Are Transaction Costs Really Just Human Distance

We connect Adam Smith’s moral psychology to the modern idea of transaction costs and argue that the biggest frictions in markets start with the cost of understanding other people. We show how sympathy, propriety, self command, and reputation turn separate perspectives into workable cooperation and why justice is the real precondition for a stable commercial order. 
• why transaction costs always exist and why institutions matter when exchange is costly 
• a brief history of the term from Coase to an early use in Scitovsky 
• transaction costs as asymmetric information and the cost of social coordination 
• Smith’s epistemic distance and why sympathy requires imaginative effort 
• propriety as social calibration through the impartial spectator 
• self command as the price of being socially intelligible 
• commerce as a practical school for restraint, trust, and predictability 
• the prudent man as a model of conduct that reduces suspicion and monitoring 
• Buchanan’s moral community, moral order, and moral anarchy as lenses on social stability 
• why society can survive without beneficence but not without justice 
• a listener’s college admissions case where interviews act as a separating equilibrium and improve aid allocation 

Links:

• Liberty Fund eBook--Theory of Moral Sentiments (PAGES DO NOT MATCH UP WITH PRINT EDITION!)
• TAITC with Steve Medema, on Coase and Transaction Costs
• Dan Klein and Russ Roberts on Theory of Moral Sentiments
• Tibor Scitovsky, 1940, Economica paper
• Gustavo Dudamel’s ‘the wealth of nations’ Melds Opera and Economics - Bloomberg 

If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !

You can follow Mike Munger on Twitter at @mungowitz 

Transcript

SPEAKER_00 0:02

This is Mike Munger, the knower of important things from Duke University. This month, an Adam Smith Lanya. What did Adam Smith think about transaction cost? And how is that a conception that might still be useful today? A new twedge, this month's letters, Book at a Month, and more. Straight out of Creedmoor, this is Tidy C.

SPEAKER_02 0:25

I don't think they talk about a system where there was no transaction cost. It's an imaginary system. There always are transaction costs.

SPEAKER_01 0:35

When it is costly to transact, institutions matter. And it is costly to transact.

