John Stuart Mill on Freedom of Contract

Allowing freedom for an individual to do as she or he chooses within a certain sphere suggests also allowing freedom for groups of individuals to interact with one another as they all choose within a certain sphere of actions. (I wrote about this before in The Free Market and Collective Liberty.) Several issues arise:

  1. protecting people from being sold out by their past selves

  2. social enhancement of people’s ability to make commitments

  3. protecting people from mistakes of their past or current selves

  4. the temptation to obstruct freedom for the sake of pecuniary externalities

John Stuart Mill’s touches on many of these issues in paragraph 11 of On Liberty “Chapter V: Applications”:

It was pointed out in an early part of this Essay, that the liberty of the individual, in things wherein the individual is alone concerned, implies a corresponding liberty in any number of individuals to regulate by mutual agreement such things as regard them jointly, and regard no persons but themselves. This question presents no difficulty, so long as the will of all the persons implicated remains unaltered; but since that will may change, it is often necessary, even in things in which they alone are concerned, that they should enter into engagements with one another; and when they do, it is fit, as a general rule, that those engagements should be kept. Yet, in the laws, probably, of every country, this general rule has some exceptions. Not only persons are not held to engagements which violate the rights of third parties, but it is sometimes considered a sufficient reason for releasing them from an engagement, that it is injurious to themselves. In this and most other civilized countries, for example, an engagement by which a person should sell himself, or allow himself to be sold, as a slave, would be null and void; neither enforced by law nor by opinion. The ground for thus limiting his power of voluntarily disposing of his own lot in life, is apparent, and is very clearly seen in this extreme case. The reason for not interfering, unless for the sake of others, with a person’s voluntary acts, is consideration for his liberty. His voluntary choice is evidence that what he so chooses is desirable, or at the least endurable, to him, and his good is on the whole best provided for by allowing him to take his own means of pursuing it. But by selling himself for a slave, he abdicates his liberty; he foregoes any future use of it beyond that single act. He therefore defeats, in his own case, the very purpose which is the justification of allowing him to dispose of himself. He is no longer free; but is thenceforth in a position which has no longer the presumption in its favour, that would be afforded by his voluntarily remaining in it. The principle of freedom cannot require that he should be free not to be free. It is not freedom, to be allowed to alienate his freedom. These reasons, the force of which is so conspicuous in this peculiar case, are evidently of far wider application; yet a limit is everywhere set to them by the necessities of life, which continually require, not indeed that we should resign our freedom, but that we should consent to this and the other limitation of it. The principle, however, which demands uncontrolled freedom of action in all that concerns only the agents themselves, requires that those who have become bound to one another, in things which concern no third party, should be able to release one another from the engagement: and even without such voluntary release, there are perhaps no contracts or engagements, except those that relate to money or money’s worth, of which one can venture to say that there ought to be no liberty whatever of retractation.

A good reason to let people change their minds on most things is to avoid letting their past self either sell them out or deliver them into a predicament through a mistake. One way of viewing this is as I did in my post “Drug Legalization and Time Slices of People as Ethical Units”: if we consider the ethical unit to be a time-slice of an individual, then there is not full consent to an engagement if the current time-slice does not consent. 

From that point of view, one should only allow previous time-slice of a person commit the current time-slice if, to the individual, the ability to commit is quite valuable to that individual. In particular, in cases where person B will only incur a significant cost if able to rely on a commitment from person A and person A following through on that commitment has a corresponding cost that is of the same order of magnitude as the cost incurred by person B, it may seem reasonable to allow people to commit their future selves. 

Nevertheless, if, say an early time-slice of person A borrows to spend on wild carousing that leaves no memories at all because of drunkenness, leaving the later time-slice of person A with nothing, why should the earlier time-slice of person A be able to sell out the later time-slice in that way? The basic answer would be that normally person B doesn’t know whether person A will use the borrowed money well or badly, and it is in A’s interest to encourage B to be willing to lend if most likely the money will be used well. But when it becomes apparent that the early time-slice of person A most likely is selling out the later time-slice of person A, in a way that is easily observable to person B, then the case for society enforcing the sell-out of the later time-slice of person A to person B by the earlier one becomes much weaker. 

Notice that this principle that an early time-slice of a person shouldn’t ordinarily be able to sell out a later time-slice gives a much different argument for people not being able to sell themselves into slavery than the one John Stuart Mill gives–and an argument that applies to much less extreme circumstances. 

Paternalism is an attempt to save people from the mistakes of their current and future selves. Behavioral Economics has enlarged our awareness of all the ways that people might not guard their own interests very well, either through ignorance, through cognitive processing limitations, or through internal conflict that can happen even within a particular period of time.

