The authors (Sven Bostyn and Nicolas Petit) of this paper, PATENT=MONOPOLY – A LEGAL FICTION, argue that patents are not a monopoly based on standard antitrust analysis. It is very unusual for an academic paper to take such an unpopular position. They must have not got the memo that the goal of all academics is to vilify inventors, patents, and property rights. Below are some the lines I thought were interesting and my comments are below.
No other property right is so expensive, time consuming and expensive to obtain title to.
“In 2011, approximately 1,000,000 patents were granted across the globe. This would mean that 1,000,000 monopolies would have been created worldwide. This clearly, cannot be true.”
“Competition is very valuable, but innovation is probably equally, if not more, valuable.”
My main critique is that they did not explain how patents are a property right or the history of property rights and patents. Under Locke’s theory of property rights, patents and copyrights are property rights – they are granted because of the creative effort (labor) of the inventor/author. This was picked up by Sir William Blackstone in his Commentaries, where he affirms that patents and copyrights are property and therefore natural rights. This was enshrined in the constitution as “securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.”
Gary Boone invented the microcontroller while working at Texas Instrument in the early 1970s. I had the good fortune to know Gary Boone in the later part of his life, he had a brilliant mind and was a good friend. It is sad day for the electronics industry and my heart goes out to his family.
IEEE did an Oral History with Gary that was lost for over a decade. You can see the agility and brilliance of this great inventor’s mind in the interview. Please read the whole oral history. Mr. Boone has a number of interesting insights in the interview. For instance, he states that he invented microcontroller while at Texas Instruments because of boredom. He was working in a group designing custom Integrated Circuits (ICs). While designing these chips he began to feel “I’m tired of doing this. I’m working long hours. My family is not happy. I have to find a better way of doing this.” He also noticed that the basic requirements for all these projects were similar and this led to the idea that a general chip that was programmable could solve multiple customers’ requirements. He also discusses the resistance in the community to this innovation.
After inventing the microcontroller, he moved to a start-up company, Litronix, that made handheld calculators. The company was not aggressive about filing patents. An overseas competitor was able to drive Litronix out of the market because of the differential tax rates, U.S. regulatory rules on consumer warranties, and their weak patent portfolio.
Because Mr. Boone was the inventor of the microcontroller, he ended being involved in numerous patent lawsuits. This has caused him to have a unique perspective on the patent system. One of the most interesting points he makes is that design teams often fail to review the patent literature before starting the design process. Because of this, they often reinvent designs and reviewing patent literature results in better designs.
Gary will be missed by all that knew him.
I have often pointed out that patents are a natural right under Locke’s theory of property rights. Locke stated, in modern language, that you own yourself so you have the right to those things you create. Many detractors have suggested that this absurd. According to Locke the three chief natural rights are life, liberty, and property. Locke states that protecting property rights is the main reason for forming governments.
Sec. 124. The great and chief end, therefore, of men’s uniting into commonwealths, and putting themselves under government, is the preservation of their property.
Inventions are the result the inventor’s labor and therefore property under Locke. Property is a natural right, so patents are natural rights. Despite this logical connection, many people have continued to deny that patents (property rights in inventions) are a natural right.
Locke’s ideas were incorporated in the law of the United States by William Blackstone’s Commentaries on the Laws of England. This treatise became the basis of common law in the US. Here is what Blackstone said about patents and copyrights (intellectual property). Note that he cites Locke’s ideas on property rights for his explanation for why intellectual property is Property.
There is still another species of property, which (if it subsists by the common law) being grounded on labour and invention is more properly reducible to the head of occupancy than any other; since the right of occupancy itself is supposed by Mr. Locke, and many others, to be founded on the personal labour of the occupant. And this is the right, which an author may be supposed to have in his own original literary compositions; so that no other person without his leave may publish or make profit of the copies. When a man by the exertion of his rational powers has produced an original work, he seems to have clearly a right to dispose of that identical work as he pleases, and any attempt to vary the disposition he has made of it, appears to be an invasion of that right.
Now the identity of a literary composition consists entirely in the sentiment and the language: the same conceptions, clothed in the same words, must necessarily be the same composition: and whatever method be taken of exhibiting that composition to the ear or the eye of another, by recital, by writing, or by printing, in any number of copies, or at any period of time, it is always the identical work of the author which is so exhibited; and no other man (it hath been thought) can have a right to exhibit it, especially for profit, without the author’s consent.
This consent may perhaps be tacitly given to all mankind, when, an author suffers his work to be published by another hand, without any claim or reserve of right, and without stamping on it any marks of ownership; it being then a present to the public, like building a church or bridge, or laying out a new highway: but, in case the author sells a single book, or totally grants the copyright, it hath been supposed, in the one case, that the buyer hath no more right to multiply copies of that book for sale, than he hath to imitate for the like purpose the ticket which is bought for admission to an opera or a concert, and that, in the other, the whole property, with all it’s exclusive rights, is perpetually transferred to the grantee.
On the other hand it is urged, that though the exclusive property of the manuscript, and all which it contains, undoubtedly belongs to the author, before it is printed or published; yet from the instant of publication, the exclusive right of an author or his assigns to the sole communication of his ideas immediately vanishes and evaporates; as being a right of too subtile and unsubstantial a nature to become the subject of property at the common law, and only capable of being guarded by positive statutes and special provisions of the magistrate.
The Roman law adjudged, that if one man wrote any thing on the paper or parchment of another, the writing should belong to the owner of the blank materials meaning thereby the mechanical operation of writing, for which it directed the scribe to receive a satisfaction; for in works of genius and invention, as in painting on another man’s canvas, the same law gave the canvas to the painter. As to any other property in the works of the understanding, the law is silent; though the sale of literary copies, for the purposes of recital or multiplication, is certainly as antient as the times of Terence, Martial, and Statius. Neither with us in England hath there been (till very lately) any final determination upon the right of authors at the common law.
But whatever inherent copyright might have been supposed to subsist by the common law, the statute 8 Ann. c. 19 hath now declared that the author and his assigns shall have the sole liberty of printing and reprinting his works for the term of fourteen years, and no longer; and hath also protected that property by additional penalties and forfeitures: directing farther, that if, at the end of that term, the author himself be living, the right shall then return to him for another term of the same duration: and a similar privilege is extended to the inventors of prints and engravings, for the term of eight and twenty years, by the statute 8 Geo. II. c. 13, and 7 Geo. III. c. 38, besides an action for damages, with double costs, by statute 17 Geo. III. c. 57. All which parliamentary protections appear to have been suggested by the exception in the statute of monopolies, 21 Jac., I. c. 3, which allows a royal patent of privilege to be granted for fourteen years to any inventor of a new manufacture, for the sole working or making of the same; by virtue whereof it is held, that a temporary property therein becomes vested in the king’s patentee. (emphasis added)
The idea that patents are a natural right is incorporated in early American law as the quote below shows.
“we protect intellectual property, the labors of the mind, productions and interests as much a man’s own, and as much the fruit of his honest industry, as the wheat he cultivates, or the flocks he rears.” (Davoll v. Brown, 7 F. Cas. 197, 199 [C.C.D. Mass. 1845].)
It is just obstinance or disingenuousness to suggest that patents are not part of natural rights.
 The Second Treatise of Civil Government; 1690; John Locke; CHAP. IX., Of the Ends of Political Society and Government.
This paper is exploratory not definitive. Comments and input is greatly appreciated. My interest in the comparison between Rand and Locke started when I wrote my book The Decline and Fall of the American Entrepreneur. My investigation was spurred on by reading the excellent book The Power and the Glory: The Key Ideas and Crusading Lives of Eight Debaters of Reason vs. Faith, by Burgess Laughlin. In my opinion, John Locke is often misrepresented by both his supporters and detractors. I admit that I do not have the time or energy to review Locke’s original writings in depth at this time. Your input is appreciated.
Charles Murray has suggested that Ayn Rand’s ideas are just a rehash of Locke, Nietzsche, and Adam Smith. I reject this out of hand. Nietzsche’s uberman influenced Rand’s fictional characters, but she rejected Nietzsche as her philosophical ideas matured. Adam Smith’s book Theory of Moral Sentiments is not consistent with Rand’s ideas at all. He wrote this book before he wrote The Wealth of Nations and the two do not appear to be entirely consistent with each other. As a result, it is hard to pin Smith down on his ethics and epistemology. The differences between Rand and Locke are more subtle.
My book mainly discusses patent law in terms of Natural Law or Locke, because that is the historical basis for the founding of the US and US patent law. Readers of my blog State of Innovation may wonder what this has to do with patent law. My answer is everything, since this is about the fundamental basis of property rights.
In my opinion all philosophers fall either into camp of Aristotle or Plato. Aristotle’s metaphysics is that we can trust our senses and there is only one universe or as Rand stated it A is A. Plato’s metaphysics is that there is more than one world and our senses cannot be trusted to understand them or that our senses only give us a vague impression of the real world. Rand and Locke are both Aristotelian in the realm of metaphysics.
Some people may object that Locke advocated there was a deity. Locke did appear to make somewhat contradictory statements on god and faith, but he was writing at a time in which you could have your head cut off for being on the wrong side of a religious debate. Locke appeared to be a deist and believed;
His philosophy on human progress proposed the following: a) human beings can progress by acquiring knowledge, b) reason and action are subject to natural law, and c) the mind (as consciousness) is subject to scientific inquiry (Smith, 1997).
