On the limits of price theory as punishment theory

When debating theories of punishment, frequently one hears metaphors rooted in free-market capitalism's classical price theory, where punishment is considered the "price" for certain aberrant behavior and (theoretically) a higher price supposedly deters the unwanted behavior.

In financial circles, though, critiques of those very theories have been thrust to the center of national debates over the economic collapse and a road to recovery less reliant on bubbles and unsustainable debt loads. Former Fed Chair Alan Greenspan famously recanted from the laissez-faire worldview that animated and drove his entire career. Even 7th Circuit Judge Richard Posner, the judiciary's most radical free market advocate, has taken to reading and advocating ideas from John Maynard Keynes and frankly discussing the limits of theories of "perfect competition" based on rational action by self-interested consumers.

For those who didn't waste much of their college years, as I did, sitting in economics classes, here's the boiled down list of seldom-satisfied assumptions which must be true for classical economic theory to work (adapted from Wikipedia):

• Large Numbers of Buyers and Sellers – Oligarchies or monopolies among either producers or consumers skew results and reduce efficiency.
  
• Zero Entry/Exit Barriers – It's relatively easy to enter or exit as a business in a perfectly competitive market.
• Perfect Information - Prices and quality of products are accurately known by all consumers and producers.
• Transactions are Costless - Buyers and sellers incur no costs in making an exchange.
• Profit Maximization - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.
• Homogeneous Products – The characteristics of any given market good or service do not vary across suppliers.

So "perfect competition" in economic theory assumes a number of conditions are true that, in practice, frequently are not.

Often there are only a few large producers or, in the case of services provided to government, only a single consumer. Some businesses - drug companies, for example, have multi-billion startup costs for anyone who wants to directly compete with the pharmaceutical oligarchs.

"Perfect information" is the most ridiculous assumption on the list - the biggest reason for "bubbles" in the market is that nobody knows the real quality or value of investments like "derivatives," real estate, or many other products. In oligarchical settings (where there are few producers), "profit maximization" may go out the window in deference to other goals like driving competitors out of the market and maximizing market share. And deviations among products (the relative perceived quality of Honda vs. Toyota vs. Ford vs. Chrysler, for example), make the model inapplicable to many products compared to, say, agricultural commodities where, at the end of the day, wheat is wheat. (See a longer list of criticisms here.)

Viewed through this lens, free-market price theories don't even work well in most real-world consumer markets. But they apply even less so to crime and punishment, where none of these assumptions are true. According to this ill-conceived metaphor, the crime rate represents demand for illegal behavior, the "price" for which is the level of punishment. What's more, the government is the supplier not of the thing "demanded" by consumers, but of punishment (read: price), which uncouples the relationship between supply and demand beyond recognition in traditonal economic terms. Let's run through the various, flawed assumptions on punishment as price-setting in the criminal justice system.

First, while there is near-infinite demand for illegal behavior, there is a monopoly on punishment vested with the government. Moreover, "barriers to entry" are not just high but insurmountable: Private interests by law cannot mete out justice, only the government.

Debates over "innocence" show that the justice system no more enjoys "perfect information" than participants in commercial markets. And not only are transactions not "costless," it costs an increasingly large amount to bring forward and adjudicate cases.

Further, the goal of the justice system is not profit maximization, but an array of more subjective social goals - from public safety to retribution to pandering to special interests - that frequently, readily ignore cost-benefit goals. And far from a "homogenous product," punishments meted out in the justice system are, and should be, individualized to the defendant.

Finally, and most importantly, since the "price" paid by consumers of illegal behavior is mostly loss of liberty - not money - a price theory of criminal justice presents the unique situation where the supplier of justice (the government) pays, not the consumer (the defendant, for whom the "price" of punishment is set), turning economic theory on its head.

Given these flawed assumptions behind punishment as the "price" for misbehavior, it's little wonder that higher "prices" don't generate the best results in terms of reducing crime. In fact, though crime has been declining nationally in recent years, that trend appears to be disconnected with incarceration rates, or even inversely related.

Adam Gelb of the Pew Center on the States points out (pdf - p. 8) that from 1997 - 2007, Nevada, Louisiana and Minnesota all saw their crime rates decline 25%. By contrast, Nevada's incarceration rate declined 3% over the same period, Louisiana's increased by 29%, and Minnesota's increased by a staggering 60% to achieve the same result. What's more (p. 9) states that reduced their incarceration rates saw the biggest drops in crime, even though nationally incarceration rates skyrocketed over this period.

So the price theory of deterring criminals doesn't work any better for reducing crime than it does establishing the value of derivatives in the financial market. Like derivatives that had to be bailed out by the feds as "toxic assets," everyone believes the criminal justice system has value, but it's difficult to concretely define what that is and by all appearances, we've been paying to much for it, with diminishing benefit to the public from greater expenditures.

We're at the end of a three-decade long incarceration "bubble" that dwarfs that witnessed by any other society in history. Perhaps, just as folks are rethinking their reliance on free-market ideology for analyzing the economy, the criminal justice system should be rethinking its reliance on this primitive, flawed metaphor based on the same principles. After all, it's taxpayers paying the price, which it turns out is not the same thing as enduring the punishment.

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