But the simple principle of letting people back out of most things because it takes some time to figure out what is going takes care of a lot of situations. One place where this is particularly important is in sexual situations that college students get themselves into. One can see from, for example, the results of this survey of University of Michigan students that there are many cases of nonconsensual sexual activity. From the experiences of a professor at another university who is on the committee worrying about such things, I have heard that a large part of the problem is that, say, a man thinks a woman doesn’t have the right to change her mind once she has gone along with things long enough to get him really going. But of course a woman always has the right to change her mind and decide to stop all sexual activities cold at any point, regardless of how encouraging she was before that. Every moment of an interaction brings her more information, and every minute allows an all-too-often alcohol or drug-addled brain to process that information. Even if one sometimes allows earlier time-slices of an individual to commit later time-slices, in this case, one can trust the later time-slice of that individual who decides to switch to non-consent much more than the earlier time-slice that had much a much more limited perspective on the erstwhile partner now forcing himself on her. 

The moral of the story is that one thing all incoming college students need to taught is that a sexual partner has not only a reasonable likelihood, but an inalienable right to change her or his mind and switch to nonconsent at any time. 

An inalienable right is one that an earlier time-slice of an individual cannot sell off. The concept of an inalienable right helps with many of the issues addressed here. 

The opposite of inalienable rights–“alienable rights”–should be those rights where allowing an individual sell off a right by committing a future self to something (such repaying a college loan) that is quite valuable to a typical person’s welfare by convincing others to do something (such as to extend the loan). 

I have focused most on freedom of contract that has an important intertemporal dimension, since many contracts do, and this raises some of the thorniest issues. When a contract involves what happens over a relatively short span of time, then the case for treating the earlier and the later time-slice of an individual almost as if they were separate people is much less. So ordinarily people should be allowed to commit themselves for short spans of time, if we have reason to believe that the slightly early time-slice of that individual is well-informed. 

An interest relatively pure case, where there is very little intertemporal aspect is when a day-laborer wants to work for less than the minimum wage. Why should the law say that if the day laborer can’t find a good job, he or she is not allowed to take a bad job? Just because someone is poor and deserves a handout doesn’t mean they are stupid about a basic job decision like that. 

Even unions often don’t want minimum wages to apply to their own members. Here from a recent Wall Street Journal article:

In at least a half-dozen of those communities, the pay-floor ordinances include a provision allowing unions to waive the wage mandates as part of a collective-bargaining agreement. Labor groups often seek the exemptions because they say they provide the flexibility to negotiate better benefits for all union members or raises for more senior workers making more than the minimum. …

The carve-outs are increasingly drawing the ire of business groups representing the hotel and tourism industries, among others. They say such exemptions are a way for unions to organize or gain negotiating power by using the ability to opt out of the wage law as leverage to achieve other goals.

For instance, business groups say, unions could advise companies that if they agree to labor representation, they can avoid paying the minimum wage, spending less on wages overall. The strategy could let unions bolster their ranks at a time when union membership is falling, business groups say.

Although minimum wages are often harmful to the individual they apply to, they may sometimes help certain other people who would otherwise have to compete with the individual who is kept out of the labor force by the minimum wage. Of course, there is always the case of someone whose firm has paid enough of a sunk cost in the employment relationship that he or she will not be fired but will instead take a bigger share of the surplus from the employment relationship by getting a higher wage. Even this person would only want the minimum wage for him or herself to apply to the current job, not to the next job. 

Thus, facing a minimum wage oneself in future jobs is a harmful restriction on one’s freedom to benefit certain other people. It is a restriction on freedom to generate a pecuniary externality. But as I wrote in John Stuart Mill on Legitimate Ways to Hurt Other People, a pecuniary externality is a legitimate ways to hurt another person. Why? In part because in every pecuniary externality, whenever someone on one side of a transaction out there is hurt by a change in the price, the other party to the transaction benefits by that change in the price. This may sound boring, but it means that the good results one get from the free market depend crucially on not trying to stop pecuniary externalities. Ordinarily, when two individuals both want to do a trade and other people care mainly because prices are affected, society is ahead overall by going ahead with the trade and letting the chips fall where they may for everyone who cares about the price, since those chips will fall in a positive and negative way that should add up to zero in dollar terms. 

And it is a myth that raising the minimum wage reduces inequality–the inequality that matters far more than any other kind of inequality is the desperation of the people at the very bottom, which is worsened by the minimum wage. The minimum wage is a way to help people one rung up on the ladder–who are more likely to vote–at the expense of people at the very bottom. (On some of the scientific issues about the minimum wage, see my recent post “The Economist–Destination Unknown: Large Increases in the Minimum Wage Could Have Severe Long-Term Effects.”) 

The Supreme Court justices who upheld freedom of contract (before the “New Deal Settlement” transformed the official interpretation of the constitution without going through the amendment process) were actually fairly sophisticated about making some of the distinctions above. They upheld many regulations that could be viewed as helping the individuals the regulations were imposed upon. In the most famous “freedom of contract” case of all, Lochner vs. New York, the US Supreme Court was taking the side of poor bakers of bread who were recent immigrants being given a hard time by richer, longer-established bakers of bread. The poor bakers knew they weren’t being “protected” by the regulations at issue, they were being pushed out of business. The book I show at the top of this post is an excellent treatment of the history.