Where Transaction Costs Come From

Smith On Asymmetric Information

Propriety And The Impartial Spectator

Self Command As Social Price

Commerce As A School Of Morals

The Prudent Man And Trust

Buchanan And Moral Order Vs Anarchy

Why Justice Makes Markets Possible

Twedge Joke About The State

SPEAKER_00 0:46

Well, as you may remember, I spent 10 episodes talking about Adam Smith and the wealth of nations. A number of listeners have asked what Adam Smith has to do with transaction costs, the supposed subject of this podcast. I thought the answer was obvious, but maybe being obvious to me is not the same as being obvious to others. And I could be mistaken. But if I'm right, how can others fail to see the connection? Well, it struck me that the answer is transaction costs, in particular, imperfect and asymmetric information. Now the phrase transaction cost is not Adam Smith's, but the idea is everywhere in the theory of moral sentiments. If we translate Smith into modern language, transaction costs are the real cost of achieving social coordination among beings who do not have direct access to one another's minds. The cost of learning another person's situation, interpreting motives, communicating clearly, restraining one's own passions, earning trust, preserving reputation, and making one's conduct intelligible to an impartial spectator. Some folks have asked about the origins of the idea of transaction cost in economics. The usual answer is Ronald Kose's 1937 The Nature of the Firm in Economica. But Coase never used that exact phrase. Instead, he said there is a cost of using the price mechanism, and he added that the cost of negotiating and concluding a separate contract for each exchange transaction must also be taken into account. But Kose was notoriously averse to defining transaction cost. There's also some other history to the concept, as was discussed in episode 27 in season one with Stephen Medima. I was interested to find the first serious use, that is the earliest documented use of the exact phrase transaction costs, in the economics literature. It appears to be, although readers correct me, but it appears that the first use was Tybor Skytovsky's piece in Economica in 1940, just three years after Kosa's piece in the same journal. Title of the article was A Study in Interest and Capital. And the way that Sketovsky described transaction cost is interesting. Quoting, the problem is in what order does the risk range in the different types of securities? Pause quote for a minute. He means how are the prices different? Back to the quote. Since all securities promise the future payment of money sums, money itself must occupy the first place as the completely riskless security. Guilt-edged securities come next. Their nearness to money seems to be the most satisfactory explanation of the great stability of the guilt-edged rate. We have not yet explained, however, the relatively high level of the guilt-edged rate. One reason must be liquidity preference. Another, perhaps equally important one, seems to be the high transaction costs, parenthesis, brokerage charges, stamp duties, commissions, etc., on long-term securities. Assuming a certain stability in the frequency of transactions, this would be an element in long-term rates, which is independent of tastes and relative quantities. End of quote. The point of liquidity preference is his next description. The reason that I hold cash instead of the best, well, we would now say triple A, but for the British was guilt-edged securities, was that it is expensive because of brokerage charges, duties, commissions, and so on to go back and forth. And so if you have one of those, you'll just hold on to it. But that means that since you're not going to convert it to money, because it the guilt-edged securities are not really exactly money, they pay a slightly higher rate of return. Even though they themselves are almost riskless, they're not quite money. So Sketovsky is explaining why investors may prefer cash rather than shifting assets back and forth across securities markets. And he says the answer is transaction cost. That's already very close to the modern meaning, the frictions and expenses of carrying out exchange. But the origins of the phrase aside, Smith's theory of moral sentiments was the first great work that recognized the importance of transaction cost in a commercial society. In particular, the cost of negotiating and enforcing agreements to cooperate in the face of asymmetric information. Smith's starting point is epistemic distance. Human beings simply cannot read off another's intentions or experience. As Smith puts it, we have no immediate experience of what other men feel. We can form no idea of the manner in which they are affected, but by conceiving what we ourselves should feel in the like situation. Though our brother is upon the rack, as long as we ourselves are at our ease, our senses will never inform us of what he suffers. They never did and never can carry us beyond our own person, and it is by the imagination only that we can form any conception of what are his sensations. Neither can that faculty help us to this in any other way than by representing to us what would be our own if we were in his case. That's on page two of Theory of Moral Sentiments. Close quote. We transact with separate persons, each locked within his own standpoint. And one basic obstacle is always asymmetric information. I do not simply believe what another person appears to feel or claims to claim to feel. I evaluate it. I try to put myself in that situation and to gauge whether their feelings are consistent with the broader way that one is supposed to feel and supposed to act in that situation. Sympathy, therefore, is possible only through imaginative effort. Even before we get to markets, contracts, or bargaining, Smith's moral psychology begins from the fact that human coordination is costly because understanding is costly. That's why Smith insists that mere emotional display is not enough. Quoting from page three. Sympathy, therefore, does not arise so much from the view of the passion as from that of the situation which excites it. An angry man, before we know the provocation, repels us more than he attracts us. A grieving person may stir only