 2024), Chapter 12.
2. On the knowledge problem, see F.A. Hayek, “The Use of Knowledge in Society,” American Economic Review 35 (September 1945): 519-530. The incentive problem is the central focus of public-choice economics. See James M. Buchanan, “Individual Choice in Voting and the Market,” Journal of Political Economy 62 (April 1954): 114-123, and Bryan Caplan, The Myth of the Rational Voter (Princeton: Princeton University Press, 2007).
3. George J. Stigler, “The Economists’ Traditional Theory of the Economic Functions of the State,” in George J. Stigler, Ed., The Citizen and the State (Chicago: University of Chicago Press, 1975), 103-113. The quoted passage appears on page 104.
4. A.C. Pigou, The Economics of Welfare, 4th ed. (London: Palgrave Macmillan, 1932).
5. Ronald H. Coase, “The Problem of Social Cost,” Journal of Law & Economics 3 (October 1960): 1-44.
6. Ronald H. Coase, “Notes on the Problem of Social Cost,” in R.H. Coase, Ed., The Firm, the Market, and the Law (Chicago: University of Chicago Press, 1988), 157-185.
7. James M. Buchanan, Cost and Choice (Chicago: University of Chicago Press, 1969).
8. As Hayek put it, “every change in conditions will make necessary some change in the use of resources, in the direction and kind of human activities, in habits and practices. And each change in the actions of those affected in the first instance will require further adjustments that will gradually expand throughout the whole society.” F.A. Hayek, The Constitution of Liberty, The Definitive Edition (Chicago: University of Chicago Press, 2011 [1960]), 79.
9. The chief idea in this section appears in an earlier form in Donald J. Boudreaux and Roger Meiners, “Externality: Origins and Classifications,” Natural Resources Journal 59 (Winter 2019): 1-33.
10. Much of this section tracks closely with Armen Alchian, “Some Economics of Property Rights,” which is Chapter 5 of Armen A. Alchian, Economic Forces at Work (Indianapolis: Liberty Fund, 1977), pp. 127-149.

Some economists have likened entrepreneurs to heroes, praising their role in disrupting industries and driving progress. Joseph Schumpeter, for instance, famously described them as agents of “creative destruction.” This description evokes the image of warriors boldly slaying the dragon of entrenched systems — tearing down outdated structures to pave the way for revolutionary innovation.

Yet Israel Kirzner, a leading economist in the Austrian tradition and a student of Ludwig von Mises, rejected this dramatic portrayal. Instead, he argued that entrepreneurship is about simply noticing opportunities that others overlook. At first glance, this view might seem to downplay the heroism of entrepreneurs. But does it really?

Exploring Kirzner’s ideas through the lens of the Hero’s Journey — a narrative framework developed by Carl Jung and later expanded by Joseph Campbell — reveals that even Kirzner’s entrepreneur is a hero, though in a subtler and less dramatic way. 

In this framework, true heroism emerges in uncovering the potential of the unknown and bringing it into the light of consciousness.

The Ordinary World: The Illusion of Perfect Knowledge

In Campbell’s theory, the story starts in the “ordinary world,” which represents a state where the surface appears stable and calm but underlying tensions and possibilities remain hidden. In economics, this is the world mainstream theories often assume: a world of perfect knowledge.

Mainstream economics operates on this assumption to simplify complex real-world phenomena into predictable models. By presuming that individuals possess complete and accurate information about prices, resources, and preferences, these models mathematically simulate equilibrium — a theoretical state where supply equals demand and all markets are clear. In this framework, all options and alternatives are known, neatly laid out for decision-makers to maximize their preferences.

But beneath this surface of apparent perfect information lies an unseen world of unmet needs and inefficiencies, with solutions that remain unnoticed. In Jungian terms, these solutions reside in the unconscious, Which means no one searches for them because no one knows they exist — a state that Kirzner aptly describes as “sheer ignorance.” This ignorance will persist until the entrepreneur steps forward to reveal what lies hidden.

The Call to Adventure: Recognizing the Unseen

In the Hero’s Journey, the call to adventure shakes the hero’s perception of the ordinary world, urging them toward the unknown. In the market, this call arises when the entrepreneur stumbles upon hidden gaps and inefficiencies — revealing that the so-called perfect information is an illusion.

This illusion is tragic. Those who possess solutions and those who desperately need them pass each other like ships in the night, unaware of each other’s existence. The entrepreneur’s discovery breaks this cycle, linking unmet needs with untapped resources.