A Deist believes in god or a deity that created the laws of the Universe and has no effect thereafter.
John Locke’s epistemology was Reason. Reason is the means of integrating and conceptualizing perceptions by means of logic. It is distinguished from rationalism which starts with reveled truths and then applies a logical system derived from these assumptions. This is distinguished from empiricism which holds that man’s only source of knowledge is his senses without any recourse to concepts. The logical positivists did us one favor in showing that all logical systems are based on either an assumption, such as Euclidean geometry’s idea that a straight line goes on forever and two parallel lines never intersect, or based on an observation.
Some people argue that Locke was an empiricist. Locke was attempting to use the techniques of science to analyze ethics and political philosophy. (Note that he also defined the metaphysics and epistemology used by science.) People who argue that Locke was an empiricist usually argue that modern science is based on empiricism. This is incorrect based on the definition given above. Science builds on observation, but it is highly conceptual and many discoveries in modern physics derive from following the logical consequences of theory. For instance, the Higgs Boson particle was first predicted by following the math of field theory and now may have been verified by experiment. Locke was not an empiricist either, based on the definition given above. He is widely quoted as having said “logic was the anatomy of thought”, which would be inconsistent with empiricism.
Rand’s epistemology was Reason also. One difference is Rand’s refutation of Kant’s epistemology that emotion is a valid path to knowledge and his attempts to limit reason. However, Locke came before Kant and therefore could not have commented on Kant. Ayn Rand spends a lot of time explaining how concepts are formed and how they relate to the real world or specific instances. An example is reproduced below:
The same principle directs the process of forming concepts of entities—for instance, the concept “table.” The child’s mind isolates two or more tables from other objects, by focusing on their distinctive characteristic: their shape. He observes that their shapes vary, but have one characteristic in common: a flat, level surface and support(s). He forms the concept “table” by retaining that characteristic and omitting all particular measurements, not only the measurements of the shape, but of all the other characteristics of tables (many of which he is not aware of at the time).
It is my understanding that Rand is explaining in modern language the concepts of Aristotle or refining them. This seems consistent with John Locke’s epistemology.
This is where we see the major differences between Rand and Locke. In my brief survey of Locke’s ethics, I found two competing concepts for Locke. One is his ideas about Natural Rights and the other is a hedonistic perspective on ethics. Locke’s hedonistic perspective on ethics is in conflict with Rand’s selfishness and I would suggest in conflict with Natural Rights.
Locke’s hedonistic ethical views start with the idea that people naturally want to maximize their pleasure and minimize their pain. Locke’s Natural Rights starts with the idea that moral laws are divine, but he does state these divine laws are discoverable by reason. This second part makes it consistent with his deist metaphysics. He does not seem to reconcile these two competing ethical systems. I will focus on Locke’s Natural Rights ethics.
Locke’s formulation of Natural Rights starts with his concept of man’s rights in a state of nature. In a state of nature a man owns himself. Since he owns himself he has a right to defend himself. Man also has a right to those things he creates, which is where the right to property comes from. From these concepts the moral repugnancy of slavery follows as well as most of traditional criminal law, contracts, and property law. Locke does not explicitly state that man is an end in himself like Rand, however ownership in one’s self certainly implies this. To the extent we focus on Locke’s Natural Rights, Rand and Locke are not in conflict and I would suggest Rand’s ideas are a refinement and provide a deeper insight. Like Relativity and Quantum Mechanics expand our knowledge over Newtonian physics, but are not in conflict with it.
Ayn Rand’s ethics starts with idea that human life has value and ethics is the actions necessary to allow man to live. By live she does not mean mere existence, but thriving. Everything else she derives from an evolutionary point of view. In Galt’s speech she states,
There is only one fundamental alternative in the universe: existence or nonexistence—and it pertains to a single class of entities: to living organisms. The existence of inanimate matter is unconditional, the existence of life is not: it depends on a specific course of action. . . . It is only the concept of ‘Life’ that makes the concept of ‘Value’ possible. It is only to a living entity that things can be good or evil.
From this she defines focuses on man and his unique tool of survival, which is his mind.
In order to sustain its life, every living species has to follow a certain course of action required by its nature. The action required to sustain human life is primarily intellectual: everything man needs has to be discovered by his mind and produced by his effort. Production is the application of reason to the problem of survival. (Emphasis added)
It is reason that requires an ethics of individuality, where each person’s life has value separate from the species. This is not true of other organisms.
Man’s mind is his basic means of survival—and of self-protection. Reason is the most selfish human faculty: it has to be used in and by a man’s own mind, and its product—truth—makes him inflexible, intransigent, impervious to the power of any pack or any ruler. Deprived of the ability to reason, man becomes a docile, pliant, impotent chunk of clay, to be shaped into any subhuman form and used for any purpose by anyone who wants to bother. (Emphasis added)
Thus Rand ends up with an ethics in which each individual person is their own end. The exercise of their mind is the means by which they attain values to live. In order to achieve their values they must not only think but act. In order for this to be true, man must own himself, which is the starting point of Locke. The main difference between Locke and Rand is that Rand starts with a scientific or metaphysical basis of the nature of man to derive her ethics. Locke starts with the assumption that each man owns themselves, but Rand proves why this must be true. Her starting point is that every living organism must value its life or go extinct. Note there are ethical systems that do not value human life, so this cannot be taken as a given. We will explore these more later. The second biggest difference between Rand and Locke is she shows the central place of reason and the mind in man’s existence. Evolution had not been discovered at the time of Locke, so he could not use it to develop his ethics. Another major achievement of Rand was to debunk the supposed is-ought dichotomy.
In answer to those philosophers who claim that no relation can be established between ultimate ends or values and the facts of reality, let me stress that the fact that living entities exist and function necessitates the existence of values and of an ultimate value which for any given living entity is its own life. Thus the validation of value judgments is to be achieved by reference to the facts of reality. The fact that a living entity is, determines what it ought to do. So much for the issue of the relation between “is” and “ought.”
This issue was supposedly first raised by David Hume who lived after John Locke died. As a result, this was not a problem which Locke could address. In fairness to Hume, Rand starts with one assumption or observation in order to solve this problem, mainly that a living entity has to value its own life. As I pointed out earlier it is impossible to have a logical system that is not based on at least one assumption or observation.
I have suggested that a deeper understanding of these issues can be had by understanding that evolution is the application of the second law of thermodynamics (entropy) to living organisms. Note I am not the first person to suggest that evolution and entropy are related. Applying entropy concepts to living organisms is fraught with potential logical errors. I have attempted to avoid them in my writings, but in passing these around I have found that even my most ardent supporters found them a little difficult to get through. My most well received post along this line is Sustainability isn’t Sustainable. My other posts on point can be found below.
Life is a fight against entropy. Entropy as applied to economics is the concept of diminishing returns. It shows that inventions are the only way to overcome entropy – production without invention leads to the Malthusian Trap. As a result, this idea is consistent with Rand’s idea that the mind and reason are the primary means of survival but refines this to the understanding of the critical role of inventions.
Why is this important? Because the intellectual battle today is against those people who have combined an incorrect interpretation of entropy with Kant’s emotion driven epistemology. These people do not believe human life is valuable, in fact they believe humans are evil because they believe we accelerate the entropy of the Universe. Other living species do not harness and use energy (outside their physical body) so they do not accelerate the entropy of the universe and therefore are not evil. These people advocate the death of at least five billion people as a moral good. The basis of their morality is founded on a flawed understanding of entropy and physics. For more information see The Pseudo Scientific Basis of Environmentalism. Defeating this evil philosophy intellectually is vital to anyone who values human happiness.
Locke formulation of property rights is based on the Labor Theory of Property, which is commonly stated as when you mix your labor with natural resources you obtain property rights in your creation. This has been purposely mischaracterized and attacked by Locke opponent. Adam Mossoff has an excellent paper on point entitled Locke’s Labor Lost. Locke’s concept of property is that your productive effort crates a property right in the thing you created. One problem or misinterpretation of Locke’s theory of property rights is that labor means physical labor. This is most likely a mischaracterization, but leaves open the question of whether intellectual property such as patents is property.
Rand’s theory of property rights is that they derive from your right to life.
The right to life is the source of all rights—and the right to property is their only implementation. Without property rights, no other rights are possible. Since man has to sustain his life by his own effort, the man who has no right to the product of his effort has no means to sustain his life. The man who produces while others dispose of his product, is a slave. (Emphasis Added)
But Rand’s understanding that man’s mind is the most important tool for survival causes her to put intellectual property rights as primary.
Patents and copyrights are the legal implementation of the base of all property rights: a man’s right to the product of his mind. (Emphasis Added)
Ayn Rand’s more detailed understanding of man leads to the primacy of man’s mind and reason as his tool of survival. This leads to a deeper understanding of property rights and the primacy of intellectual property rights. My refinement of Rand’s ideas leads to the primacy of property rights for inventions.
Locke and Rand are not in conflict philosophically, but Rand provides a coherent ethics based on the fundamental nature of man and living organisms, which Locke did not. Rand’s main difference in her epistemology is to dispense with the need for a deity, even one whose only effect was to create the world and her tackling of Kant’s emotion is a path to knowledge. I see the relationship between Rand and Locke as the difference between Newton and Einstein or Algebra and Analytic Geometry; refinement not opposition. I believe that Rand’s ethics can be further refined by understanding how entropy and evolution are related. This leads to a slightly different understanding of property rights, but more importantly provides a direct argument against the religion of environmentalism and the related we are running out of natural resources Malthusian economic argument.