weak, fellow feeling until we know what happened. In modern terms, Smith is saying that one major transaction cost is informational. Others must know the relevant circumstances before they can judge or cooperate. Social life therefore requires narration, explanation, and contextualization. We must tell others what has happened. They must take time to consider it. Without those efforts, the sentiments of speaker and hearer do not converge. Smith then defines propriety in a way that makes this social calibration central. On page six of Theory of Moral Sentiments, he says, in the suitableness or unsuitableness, in the proportion or disproportion which the affection seems to bear the cause or object which excites it, consists the propriety or impropriety of the action. And the standard of judgment then is social, rather than purely inward. Continuing on page seven. If upon bringing the case home to our own breast we find that the sentiments which it gives occasion to coincide and tally with our own, we necessarily approve of them, as proportioned and suitable to their objects. If otherwise we necessarily disapprove of them, as extravagant and out of proportion. Every faculty in one man is the measure by which he judges of the like faculty in another. I judge of your sight by my sight, of your ear by my ear, of your reason by my reason, of your resentment by my resentment, of your love by my love. I neither have nor can have any other way of judging about them. And again, that's from page seven. So propriety is not merely sincerity. It's not enough that I really feel something. My feeling must be brought into a proportion that another person, imaginatively informed, can go along with. This proportion is judged and filtered through the impartial spectator. So even if you claim to feel a pain or a joy, and my immediate reaction is to go along or disagree, my impartial spectator is trained to temper or expand my reaction to the proper proportion based on the overall cultural propriety of those sorts of activities. The cost of achieving that correct proportion is one of Smith's most important transaction costs. This becomes clearest in cases of injury, grief, and resentment. Smith says that when something affects me personally, quoting, my companion does not naturally look upon the misfortune that has befallen me from the same point of view in which I consider it. Close quote. For harmony to arise, the spectator must work. He must, quoting, endeavor as much as he can to put himself in the situation of the other and to bring home to himself every little circumstance of distress. He must adopt the whole case of his companion, with all of its minutest incidents. Again on page eight. But the sufferer must also work. He cannot simply demand that others feel exactly what he feels. Smith's crucial sentence is that the sufferer, quoting, can only hope to obtain this by lowering his passion to that pitch in which the spectators are capable of going along with him. He must flatten the sharpness of its natural tone, end quote. So that's one of the most revealing passages in all of Smith. Self-command is not just stoicism. Self-command is the price of social intelligibility. It's not doing it for the moral sake of not showing your feelings. It is recognizing that you have an obligation to participate in society according to the rules of propriety. Smith makes the point even more explicitly when he says, though they will never be unisons, they may be concords, and this is all that is wanted or required. Close quote. So what's interesting about that is he's using a musical metaphor, and not everyone has to hit the same note. We can hit different notes, but those notes need to be perhaps something we would now call a chord, or different notes that sound good together rather than something that is discordant. This is a remarkably economical conception of social order. Human beings do not need perfect identity of feeling. What they need is enough fit, enough concord, as Smith said, enough shared measure to sustain the harmony of society. That's exactly how a modern economist might think about transaction cost, not the elimination of difference, but the reduction of frictions to a workable level. So Smith's concern is not some mystical union, it's just practical alignment sufficient to generate cooperation. That explains why self-command is so central to daily life. Smith says on page nine, we always endeavor to bring down our passion to that pitch, which the particular company we are in may be expected to go along with. And that will cause you to modulate the extremity of those passions. Smith links propriety and virtue through a two-sided adjustment. Upon these two different efforts are founded two different sets of virtues, the amiable virtues of sympathy on one side and the virtues of self-denial, self-government on the other. Close quote on page nine. The key virtue for hard cases is precisely the power to bring one's passion down to what others can enter into. Even resentment, if proper, is guided not by the sufferer's rage, but what the impartial spectator would approve. On page 10, he says that resentment allows no word, no gesture to escape it beyond what this more equitable sentiment would dictate. Close quote. So resentment, when it is justified, can even be morally admirable, but it can't be excessive. It cannot go over into rage. So instead of waiting others to rebuke me, I, in effect, rebuke myself in advance. I internalize the external judge. That makes cooperation cheaper and conflict less destructive. The connection to commerce becomes explicit later in theory of moral sentiments. On page 62, Smith writes that quoting, when the happiness or misery of others indeed in no respect depends upon our conduct, when our interests are altogether separated and detached from theirs, so that there is neither connection nor competition between them. We do not always think it so necessary to restrain either our natural and perhaps improper anxiety about our own affairs, or our natural and perhaps equally improper indifference about those of other men. The most vulgar education teaches us to act upon all important occasions, with some sort of impartiality between ourselves and others. And even the ordinary commerce