Market Process Blog

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

2012-01-25T07:55:00.000-08:00

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?

2012-01-05T13:27:00.000-08:00

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?

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

2011-11-17T15:45:00.001-08:00

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.

the difference/divorce between worker pay, worker compensation, and the cost of hiring workers

2011-11-03T14:22:00.001-07:00

A huge and oft-overlooked distinction: Workers, reasonably, focus on wage/salary. To a lesser extent-- and usually when forced to think about it once per year-- they look at compensation. And rarely do they look at what it takes to hire them. (And then there's the risk / rate-of-return calculation based on expectations of future productivity, costs, etc.-- all of which has had more variance injected into it by the policies of Bush, Obama and Congress.)

Excellent article in the WSJ...

Employees may not realize it, but they are getting more expensive.

It isn't that their paychecks have suddenly started bulging. It's that other employment costs—like health and retirement benefits—continue to rise. Benefit costs in the private sector were up 4% year-on-year in the second quarter, more than double the 1.7% increase in wages and salaries. On Friday, the Labor Department's employment-cost index for the third quarter is likely to show this trend continuing...

The trouble is, this means employers are paying more for workers without actually paying their workers more. Higher benefit costs eat into profits without directly raising a company's output in the way hiring more workers would. In fact, this can actually discourage hiring. And the more that companies have to spend on benefits, the less take-home pay goes to workers...

Americans, in fact, sense this already. "People are worried about income security to an unprecedented degree," says Moody's Analytics economist John Lonski. Indeed, the share of those expecting their income to fall remains higher than the share expecting income to rise over the next six months, as per the Conference Board's October confidence survey. This situation never occurred in the survey's 30-year history prior to 2008. Now, it has become the norm. Low wages at least could spur hiring. But if employees are getting more expensive for other reasons, the risk is nobody benefits.

Post Office woes: What to do with a govt-run, monopolistic, delivery dinosaur?

2011-11-03T14:21:00.001-07:00

(A version of this later appeared in print.)

If you're a fan of evolution, the marketplace, or competition, the answer is obvious. If you don't like monopolies or corporate subsidies, the answer is obvious.

But if you're someone who benefits from the status quo, is a fan of big government or labor cartels, or has a limited policy imagination, then you're in an increasingly difficult position-- trying to prop up an expensive, unwieldy dinosaur. (Check out this identical editorial "written by" various postmasters-- which appeared in various newspapers around the country, including the Courier-Journal! LOL!)

As an economist, part of me loves bad policy, since it gives me great examples to use in the classroom. Take away the Keynesian stimulus efforts of Bush, Obama and Congress-- and Macro fiscal policy becomes mostly a theoretical and historical exercise. Take away our country's sugar policy and I have to find a new opening example of the need to think through the primary and secondary consequences of our choices.

Take away the Post Office, in its present form, and I lose a great opportunity to talk about the limited term "monopoly", the powerful concept of "degrees of monopoly power", the trade-offs inherent in "elasticity" (how much will quantity demand decrease with the rate raise in January to $.45?), and the ability of technology and market competition to erode even a monopoly established by government.

For years, it's been easy to predict that the Post Office would struggle more and more, as market participants erode its first-class mail monopoly at the margins-- and especially, as technological advance renders its services increasingly obsolete. One can even throw in some cultural/economic discussion-- such as the difference between generational use of the USPS and its continuing fade. It's great stuff for the classroom! (See also: Amtrak which has been subsidized for its entire existence, even when it sets records for ridership.)

Some of the more subtle details are hilarious and point to inefficiencies: The USPS doesn't own their own planes-- to do their own Express Mail. I'm told that it's common to take advantage of their "next-day guarantee", knowing that it's unlikely that they'll meet the commitment. So, you can get a package delivered quickly (in two days)-- for free. Labor costs for the USPS are 80-89% and 48-53% for UPS. (NY Times has the more modest numbers; Harpers has the more extreme numbers.) The USPS does not pay property taxes or vehicle registration fees. The recent proposal to reduce in mail processing services indicates that it was grossly inefficient for awhile or it can't be expected to do much to decrease costs.

In recent months, the Post Office has gotten a lot of attention, because its subsidies have grown, its future has become more obviously bleak, and likely, that we've reached some sort of threshold in terms of the public's perception of its tenuous future. Like many other government services (federal, state and local), the Great Recession has exacerbated this focus-- an interesting by-product of the Bush/Obama/Congressional bungling efforts with our economy.

In the absence of disbanding the Post Office or reducing its function to subsidized services for those in rural areas, we're just tweaking a bad institution. But that's probably the way things will go for another few years, since special interest groups-- corporate and labor-- have so much to lose. As such, assuming away dramatic reform, what should the USPS do?