 Ayn Rand’s Critics, Capitalism Magazine, by JAMES VALLIANT, http://capitalismmagazine.com/2011/08/ayn-rands-critics/, accessed 3/20/13.
 The Empiricist John Locke, http://nmalbert.hubpages.com/hub/The-Empiricist-John-Locke, 3/18/13.
 “Concept-Formation,” Introduction to Objectivist Epistemology, 11–12
 The state of nature concept has been much maligned by Marxists and others. They have purposely distorted his argument into an anthropological statement. This clearly was not Locke’s intent and shows an intellectual dishonesty on the part of Marxists.
 For those people who do not know, Relativity and Quantum Mechanics are in complete agreement with Newtonian physics except in the realms of very fast systems, very high gravitational fields, and very small distances. This is part of how we know they are correct.
 It is surprising that Rand was indifferent on the idea of evolution. Her ethics is clearly based on the same concepts. I believe the reason for this is she was worried it would lead to erroneous ideas about Determinism.
 What Is Capitalism?” Capitalism: The Unknown Ideal, 16
 The Comprachicos,” Return of the Primitive: The Anti-Industrial Revolution, 84
 “The Objectivist Ethics,” The Virtue of Selfishness, 17
 This is a favorite argument of Christians. They believe it shows morality is impossible without god. This is inconsistent with both Locke and Rand.
 The Science of Economic Growth 1-3, http://hallingblog.com/the-science-of-economic-growth-part-1/, http://hallingblog.com/the-science-of-economic-growth-part-2/, http://hallingblog.com/the-science-of-economic-growth-part-3/; and
The Pseudo Scientific Basis of Environmentalism http://hallingblog.com/the-pseudo-scientific-basis-of-environmentalism/.
 “Man’s Rights,” The Virtue of Selfishness, 93
 Rand, Ayn, Capitalism: The Unknown Ideal, Signet, New York, 1967, p. 130.
Fox News has an article, Wright brothers flew 2 years after Gustav Whitehead, Researcher Claims, that suggests that Wright brothers did not invent the airplane. The article is correct; the Wright brothers invented the system that allows for controlled, powered flight. Their plane used wing wrapping, but their patent application made it clear that they could use control surfaces (ailerons, elevators, and rudders). Rudders were known before the Wright brothers. The article suggests that Whitehead was the first person to achieve powered flight, but this is clearly incorrect. There were numerous people before Whitehead and the Wright brothers who had achieved powered flight. Others had also understood the need for a rudder, but only the Wright brothers understood the need for all the control surfaces.
I decided to investigate if Whitehead had any unique control surfaces? Since most people do not understand what the Wright brother invented, this information is difficult to come by. But as best as I can tell Whitehead had a rudder and shifted his weight in the aircraft to control the plane. This was not unique when Whitehead undertook his flight. In other words Whitehead’s flight was a demonstration of what was known, not an invention.
This article is typical of the ignorance in the debate about invention and patents.
For another example of this ignorance see Did Edison Invent the Light Bulb?
I would like to believe these are innocent mistakes – but I don’t. I think they are a coordinated attack on the patent system and individual inventors. The goal of this attack is to suggest that no one invents anything and therefore the patent system is unfair and should be eliminated.
It is quite common for Austrian Economists and others to suggest that the Federal Reserve created a Tech Bubble (Dot-Com Bubble). If by a technology bubble they mean that real wealth was not created in the 90s this is nonsense. First of all the price of gold fell from 1998 until around 2001. The price of gold is one of the best indicators of inflationary policies. Second, the Fed started raising interest rates in June of 1999 from a Fed Fund Rate of 4.5% to 4.75%. This persisted until January of 2001, when the Fed Fund Rate stood at 6.5%. This is hardly an accommodative monetary policy. Third, industrial production grew by about 42% from the end of the recession in the early 1990’s to the end of the recession in 2001. Fourth, median household income increased by 34% in the 1990’s. Fifth, the stock market had real gains even after the bust of 2000. In the 00s, industrial production actually fell from the end of the recession in 2001 to the end of the recession in 2009, median household income declined, the price of gold soared, the Fed lowered interest rates to zero, the stock market did not grow at all. To lump the 1900′s with the housing bubble of the 2000′s is wrong and misleading.
The facts just do not support the Bubble myth of the 90s. Real wealth was created in the 1990’s. The stock market had probably gotten ahead of itself, but the Fed’s attempt to engineer a soft landing just made the correction worse. This caused Congress to get involved and pass Sarbanes Oxley that destroyed the IPO market. They also made changes to the patent laws – weakening them, changed the accounting rules on stock options – requiring a phantom expense, eliminated pooling of interests accounting for mergers – making it less attractive for technology startups to merge. But for these stupid policy changes, the technology market and economy would have started growing again. In any large group of people, the only way to increase the per capita income/wealth is to increase the level of technology. US policies since 2000 have stifled technological innovation.
The so-call Dot-Com bubble is a myth. Misdiagnosis of what happened in the late 1990’s has resulted in bad policy decisions. Jack Kemp exposed this issue in Criminalizing Corporate Behavior http://www.jewishworldreview.com/cols/kemp.html.
Dot-Com Bubble Myth, Dot-Com Bust, Tech Bubble
Edwin Armstrong is the inventor of FM, the Regeneration receiver, Super Regeneration, Superheterodyne, and many others. This creative genius’ life was wasted fighting RCA who blatantly stole his patents for FM and the FCC arbitrarily moved the FM radio range from 44-50 MHz to 88-108 MHz, where it is today, just to destroy the network of radio stations Armstrong had built up. Channel 1 on you TV would be at 44-50MHz and this is why it does not exist. The failure of our government to protect property rights and the arbitrary power given the FCC, kept all of us from enjoying FM radio decades earlier, arbitrarily destroyed the investment of hundreds of people, and diverted Armstong from inventing, which probably deprived us of other great inventions. Mr. Armstong’s life encapsulates everything that is wrong with the United States today.
Here is a great article on Amrstrong http://www.k3dav.com/edwinhowardarmstrong.htm.
Of course the anti-patent crowd does not believe in genius, at least in the technical arts. Economist argue against that someone would of come up with these inventions because of market demand. First of all there is no “market demand” for something that does not exist. Second, all macroeconomic evidence shows that in the absence of property rights for inventions, technological change is glacially slow and mankind falls back into the Malthusian Trap.
The Federal Reserve caused the financial crisis of 2008, according to many of its critics. On the other hand, many people have credited the Fed with avoiding another great depression. This debate often becomes confused because people intermingle the concepts of a central bank, fractional reserve banking and legal tender laws. For instance, Ron Paul has argued that fractional reserve banking creates money out of thin air and intersperses this with his arguments to end the Federal Reserve. A commonly proposed solution is a return to the gold standard. Proponents of the Federal Reserve also seem to believe that these concepts are a package deal.
The idea of a modern central bank that controls the money supply, sets interest rates separate from market forces, and is allowed to create money to buy government bonds, is relatively new. In the case of the US this dates from the creation of the Federal Reserve in 1913. As explained in the article A Brief History of Central Banks on the Federal Reserve Bank of Cleveland’s website,
A central bank is the term used to describe the authority responsible for policies that affect a country’s supply of money and credit. More specifically, a central bank uses its tools of monetary policy—open market operations, discount window lending, changes in reserve requirements—to affect short-term interest rates and the monetary base (currency held by the public plus bank reserves) and to achieve important policy goals.
When you read this explanation of the functions of a central bank in black and white it is clear that it is a central planning system for a country’s money and credit. Central planning of economic activity has always resulted in market distortions and the Federal Reserve is no different.
A central bank is different from a national bank, such as the First National Bank (FNB) of the United States setup during Washington’s presidency. The FNB was a private bank in which the federal government had a twenty percent equity interest. It was forbidden from buying government bonds, had a mandatory rotation of directors, it could not issued notes or incur debt beyond its capitalization, and the federal government could withdraw its money from the FNB and place it with another bank. The FNB of the United States was a truly a private bank not a central bank. It did not set the policies that “affect a county’s supply of money and credit.”
The First National Bank of the United States was a fractional reserve bank however. A fractional reserve bank is a bank in which a fraction of the bank deposits are kept in reserve. Or stated another way the bank’s loans exceed its capital. The Riksbank, founded in Sweden in 1656, is commonly accepted to be the first fractional reserve bank. Murry N. Rothbard has argued that fractional reserve banks are counterfeiting money. This is incorrect. Unfortunately, in order to explain it is wrong it is necessary to delve deeper into the history of banking. Originally, bank notes were issued by a bank to indicate that a depositor had so much gold or silver on deposit. When the depositor wanted to retrieve their gold, they would present the bank note to the issuing bank. Since bank notes were bearer notes, meaning the bank paid whoever presented the note, holders of the notes started exchanging these notes instead of going to the bank and pulling out coins. The cost and risk of transporting large sums gold made bank notes a much more practical currency. Think about a merchant living in England that needed to purchase large sums of tobacco in the colonies or spices from the Far East or lumber to repair his ship.