These discoveries are not the result of systematic search, because, as explained earlier, information lost in the unconscious cannot be searched for. Yet this does not suggest sheer luck; rather, it highlights the entrepreneur’s unique “alertness” — a heightened sensitivity to opportunities that others fail to see.

In archetypal stories, the call to adventure is often symbolized by an encounter with something extraordinary — like a dream, or, for example, an animal guide such as the white rabbit in Alice in Wonderland. Although the encounter seems accidental, Jungian theory suggests these symbols represent an unconscious recognition of something worth pursuing. Just as the rabbit calls Alice into her journey, entrepreneurial opportunities reveal themselves only to those with the alertness to perceive them.

Meeting the Mentor: Inner Vision and Instinct

In the Hero’s Journey, the mentor — often depicted as a wise old man — provides wisdom and encouragement, representing an inner guide. For entrepreneurs, this mentor is their unique instinctive vision. 

This vision is essential in navigating the uncertainties and facing the inevitable challenges ahead. It is not blind gambling but more like traveling at night, where limited vision still provides enough guidance to move forward while others remain paralyzed. As the journey unfolds, the entrepreneur must rely on their inner guide to endure and overcome trials.

Trials and Challenges: Risk and Uncertainties

No hero’s journey is complete without trials and challenges, and entrepreneurship is no exception. Entrepreneurs do not simply uncover hidden opportunities; they must act on them by venturing into uncharted territory. 

This requires imaginative, prudent decision-making, as they must evaluate incomplete information, anticipate market reactions, and adapt to unforeseen changes. Losses can occur if predictions about future demand or market conditions prove incorrect, or if competitors bring even better solutions to light.

In Jungian terms, these trials and challenges reflect the hero’s confrontation with the unknown — the shadowy, chaotic aspects of the unconscious, which is what the dragon symbolizes in this framework.

The Reward: Profit as Motivator

In the Hero’s Journey, the reward is the immediate recognition of the hero’s success, often symbolizing the value they’ve brought back from their trials. For the entrepreneur, this reward is profit.

The beauty of the market economy lies in its ability to transform gaps in knowledge — those hidden solutions waiting in the unconscious — into profit opportunities. When entrepreneurs recognize and act on these gaps, the market validates their success, providing the motivation to continue innovating.

Profit is not the only reward. Entrepreneurs also experience deep personal satisfaction from solving meaningful problems or creating something new. Yet, the true measure of their heroism lies in the broader gift they bring to society.

The Elixir: Uncovering New Knowledge

In the Hero’s Journey, the elixir symbolizes the ultimate reward — the treasure the hero brings back to the ordinary world to benefit others. For entrepreneurs, their discoveries do more than solve problems or satisfy unmet needs; they expand the boundaries of what society knows and can achieve by bringing previously unconscious knowledge into the light.

But the impact of entrepreneurship goes further. Entrepreneurs build bridges between people with complementary resources and needs, fostering cooperation and creating opportunities for mutual benefit. In doing so, they bring people together, contributing to a more peaceful and harmonious social order.

The Dangers of Perfect Knowledge Framework

The importance of entrepreneurial discovery cannot be overstated. By failing to grasp this crucial concept, the theory of “perfect knowledge” paves the way for central planning and massive regulations that obstruct individuals from freely exploring opportunities. 

In their imagined world, where all paths are already known and everyone follows the same route, there is no room for any discovery. Without the freedom to venture into the darkness, vast potentials would remain locked in the unconscious — not only depriving us of them, but more tragically, leaving us unaware they ever existed or could have been discovered. 

Every breakthrough, whether major or minor, every improvement in living standards, whether transformational or incremental, and every leap forward in human history has been an elixir brought back by entrepreneurs. Their heroic quests remind us that the unknown holds boundless potential waiting to be realized. 

To safeguard this vital process of discovery, we must preserve the freedom that allows entrepreneurs to explore the unknown and illuminate new paths, ensuring humanity’s continuous cycle of innovation and flourishing.

A Congressman from Tennessee recently advanced a proposal to modify the Twenty-Second Amendment to allow President Trump to serve a third term in office. While a publicity stunt that will appropriately fail to achieve the tall criteria required for an amendment, this episode does raise an important constitutional question.

Does a democratic majority have the right to constrain future democratic decision-making? Nancy MacLean, a critic of public choice economics, would argue no. She construes any such attempt to put limitations on majoritarian decision-making as a sinister effort to put “democracy in chains.”

But most students of democracy, not to mention most democracies in practice throughout world history, have allowed some form of supermajority to create constitutional rules to constrain future democratic decision-making. The only exception is if those future democratic decision-makers can muster a similar supermajority to overturn the previous constitutional rule.