of the world is capable of adjusting our active principles to some degree of propriety. But it is the most artificial and refined education only, it has been said, which can correct the inequalities of our passive feelings. We must for this purpose, it has been pretended, have recourse to the severest as well as to the profoundest philosophy. It's a pretty remarkable claim. It makes me think of James Odison's work in his book Adam Smith's Marketplace of Life, where he argues that Smith's method is Newtonian and observational. The philosophers who use a different method may some may say some true things, but they can't get to the truth through theorizing. Smith's argument is primarily empirical. So commerce is not here opposed to morals. It's not the opposite of morality. Commerce is one of the practical schools in which morals are learned. Repeated dealings with others teach us not to act from our own immediate passion alone. Smith deepens the point when he says that the child, quoting, enters into the great school of self-command, close quote, by learning to moderate, feeling to what companions can accept, and that the fully formed person carries this discipline, quoting, in the bustle and business of the world. So it becomes a habit. This is quite an Aristotelian riff. This self-command and the ability to make yourself act according to propriety becomes such a habit that you don't really notice it. You just carry it into the bustle and business of the world. So business is not only an arena where self-command is useful, it is partly the arena that actively forms self-command and propriety. Smith's portrait of the prudent man, it's kind of long, but it's worth quoting at length, shows how moral and commercial transaction costs intersect. Quoting, we suffer more, it has already been observed, when we fall from a better to a worse situation than we ever enjoy when we rise from a worse to a better. Security, therefore, is the first and the principal object of prudence. It is averse to expose our health, our fortune, our rank or reputation to any sort of hazard. It is rather cautious than enterprising, and more anxious to preserve the advantages which we already possess than forward to prompt us to the acquisition of still greater advantages. The methods of improving our fortune, which it principally recommends to us, are those which expose us to no loss or hazard. Real knowledge and skill in our trade or profession, assiduity and industry in the exercise of it, frugality and even some degree of parsimony in all our expenses. The prudent man always studies seriously and earnestly to understand whatever he professes to understand, and not merely to persuade other people that he understands it. Though his talents may not always be very brilliant, they are always perfectly genuine. He neither endeavors to impose upon you by the cunning devices of an artful imposter, or by the arrogant airs of an assuming pedant, or by the confident assertions of a superficial and impudent pretender. He is not ostentatious even of the abilities which he really possesses. His conversation is simple and modest. He is averse to all the quackish arts by which other people so frequently thrust themselves into public notice and reputation. Let me pause the quote there for a second. So this is partly aspirational. So when Smith is describing the prudent man, and all of this is on page 99, by the way. So when Smith is describing the prudent man, he's partly trying to give an empirical description. But he's also saying that this is something to which we should all aspire, because we are trying to develop our characters. And in fact, we might think of our characters as being our personal entrepreneurial project. That's one of the main things that we should be working on, is improving our characters. Well, back to the quote. Prudent man is always sincere and feels horror at the very thought of exposing himself to the disgrace which attends upon the detection of falsehood. But though always sincere, he is not always frank and open. And though he never tells anything but the truth, he does not always think himself bound when not properly called upon, to tell the whole truth. As he is cautious in his action, so he is reserved in his speech, and never rashly or unnecessarily obtrudes his opinion concerning either things or person. End of quote. And as I said, that was on page ninety-nine. He then continues, and this is something that Dan Klein has actually called attention to. In my own experience, I have long thought that in academic administration, one disqualification should be an actual desire to be an academic administrator. We all recognize we need administrators, and being in a department with a good administrator is much better than if you're in a department led by a bad administrator. But no one who has any sense should want to be an academic administrator. And so when it comes your turn to do it, you should do it and do it well. That's that Smith's prudent man doesn't want to be in charge of other people, but when asked to be in charge of other people, he works on it hard and does a good job. Back to the quote on page 99. He, the prudent man, is sincere, cautious in speech, and unwilling to assume needless responsibility. The prudent man is not willing to subject himself to any responsibility which his duty does not impose upon him. He is not a bustler in business where he has no concern, he is not a meddler in other people's affairs, he's not a professed counselor or advisor who obtrudes his advice where nobody's asking for it. He confines himself as much as duty will permit to his own affairs, and has no taste for that foolish importance, which many people wish to derive from appearing to have some influence in the management of those of other people. He is averse to enter into any party disputes, hates faction, and is not always very forward to listen to the voices even of noble and great ambition. When distinctly called upon, he will not decline the service of his country, but he will not cabal in order to force himself into it, and would be much better pleased that the public business were well managed by some other person. That ends on page 100, close quote. That last sentence is great. Would be much better pleased