What the banks had done with bank notes is securitize the gold they had on deposit. However, gold and silver are not the only things of value. Banks realized that they could securitize other property. For instance, quality farm land had significant value. There was a difference of course. You cannot put your land on deposit with a bank. However, the bank could have a contingent legal title to the land. The bank did not need land, so it would provide you with a loan against this contingent title, known a mortgage or deed trust. The borrower would pay the bank back in bank notes or species that he earned from his farm. If the farmer defaulted, then the bank would take legal title to the land and sell it. A bank could only loan money from its capital reserve making it a 100% reserve ratio bank. But there is no logically reason that bank notes should only be backed (secured) by gold. If I want to buy some land adjacent to my farm, but I do not have the funds it makes economic sense to take out a loan. I could pledge to pay the widow who owns the farm over time. This might work, but she may have pressing financial needs and a payment plan is not a good solution for her. This problem is compounded if the farmer/borrower needs to buy extra seed corn, build a barn on the property, and pay extra laborers to realize the full economic potential of the farm he is buying. He cannot promise to pay all these people on time. The bank steps in and issues bank notes that are recognized as currency secured by the land owned by the farmer. If the farmer dies, becomes disabled, or is just not able to pay back the loan, the bank takes over the farmer’s loan and sells it for currency, which could be bank notes or gold coins. This ensures that they have enough gold on hand to pay off any holder of their bank notes. In a fractional reserve bank, the bank has not created money out of thin air they have backed their bank notes by both gold deposits, their capital reserve, and the farmers land or whatever other collateral they have for the loans they have made.
It may be legitimate to require a bank to disclose that they are a fractional reserve bank to their depositors. I asked a former president of a bank if they ever did disclose this to customers when they setup an account. The answer was no. As a lawyer, it seems that banks should have to disclose that they are a fractional reserve bank. However, in discussions with mid-level bank employees, most of them do not know they work at a fraction reserve bank.
Bank securitization of farms is no different than a company selling bonds against its assets and future earnings. The bonds it issues are not backed by gold, they are backed by the assets of the company. You might argue that the purchasers of the bond have given gold to the company. This may be true, but a company does not hold the gold in reserve. It spends the gold for plant and equipment or expansion. You may argue that a bond is not money. That is true in this day and age of legal tender laws, but before legal tender laws there was very little difference. Even today if you owe someone $10,000 you might sign over some bonds to that person to pay them. Clearly, those bonds are acting like money. Money is anything that functions as a medium of exchange and a store of value. Rocks, tobacco leafs, paper, bonds, stock options, gold, silver, computer entries and bonds, are just a few of the ‘things’ that have functioned as money in history. An interesting experiment in money is being conducted by the company Bitcoin. Bitcoins have appreciated significantly against other currencies in the last couple of years and they are just computer entries.
Legal tenders laws mandate that certain state approved money can be used to satisfy debts within the country. The first legal tender law in the United States was passed by the North during the Civil War. Eventually this law was declared unconstitutional in Hepburn v. Griswold, 75 U.S. 603 (1870). The Court reasoned that the Constitution allowed the federal government to coin money, but not the power to make paper legal tender. The government argued that since it had the power to carry out war and the issuance of the legal tender was necessary for carrying on the war, then legal tender laws fell under the “necessary and proper’ clause of the Constitution. The Court rejected this argument and also pointed to the fact that the Constitution prohibited the states from interfering with contracts. The Constitution did not specifically, prohibit the federal government from interfering with private contracts, but it would be against the spirit of the Constitution to allow the federal government to do so. Unfortunately, this case was quickly overruled by the Knox v. Lee, 79 U.S. 457 (1871) Supreme Court decision. Multiple competing bank notes were the norm at that time. According to the Cato Institute, “the government did not entirely monopolize issuance of notes until 1935, but the laws that made the monopoly possible date from the Civil War.” Today the legal tender law in the US is 31 USC § 5103 which states:
United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues. Foreign gold or silver coins are not legal tender for debts.
Legal Tender laws are necessary for government counterfeiting to be successful. Without legal tender laws, people would quit accepting the money government printed. A central bank is not necessary for the government to counterfeit money. The Union was able to print $450,000,000 of counterfeit money without a central bank.
The Federal Reserve uses a more sophisticated method of printing money. The Federal Reserve can affect the money supply by either changing the interest rates or by buying and selling bonds. However, the money supply in a free market also varies. A fractional reserve bank is not a government creation and neither are bonds. When a bond is issued or a bank funds a loan, they both increase the supply of money. However, the amount of money that can be created in this manner is limited by the size of the economy, since bonds and loans have to be backed by productive assets. If too many loans are funded, then the bank goes out of business, which shrinks the supply of money. If too many bonds are floated, then they are not repaid and become worthless shrinking the supply of money. The Federal Reserve can use its interest rate setting mechanism to encourage too many bad loans, but eventually this short term increase in the money supply will evaporate. If the Federal Reserve wants to permanently increase the money supply, then it needs to use its open market operations to buy Treasury Bills or more recently to buy bad mortgages from private banks. It is these open market operations that are used to create money out of thin air and why the Federal Reserve’s balance sheet is the best way to determine how much money the Federal Reserve has counterfeited.
The most effective way to stop the damage caused by government manipulation of the money supply and interest rates is to repeal the legal tender laws. The North was able to print money without a central bank, but not without legal tender laws. If the Federal Reserve attempted to flood the market with counterfeit money and there were no legal tender laws, the market would quickly discount the value of government issued currency and individuals would price their contracts in other more stable currencies. This is why FDR outlawed the ownership of gold and gold clauses in contracts. From a political point of view it will be easier to repeal the legal tender laws than to eliminate the Federal Reserve.
Presently, the Federal Reserve and other central banks are convinced that by counterfeiting money as fast as they can, they can create wealth. Ben Bernanke believes that wealth can be created by the government dropping money out of a helicopter. If this were true, we could be really rich if every citizen were given the power to print money or just go online and change the amount of money in their bank accounts. This insanity ensures that we are headed for a huge financial crisis that will make the 2008 recession seem trivial. This financial crisis will be caused by both central banks and legal tender laws, but it will not be caused by fractional reserve banking.
 Bordo, Michael D., A Brief History of Central Banks, Federal Reserve Bank of Cleveland,
http://www.clevelandfed.org/research/commentary/2007/12.cfm, A Brief History of Central Banks, December 1, 2007.
 I think there is a quote on this from the book Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse Unfortunately, I do not have a copy of this book anymore.
 The book, Hamilton’s Blessing, is a great reference for this but I do not have a copy anymore.
 Rothbard, Murray N., Taking Money Back, Ludwig Von Mises Institute website, June 14, 2008, http://mises.org/daily/2882, This article originally appeared in The Freeman, September and October 1995.
 Schuel, Kurt, Cato Journal, Vol. 20, No. 3 (Winter 2001) p 454.
 Counterfeiting in an economic sense is any currency that is not backed by productive or creative effort that someone willing exchanged their creative effort for. Gold is clearly not counterfeit money, since it requires productive effort to mine gold. Buy paper money presents a problem. It takes productive effort to make and print paper, but no one would trade twenty dollars of their effort for someone who printed a twenty dollar bill. Economic counterfeiting is really a fraud where someone believes the other person has provided value that they did not provide and purposely withheld this fact from the other party.
Twitter posted their Innovators Patent Agreement (IPA) https://github.com/twitter/innovators-patent-agreement/blob/master/innovators-patent-agreement.md with much ballyhoo yesterday. Despite the claim that Twitter will only assert patents defensively, part 2(b) of the IPA allows Twitter to assert patents against anyone who has asserted their patents. This will only exclude a very few companies, mainly startups. Twitter’s stated goal is to promote innovation, but the real result if Twitter is successful will be that companies will rely on Trade Secrets. Trade secrets decrease innovation, because the information is not shared. Inventors cannot build on the work of previous inventors and they are more likely to waste resources rediscovering other people’s work (reinventing the wheel). History clearly shows that when a country relies on trade secrets instead of patents, innovation is impeded. Those countries with weak or nonexistent patent systems are not innovators and their people live on the edge of starvation.
Forbes magazine has an excellent article that provides the real facts behind the so called patent litigation explosion entitled “No, the Patent System Is Not Broken.” The article explains:
“The truth is that today’s patent litigation rate is less than half what it was in the mid-nineteenth century, a period widely recognized as the golden age of American innovation.”
According to Lex Machina’s authoritative “Database of U.S. Patent Litigation 2011,” the number of patent suits filed between 2001 and 2010 has held steady at less than 3,000 per year. Only about a hundred of these cases actually went to trial each year
To put it in even broader historical context, the estimated 100 patent suits currently filed in the smartphone industry is actually less than one-fifth the number of suits filed during the first “Telephone Wars” of Alexander Graham Bell’s time. Back then, the American Bell Telephone Company and its successor, AT&T, litigated a whopping 587 patent cases alone.
Perhaps even more importantly the article explains that a strong patent system creates a division of labor between inventors and manufacturers. According to Adam Smith the division of labor is key to increasing our wealth.
“The growth of market trade in patents raised the returns to invention and encouraged a division of labor whereby technologically-creative individuals increasingly specialized in their comparative advantage—invention,” observed Lamoreaux and Sokoloff. “It was the expanded opportunities to trade in patented technologies that enabled the independent inventors of this golden age to flourish—and that stimulated the growth of inventive activity more generally.”
