The Answer Is Transaction Costs
"The real price of everything is the toil and trouble of acquiring it." -Adam Smith (WoN, Bk I, Chapter 5)
In which the Knower of Important Things shows how transaction costs explain literally everything. Plus TWEJ, and answers to letters.
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The Answer Is Transaction Costs
Barking Cats: On the "Nature" of Bureaucracy
Transaction costs are the friction in the gears of society, but the worst transaction costs are the ones that reflect government failure. You can see it in ever cliche about government, from the dreaded DMV lines to the passport control bottleneck. Drawing on Milton Friedman's "Barking Cats" essay from 1973, I explore why bureaucracy remains fundamentally immune to reform efforts, regardless of which political party holds power.
The frustrating reality is that bureaucracies operate with completely different incentives than private businesses. While companies balance money costs against convenience to attract customers, government agencies focus solely on their budgets while taxing citizens with enormous "trouble costs." North Carolina's DMV perfectly illustrates this dysfunction—appointments require six-month waits while the state proudly touts its budget savings. Most maddening is that these aren't even genuine services, but rather artificial permission requirements the government imposes before allowing us to live our lives.
This represents a textbook government failure—what economists call a Pareto inferior outcome. Most citizens would gladly pay slightly more in fees or taxes to avoid wasting hours (or months) of their lives in bureaucratic purgatory. That additional revenue could easily fund more staff and faster service. Yet the system has no mechanism to capture these preferences or respond to them.
The problem isn't partisan, and it can't be fixed by shuffling leadership or staff. As Chris Rock might say about bureaucracy—"that tiger ain't go crazy, that tiger went tiger." Bureaucracy simply acts according to its nature. Reformers who believe they can fundamentally change how these institutions function are like people who want cats that bark—they fundamentally misunderstand the beast they're dealing with.
Listen in for insights on why bureaucratic inefficiency persists despite our best efforts, complete with revealing (but not really funny) quotes from political thinkers ranging from Schumpeter to Trotsky. Have your own bureaucratic horror story to share? Let me know in the comments or on social media.
Links:
Michael Munger: The "Trouble Tax"
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This is Mike Munger, the knower of important things from Duke University. Today I'll be talking about bureaucracy and barking cats. Why is the DMV so awful and why is bureaucratic reform so frustrating? Spoiler alert the answer is transaction costs. Some new twedges this month's letter plus book of the month and more Straight out of Creedmoor. This is Tidy C. I thought they'd talk about a system where there were no transaction costs, but it's an imaginary system. There always are transaction costs. When it is costly to transact, institutions matter and it is costly to transact, institutions matter and it is costly to transact.
Speaker 1:I'm going to read from a column by Milton Friedman called Barking Cats. It was published in Newsweek on the 19th of February 1973. In a recent column I pointed out that approval of drugs by the Food and Drug Administration delays and prevents the introduction of useful as well as harmful drugs. After giving reasons why the adverse effects could be expected to be far more serious than the beneficial effects, I summarized a study by Professor Sam Peltzman of UCLA of experience before and after 1962, when FDA standards were stiffened. His study decisively confirmed the expectation that the bad effects would much outweigh the good.
Speaker 1:The column evoked letters from a number of persons in pharmaceutical work, offering tales of woe to confirm my allegation that the FDA was indeed frustrating drug advancement, as I titled that column. But most also said something like well, but in contrast to your opinion, I do not believe that the FDA should be abolished. I do believe that its power should be, and then changed in such and such a way. To quote from a typical letter, I replied as follows what would you think of someone who said I'd like to have a cat, provided it barked? Yet your statement that you favor an FDA provided it behaves as you believe desirable, is precisely equivalent. The biological laws that specify the characteristics of cats are no more rigid than the political laws that specify the behavior of governmental agencies once they're established. The way the FDA now behaves and the adverse consequences are not an accident, not a result of some easily corrected human mistake, but a consequence of its constitution, in precisely the same way that a meow is related to the constitution of a cat. As a natural scientist, you recognize you cannot assign characteristics at will to chemical and biological entities, cannot demand that cats bark or that water will burn. Why do you suppose that the situation is different in the social sciences? Why do you suppose that the situation is different in the social sciences. The error of supposing that the behavior of social organisms can be shaped at will is widespread. It is the fundamental error of most so-called reformers. It explains why they so often believe that the fault lies in the man, not the system, that the way to solve problems is to throw the rascals out and put well-meaning people in charge. It explains why their reforms, when ostensibly achieved, so often go astray. End of quote from Newsweek column by Milton Friedman.
