4th Annual Adam Smith Week

The Initiative for Public Choice & Market Process is pleased to announce the 4th Annual Adam Smith Week March 19-23, 2012.  We have a fantastic line up this year that includes:

Will Wilkinson
Bruce Yandle
Peter Klein
and Art Carden

There are lecture, debates, and movies so be sure to check out the full schedule.  You can keep up with events by liking us Facebook as well.  Finally we have gone high-tech look for the QR Codes on all the flyers.

If you have never attended an Adam Smith Week event before check out the videos of the great talks from last year.

the benefits and costs of "Fair" (Free) Trade

A really nice book, by Sushil Mohan, on a neat little topic, "Fair Trade" (available as a free PDF)...

Some of the summary points:

• Fair Trade is part of the market economy and is not, in any way, in opposition to free trade.

• Fair Trade brings certain benefits to producers...These benefits may not be as great as many of Fair Trade’s
proponents imply...

• Criticisms of Fair Trade are also exaggerated...
 

• The benefits of Fair Trade also come at a cost. There is a levy on the wholesaler as well as a certification charge for producers. The certification charge starts at £1,570 in the first year – a huge sum of money for producers in the poorest countries.
 

• Fair Trade does not focus on the poorest countries. Fair Trade penetration is greater in middle-income than in poor countries.
 

• The benefits claimed by Fair Trade can also be obtained from the normal business relationships that exist between primary product producers and buyers. Attempts by proponents of Fair Trade to denigrate free trade and normal market practices are not helpful and distort realities.

Citizen’s United and Rent Extraction

Citizen’s United allows corporations and unions to spend money without limit to support a candidate. There are still disclosure rules, and the candidates must have some independence from the organizations, but supporters can put together Super-PACs (Super-Political Action Committees). These Super-PACs have tremendous amounts of money. One Super PAC alone, Restore Our Future, has raised over 30 million dollars.

According to OpenSecrets.org, “Outside interest groups spent more on election season political advertising than party committees for the first time in at least two decades, besting party committees by about $105 million.” [Very interesting link: http://www.opensecrets.org/news/2011/05/citizens-united-decision-profoundly-affects-political-landscape.html]

There’s a lot of money at stake. Most people are worried that corporations will funnel money through various Super PACs to buy off politicians. Of course it is also possible that the politicians will use Citizen’s United for rent extraction. Politicians could “force” corporations to form those Super-PACS. That could help incumbents and make it even harder to throw the bums out.

When politicians threaten a company or an industry with more regulation or taxation unless campaign contributions are forthcoming, it’s called rent extraction.

Now that corporations and unions are allowed to spend tremendous amounts of money [indirectly on campaign contributions], what keeps politicians from insisting that those corporations and unions do in fact spend the money? That is exactly what happened to Microsoft and a handful of other tech companies during the 1990s. (http://www.amazon.com/Trust-Trial-Microsoft-Reframing-Competition/dp/0738204811/ref=sr_1_8?s=books&ie=UTF8&qid=1329534939&sr=1-8)

Surely this wouldn’t happen, would it? After all, there is a big hurdle preventing CU from becoming a major new source for rent extraction. The rent extraction would have to take a circuitous route. A politician could never tell a corporation or union “Give me $X or I'll do something bad to you,” i.e. “I hope we don’t have to impose new regulations on you.” Remember, corporations cannot contribute to political candidates. In the past, politicians were able to say “Give my party $X, or I'll do something bad to you,” but that path was cut off by McCain-Feingold (which was upheld in McConnell v. FEC).

Now, so goes the logic, CU will let politicians say, “Run a favorable ad on my behalf, or I'll do something bad to you.” But that runs into a host of problems. The first is legal: A request like that would be flatly illegal (as it would break the law on coordinating communications) for both the politician AND the company. The second is practical: Independent expenditures are very tricky and can often hurt more than they help. Because Super-PAC political speech (advertising) has to be independent, the politician can't make sure the company says what he wants. That limits the utility of the ad and, in some cases, makes it counterproductive.

With about two years of experience, it does not seem like CU has become a new avenue for rent extraction. Very few corporations have made independent expenditures (far fewer than the critics of CU expected) and there really hasn’t been any sense that incumbents have tried to solicit independent expenditures as protection money.

But politicians are entrepreneurial. There are many, many ways to start extorting money from groups. There are 435 members of the House and 100 Senators. That’s just at the Congressional level. That’s 535 political entrepreneurs trying to invent ways to get money for their reelection. What about all of the incumbents at the state and local level?

Bachus Not Smart Enough to Have the Job

Spencer Bachus (R-AL 6^th) isn’t smart enough to be the chairman of the House Committee on Financial Services (aka House Banking Committee). That committee oversees the entire financial sector: banking, insurance, credit cards, banking, and investments. As part of their duties the committee oversees the Fed, the Treasury, and the SEC. It’s a big time job.