that the public business were well managed by some other person. I've heard many people say if I could somehow clone myself and my clone could be department chair, that would be ideal. So I don't want to be department chair myself, but given that there's not really an alternative, I'll go ahead and do it. But I would prefer that someone else would do the things that I think are right and I not have to do it. There are many academic administrators that don't really care that much about what they do. What they care about is having the title and the power to order other people around. These are not merely personality traits. This is Smith's account of how trustworthy conduct lowers the cost of dealing with others. Skill reduces uncertainty. Frugality reduces hazard. Sincerity reduces suspicion. Reserve reduces needless offense. Reputation substitutes for constant monitoring. In short, the prudent man makes social and commercial exchange smoother because he's predictable, competent, and decent. The bridge to the wealth of nations is therefore strong, even when Smith does not use the same vocabulary. Theory of moral sentiments supplies the moral psychology that makes market society workable. In wealth of nations, exchange requires people to address others as independent agents, whose consent must be won, not as instruments to be pushed around. Theory of moral sentiments explains the inner disciplines that make that possible sympathy, propriety, prudence, reputation, and above all, self-command. Smith's transaction cost in this broad moral sense are the costs of turning separate, partial, self-involved persons into beings capable of concord. Markets later economize on some of these costs through rules, prices, and institutions, but the human foundation is already in theory of moral sentiments. For Smith, commerce works best, not when people cease to have passions, but when they learn how to render their passions legible, proportionate, and trustworthy to others. So the best concise answer is to the question, what does Smith think about transaction costs? For Smith, transactions costs are the frictions created by separateness of perspective. Because I cannot directly feel your feelings or know your intentions, and you cannot directly feel mine, we must spend effort on imagination, explanation, judgment, restraint, and importantly, reputation. Smith uses that idea to explain propriety. Passions are proper when they can be shared from the standpoint of a spectator. And he uses it to explain self-command. We flatten and moderate passion so that others can go along with us. And he uses it to explain daily life and commerce. The ordinary intercourse of the world educates us into predictability, prudence, and social trust. That's why the theory of moral sentiments can be read very plausibly as Smith's deepest account of the moral origins of low transaction cost social order. This notion of a low transaction cost social order, James Buchanan later divided into three categories moral community, moral order, and moral anarchy. Now a moral community is one where we can all trust each other because we all know each other and we care about each other and we care about other people's opinions of us. A moral order lacks those personal connections, but we are all committed to the idea of justice and our commitment to the fact that the rules work. Moral anarchy is one where we don't even really care about the rules when we try to cheat on every margin. And the sort of person in a moral anarchy is very close, unfortunately, to the kind of person that modern economics thinks of as homoeconomicus, someone who tries to maximize on every margin without regard to what other people think of her. Buchanan is really summarizing, and he says this explicitly, Adam Smith's remarkable insight. And this is my favorite passage in all of theory of moral sentiments. It is quite long. I apologize for quoting it, but it is worth quoting because it is a remarkable insight. Quoting, it is thus that man, who can subsist only in society, was fitted by nature to that situation for which he was made. All the members of human society stand in need of each other's assistance and are likewise exposed to mutual injuries. Where the necessary assistance is reciprocally afforded from love, from gratitude, from friendship and esteem, the society flourishes and is happy. All of the different members of it are bound together by the agreeable bands of love and affection, and are, as it were, drawn to one common center of mutual good offices. So pause there for a second. That's a moral community. We are all bound together by the agreeable bands of love and affection, and drawn to one common center of mutual good offices. But Smith goes on and says you can't really expect moral community. And something like a moral order is enough, going back to the quote now. But though the necessary assistance should not be afforded from such generous and disinterested motives, though among the different members of the society there should be no mutual love and affection, the society, though less happy and agreeable, will not necessarily be dissolved. Society may subsist among different men as among different merchants, from a sense of its utility without any mutual love or affection, and though no man in it should owe any obligation or be bound in gratitude to any other, it may still be upheld by a mercenary exchange of good offices according to an agreed valuation. Society, however, cannot subsist among those who are at all times ready to hurt and injure each other. So pause the quote again for a minute. So the first part, where he's talking about a mercenary exchange of good offices, we're all committed to keeping the rules because we're committed to justice. That's what Buchanan called a moral order. A moral anarchy is those who are at all times ready to hurt and injure each other. Back to the quote. The moment that injury begins, the moment that mutual resentment and animosity take place, all the bands of it are broken asunder, and the different members of which it consisted are, as it were, dissipated and scattered abroad by the violence and opposition of their discordant affections. If there is any society among robbers and murderers, they must at