How “Second-Best” Arguments Can Make Things Worse

James Rogers has argued that private-sector unions may be justified because they help compensate for some of the costs of crony capitalism. He acknowledges that the unions are not the first-best solution to crony capitalism, which would be the elimination of government structures that allow some companies to obtain rents. But he argues that in the United States today, many companies exist in imperfect markets in which they earn excessive rates of return. Unions at least can help assure that these excessive profits are more diffusely distributed.

My response here is not so much to disagree directly with my esteemed colleague (although I am not generally persuaded by his case for unions) than to note the problems with this general type of argument, which goes under the name of the “second best.” Second-best claims purport to show that if the social baseline is already distorted, further departures from an optimal baseline may improve the situation rather than worsen it. But such arguments face two very substantial counterarguments: First, it is hard to figure out even in the short-term whether further departures will make things better. And second, in the long-term, introducing more social distortions will make it harder to rely on principled arguments and rally coalitions to move toward the first-best world.

The argument for the second best got its start in economics. A paradigm example from economics comes from the ideal of efficient markets. In general, it is well settled that cartels—firms that do not compete but instead agree on a common price for their products—distort efficient markets. That is why antitrust law makes them illegal. But consider a hypothetical case where a smelter of iron ore is the only smelter for miles around. That monopsony would already distort the efficient sales price for iron ore. If the miners then created a cartel, it is conceivable that their joint action would move the price toward a more efficient equilibrium.

But the argument for the second best is not limited to economics; it can be applied more generally to argue for compensating adjustments that may be suboptimal considered on their own terms but which move an already suboptimal system to a better state. Let’s assume for instance, as I believe, that the best interpretive theory for the Constitution is to follow its original meaning. But further assume that the Supreme Court has already misinterpreted the Constitution when it upheld Congress’ delegations of its legislative power to administrative agencies and, further, that this precedent is too entrenched to be overruled without throwing modern government into chaos.

By providing an alternative to overruling precedents, the possibility of compensating adjustments reduces the pressure to reconsider them and therefore frustrates efforts to revive the Constitution’s original meaning.

It might then be argued that further departures from the original meaning of the Constitution would bring us closer to the values encoded in the Constitution. For instance, if delegations of legislative power provide excessive power to the executive, Congress could impose greater constraints on that power by retaining a legislative veto by which it could disapprove administrative regulations after they are promulgated. To be sure, a legislative veto violates the formal, original meaning of the Constitution by changing the law without presenting a bill for the President’s signature or veto. Nevertheless, despite its unconstitutionality as a matter of original meaning, the legislative veto might be upheld under the theory of the second best as a compensating adjustment for delegations that were themselves excessive, thus returning us closer to the balance of powers contemplated by the original Constitution.

But both these economic and legal examples also illustrate the perils of second-best arguments. There is no certainty that a cartel would move us toward the efficient price. Depending on supply and demand for iron ore, legalizing a cartel may raise the price of ore farther above the competitive price than the monopsony had lowered it. Moreover, even without permitting an otherwise illegal cartel, normal market forces would encourage other companies to enter the smelter market because they would benefit from the low price, ultimately moving the market to equilibrium.

The legislative veto example also illustrates some of the costs of second-best arguments, as Mike Rappaport and I have shown elsewhere. First, allowing a legislative veto would encourage additional and broader delegations because the legislative veto allows members of Congress more power to control such delegations. As a result, it is difficult to know whether the legislative veto would increase or decrease the overall amount of executive discretion.

Moreover, updating through compensatory adjustments ensures that every nonoriginalist precedent has potential ripple effects, greatly magnifying the distortions that such precedent has on the Constitution’s original meaning. Each new nonoriginalist resolution can form the basis for more compensatory adjustments in favor of further nonoriginalist decisions. In the real world, second-best originalism becomes the first best recipe for a feast of nonoriginalism. Finally, by providing an alternative to overruling incorrect precedents, the possibility of making compensating adjustments reduces the pressure to reconsider them and therefore frustrates efforts to revive the Constitution’s original meaning. This latter point underscores a general problem with the second-best argument: it may diminish the power of the ideal of the first best.

Rogers’ argument for labor unions has some of the same problems. It is not clear, even statically, that unions get us to a better world. First, in the short run, the higher-than-efficient wages that unions prompt have ripple effects: they would draw people from other jobs where they would add more to the overall productivity of the nation. Over time these ripple effects would increase: they would also make it less important to acquire relevant skills because one could get high-wage, but relatively non-productive jobs protected by the union.

Moreover, crony capitalism is not the only reason that companies earn above-market rates of return. Super-competitive profits earned for a period reward and encourage innovation in technology and business methods that make a firm the market leader. As a result, it is not even clear to me whether crony capitalism is currently the largest cause of higher-than-market returns. But unionization is likely to cut into both kinds of returns and thereby diminish incentives for market-changing innovation.

Even more troubling are the long-run effects on reform of crony capitalism. Unions are likely to impede that effort because they are getting a share of the rents. Worse, they will also tend to increase the scope of crony capitalism. Take the issue of free trade. Domestic manufacturers would like to prevent competition from abroad. They are a concentrated interest group that can often defeat the diffuse interests of consumers and get higher tariff barriers. But they will be even more likely to succeed if they are joined in their efforts by a union that cannot only lobby but also get out the votes of its members. And this power becomes disheartening to those who want to press for the free trade ideal. They are then likely to make less of an effort to realize it.

This analysis does not rule out the possibility that the second best can be better in some circumstances. But the departure from ideals has very substantial costs that create at least a presumption against it in the absence of compelling evidence of its necessity. It is hard to be sure second-best arguments create benefits even in the short run. And in the long run, they sap the vitality of our ideals.