By 1865 the per capita patenting rate in the U.S. was triple that of Britain, and the vast majority of those citizen-inventors were what we now call “non-practicing entities,” or NPEs, who licensed their patents to others to commercialize into new products. Indeed, patent and legal records from the nineteenth century indicate that more than two-thirds of the 160 so-called “great inventors” of the Industrial Revolution, including Thomas Edison, were NPEs.
Please check out the full article at:
It Is Dangerous to Be Right When the Government Is Wrong: The Case for Personal Freedom, by Andrew P. Napolitano
Judge Napolitano has written an excellent book on Natural Law from the perspective of an attorney. He attacks legal Positivists, who believe the law is whatever the government says it is. He points out the moral bankruptcy of Positivists by pointing out that they have no logical basis to be against Hitler’s final solution of wiping out all Jews – since it was a validly passed law. He also rejects the non-sense of “majority rule” or Democracy.
He explains that Natural Law is like science. He states:
Only man-made theories for what those rules are and how the operate may change.
However, without an explanation or understanding, those rules remain just as “true”: Penicillin will combat certain infections, and gravity will always pull things toward the center of the Earth, regardless of whether or not we understand how.
He also states something that will not sit well with conservatives:
Truisms reject moral relativism, and American Exceptionalism. They compel and understanding of the laws of nature that animate and regulate all human beings at all times, in all places, and under all circumstances. And truisms equal freedom.
The book starts off with the Declaration of Independents. It moves onto eminent domain issues where the judge has a number of illuminating points. I particularly liked the freedom of association chapter. Napolitano I think is one of the few people to write about this issue. I also found the right to petition chapter illuminating. I believe that only someone with Judge Napolitano’s legal background could have done this chapter justice. His chapter on the growth of the Defense Industry was illuminating. While I did not agree with all his points, he makes it clear that the Defense Industry has grown completely out of control. According to the Judge the US military is in over 130 countries. The quote from Fredrick the Great comes to mind “in trying to defend everything he defended nothing.” The US military has become just another welfare/crony capitalism project. The military will complain that defense spending as a percentage of GDP is less than it was during the Korean War. However, we did not have the Department of Homeland Security, the Department of Energy, the Border Patrol, etc, which are all really part of our defense spending at the time of the Korean War.
Unfortunately, the book is marred by two problems. I am in complete agreement with the Judge’s emphasis on Natural Law, but he defines it in terms of “essential yearnings.” Someone might have an essential yearning to torture people or kill them. That does not make it a natural right. It is enough to state that people have ownership of their body. The rest of Natural Law and Natural Rights flows from this simple concept. Once I own myself, I clearly own the product of my labor which leads to all of property law, including patents. Criminal law comes from violating my rights in my body or in my property. The “essential yearnings” adds nothing to the concept of Natural Law and Natural Rights.
The second problem with the book is Judge Napolitano’s analysis of fractional reserve banking. The Judge and some Austrian economists incorrectly state that fractional reserve banking allows banks to create money out of nothing. A fractional reserve bank is a bank that lends out part of its depositors money. Fractional reserve banking is how all modern banks (since at least 1750s) operate. Wikipedia defines a Fractional-reserve banking as a type of banking whereby the bank does not retain all of a customer’s deposits within the bank. Funds received by the bank are generally on-loan to other customers. This means that available funds (called bank reserves) are only a fraction (called the reserve ratio) of the quantity of deposits at the bank. As most bank deposits are treated as money in their own right, fractional reserve banking increases the money supply, and banks are said to create money.
The history of fractional reserve banking starts with the concept of an exchange bank. I explain in my book, The Decline and Fall of the America Entrepreneur: How Little Known Laws and Regulations are Killing Innovation:
Modern banking started in the early 1600s with the Bank of Amsterdam. Merchants could deposit coins with the Bank of Amsterdam and use this account to pay for transactions. Using checks, a merchant’s account was debited and another merchant’s account was credited. This meant that coins did not have to be transported from one merchant to another with the attendant risk of theft and loss or the cost of transportation. The Bank of Amsterdam was just an exchange bank that facilitated transactions between merchants. Next came the Swedish Riksbank established in 1656. The Riksbank was not only an exchange bank, it also lent money making it the first modern fractional reserve bank. Fractional reserve banking is the banking practice in which banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder, while maintaining the simultaneous obligation to redeem all these deposits upon demand. Commonly, loans are made against collateral such as land or jewelry. … Some people believe fractional reserve banking creates money out of thin air, but what really happens was the money for these loans were backed by some collateral other than coins or bullion. The downside of other types of collateral is they are not as liquid as species (coins, bullion). As a result, if large numbers of customers of a fractional reserve bank wanted species (currency) at the same time, the bank would not able to fulfill all its customer’s demands. This is a classic run on a bank. A run on a bank is a cash flow issue. A sound bank may have plenty of collateral and performing loans, but if most of its customers demand species at the same time it will not be able to fulfill these requests. Fractional reserve banks free up capital from low performing assets so that they can be invested in higher performing assets. For example, if you owned a large tract of ranching land that was not highly profitable but represented a large amount of capital and you want to invest in an oil well, without fractional reserve banking you would have to sell some of the land in order to invest. With fractional reserve banking you could convert your land into a generally accepted form of money, by pledging your land as collateral to a bank for a loan. In the modern world, the loan to you is just a computer entry in your bank account.
It is clear from history that fractional reserve banks are not some sort of government institution, like the Federal Reserve. Without fractional reserve banking it is would be very difficult to securitize (Collateralize) many assets, such as houses and land. This would significantly impede the economic growth of a country. Logically if you are against fractional reserve banking you should be against a stock market. Both are just a way of securitizing assets. The stock of paper money act as a claim against various assets and/or future earnings.
As I began to explore this idea that entropy was a key concept in understanding economics and putting it on the path of a true science, I investigated whether other people had made this connection. I found that Edwin Schrödinger, Nobel Prize winner in physics, wrote the book, What is Life. He pointed out that life was a struggle against entropy. There is also a field of study called thermoeconomics or biophysical economics, which focuses on the role of entropy in economics. An article in Scientific American featured the ideas of thermoeconomics. According to the article:
Central to their argument is an understanding that the survival of all living creatures is limited by the concept of energy return on investment (EROI): that any living thing or living societies can survive only so long as they are capable of getting more net energy from any activity than they expend during the performance of that activity.
This appears to be completely consistent with my thesis. From this hypothesis thermoeconomists draw the conclusion that peak oil is real because it takes more and more energy to extract oil. They even acknowledge that technology could allow for greater efficiencies.
“It isn’t that there’s no technology,” Hall said. “The question is, technology is in a race with depletion, and that’s a whole different concept. And we think that we can show empirically that depletion is winning, because the energy return on investment keeps dropping for gas and oil.”
The article argues that it use to take 1 barrel of oil to extract 100 barrels of oil in the 1930’s and in 2006 in the U.S. it now takes 1 barrel of oil to extract 19 barrels of oil. Their prediction is that at 1 to 3 ratio the system fails. Neoclassical economics look at the inflation adjusted price of oil and argue that there is no evidence of diminishing returns for oil. The thermoeconomists’ response is that prices are a poor way of measuring diminishing returns for energy. If the price of oil has not increased appreciably and the cost of extraction has increased, then some other factor must have decreased. For instance, the cost of transporting oil may have gone down. The neoclassical economic approach to this question seems to take into account all the factors that define the energy return on investment. The value of oil is not just in the extraction, but in the transportation and refining of the oil. If the cost (energy) to extract oil goes up, but the cost (energy) of refining oil goes down an equal amount, the energy return on investment remains the same.
This debate about peak oil is an example of a bigger debate in economics that I believe is the cornerstone of many of the arguments in economics. The bigger debate is whether it is possible to escape the Malthusian Trap. Is the present situation where humans have escaped this fate temporary? The two camps are pessimists who believe that it is impossible for humans to escape the Malthusian Trap permanently versus the optimists who believe we can permanently escaped the Malthusian Trap. Pessimists always point to the diminish supply or return associated with various natural resources. The pessimists have about 489,800 years of human history on their side. They also point to projections based on science that various natural resources will run out.
The optimists point to the repeated scare stories of natural resources or more commonly food running out that did not come true. For instance, ever since oil was found people have been projecting the end of oil. The pessimists have data showing trends based on scientific evidence that the present course is unsustainable. The optimists have evidence that during the last 200 years the pessimists’ scenarios have been wrong time and time again. Optimists point out that the pessimists ignore that people invent substitutes and therefore the doomsday scenarios, no matter how logical, do not occur – at least not during the last 200 years.
This point about substitutes was studied by Howard Barnett and Chandler Morse in their paper Scarcity and Growth where they concluded that resource scarcity did not threaten economic growth. In an updated version of their paper they state:
The efficiency with which raw resources are converted into what physicists call “useful work” has improved markedly over the past few centuries. This finding is entirely consistent with the results derived by Barnett and Morse and later optimistic authors. If, however, progress is tied to the consumption of particular resources rather than being “disembodied,” the scarcity of such resources would constrain growth.