Two things seem like no-brainers to me. "Reformers" are talking about dropping Saturday delivery, but that's just a tweak. Home delivery should be reduced to once or twice per week. If mail was delivered twice a week, you could reduce labor costs dramatically. And how often do you need to receive mail? For individuals who want more frequent delivery, they can pay additional for the service or get a P.O. Box. Business delivery would continue daily for a charge based on volume.

Among more significant reforms, we should no longer subsidize "junk mail"-- or any mail, except perhaps to rural areas (if voters want to continue those subsidies). Unfortunately for the USPS, this would significantly reduce the need for their services, in terms of quantity and especially weight/volume. Not surprisingly, although already about half of their volume, they want to deliver more of this type of mail.

Other options: outsource inefficient functions or focus more efforts on logistics; sell advertising on vehicles. (AEI will have a conference on November 4th, with Richard Geddes 2003 book as the foundation of the discussion. Click here to hear it on-line.) But all of this is rearranging packages on the shelves of a sinking ship.

The long-term will deliver a defunct or greatly diminished Post Office. What remains will be subsidized since it is inefficient. The question is whether its size and subsidy will be small or large.

Entrepreneurs Must Stop Apologizing

2011-10-24T11:17:00.000-07:00

The occupy movement seems to have various messages, but one of them is that business control all the wealth and that the wealth needs to be redistributed. It is the business leaders the entrepreneurs that are the heroes of a free market system. Gerry Nicholls in the Huffington Post writes that Entrepreneurs Must Stop Apologizing "here's one key reason: the people who the make the free market system work -- i.e. entrepreneurs -- are often like the rest of the population; they don't understand the values which underpin capitalism. Consequently, they all too often fail to defend themselves in the market place of ideas. They cede the moral high ground to leftists, to politicians and to assorted other anti-free market types. Rather than standing up for free markets, business people often become defensive, sometimes even apologizing for being capitalists. This is a problem because if business people don't stand up for capitalism, who will? This is why an organization in the United States called the Bastiat Society exists. Named after the famed French economic theorist Frédéric Bastiat, the society's purpose is to "educate other wealth creators on their right to the moral high ground." The motto of the group is "Those who work in freedom should know how freedom works." Canada should sure could use a group like the Bastiat Society. Entrepreneurs in this country need to be convinced that they are the good guys."

Nicholls highlights the Bastiat Society an organization that started here in Charleston, SC and I have been involved with for the last several years. The Bastiat Society focuses not on politics, but on economics ideas not necessarily practical business knowledge. The Bastiat Society now has a board of directors, and an advisory board, which I have the pleasure to chair. They now have several chapters and some of them are international so maybe some bright and energetic entrepreneur in Canada can start a chapter the way Gerry Nicholls wants.

'via Blog this'

The problem is not C or G, but I

2011-10-22T08:20:00.000-07:00

Steve Horowitz has a great post on Coordination Problem regarding economic historian Bob Higgs. Principles of macroeconomic students know that national income Y = C+I+G+(X-M). Keynesian theory argues that when C, consumption declines, aggregate demand is less than the full employment level that we need to increase G, government spending to fill the gap. This was the point of the stimulus spending. Horowitz notes "Bob [Higgs] points out that all the talk about "stimulating consumption" is beside the point because consumption spending is not the problem! Real personal consumption spending is now above its pre-recession peak. And Lord knows government spending isn't the issue either. Anyone who's taken intermediate macro knows what's coming next: if GDP is lagging, and it's neither C nor G that's the problem, it's a pretty good bet that it's investment." Higgs writes:

"The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase, but because the true driver of economic growth—private investment—remains deeply depressed. Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its pre-recession peak. This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the ”capital consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.

The key variable is net private domestic fixed investment—the investment that builds the productive private capital stock. Quarterly data through this year are not currently available at the BEA website, but the annual data show that an index of its real amount peaked in 2006, fell substantially in each of the following three years, and recovered only slightly in 2010, when the index showed net private domestic fixed investment was running about 78 percent below its level in 2005 and 2006. Here is the true reason for the recession’s persistence.

Private investors, despite the full recovery of real consumer spending and the increase of real government spending for final goods and services, remain apprehensive about the future of new investments, especially new long-term investments."

'via Blog this'

Flow Chart for Students Considering Grad School in Economics

2011-10-11T15:29:00.000-07:00

How a "Socialist" State Deals with a Failing Auto-Maker

2011-09-15T15:39:00.000-07:00

Saab recently turned to the Swedish courts for protection from its creditors. The company was unable to pay its employees in August and hasn't actually been producing cars since June.

The response from the court in "socialist" Sweden: Take a hike!

