Must Free Market Anarchism Lead to a State?

A number of years ago there was an interesting back and forth among libertarian scholars on the feasibility of free market anarchism — a society where law (security and arbitration) is provided entirely by private agencies. Tyler Cowen published a paper arguing such a system was doomed to either collapse into violence or (more likely) to form a state. David Friedman, Bryan Caplan, and Roderick Long wrote responses.

In his paper, Cowen argued the same forces that would enable a network of security and arbitration firms to collectively sanction outlaws, would also provide the means for collusion, cartelization, and ultimately monopolization. He explained that if security agencies are able to cooperate to the extent that they can boycott criminal agencies (we might simply call these gangs), then they can also cooperate in order to form a cartel, exclude new (non-criminal) agencies from the market, and become a de facto state monopolist who can lower output of security services and raise prices. He concludes that by necessity then, either mass boycotts of criminal agencies won’t be possible or that if it is possible so is cooperation in the form of a cartel. The former suggests the gangs will at least be a common part of society, which means quite a bit of violence, while the latter suggests a market for law is inherently unstable.

An Assertion Without An Argument

Cowen’s fatal error here is the way he thinks about the operation of a network of agencies. He asserts that this network is the same as a single firm. As David Friedman pointed out in his reply, nowhere does Cowen justify this claim. Friedman explains:

…a “network” is simply a set of private firms-protection and arbitration agencies-linked by a large number of contracts. Each pair of protection agencies has a contract specifying an arbitrator for disputes between their customers, and each protection agency has contracts with one or more arbitration agencies specifying the terms on which they will arbitrate its disputes with specified other protection agencies.

Cowen’s unbacked claim leads him to assume that each member-agency in the network will then “favor the interests of the entire network.” To reiterate, he has made a leap in assuming that firms that have contracts with one another will no longer act in their own profit-maximizing self-interest, but will instead function as a single entity that aims to increase the profits of every part of the network. In Cowen’s mind, this collective network can then act to exclude both aggressive gangs and legitimate competitors.

Friedman explains how it is competitive forces that force out the criminal agencies, not collusion:

In a system of a hundred agencies of equal size, one of which is an outlaw, each of the ninety-nine others settles ninety-nine percent of its conflicts by arbitration and one percent by violence. The outlaw agency settles a hundred percent of its conflicts by violence. Since violence is much more expensive than arbitration, the outlaw’s costs are much higher than the costs of its competitors. Agencies that are unwilling to sign arbitration agreements acceptable to most other agencies with which they are likely to come in conflict are prevented from gaining market share not by some collective action by “the network” but by the difficulty of selling a product when your production cost is much higher than your competitors’.

Bryan Caplan responded similarly to Cowen:

However, punishing outlaws is surely a self-interested boycott: dealing with them is likely to get you or your employees killed. But punishing collusion is an altruistic boycott: it benefits the whole industry, not the individual firm doing it (which actually loses out by refraining from a profitable trade). Since collusion is rarely the kind of thing motivated by ideology, coercion would be necessary to make it work. The theory that boycott can squelch open violence and outlawry without facillitating collusion is therefore consistent.

Roderick Long has expanded further on why certain types of collective action are likely and others are not. Long argued, “collusion among protection agencies is a form of selective cooperation, and so is likely to be undermined”. A network of firms that only cooperate with each other leave open the opportunity to be outcompeted, while needing to deal with the fact that each member can profit by betraying any attempted cartel.

A Network Industry

While Cowen readily admits that collusion between competitive firms in a free market is unlikely, he argues the security/arbitration industry represents an exception to this tendency because it is a network industry. In addition to the above arguments, he points out that unlike, for instance, grocery stores, competing security firms will need to constantly be working with one another. This is true enough. Whenever customers of different agencies have a dispute, their security representative will need to work with the other party’s representative.

Caplan responds that Cowen:

…neglects the possibility of competing networks. Granted, that collusion within a network can work; but is it the case that every industry with network properties automatically gets just one network? One obvious counter-example is the credit card industry. VISA, Mastercard, Discover, American Express, and other competing issuers exist. Some of these, like VISA and Mastercard, are actually just networks for member banks who do the real work of issuing the credit cards; clearly, the credit card industry has strong network features. But nevertheless, competition exists.

Cowen’s crucial misstep is in treating firms with contractual relationships as a single firm. This actually amounts to circular reasoning. He is ultimately arguing a single monopoly firm is the predictable outcome from competing security firms, but he assumes (without justification) that a network of agencies already represents the equivalent of a single firm. The industry of security is similar to other industries, as there remain incentives in place for each agency to undermine cartelization. The fact that the production of security and arbitration requires cooperation between competing agencies does not prove that this network will lead to monopoly.