Using this thought process we should rephrase the question of peak oil as will we hit peak energy. The question of peak energy is not a question of a lack of natural resources but lack of inventions. Berkeley astronomer Don Goldsmith reminds us that the earth receives about one billionth of the suns energy, and that humans utilize about one millionth of that. So we consume about one million billionth of the suns total energy. Civilizations can be characterized as Type 1, 2, and 3 on the Kardashev scale. A type I civilization is able to harness all of the power available on a single planet. A type II civilization is able to harness all of the power available from a single star. A type III civilization is able to harness all of the power available from a single galaxy. Physicist Freeman Dyson of the Institute for Advanced Study estimates that, within 200 years or so, we should attain Type I status. In fact, growing at a modest rate of 1% per year, Kardashev estimated that it would take only 3,200 years to reach Type II status, and 5,800 years to reach Type III status. Living in a Type I,II, or III civilization. Based on this modest growth rate of 1% in energy use, it seems entirely possible for technology to keep up or exceed this growth rate.
I believe this debate between the optimists and the pessimists about natural resources and technology is about what I call the instability postulate.
Instability Postulate: Present technology cannot support present population income levels.
I cannot prove this, so it is labeled a postulate. If we were still in the Malthusian Trap, the postulate would have just stated that present technology cannot support present population levels. Since we have escaped (presently) the Malthusian Trap I have to state that we cannot support the present population at its present life style (income) levels. This may be a restatement of the idea of diminishing returns. However, I believe that even if we could increase our technology at exactly the same rate as the projected diminishing returns of present resources this state is not stable. Various random perturbations in the environment make this perfect balance impossible. For instance, variations in the amount of rain or output from the Sun will upset this instability. The huge meteor that wiped out the dinosaurs is an example of such an instability.
If we accept the pessimist point of view on this argument we are condemning billions of people to death and the survivors to a subsistence life on the edge of starvation. Even if we fail, morally we have to side with the optimists. From a logical point of view, inventions are not subject to diminishing returns. Every invention is a combination of known elements – you cannot create something from nothing. This follows from the conservation of matter and energy. As a result, every invention opens up the possibility of more inventions. Creating these inventions takes real energy, but the number of potential inventions we can conceive increases with every invention we create. As a result, the number of potential inventions grows factorially. Thus, it appears entirely impossible to grow our technology faster than the limitations of diminishing returns and the instability postulate. Modest gains of 1% per year in energy will result in humans advance fairly quickly to a type I civilization, which are energy usage rates that seem unthinkable today. Invention is the key to escaping the Malthusian Trap and growing real per capita income.
Fundamental Observation of Economics (restatement): Inventing is the only way humans can increase real per capita income.
 Wikipedia, What is Life?, http://en.wikipedia.org/wiki/What_is_Life%3F_(Schrödinger), 10/6/10.
 Does Economics Violate the Laws of Physics?, Scientific American, October 23, 2009, http://www.scientificamerican.com/article.cfm?id=does-economics-violate-th, 10/9/10.
 Does Economics Violate the Laws of Physics?, Scientific American, October 23, 2009, http://www.scientificamerican.com/article.cfm?id=does-economics-violate-th, 10/9/10.
 R. David Simpson, Michael A. Toman, and Robert U. Ayres, Scarcity and Growth in the New Millennium: Summary, Resources for the Future, 2004, http://www.rff.org/documents/rff-DP-04-01.pdf, 10/10/10.
 R. David Simpson, Michael A. Toman, and Robert U. Ayres, Scarcity and Growth in the New Millennium: Summary, Resources for the Future, 2004, http://www.rff.org/documents/rff-DP-04-01.pdf, p. 8, 10/10/10.
It is the premise of this post that economics is objective and therefore can be a hard science, based on empirical observation, logic, and reason. Some clear objective results in economics include that failure of a person to produce (consume) enough food results in starvation and death. It does not matter how much someone feels or believes (or has faith) that they should not have to produce (consume) enough calories, they will starve to death. There is overwhelming empirical evidence for this proposition, including the purposeful starvation of numerous people by totalitarian governments in the last century. Another example is that if the government raises the cost (or reduces the return) of performing an activity, you will have less of this activity than would have occurred without the government interference, as long as you have statistically large enough group. For instance, if a government raises the cost of food or reduces the return for producing food enough people starve. The empirical evidence includes numerous African countries that have held the cost of food below the cost of production and this inevitably results in mass starvation. This is true no matter how much faith the government has that it should not occur, or how much they feel it will not occur, or how much they believe it should not occur. Similarly, a person can deny the existence of gravity, but gravity will act on the person no matter what they believe about gravity. Gravity is not a matter of belief, it is a matter of understanding. It is clear that at least some of the laws of economics are as immutable as the laws of gravity.
All science is based on certain fundamental empirical observations. One of these fundamental observations is that reality is objective. This means that reality exists independent of any persons’ belief, hope, faith, or desire. The evidence for this proposition is overwhelming and includes all the incredible advances in physics, chemistry, biology, geology and the applied sciences (engineering).
Fundamental Observation: Reality is Objective
The second fundamental observation of science is that reality is understandable or discoverable using observation, logic, and reason. In science, we follow logic and reason even if it seems counterintuitive. For instance, the implications of special and general relativity predict that clocks on GPS (Global Position Satellites) will run at a different rate than clocks on earth. This appears counterintuitive, but empirical evidence shows that this is true and that failure to account for this difference will result in meaningful navigational errors.
Fundamental Observation: reality is understandable or discoverable using observation, logic, and reason
If economics is going to be a science, it must be based on these two fundamental observations/assumptions. Some people may object that science is based on observations. It has been shown that all logical systems are based on either an observation or an assumption, in the case of mathematics. For instance, Euclidean geometry is based on the assumption that a line goes on forever and two parallel lines never intersect. Spherical geometry is not based on these assumptions. It assumes that a line will wrap around on itself. In science we do not arbitrarily pick the starting point, we base them on observations. Unfortunately, the science of economics is in the same state as physics before Newton.
Life is a fight against entropy, the second law of thermodynamics. Entropy is normally defined as the measure of the disorder of a system. Entropy was discovered as part of thermodynamics (statistical mechanics) and it explains that a perpetual motion machine is impossible. Entropy always increases in a closed system. Luckily for us, the Earth is not a closed system. For instance, we receive energy from the Sun. The only way to increase order is by the input of energy. Life represents increasing order and therefore just to sustain life at its present level requires energy to overcome entropy. Edwin Schrödinger, Nobel Prize winning physicist, proposed this in his 1944 book, What is Life.
Fundamental Observation: Life is a fight against entropy
Plants create this energy by photosynthesis. They convert carbon dioxide into sugars (energy) using light. They use this energy to create order. Animals eat plants or other animals and use the energy to create order. Note that when animals eat plants or other animals, they are increasing the disorder of the plants and animals they eat. Thus, there are two general mechanisms which increase the entropy of life forms: 1) internal and 2) external. Internal mechanisms are those that result from the failure to consume enough calories (energy) and aging. Animals require oxygen, water, and food in that order to survive. Without oxygen, the animal cannot oxidize enough sugar (fat, protein) to survive – overcome entropy. Without water, the animal’s cells are unable to absorb energy and expel wastes. As a result, the animal does not receive sufficient energy to overcome entropy. Aging is a process of increasing disorder – entropy. This disorder is caused at least in part by disorder in genetic information. External mechanisms include being eaten or attacked by other living organisms, diseases, accidents (for animals), and the elements.
In general, living organisms use energy to overcome entropy first and then to increase their size. However, some animals also create simple shelters or seek shelter to ward off the entropy increasing effects of the elements and predators. Rain, sun, hail, snow, heat, or cold all contribute to the increase in entropy of living organisms (disorder). A living organism dies when its entropy increases above a certain level. Life has two main methods of overcoming the effects of the second law of thermodynamics: 1) food consumption and 2) shelter creation (inhabitation).
A species of life becomes extinct when the species as a whole reaches a certain level of entropy either because it cannot consume enough energy or because external mechanisms increase its entropy to the extinction level. A species reaches the Malthusian Trap when increases in population of the species results in the total required energy (food) to support the population is greater than supply of food. Total available energy is less than the energy required to overcome the total entropy of the species population. Most life forms exist in the Malthusian Trap, including humans until the Industrial Revolution.
Homo sapiens also consume food and create shelter to overcome the effects of entropy. Unlike other living organisms, homo sapiens also organize their environment to minimize the effects of entropy. For instance, humans have invented agriculture to increase their supply of food (energy) and therefore order. Humans also harnessed the physical strength of animals, created internal combustion machines, electric lights, electricity, washing machines, tractors, computers, the internet, email, lasers, fiber optics, etc. All of these are inventions. Humans alter their environment by creating inventions. This is different from every other animal. This should not surprising, since the distinguishing characteristic of homo sapiens is their ability to reason. Man is a rational animal according to Aristotle’s classical definition. Being rational is the distinguishing characteristic of humans. Man uses his reason to alter his environment (invent) and increase order for himself. Invention is the unique way in which man is able to create order – this is the fundamental observation of economics.
Fundamental Observation of Economics: Man’s unique ability to increases order (wealth) is his ability to invent.
Inventing first results in the increased success of the species. Homo sapiens populated most of the world in less than 500,000 years because of this unique ability. As long as the rate of technological progress is slower than the growth in population, man is stuck in the Malthusian Trap. Sometime around 1800 in Europe and the United States, the rate of invention exceeds the rate of growth in population and man escapes the Malthusian Trap at least in the West. When man escapes, he is no longer subject to biological evolution. As far as we know, homo sapiens are the only species to ever escape the Malthusian Trap.