Speaker 1:Well, adam Smith really said it all in the Wealth of Nations the real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. Now we might interpret toil as the cost or the money price of the thing. Now Smith had a labor theory of value. But let's just let toil stand for money cost. Let's let trouble of acquiring a thing stand for transaction cost. Then an increase in either the money price or an increase in trouble are both cost increases. Now, for private businesses these costs are substitutes. Demand curves slope downwards. If I can reduce the money cost or the price, people will buy more. But people will also buy more if I can make the purchases more convenient. Okay, that's not true for bureaucracy. Those two costs money costs and inconvenience costs are not treated equally by bureaucracies.
Speaker 1:Bureaucracies have no way to capture a profit the residual of revenue over costs. A bureaucracy is given a budget and then it's asked to deliver a service, but the service is almost always something artificial, something that's only a service because the state passed a law saying you had to do this thing, you have to have this permission form, you have to have this card on your person. It's not really a service at all. A driver's license, a passport, a building permit, permission to sell a drug Bureaucracies provide us with this, and I'm making air quotes service because the government has required us to have this permission before we can act or live our lives. We have to have dozens of permits before we can build housing or start a restaurant. Now, earlier I did a podcast on permissionless innovation. Bureaucracy is permissionful non-innovation, where at every step, the effective cost of doing things are artificially raised by having to wait in line or wait while some bureaucrat processes, and at a very sedate, dignified and majestically unhurried pace they process it all the applications ahead of you. Now, often legislatures want to keep costs low so that they can cap the money prices that bureaucracies charge because people don't like paying money prices. But remember, money price is only part, and often a small part, of the total toil and inconvenience involved.
Speaker 1:It's easy to think of examples You're trying to enter a country after a trip abroad. There's only two stations open at the passport control barrier. Hundreds of people are in line. Now the government could easily hire more passport agents, but that would cost money. Instead, a terrible trouble tax is imposed. People have to wait in line for more than two hours just to have some very sedate, unhurried bureaucrat spend seven or eight seconds looking at a passport and waving you through.
Speaker 1:This is not hypothetical. It happened to me in Charlotte this year. There were literally two agents working. We were told that there's a shortage of inspectors, as if that the result of thunderstorms or some accident. Look, it's not an accident. It's an intentional consequence of trying to save money cost while taxing citizens with enormous costs of trouble and inconvenience. Now, before you write in a letter, I have global entry. Donna did not, and so we had to wait in line. Each of the hundreds of people in line, many of whom missed their connection, would happily have paid $10 or $20, I'd have paid $50, to have a 10-minute wait instead of two hours. If you add up all of the people waiting in line, that would have been thousands of dollars of extra revenue could easily have paid an hour's salary and benefits for five more bureaucrats to process passports.
Speaker 1:This is a government failure. The outcome is Pareto inferior. The new bureaucrats would be better off being paid. Customers would have been happy to pay, but the transaction fails to take place, resulting in what economists call dead weight loss. So this is a classic government failure. There's no Pareto optimum and it happens everywhere. Government failures are worse and more frequent than market failures. I wrote a paper in 2015 with William Keech. It was published in Public Choice about the anatomy of government failure and I'll put up a link to it in show notes. This kind of failure is an epidemic in our current system of government and it's getting worse, not better.
Speaker 1:A friend who has young children recently recounted his experience getting school supplies. Parents were given a specific, mandatory list of items. The pencils had to be of a certain type, no notebooks of certain dimensions. No single store had every particular item that was required, so my friend had to go to multiple stores to buy just a few items at a time. The parents of all 30 kids in the class had to go through this tiresome quest of search and purchase, spending hours they would have paid to avoid. Why doesn't the school buy these items of the correct type and in bulk and then distribute them on the first day of class, as my friend said in the email? Sure, that would cost money, but they can just send me a bill or raise my taxes. Whatever amount offsets the cost.