Why would democracies wish to set constitutional rules to constrain themselves in the future? The concept is relatively simple when you think about the conflicts that each of us faces in our own lives between our current and future selves. The current self wants to wake up early, to eat healthy, and to exercise. But we know our future self may shirk from the hardship of achieving these goals in the heat of the moment, so we craft an array of constraints, such as self-regulating rules or alarm clocks, to keep our future selves in line.

In the same manner, democratic supermajorities, perhaps through foresight or hard-learned experience, may seek to prevent outcomes that may be pursued by democracies in the heat of the moment but are inconsistent with the long-term principles of a free, democratic society. 

Public choice scholars have identified a wide range of troubling tendencies of democracies, such as the tyranny of the majority or even the potential for voters to vote themselves out of democracy. A serious consideration of these tendencies forces even the most ardent defender of democracy to admit that, ironically, one of the most significant threats to democracy is unconstrained democracy. That is why constitutions and an appropriately difficult supermajority process to amend them are fundamental for sustaining democracy.

Strictly speaking, amending the Constitution in the United States is not a strict democratic referendum. This makes it even more difficult to pass or repeal amendments. Ironically and inconsistently, one of Nancy MacLean’s fears is that the threshold for amending the Constitution is too easy. Reasonable scholars can certainly debate the appropriate strenuousness of the amendment process. However, most recognize that while simple majorities are desirable to prevent gridlock in everyday political decision-making, substantially higher majoritarian thresholds are appropriate for meta-rules.

One of the longest-standing meta-rules passed down to us from early democracies was chief executive term limits. In my research, for instance, I have documented how historical Venice was obsessed with term limits. Binding constitutional limitations on the period of time that a single individual can hold a chief executive position helps balance power, discourage potential tyrants from seeking office, and mitigates conflict among factions. Most importantly, it protects democracies from the threat of tyranny that can emerge from a single individual accumulating excessive power from holding office too long. 

The immense power, including military control, held by a chief executive alone makes it easy for ambitious or powerful officials to disband term limits. Vladimir Putin’s unilateral maneuvering in Russia offers a telling recent example. An approving democratic majority would make this process all the easier.

Even if, after President Trump’s second term, a simple democratic majority would be willing to elect him for a third term, they would likely come to regret their decision. An ancient adage states, “Do not wield a sword you don’t want to be wielded against you.” 

While a third term for Trump may be too enticing for Republicans to resist, even in the best-case scenario, this opens the possibility of three terms for a future Democratic, populist president. 

Thankfully, unlike the chocolate cake tempting dieting patrons at a restaurant, we have a Constitutional rule that prevents a democratic majority from indulging itself. And we should readily nix attempts to reject the centuries of historical wisdom and experience behind the twenty-second Amendment.

I recently reported something that, as someone who desires social harmony, I was glad to see but, as someone who desires harmony, made me nervous. I reported that culture war in public schools had abated significantly in 2024. As catalogued on the Cato Institute’s Public Schooling Battle Map, an interactive database of values and identity-based conflicts in public schools that I maintain, battles fell from 549 in 2023 to 321 in 2024, a 42 percent drop.

Why was I nervous? Because there is a myth that government-funded and run schools — public schooling — foster peace, and that without them, and especially were public dollars to follow children to schools their families chose, Americans would be balkanized. We would be both separated and at each others’ throats. The Battle Map is an effort to illustrate the falsehood of this premise. Far from fostering peace, forcing people with diverse values to fund a single system of government schools fuels constant political and social conflict.

My concern is that, after several years of feverish battles nationwide, those who accept this dangerous myth could conclude that the recent scourge of culture war in public schools — book “banning,” bathroom battles, and more — was an aberration. A product of a once-in-a-century pandemic that frayed all of our nerves. They could go back to assuming public schooling is a uniting force.

But public schooling fueling culture war is not a one-time thing. Both logic and evidence tell us that culture war is inherent to public schooling, while being largely avoidable through school choice. To the detriment of everyone, it is a reality that most public schooling advocates, academics, and journalists seem to ignore, and that must not continue.

Why Does Public Schooling Fuel Conflict?

Understanding why public schooling fuels social conflict is not difficult. People have different values, needs, and desires, with religious beliefs, ethnicity, and other differences being especially personal. Public schooling requires that all, diverse people pay for a single system of government schools, which often means that only one set of values, or views of history, can prevail, and what those are is determined by political power. Whether transgender students can choose bathrooms or locker rooms, whether Advanced Placement African American Studies is taught, and whether school libraries stock the graphic novel Gender Queer is decided by democratic control that inherently creates winners and losers, and forces people into warring political camps to get what they think is right for their children.