Trade enhances man’s ability to invent. By trading the products of each others’ inventions both trading partners can specialize in the inventions and both end up wealthier. David Ridardo explained how both parties are better off because of trade using the example of England trading cloth for Portuguese wine:
England may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempted to make the wine, it might require the labour of 120 men for the same time. England would therefore find it in her interest to import wine, and to purchase it by the exportation of cloth. To produce the win in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth. This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced with less labour than in England.
Using the example above if England produces twice as much cloth as it needs, it has invested 200 man hours. If Portugal produces twice as much wine as it needs it has invested 160 man hours. Now if England and Portugal trade their excess cloth for the excess wine, England has invested 200 man hours for all its cloth and wine, while Portugal has invested 160 man hours for all its cloth and wine. If England had produced both all its cloth and all its wine locally, then it would have invested 220 man hours for the same goods. This means that England requires 10% more man hours if it does not trade. If Portugal had produced both all its cloth and all it wine locally, then it would have invested 170 man hours for the same goods. This means that Portugal requires 6.25% more man hours if it does not trade.
Trade is a rational activity and humans are the only animals to engage in trade of non-like items and trade between non-related individuals. Classical economics has focused on trade and the related supply and demand curves instead of the role of invention in economics. This might have occurred because the beginning of classical economics was in reaction to the Mercantile system and its limitations on trade. Adam Smith’s book, The Wealth of Nations, is often seen as a refutation of the Mercantile system. Matt Ridley, in his book, The Rational Optimist, has suggested that trade is the key to creating wealth. This emphasis on trade has been misplaced. Invention proceeds trade. If everyone produces the same thing, then there is no reason to trade. It is only because someone has invented a new product that trade becomes a rational choice. For instance, one group of people may have invented a process for skinning animals and using them as clothing. They may have traded this with people who had access to flint and invented a system for making simple axes. Invention has to proceed production, which has to proceed trade logically. Of course, without trade the value of invention is severely diminished.
 Hard science, such as physics, chemistry, and biology, as opposed to “soft science”, such as psychology, sociology, and political science. In general, soft sciences are not science at all. For instance, Freud’s formulation of the id, ego, and super ego is not science. This formulation is not testable and is not based on objective empirical evidence. In fairness, psychology to the extent it is based on neurobiological processes is real science. The first step in any science is categorization and psychology has attempted to categorize various behaviors. Unfortunately, many of these categorizations are too vague to be testable or objective. As we have gained more information some formally vague definitions have become objective. Political science is not a science it is a study of politics. Sociology also has no basis in science. This is not to say that there is no value to studying politics or the interaction of groups. History and literature do not call themselves a science, but there is great value in the study of history and literature. History even uses science to discover new facts about history, but it is not a science. The soft sciences use the nomenclature of science to aggrandize themselves. This propaganda has undermined the value of science in the eyes of the general public.
 Even the bizarre results of quantum mechanics are repeatable and independent of the observer’s hopes, desires, faith, opinion.
 Real-World Relativity: The GPS Navigation System, http://www.astronomy.ohio-state.edu/~pogge/Ast162/Unit5/gps.html, October 3, 2010.
 Wikipedia, What is Life?, http://en.wikipedia.org/wiki/What_is_Life%3F_(Schrödinger), 10/6/10.
 BNET, Physiological Effects of Dehydration: Cure Pain and Prevent Cancer, http://findarticles.com/p/articles/mi_m0ISW/is_2001_August/ai_78177228/, 10/6/10.
 Hayflick, Leonard, Entropy Explains Aging, Genetic Determinism Explains Longevity, and Undefined Terminology Explains Misunderstanding Both, PLoS Genetics, http://www.plosgenetics.org/article/info:doi/10.1371/journal.pgen.0030220, 10/7/10.
 Ridley, Matt, The Rational Optimist: How Prosperity Evolves, Haper Collins, New York, 2010, p. 75.
 Ridley, Matt, The Rational Optimist: How Prosperity Evolves, Haper Collins, New York, 2010, p. 56.
The author, Matt Ridley, has written an excellent book that is epic in the scope of issues he tackles. The book covers why homo sapiens thrived while other members of the homo genus fail. He shows that on average the human condition has gotten consistently better and this increase in wealth has been especially true in the last 200 years. He destroys the noble savage myth. He shows the intellectual failings of Marxism, environmentalism, self sufficiency, and renewable energy. His two main themes underlying these vast topics are: 1) trade leads to division of labor, which leads to invention and 2) the inexorable march of human progress.
Despite Mr. Ridley’s incredible breadth of knowledge, there is a logical gap in his first thesis when he attempts to explain the industrial revolution and why it took off in England. This logical gap is the result of his misunderstanding of intellectual property.
This misunderstanding of intellectual property is most likely due to his open source utopianism. This utopianism leads the book to conclude “Thanks to the internet, each is giving according to his ability to each according to his needs, to a degree that never happen in Marxism.” P. 356. Even with this imperfection, this is an incredible book that I highly recommend to anyone.
Population Density – Good or Bad for Wealth Creation?
The book argues that population density is necessary for trade and division of labor, which is the route to economic prosperity. It also argues that the division of labor leads to inventions, which leads to further specialization. Specialization requires a large enough market to support it and as a result population density is the friend of economic progress. However, later in the book it argues that increasing population caused a decline in the living standards of Japan and Denmark. This decline supposedly occurred because the increasing population decreased the value of labor and therefore the market for specialization and inventions. England escapes this fate because of coal and phantom land in the colonies. This contradiction between the need for human density for specialization and economic progress and the idea that increased population density reduced the value of labor destroying the market for inventions is not adequately resolved.
The book argues, starting on page 52, that trade is what allowed homo sapiens to succeed where other apes failed and even other humans failed such as Neanderthals. It provides numerous examples of how various groups of humans regressed technologically because of inadequate population densities to support specialization, such as Tanzania. The book summarizes the lessons by quoting economist Julian Simon “population leading to diminishing returns is fiction: the induced increase in productivity is scientific fact.” P. 83.
In a chapter entitled “Escaping Malthus Trap,” Ridley discusses how Japan after a period of prosperity gives up its technology. He states “that sometime between 1700 and 1800, the Japanese collectively gave up the plough in favour of the hoe because people were cheaper to hire than draught animals.” P. 198. The reason for this according to Ridley was rapid population expansion due to paddy rice technology. This population boom made labor cheap and killed the market for technology. Denmark follows the same path as Japan and by the 1800s becomes “trapped by its own self sufficiency.” P. 200. Britain escapes the Malthusian trap that Japan, Denmark, and Ireland suffer, according to Ridely, because of selective breeding (maybe p. 200), ghost acres provided by the colonies (p. 202), release valve emigration to the colonies (p. 202), and coal (sustained industrial revolution p. 216.)
There is a logical inconsistency between the conclusion early in the book that population density is necessary for prosperity, but later in the book arguing that prosperity stalled after a burst in population in various countries. The explanation of selective breeding, does not explain why the US or Australia prospered. These countries were heavily populated by British rejects. Similarly, the ghost acres provided by the colonies were eventually used up. It might be argued that there was some tipping point that could only be achieved with ghost acres. I think this fails also, because it flies in the face of the book’s earlier argument that increased population densities allow more specialization and invention to increase everyone’s standard of living. The release valve emigration fails for the same reasons as the ghost acres. The emergence of coal is also unsatisfying. Coal mining was known before the birth of Christ and trade in coal occurred in England as far back as the 1300s, according to Wikipedia. The book also argues that many surges of economic growth were extinguished by parasitic political systems. However, it never states this is why Japan’s and Denmark’s prosperity was reversed.
What was new in the industrial revolution was not coal, but the machines to use coal and numerous other inventions. The book argues that these inventions were not in general due to new scientific discoveries, p. 255, and I agree. So why at this particular point in time did we have a sudden increase in rate of technological advance, including machines that used coal? The beginning of the industrial revolution coincides with the recognition of property right’s in inventions. The US constitution states (Article 1, section 1, clause that inventors have ‘RIGHTS” in their inventions. Patents, which are legal title to an invention, are the only free market system for encouraging people to invent. While Britain had a patent system at least back to the Statute of Monopolies, 1623, it did not recognize a right to property in one’s invention. It was a royal grant, subject to the whims of the ruling monarch. As a result, it was expensive and arbitrary. However, when the United States recognizes that inventors have a property right to their invention, this provides a whole new incentive to inventors and their financial backers. No doubt this attitude towards inventions also infected Britain. For more on the correlation between real per capita increases in income and patent systems see Source of Economic Growth.
Mr. Ridley argues that patents at best have marginal effect on the rate of invention. However, Mr. Ridley shows an appalling lack of knowledge about patents and intellectual property. He also has a number of inconsistent statements about intellectual property. For instance, on page 267, he states that copyrights have little effect on the creativity of musical composers. However, on page 326 he states that Nashville was saved by music entrepreneurs using good local copyrights in the 1930s. Not only are these two statements contradictory, there is no such thing as local copyrights in the United States.