Saab and two subsidiaries had petitioned the District Court in Vänersborg, Sweden, on Wednesday for “voluntary reorganization,” a move to gain time for Chinese partners to come through with long-term financing and prevent the legal challenge from unions.

But the court was not convinced by the plans.

Noting that Saab had just undergone a restructuring in 2009, when it was owned by General Motors, “the court did not see sufficient reason to believe that the chances were any better today than they were then,” said Cecilia Tisell, a court spokeswoman.

The court also found that the financing plans of Saab’s parent, Swedish Automobile, relying as they did on Chinese companies that had not yet received Beijing’s approval, were not concrete enough, Ms. Tisell said.

A further consideration, she added, was that Saab’s production lines completely stopped operating in June, and the court believed that even if production resumed, it might be difficult for the company to begin selling cars again.

Wow! Seriously! Let me get this straight. When a firm is consistently unprofitable this is a sign that it should go out of business?!

Thank goodness we live in the "capitalist" US of A. We know better. We know that auto-makers should be kept on taxpayer-funded life support no matter how many times they need to be bailed out; no matter how many decades their failure continues.

HT to Roger Congleton for bringing this to my attention.

Economics joke of the day

2011-09-14T06:10:00.000-07:00

A lone sailor finds himself shipwrecked on a small island. Fortunately he's not alone, as he finds a small community. The sailor comes across a butcher on the street selling some rather unusual produce. The butcher has in stock human brains, collected together according to the source. The sailor reads the sign:

Laborer: $9/lb
Artisan: $14/lb
Scientist: $21/lb
Politician: $39/lb

The sailor exclaims, "Wow, I guess politicians must be really smart and popular!"
To this the butcher grumbles, "You must be kidding. Do you have any idea how many politicians I gotta kill for a pound of brains?"

HT: a former student (J.S.)

The Great Recession and Government Failure

2011-09-02T09:01:00.000-07:00

In the Wall Street Journal today Nobel Prize winning economist Gary Becker reminds us there is such a thing as government failure. In his article The Great Recession and Government Failure he writes:

"The origins of the financial crisis and the Great Recession are widely attributed to "market failure." This refers primarily to the bad loans and excessive risks taken on by banks in the quest to expand their profits. The "Chicago School of Economics" came under sustained attacks from the media and the academy for its analysis of the efficacy of competitive markets. Capitalism itself as a way to organize an economy was widely criticized and said to be in need of radical alteration. Although many banks did perform poorly, government behavior also contributed to and prolonged the crisis. The Federal Reserve kept interest rates artificially low in the years leading up to the crisis. Fannie Mae and Freddie Mac, two quasi-government institutions, used strong backing from influential members of Congress to encourage irresponsible mortgages that required little down payment, as well as low interest rates for households with poor credit and low and erratic incomes. Regulators who could have reined in banks instead became cheerleaders for the banks. This recession might well have been a deep one even with good government policies, but "government failure" added greatly to its length and severity, including its continuation to the present." read more here ...

Futurama on Public Choice

2011-09-01T18:33:00.000-07:00

Futurama

This clip from Season 2 of Futurama captures several important public choice concept including the Median Voter Theorem and rational ignorance. These are common public choice concepts that have been discussed on this blog before. Yet again, we see that economics is pervasive in our lives including our cartoons. (HT: Art Carden)

American Workers Deserve Better

2011-08-24T09:34:00.000-07:00

Here's my attempt to understand the avoidable 'new normal' in unemployment.

Martians

2011-08-18T11:57:00.001-07:00

Paul Krugman has proposed that if Martians were to attack we would spend to defend ourselves and this would move us out of the recession. This idea brings up two questions. First, suppose that the only way to kill the Martians is by mixing corn with salt water. Similar to the War of the Worlds, it might be the fumes from this combination that actually kills the Martians. Also suppose that this defense required eighty percent of the working age population to grow corn and throw it in the ocean. Then Krugman’s solution would be that the government would pay these people, unemployment would drop, people would have more money to spend and this would end the recession. The question here is “What do they spend it on?” Only 20 percent of the population is producing goods and services that everyone would want. The prices of these goods and services would increase dramatically. My guess is given that there would be so few goods available, the Obama administration would use some sort of rationing. Would our society now be better off than we currently are with our high unemployment? The answer is clearly no. Right now those who are working are producing goods and services that all consumers want and are willing to pay for. In the case of the Martian invasion, we would be producing defensive corn and not many goods and services would be available. So more people might be working, measured GDP might be higher, but consumers would be much worse off.

The second question is why are we defending ourselves from these Martians? Perhaps we are afraid that they will take away some of our freedoms. They might force us to work half of the year for them and then only let us have what we produce in the other half. To show that they are not evil, they may provide goods to those who do not work for free by taking them from workers. They might require children and grandchildren to be enslaved to them for several years to pay for all of the wonderful things they are currently providing us. They might make rules and regulations that limit our ability to engage in activities that harm no other individuals.