Battles in American History, Old and Recent

This is not just the realm of theory. It has been borne out in reality countless times since public schooling gained ascendance around 1837, with the appointment of Horace Mann as the first secretary of the state board of education in Massachusetts. A few, stark examples: · In 1844, neighborhoods around Philadelphia were engulfed in street-level warfare between Roman Catholic and Protestant mobs, touched off by which version of the Bible — the Protestant King James, Catholic Douay-Rheims, or none at all — would be used in the public schools. 

By the conclusion of the two waves of violence, homes and churches had been burned to the ground, hundreds of people had been injured, and tens of people had been killed. · In 1859, a ten-year-old Catholic student in Boston refused to read the King James version of the Ten Commandments. When he persisted in his refusal, he was rapped on the hand with a rattan cane until he bled, and ultimately hundreds of students who refused the order were expelled from the school. The boy’s father sued the school’s assistant principal, who administered the beating, for assault and battery, but a court ruled that the principal was simply doing his job.

· In 1974, the Kanawha County, West Virginia, school district was paralyzed by the “Kanawha County Textbook War.” The battle began in the district containing progressive urban and conservative rural populations after the school board adopted a number of books that many conservative residents found unacceptable for moral and political reasons, including The Autobiography of Malcolm X and a textbook that discussed Freud’s theory that children have sexual attractions to their opposite sex parents. The battle resulted in mass student walkouts, bombings of schools and the board of education, an anti-textbook protester being shot, and more turmoil. Of course, this is not just dusty history. In just the last few years we have seen the arrest of upset speakers at school board meetings, student walkouts, and a plea by the National School Boards Association for the federal government, including the FBI, to investigate real and perceived threats to members. Prior to 2021 battles were less frequent — or at least less frequently reported — but nonetheless Cato’s Public School Battle Map contains nearly 2,500 conflicts collected between 2004 and 2020, with contests over everything from teaching the origins of life to student hairstyles.

Is There More Peace Than There Seems? That said, only around 13 percent of the country’s roughly 13,300 school districts are on the map. This could indicate that the vast majority of districts have been at peace. Which is plausible: One of the pacifying forces in American public schooling has been local control, which allows members of often small communities to make their own curricular and administrative decisions. To the significant extent that people with similar backgrounds and values tend to live with one another, this has helped to avoid conflict.

But do not suddenly feel comfortable. For one thing, the Battle Map is populated with conflicts we find via media reports. Many districts might be too small to get dedicated — or any — coverage, with around 47 percent enrolling fewer than 1,000 students. Consistent with this, while we have found at least one battle in only 13 percent of districts, those districts account for nearly half of all public-school students. And a lot of conflict occurs at the state level — think “Don’t Say Gay” or mandatory ethnic studies — which pulls everyone in the state into education culture war. The Map contains nearly 850 state-level conflicts.

Freedom Brings Peace

If force is the spark of conflict, freedom puts away the matches. Rather than require all, diverse people to fund government schools, funding could follow children to educational arrangements their families choose. The idea of such funding goes at least as far back as Thomas Paine, who wrote in 1791 that “education to be useful to the poor, should be on the spot, and the best method, I believe, to accomplish this is to enable the parents to pay the expenses themselves.” If we fund students, and let all families choose among diverse educational options, the major impetus for conflict disappears — no one has to impose on someone who wants something different to get what they want for themselves.

When we look outside of our borders, we see that choice has, at least to some extent, been embraced in countries all over the world. As UNESCO recently reported, “Governments financially support non-state schools in 171 out of 204 countries: these include private schools in 115 countries, faith-based schools in 120 countries; and non-governmental organization and community schools in 81 countries.” In the Netherlands, which is arguably the leading country for choice, if as few as 200 families desire a type of school not currently available to them — Catholic, Steiner, and so on — government will pay for it. Many countries have incorporated choice at least in part to resolve or avoid political battles for supremacy among diverse groups, as well as to affirmatively support plural society. This is not typically fully free-market choice — governments set many regulations about curriculum, teacher hiring, and more — but it supports the fundamental right of families to choose among schools holding worldviews they think are correct.

Conclusion

Why am I worried to report that culture war in public schooling has declined over the past year? Because I want lasting peace, and that will only come when the public realizes that not compulsion, but choice, is key to diverse people peacefully living together.