least, according to the trite observation, abstain from robbing and murdering one another. Beneficence, therefore, is less essential to the existence of society than justice. Society may subsist, though not in the most comfortable state, without beneficence, but the prevalence of injustice must utterly destroy it. And then Smith delivers the real message, which is fascinating. He talks about the Chinese earthquake and the little finger example, which I commend to you, but is beyond our scope in this podcast. But so after he has pointed out that we care more about losing our little finger than we would about a hundred million people dying in a faraway earthquake, he asks the money question. And here it is, quoting, When our passive feelings are almost always so sordid and so selfish, how comes it that our active principles should so often be generous and noble? When we are always so much more deeply affected by whatever concerns ourselves than by whatever concerns other men, what is it which prompts the generous upon all occasions, and the mean upon many, to sacrifice their own interest to the greater interests of others? It is not the soft power of humanity. It is not that feeble spark of benevolence which nature has lighted up in the human heart, that is capable of counteracting the strongest impulses of self-love. It is a stronger power, a more forcible motive which exerts itself upon such occasions. It is reason, principle, conscience, the inhabitant of the breast, the man within, the great judge and arbiter of our conduct. It is he who, whoever we are about to act so as to affect the happiness of others, calls to us with a voice capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it. When we prefer ourselves so shamefully, so blindly to others, we become the proper objects of resentment, abhorrence, and execration. It is from him only that we learn him meaning the impartial spectator, the person inside us, our conscience, our character. It is from him only that we learn the real littleness of ourselves, and of whatever relates to ourselves and the natural misrepresentations of self love that can be corrected only by the eye of this impartial spectator. It is he who shows us the propriety of generosity and the deformity of injustice, the propriety of resigning the greatest interests of our own for the yet greater interests of others, and the deformity of doing the smallest injury to another in order to obtain even the greatest benefit to ourselves. It is not the love of our neighbor, it is not the love of mankind, which upon many occasions prompts us to the practice of those divine virtues. It is a stronger love, a more powerful affection, which generally takes place upon such occasions. The love of what is honorable and noble, of the grandeur, dignity, and superiority of our own characters. So that's from part three, chapter three in Theory of Moral Sentiments. Well, what's great about that passage is that it actually reconciles the a lot of what seems like the contradictions of theory of moral sentiments with the later story of self-interest in Wealth of Nations. And this is what James Odison's Adam Smith's Marketplace of Life picks up on so well. This is the solution to the false dichotomy that's often posed as das Adam Smith problem. Smith explained that society evolved norms, rules, and guidelines for self-command. A society peopled by such citizens would have a strong concern for justice, defined as abstaining from what is another's. In such a society, the practices of commerce would be far less costly and much more efficient. In fact, it's possible to go so far as to say that without this concern for justice, if people were instead to act like the solipsistic caricature assumed as homo economicus, the society could not survive in a liberal state. It would collapse into authoritarianism. So as Smith put it in the quote above, but I want to say it again, society may subsist, though not in its most comfortable state without beneficence. But the prevalence of injustice must utterly destroy it. We don't need beneficence. When in the Wealth of Nations, Smith says we do not depend on the benevolence of the butcher, the baker. That's right. And he's actually saying in theory of moral sentiments, we're not depending on beneficence. What we're depending on is people's self-interest in being able to look at themselves in the mirror. So he is saying that we internalize the way that we are perceived by others and we want to deserve any merit other people perceive in us. That's enough to reconcile us to moral order. And that, like concord, is generally all that society needs. So a just society is one where the citizens have mastered themselves, not where self-command provides a full moral community. A full moral community isn't necessary. And in fact, it's been argued earlier that the need to operate at scale, in an earlier podcast, when I've talked about division of labor, the need to operate at scale precludes that kind of community in many cases. The collapse of nations into injustice, as in the former Soviet Union, meant that the attempt just let there be markets, without any of these preconditions, without any of Smith's notion of propriety being internalized in the way that people deal with each other, meant that markets had no chance of succeeding. The let there be markets claim was just doomed to failure. Because, like Smith said, the prevalence of injustice must utterly destroy any chance of commercial emergent order. And that's Adam Smith's notion of transaction costs. Whoa, that sound means it's time for the twedge. Bernie Sanders, Karl Marx, and Adam Smith all die and arrive at the gates of heaven. St. Peter says, Look, before I let you in, I have one classifying question. What should the state do? Well, Bernie, of course, steps forward first. Well, that's simple. The state should know where everyone is, what everyone has, what everyone needs, and what everyone is paying. Only then can things be fair. Marks interrupts impatiently. That is not enough. The state must not nearly know everything. It must direct. It must direct production, distribute goods, organize labor, and abolish exploitation. In short, it must do everything, not just know everything. Adam Smith smoothed his woolen coat