Speaker 1:It would surely be socially effective to allow a procurement specialist to take care of this, rather than outsourcing it to hundreds of families in the whole school, each of whom is just going to buy one of the items. That's what the money is for. Now, notice that the money cost is the same either way. The parents are going to pay for the supplies. Either they pay directly to the retail store or they pay taxes and have the money go to the purchase of the supplies. Now, actually, since having the school buy in bulk would be cheaper in money terms, the tax cost would be less. Let's ignore that and call it evenin'. So the government cuts money taxes but raises transaction cost taxes by three or four times the amount saved in money. People would happily pay more money for lower transaction costs, but bureaucracy is just unable to process that. It's not that it's possible to reform it. That cat is not going to bark Now.
Speaker 1:In North Carolina, my home state, the need to hire more workers is particularly egregious at the Department of Motor Vehicles In order to get an appointment to renew your driver's license, and you can only get in with an appointment. You have no hope of standing in line. Even if you get there first thing in the morning, they don't clear the line by the end of the day. You could come the next day. The next day you would never get in. So because most of what they are processing are appointments, appointments have to be made at least six months in advance. Now North Carolina General Assembly is proud of its tax cuts and its savings on the DMV budget. The governor has responded by refusing to use what money is available to hire new inspectors and clerks. So, as a result, the average wait time for a driver's license is six months, or it's impossible to get one at all. Of course, it's illegal to drive and impossible to fly without a passport. Can't drive without a real ID driver's license. Citizens have no choice but to pay this trouble tax. It is an artificial requirement. It's not a real service.
Speaker 1:This kind of government failure, driven by the fact that employees of the state focus on money but care nothing about the time of citizens, is a product of monopoly bureaucracy power. There is no reason to make the system more convenient or more efficient. There's no profit incentive. There's no payoff to providing good service. We are all forced, literally at gun point, to line up and accept whatever service the state deigns to provide, having made the service required in the first place.
Speaker 1:Paul Tyne, the new head of the Department of Motor Vehicles in North Carolina, is now a month into the job. He's very busy, working on 85 different projects going to do a lot of reform. This is the head of the DMV. I'm quoting my son had his learner's permit expire because he wasn't able to get into an appointment within six months. This is the head of the DMV. Reform's not going to help. The high transaction cost taxes are the nature of bureaucracy. That cat is just not going to bark the and it's. We're seeing the new trump administration. What they seem to be doing with the obviously ridiculous uh doge theater is not a solution at all. The incentives and folkways of bureaucracy are not partisan. When it's not like we're going to take out all of the people wearing blue hats and replace them with red hats and that's going to make bureaucracy more efficient. It's bureaucracy itself that's holding us back.
Speaker 1:Bureaucracy is the sine qua non of the territorially extensive state. Reminds me of what Chris Rock said. He heard that a tiger in a zoo had attacked a person who had entered the tiger compound. And Chris Rock I will not attempt to do his accent, but Chris Rock said that tiger ain't go crazy. That tiger went tiger. What that means is that the nature of the beast is to act in this way. Tigers eat meat.
Speaker 1:Government bureaus gobble up resources and issue a fog of regulations and rules, and then it takes forever to provide the service that the bureaucrats themselves are requiring citizens to obtain. Trump's bureaucrats aren't going to go crazy, they're just going to go bureaucrat. Bureaucracy cannot be improved. Its performance is simply not comparable with profit-seeking organizations, because the incentives and hierarchies in the two forms are incurably different. Red bureaucracy is not noticeably better, or, in fact, any different, from blue bureaucracy, because bureaus attract colorless people who don't care about providing service. Whoa, that sound means it's time for the twedge.
Speaker 1:I have several quotes about bureaucracy that I found amusing, but these quotes are not really intended to be funny, it just turns out that well, at least I think they are. Joseph Schumpeter, the Austrian political economist Bureaucracy is not an obstacle to democracy, but an inevitable complement to it. That is, if you want to do things through democracy, you're going to deliver things through bureaucracy. You can't avoid it. Democracy, you're going to deliver things through bureaucracy. You can't avoid it. Leon Trotsky, the Russian revolutionary Bureaucracy and social harmony are inversely proportional to each other. What's bizarre is that Trotsky never realized that the system he was advocating for, which was socialism, was inevitably going to use bureaucracy to deliver literally everything. I mean, he didn't want to nail my head to the floor. I had to insist. He wanted to let me off. He was a cruel man, but fair.