The book has numerous other errors about intellectual property. For instance, it states that intellectual property is not like other property, because it is useless if you keep it to yourself, p. 262. This statement is nonsense. The Coca Cola formula is not shared and this is the only reason it has any value. A patent to an invention (legal title to an invention) only has value if there is some ability to exclude others from using it – as opposed to knowing about it. If everyone can make a laser without pay royalties, then it may have value to the world but it has no differential value to the inventor. Patents are derived from exactly the same philosophical basis as real property. Namely, Locke’s theory of Natural Rights. For more information see Scarcity – Does it Prove Intellectual Property is Unjustified? Below are a list of some, but not all, of the book’s errors related to patents:
1) The book then states that people get rich by selling each other things and services not ideas, p. 263. What are authors, professors, engineers, scientists, really selling? Authors are not selling books, they are selling ideas that just happen to be embodied in books. The Kindle proves this. The Kindle does not allow the user to buy a book, but to buy the ideas in a book. Professors are either selling the teaching of ideas or just an expensive way to bore students. Engineers are selling a service, which encompasses ideas not the paper (digital ones and zeros) on which it is written. Most companies do not make money manufacturing things, they make money with inventions (ideas) that are implemented in things. When a company only sells things with no (new) ideas in these things, then their profit margins are extremely narrow. One of the limitations on growth has been this Luddite refusal to allow inventors to specialize in inventing. This book’s premise is built on the division of labor, but the author rejects this idea when it comes to inventing.
2) Mr. Ridley also seems to be confused between the spread of information related to inventions and the legal right to use that information to build an invention. It is a major goal of modern patent systems to spread information about inventions so that they can be used by other people to build other inventions. In the U.S. we built patent depository libraries to spread the wealth of information in patents (before the internet). Patents encourage people to share the information associated with their inventions instead of keeping them a trade secret. Countries without patent systems tend to invent mainly things that can be protected with a trade secret. (See Switzerland before they adopt a patent system) As a result, other inventors do not get learn from these inventions and the rate of technological progress is inhibited.
3) The book perpetuates the first mover advantage alternative to patents. Xerox had the world’s greatest first mover advantage in plain paper copiers, when it agreed to settle an antitrust lawsuit in 1975 by giving away its patent portfolio. Its market share went from almost 100% in plain paper copiers to 14% in just four years. The first mover advantage is a fairy tale.
4) The book argues, p. 264, that there is no evidence that patents are what drive inventors to invent. This statement is completely illogical. Real property rights are not what drive farmers to farm or builders to build houses. Nevertheless, there would be a lot less building and less efficient farming, if we did not have real property rights. Just look at countries, where property rights in buildings and land are hard to impossible to obtain.
5) The book states that a number of inventions were never patented, p. 264, such as automatic transmission, Bakelite, ballpoint pens, cellophane, cyclotrons, gyrocompasses, jet engines, magnetic recording, power steering, safety razors and zippers. While it is possible that the first version of some of these inventions were not patented, all of these inventions were subject to numerous patents. This can be easily verified with a simple patent search. For instance, there are at least 20 patents and probably hundreds of patents on automatic transmissions. The same is true of ballpoint pens, gyrocompasses, jet engines, magnetic recording, power steering, safety razors and zippers. A simple internet search shows that chemist Leo Hendrik Baekeland (1863-1944) invented and first patented the synthetic resin that we know as Bakelite in 1907. Jacques E Brandenberger was granted patents to cover the machinery and the essential ideas of his manufacturing process of the new film (cellophane). The assertions of no patents for the zipper is also easily shown to be incorrect. Elias Howe, who invented the sewing machine received a patent in 1851 for an ‘Automatic, Continuous Clothing Closure’ (zipper).
6) The book argues that the Wright brothers, enforcing their patent on airplane control surfaces, supposedly shut down the airplane industry in the US. This is the typical propaganda of open source community. First of all the Wright brothers were building airplanes, so the industry was not shut down by enforcement of the patents. Second stealing other people’s property is not shutting down industry, it is shutting down theft. We would not say that someone stopped the harvest of wheat, because they did not let someone else reap the wheat they planted on their land.
7) The patent thicket argument is repeated by Mr. Ridley to suggest that patents inhibit advances in technology. A number of papers have shown that there is no empirical evidence for the patent thicket argument and that the logical analogies on which it is based are flawed. For more information see Intellectual Property Socialism: Part IV USPTO Takes Aim at Inventors.
Mr. Ridley further demonstrates his ignorance of patents by repeating the concern that the US Patent Office was issuing patents for human genes in the 1990s, p. 265. What the Patent Office did and does was issue patents on “isolated genes.” This is similar to patents on things like isolated forms of vitamin B12, which was patented. For more information see Gene Patenting Debate Continues.
9) The book also mistakenly calls a patent a “temporary monopoly.” A patent is a property right, just like property rights in land, houses, cars, etc. The logical basis for patents is exactly the same as other property rights. Property rights are based on Natural Rights, which states that since you own yourself you own the product of your labor (physical and mental). For more information see The Myth that Patents are Monopolies.
10) He also implies that patents are top down solution to encouraging invention. Nothing could be further from the truth. All a patent system does is provide property rights to inventors for their inventions. This is similar to property rights for land, which is a bottom up way to increase the productivity of farming for instance. Just giving pseudo property rights to peasants in the USSR and China caused enormous increases in farm production. Property rights are a bottom up solution, not a top down solution. In fact, the genius of the United States patent system (as opposed to Britain’s) is that it was accessible to all people, including women and slaves that had no property rights under their state laws. This encouraged a torrent of inventive activity in the U.S. that propelled it from a backward farming country to an economic and technological powerhouse in the world in less than 60 years. For more information see the excellent book by B. Zorina Kahn, The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790-1920.
I am convinced that Mr. Ridley’s poor research on patents and intellectual property is due to his infatuation with the open source movement. On page 356 he opines that genetic research will soon go open source. He is so excited about open source that he eventually suggests a Marxist’s open source utopia – “Thanks to the internet, each is giving according to his ability to each according to his needs, to a degree that never happen in Marxism.” P. 356
The open source movement has been a dismal failure. Its biggest success has been to extend UNIX (LINUX) to personal computers, other platforms, and add new features. Open source has mainly extended existing technologies, much like the incremental invention that can be expected from large companies. The open source movement deludes itself into believing they are fighting some sort of David versus Goliath battle against large corporations and the patent system. The reality is that open source developers are giving large corporations, such as IBM, their efforts for free and weakening the bargaining power of technical personnel. The open source movement plays right into the hands of large corporations and other large institutions, by weakening the property rights of developers in their work. It should be no surprise that open source has been an abysmal failure, since this exactly the situation most of the world lived under until 1800. Before modern patent systems, new inventions were rare and the return for the invention was often controlled by a trade guild. The members of the trade guild profited equally, meaning there was little incentive for the inventor to spend time creating. Per capita income of the world before 1800 had been stagnant for millennia. Where modern patent laws were adopted around 1800, incredible increases in per capita income occurred. Mr. Ridley trumpets this progress throughout his book. In areas without patent systems, we see stagnant growth in per capita income. For instance, Japan’s per capita income does not take off until they copy the US patent system in the 1860s.
It is unfortunate that this excellent book is disfigured by the author’s irrational infatuation with the open source movement. This infatuation causes the author to embrace the logical contradiction that increases in population density increase economic growth and also causes the Malthusian trap (decreases in economic growth). It also causes him to reject the solution to the Malthusian trap, which is the recognition of property rights in inventions.
 http://bakelitecollector.com/bakelite-history 7/21/10
 Ted Buckley, Ph.D., The Myth of the Anticommons, Bio, www.bio.org (2007); Epstien, Richard A., Kuhlik, Bruce N., Is there a Biomedical Anticommons, Regulation, (Summer 2004), pp. 54-58
There has been a lot of anger at corporations lately and many people are wondering when and why the courts ever stated that corporations have the rights of a “legal person.” The case Citizens United v. Federal Election Commission, recently overturned the limits on corporate spending on elections based on the idea that corporations have free speech rights under the 1st amendment. This upset many people and many questioned why the court believed that corporations should have rights under the 1st amendment. The crony capitalism of the Bush and Obama administrations has added to this frustration at corporations. The British Petroleum Gulf oil spill debacle is adding fuel to the flames. Is this idea that a corporation is a “legal person” with rights some sort of judicial activism?
The first US case to recognize that a corporation is a “person” for legal purposes, able to sue and be sued was Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat.) 518, 4 L. Ed. 629 (1819) (see http://caselaw.lp.findlaw.com/scripts/getcase.pl?court=US&vol=17&invol=518)
This 1819 case was really about the Contract Clause of the Constitution and in today’s world would be characterized as a property right’s issue.
“Trustees of Dartmouth College v. Woodward“, 17 U.S. (4 Wheat.) 518 (1819), was a landmark United States Supreme Court case dealing with the application of the Contract Clause of the United States Constitution to private corporations. The case arose when the president of Dartmouth College was deposed by its trustees, leading to the New Hampshire legislature attempting to force the College to become a public institution and thereby place the ability to appoint trustees in the hands of the governor. The Supreme Court upheld the sanctity of the original charter of the College, which pre-dated the creation of the State. (http://en.academic.ru/dic.nsf/enwiki/101008)
Since the case did not revolve around whether a corporation was a “legal person” it is my opinion that this was a generally accepted principle in the legal community at the time. As this case shows, if corporations are not treated as a “legal person” then the government will use this as an excuse to violate private property rights. The idea that a corporation is a “legal person” is not new and makes sure that private property rights are not violated.
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