Suppose that a private corporation invests resources in projects that address a critical social problem. Which is the appropriate public policy toward that corporation?

The compassionate libertarian answer would be (a). The opposite philosophy, which chooses (b), might be called cruel paternalism.

Two examples of cruel paternalism are the California government's approach to the energy market and AIDS activists' approach to the issue of providing treatment to Africans with HIV. It turns out that there are companies trying to develop energy supplies and anti-AIDS drugs, which puts them squarely in the cruel paternalists' line of fire.

In California, the price of energy to consumers is held below market levels. While the energy cost to heat my home in Maryland has risen dramatically compared with last winter, California consumers are living in la-la-land, with retail energy prices that are capped close to last year's levels.

Because energy prices for consumers are lower in California than elsewhere, it is difficult to draw energy into California. California's utilities were brought to the brink of bankruptcy by having to pay market prices for wholesale energy which they resold at below-market retail prices. California's state government currently is purchasing energy, using tax revenues to subsidize continuation of the "buy high, sell low" approach.

What California proposes is that the Federal government should impose price controls on the wholesale market for energy. This would lower the cost to California of subsidizing retail energy consumption.

If California's proposal of price controls on wholesale energy were adopted, the result would be a larger, more widespread shortage of energy. For non-California consumers, this would mean higher retail energy prices. This in turn might lead the government to impose controls on retail energy prices, and then the rest of us could enjoy the blackouts that right now are limited to California.

The objective of the California energy policy is to try to minimize the profits that accrue to energy producers as a result of increased demand for energy. Producers of energy have become the enemy. Paul Krugman has hinted darkly that some energy is produced in Texas, which for California cruel paternalists is prima facie evidence that they are victims of a conspiracy.

The compassionate libertarian solution to California's energy crisis is to let the market work. Let retail energy prices seek their own level. This will induce conservation on the part of consumers and draw in supplies from producers. Instead of using tax dollars to "buy high, sell low," California could use those funds to give generous payments to low-income consumers.

If trying to supply energy is a punishable offense, then trying to find a cure for AIDS is even worse. The pharmaceutical companies now stand accused of "murder" by AIDS activists. For an expression of this point of view, see an article in Technology Review called, Owning the Future: In Africa, Patents Kill.

The cruel paternalist argument runs as follows. The marginal cost of manufacturing AIDS medicines is low. African AIDS sufferers cannot afford to pay much for medicine. Therefore, the patents that protect the pharmaceutical companies that developed AIDS drugs ought to be set aside to allow the cost of these medicines to fall to a competitive price that is closer to their cost of manufacture.

I am perfectly willing to subsidize the treatment of African AIDS sufferers. However, this should be done using foreign aid, which can be used to purchase AIDS drugs and to provide them to AIDS sufferers at little or no cost.

The AIDS activists' approach to providing assistance to African AIDS victims is to confiscate drug company assets for that purpose. However, there is no economic or moral reason to hold drug company shareholders more responsible than anyone else for relieving the plight of AIDS in Africa.

The contrast between compassionate libertarianism and cruel paternalism concerns the relative importance of various effects of prices.

1. Prices signal consumers and producers about near-term scarcity.
2. Prices provide long-term investment signals to producers.
3. Prices affect the distribution of well-being.

The doctrine of compassionate libertarianism is focused on the first two points. It takes the view that the government should deal with distributional issues by using general taxes and transfers rather than by interfering in particular markets.

The problem with cruel paternalism is that it creates perverse incentives for the private sector. To the extent that you try to develop a product or service that can help the unfortunate, your assets are subject to confiscation. To protect your shareholders from cruel paternalists, it makes more sense to invest in products or services that have little or no use for poor people.

If the rate of return for energy producers is subject to political risk, capital will flow out of the energy sector and into sectors with less political risk. If the rate of return on drug research is limited for drugs that treat AIDS because AIDS activists demand that patents be forfeited, then drug research will focus on other maladies.

For a compassionate libertarian, it warms the heart to see companies earning profits from investments in things like energy production and research on AIDS therapy. Cruel paternalists find such profits appalling. If cruel paternalists get their way, they will control the allocation of energy and AIDS drugs. Too bad there will not be anything to allocate.