Speaker 1:Charles Peters, an American journalist, said bureaucrats write memoranda both because they appear to be busy when they're writing and because the memos, once written, immediately become proof. They were busy. So when Elon Musk and Doge sent out the famous email saying what did you do last week, a lot of bureaucrats probably were able to say well, I wrote these four memos, now you also. Then those things get filed away, used to be in file drawers and manila envelopes. Now they're on a computer drive somewhere. No one ever reads them or looks at them. But that's what I did and writing those memos, that's literally what it says in my job. So I'm doing my job.
Speaker 1:Robert Meltzer, an American artist, said Paperwork is the embalming fluid of bureaucracy, maintaining an appearance of life where none exists. So you have these mummified workers that appear to be alive because they're still producing memos, but there's nothing that involves any kind of actual service, because the supposed service that's being provided is artificial, made up and should be eliminated. Then last, and I'll put up a link to Parkinson's Law, there was an article in the Economist in 1955 on Parkinson's Law, which it's easily worth reading the whole thing. But Parkinson's law is that work expands so as to fill the time available for its completion and therefore the number of workers within public administration, bureaucracy or officialdom grows regardless of the amount of work to be done. So officials want subordinates, not rivals, and officials make work for each other. So if you hire two bureaucrats soon, there's going to be so much work to do that you're going to need eight, ten. And it's not that they're actually providing more of a service they're providing less because they're going to make more and more regulations that are going to force people to wait in longer and longer lines. It's the opposite of service. It's, though, the logic of bureaucracy. Bureaucracy is a cat that will never, never bark, no matter how much we try to reform.
Speaker 1:This week's letter is a listener from Quebec. Hi, mike, I'm listening to your episode on pins and division of labor and it makes me think about how specialization of labor can be misleading, at least in today's economy. It may be that specialization in a particular factory job involves being particularly capable at a rote task laying a brass wire flat but equally, a person who has particular knowledge of law, biology and programming may be, in a sense, exceptionally specialized in the task of using large language models to aggregate medical patents. Multidisciplinary and specialized sounds like they should be opposite, but they're really not. End of letter.
Speaker 1:Well, listener from Quebec, that's absolutely right, in fact, in class, the example that I usually use is in 2010, I had a detached retina. I had surgery using a process that had been developed only 10 or 15 years earlier, at that same Duke clinic, where the person who did the surgery was also a biomechanical engineer and she had helped design some of the lasers that they were using to do the surgery. That's extremely specialized and you are exactly right, that's a consequence of division of labor. So division of labor is also involved in the production and use of knowledge and new techniques. So it is, you're exactly right that division of labor involves both the person who puts the seventh knot on the bolt, that's, in the tenth grommet in a factory, a retina surgeon who has designed a new laser technique because she has enough time and resources to specialize on a very narrow, small medical problem, a particular kind of detached retina.
Speaker 1:So, as a result of that, I have very good vision in my left eye, where 30 years ago I'd be blind in my left eye. Is that of some advantage? Yes, very good vision in my left eye, where 30 years ago I'd be blind in my left eye. Is that of some advantage? Yes, the difference between being blind and not being blind is enormous. All of that comes from division of labor. But, as I talked about last week, division of labor is limited by the extent of transaction costs, the fact that it is possible for this woman to achieve both a medical degree and a degree in biomechanical engineering and to acquire the resources that she needed in order to make these innovations is a demonstration of how important it is to find ways to reduce the permissions and transactions costs that are required in order to achieve innovations. Thanks for that letter.
Speaker 1:The Book of the Week your Body, your Healthcare by Jeffrey Singer, cato Press 2025. Jeffrey Singer is both a policy analyst and a physician another highly specialized because of division of labor kind of activity and the book is both an indictment of and a history of the US health care system and I recommend it. The next episode will be released next week, tuesday, june 17th. We'll have a new topic, some letters and, of course, hilarious new twedges. All that and more next week on Tidy C.