Bachus has been accused by CBS of insider trading. The idea is that Bachus used inside information from closed-door meetings with Ben Bernanke and the Secretary of the Treasury. He bought stock options betting that the market would crash.

So stupid he only made $150,000

Peter Schweizer of Stanford University argues that whether Bachus made $15,000 or $150,000, the action is dishonorable. Sure it is dishonorable, but the real problem is that it shows that Bachus isn’t very smart. Let me have inside information from the Fed and the Treasury, and I’ll make much more than $150,000.

You might argue that poor Congressman Bachus didn’t want to alert people to his trades by buying lots of options all at once. If only there was a way to break apart your trades and make it look like there were many, many small trades instead of one Congressman trading. Oh wait. There is a way to do that. If Bachus doesn’t know how to do that, maybe his knowledge of finance isn’t very good.

Perhaps Bachus didn’t want to take “too much money,” thinking that it would infuriate his constituents. Or perhaps he didn’t need that much money. Though as of November 22, 2011, he’d raised $1,595,010 for his reelection campaign. So maybe he does like money.

If he only earned $150,000 so that he wouldn’t infuriate his consituents, he did a great job. The average household income in his district is $58,545, so those options didn’t even earn Bachus triple the going income in his district. What voter could be mad that her Congressman earned almost triple her annual income in a few days? Sure he bet against his country, but money was at stake.

Links:

Open Secrets: http://OpenSecrets.org

Peter Schweizer : http://www.hoover.org/fellows/9706

Proximityone: http://proximityone.com/

New York Times Elections data: http://elections.nytimes.com/2010/house/alabama/6

CBS 60 Minutes: http://www.cbsnews.com/video/watch/?id=7388130n

Romney vs. the teacher (in terms of "tax rates") and confusion over MTR vs. ATR

Romney and (supposedly) Buffett pay lower tax rates than common people?!

Variations of this story have been increasingly popular over the last few years. (Apparently, the President used this in the SOTU last night!) This isn't too surprising, given the economic doldrums inspired by the "Financial Crisis" and extended for more than four years now by the policies of Presidents Bush/Obama and their Congresses. Envy and resentment find more fertile ground in tougher times. (I wonder whether the politicians are dopes or are doing this on purpose, but that's another story.)

There are a variety of factors to consider-- differential taxes on capital gains vs. labor income; whether to include onerous payroll taxes on income in the calculations (but we usually ignore these, despite the pain inflicted on the lower-middle and middle classes, so why start now?); whether to include state and local taxes (more complicated and difficult to compare cases). In any case, the most common comparisons are simple (and simplistic), focusing on federal income taxes only.

Unfortunately, the comparisons often suffer from ignorance of the tax code and different expressions of "tax rate". Most notably, few people understand the difference between average tax rates (ATR) and marginal tax rates (MTR).

ATR is the proportion of one's income devoted to a tax or taxes in general. For example, if one has an income of $100K and pays federal income taxes of $12,000, then their ATR is 12%.

MTR is the proportion of tax paid on the last dollar earned. If one is in the 28% "tax bracket", then the last dollar earned is taxed at 28%. Each dollar earned is taxed in its respective tax bracket. Instead, most people believe that if you're in the 28% tax bracket, then every dollar earned is taxed at 28%. Not true! (The Tax Foundation does a really nice job with the big picture.)

For example, singles have a standard deduction of $5,800 and exempted income of $3,700. So, the first $9,500 earned is not exposed to any federal income taxes. (They've already lost about $1,400 to payroll taxes, but who cares about that?) If they earn $10,000, only the last $500 is exposed to the 15% MTR in the lowest tax bracket, resulting in taxes of $75 and an ATR of .75%.

In the Romney example popular on Facebook, Romney is said to have a tax rate of 13.9% while a teacher is said to have a 25% rate. Since there is no 13.9% tax bracket, the author must be referring to Romney's ATR. But if you do the calculations, a teacher who is single would need to earn at least $232,600 to have a 25% ATR (married with no children = $367,000; head of household with only one child = 314,700.) Why do I say "at least"? I'm assuming no itemized deductions, so our prospective teacher is a miser and doesn't have a mortgage on her home.

The irony of a valid comparison? The Occupy Wall Street crowd would say that she needs to be paying higher taxes!

Of course, teachers don't make this much money. So, those making such comparisons are invoking Romney's ATR and the teacher's MTR-- comparing apples and oranges, or better, apples and rocks.

What does it mean when professors don’t grade their own assignments?

Western Governors University hires outside graders to grade assignments. Ideally this will let professors focus on their teaching and free professors from the pressure to inflate grades. The idea of letting outsiders grade assignments really cuts to the two things that colleges do for students. People know that colleges teach students, but colleges also certify their students. Colleges certify that their students are smart, hard-working, and have the perseverance to complete something that takes four years.