and said, Well, I guess I have a different view. The state should provide defense, domestically and against foreign invaders, should administer justice, provide dispute resolution mechanisms, provide the few public goods that markets can't provide and that benefit everyone. After that, the state should do little, and it should know even less. Saint Peter thinks for a moment and he says, That's interesting. We actually we're set up for this. We have three doors, one for each of you. He points to the far left. Bernie, down those stairs is a place where every action is recorded, every appetite is monitored, and everyone fills out forms every day forever. Bernie asks, Well, is it equitable? And C. Peter says, Well, yes, because everyone has to fill out the same documents. And then Saint Peter points to the middle door. Carl, down those stairs is a place where central authority assigns every task, every ration, plans every job, and dictates every opinion. And Mark smiles. Oh, at last. Paradise. And Saint Peter shakes his head ruefully. Well, no, not exactly. You'll notice that both Bernie's vision and Carl's vision lead, well, downward, though in different directions. Way, way downward. We couldn't make those systems work in heaven. Not even God knew enough. And then St. Peter turned to Adam Smith. Your door is right there on the right. There's a short flight of stairs going up. Welcome to heaven. The book of the month this month is by Alex Rosenberg. It's called Blunt Instrument: Why Economic Theory Can't Get Any Better and Why We Need It Anyway. It was published in 2025 by MIT Press. And we have two letters. First, from BR. Hi Mike, congratulations on your terrific series on Adam Smith. I am now going through it for the second time. There'll likely be a third. In the unlikely event you haven't already seen this, Bloomberg reports today, finally an opera about economics. Superstar conductor Gustavo Dudamel takes on the wealth of nations. Here's the link, and I'll put the link up in show notes. Keep up the great work, and I look forward to the next Tidy C. Signed BR. Well thanks, BR. No, I'd not heard of that opera, but I'm happy to share the link and thanks very much for listening. Letter two. Hi Mike, I'm writing because I'm catching up on the backlog of Tidy C. Specifically, your episode that came out August 27th, 2024, a listener writes asking about what seems to be the extremely costly practice of interviewing college applicants. As it turns out, I work at a private university that enacted an interview policy in a quasi-random way, and the university president gave me permission to share. Initially, my university did not interview standard applicants. Our aid packages were poorly designed because applicants tend to look similar on paper. There's a pooling equilibrium at the application stage. That is, we you can't tell people apart, they all pool together. As a result, we accepted nearly everyone and offered some generous aid packages to students who were actually not good mission fits, and we neglected some who would have been terrific for our school. Aid packages are a scarce resource and we didn't have enough information to economize on them well. The situation was impossible for the admissions team. The amount of aid that they could award was endogenous to the number of applicant deposits because student attendance drives revenue. But the deposits were themselves endogenous to the aid packages that were offered. There's a separating equilibrium where some fine students attended along as well as the students who were a poor fit and were over awarded aid. They attended one semester before departing the university, which harmed our retention revenues. Great, but underrewarded students didn't attend our university. Student morale was also low due to poor fits and their friends leaving. Partway through an admission cycle, we instituted universal scheduled mission fitness interviews after the online application form was completed. The interviewer would rate the applicant on multiple margins. The interview was a prerequisite to receiving an aid offer. Suddenly we had our separating equilibrium. Low desire students wouldn't even bother with the interview scheduling. High desire students would. Almost everyone scored well on the interview because the filter was mostly the scheduling of the interview itself. The university could now target aid packages much better and attract quality students of good mission fitness. Retention and revenue improved along with student morale. So for my university, interviewing applicants was relatively cheap given that first, the subset of Mission Fit students overwhelmingly self-selected to be interviewed, while the poor mission fit students didn't bother to interview at all. And two, the interview solicited useful information to help allocate the scarce tuition aid dollars. This alone paid for the cost of the interviews. But the downstream effects on retention, revenue, and morale made the interviews a permanent part of our admissions process. I mentioned the quasi experiment when the interviews became policy. The students who had been accepted in the same year but prior to the interview policy had all of the prior worse stats, worse GPA, retention, and rates of deposit. Students who happened to apply just after the policy was enacted and who scheduled an interview had far better stats. In this case, the transaction cost of scheduling and participating in interview was the only sensible thing to bear for those students who most desired to attend. I love the show, ZB. Well, thanks, ZB. That's really interesting. I appreciate the actual information from someone on the inside. It's always better, as Ronald Coast said, to try to figure out how things actually work rather than speculating about it. So I appreciate the letter. Well, that's it for this episode of March of 2026. The next episode in April will be with Anya Shortland, professor at King's College, London. This marks her second appearance on Tidy C. The first was February 27, 2024, on the economics of ransomware and cybersecurity. This time we'll talk about her new book on ransomware entitled Dark Screens. It'll be out in the U.S. on April 28th, and Professor Shortland was kind enough to give us a peek inside.