That certification means something to employers. Why do employers want college graduates? Is it because employers want people who took English literature and art history? Maybe. I think that there are benefits to those liberal arts courses, but a big reason that employers prefer college graduates is that college grads have been certified by their university as being good. The certification is more valuable when the school has a better name and the major is a tough one.

When professors don’t do the grading, what message does that send to employers? Does it say that the school is really serious about teaching and avoiding grade inflation? Or does it say that the school doesn’t think its own faculty are competent to do the grading? Certification from a school that doesn’t trust its faculty can’t be very valuable.

If a school’s faculty can’t be trusted to avoid grade inflation, how good can the faculty’s certification really be?

See more

Professors Cede Grading Power to Outsiders—Even Computers

One college gives the job to software, while another employs independent 'evaluators'

http://chronicle.com/article/Professors-Cede-Grading-Power/128528/

The Big Short

A friend loaned me Michael Lewis' The Big Short. Really good stuff-- as usual from (what I've read of) Lewis. As a popularized of history, his work is readable and seems accurate. He does a nice job painting portraits of characters and laying out institutional and historical detail. (The one big disappointment-- an omission-- is that Lewis did not address the role of "mark-to-market" regulations as a catalyst for the crash, or at least its timing.) Overall: an easy, good read. 

The primary topics of the book are the burgeoning "subprime" home mortgage market (from $130B in 2000 to $625B in 2005), the subsequent market for investments connected to those mortgages (from $55B to $507B), and the failure of the market and govt regulating authorities.

A number of concepts are in play here, from economics and political economy: 

1.) A "subprime" mortgage is not inherently troubling, as long as the underlying (greater) risks are correlated with higher rates of return. If those risks are not easily understood, then the market will struggle. If those risks are subsidized, then the govt is causing inefficiency and other troubles within markets. Both occurred here. 

2.) Likewise, a subsequent market for mortgage-related investments is not inherently troubling, as long as the nature of the investments is understood and their risk is not subsidized. We see such financial markets arise to act as a form of insurance-- a "hedge" against various future outcomes. The problem in this market is that the investments were very complex AND the ratings agencies (in whom investors placed their faith) were a combination of inept and greedy. (Lewis noted that Warren Buffett had/has a 20% ownership stake in Moody's!) Moreover, the govt regulation of those agencies was insufficient-- whether more regulation was needed or whether existing regs should have been observed more closely. And govt policies proved subsequently to encourage the "moral hazard problem" through bailouts-- that failure would be bailed out will encourage more risky behavior.

3.) The key to the story is "imperfect information"-- in particular, information that was highly imperfect and worse yet, highly asymmetric. In the face of such information asymmetries, markets have some remedies and govt regulation can, at least in theory, provide a defense. Think of buying gasoline. How do you know how much gas you received? The little numbers say 9.3 gallons, but how do you know? The gas station has a reputation to uphold and some investigative journalism from a local TV station could bring down the company. But what sort of defense is this, really? Modest. The govt promises to help and hires inspectors to monitor this and affix stickers to the pumps, certifying their approval. But what does this promise? Do we faith in the sticker-placer and do we ignore the firm's post-sticker incentive to cheat and actually take advantage of our faith in the sticker?

In the case of investments, investors rely on credible/objective ratings agencies to step into this information breach. From Lewis' work, it seems clear that the agencies were mostly confused-- but in some cases, unwilling to pay the price for negative assessments of these instruments. Consider "house inspectors" as a parallel example. What makes for a "good" house inspector? Finding all the significant faults in the quality of a house, right? But that's only from the perspective of the buyer. From the perspective of the seller, a good inspector would turn a blind eye to less obvious faults. And more troubling, a realtor has similar incentives. What makes a good ratings agency? It depends on your perspective. And in this case, they failed to provide accurate, objective information. 

Lewis argues that the ratings agencies failed, in terms of competence (vs. motives), given the complexity of investment vehicle, by mistaking diversity for lower risk. Often, diversity lowers overall risk by spreading risk. But in the case of the mortgage-based securities, there was a bundling of diverse, but still highly risky loans (within the subprime housing market). Moreover, the agencies and the market participants who guessed incorrectly failed because their statistical models, based on historical data, assumed housing prices that would increase forever. 

All of this points to "market failure" (the academic term)-- or "market struggle" (to choose a more accurate term). But as always, market struggle must be contrasted with government failure/struggle. Will govt agents be able to regulate something they cannot understand either? The general public's reflex-- and for Congress as well-- is to seek more regulation. But as in many other cases, the record is that existing regs were not embraced to anything near their full extent. (Lewis discusses these failures in passing-- most notably on p. 166.) It is then an act of faith to believe that govt regs will improve things. Perhaps-- but perhaps not-- especially with the reality of interest group politics.