Come to think of it, if this is what the Martians are going to do, then Krugman is right – we should spend to defend ourselves. It might not bring us out of the recession but getting rid of these horrible rules would lead to greater long run growth. I wonder if Krugman would be in favor of us fighting for these freedoms?

The next financial bubble to burst?

2011-08-10T05:05:00.000-07:00

As described in this Huffington Post column, Moody's has joined many economists in warning of a bubble in higher education, and the impending burst of the bubble in higher education financing. In short: Students are racking up more and more debt--through more people enrolling and to people staying in school longer to avoid the harsh realities of a less than stellar labor market--but they are unable to pay off the loans because they are not getting jobs or are not getting high-paying jobs to warrant such debt accumulation. Thus, there is a wave of defaults and bankruptcy building (although much education debt is excluded from bankruptcy proceedings, not allowing the individual to avoid payment).

But, even when they get it, they don't get it. The author writes: "In the short term, if fewer people pursue higher education and avoid student debt altogether, it would cause a drag on consumption. In the long term, a less educated workforce would put the U.S. at a disadvantage." This could not be more wrong, and it is clear that the author simply doesn't understand what the idea of a bubble. The fact that there is a bubble in higher ed--as described above--indicates that the investment in human capital is malinvestment for a sizable share, although certainly not all or even a majority, of those getting a college degree. This means that they would have been better off to have never went to college (or accumulate higher ed debt).

Yes, it is quite likely that spending in the short-run would be lower had these individuals not taken out debt to attend college. But, that's a good thing! The spending would have been more appropriately directed and the loanable funds would have been freed up for other more productive purposes.

The comment concerning a less education workforce holding back the U.S. in the long-run is ridiculous! It's the debt accumulated through the malinvestment in higher education that is currently holding back the U.S. We have a well-educated population, but much of that education is in areas that are not valuable to society. There are only so many people needed with BAs in Basket Weaving (I will allow you, the reader, to fill in actual majors to which this comment applies so as to not directly offend any of our readers). We are spending billions of dollars to obtain degrees that will enable us to earn less marginal income (the extra income beyond that which could have been earned with the next lower degree) than it cost to earn the degree itself. In other words, we are spending $100 today (through borrowed funds) in order to earn $90 in the future. This is a losing situation. The solution: stop encouraging so many people to get a college degree. Just like not everyone should own a house, not everyone should hold a college degree. The author of the Huffington Post got it backwards. S/he should have said: The over-investment in human capital--the college degree--is one of the many things holding the U.S. back in the long-run.

Note: the idea of the higher education bubble was first brought to my attention in 2009 by one of my students, Eliska Repkova, who is currently working toward her PhD in economics at Emory University.

HT: Ed Miseta

Default not end of the world

2011-07-28T23:56:00.000-07:00

With all the discussion of the how the sky is falling if we do not raise the debt ceiling and talk of "default" Peter Klein has a different take on the situation that you have probably not seen discussed. In his recent article Default not end of the world he writes "Financial markets have been restructuring debt for many centuries, and they’ve gotten pretty good at it. From the discussion regarding T-bills, you would think no one had ever heard of default-risk premiums before.

Interestingly, this seems to be a case of American exceptionalism: People aren’t particularly happy about Greek, Irish and Portuguese defaults, but no one thinks the world will end because of them.

So, isn’t it time to demythologize all of this? Treasuries are bonds just like any other bonds. There’s nothing magic, mythical or sacred about them. A default on U.S. government debt is no more or less radical than a default on any other kind of debt.

“What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom,” Adam Smith famously observed. Bankrupt firms, like bankrupt families, restructure their debt obligations all the time. The notion of T-bills as sacred relics to be once and forever “risk-free” seems more like religion than economics to me."

Klein argues that we should be willing to consider that financial markets are capable of restructuring debt even government debt.

The Debt Crisis and the Fiscal Leviathan State

2011-07-28T07:12:00.000-07:00

My former professor, mentor and friend Richard Ebeling has a new blog post/article on the current debt crisis. The Debt Crisis and the Fiscal Leviathan State. In the article he explains that virtually all that is going on in Washington about the government’s debt is really smoke and mirrors because everyone there accepts the premises of the “entitlement” society. As a result, practically no one is willing to call for the real cuts in government spending that would bring about a reduction of the government’s “slice” of the national economic pie; and put the country on a real solution to the debt problem.

He goes on to explain that the reason for this unwillingness has two origins: First, an ideological one, which takes the implicit form of the acceptance of the socialist critique of capitalism. Left to its own devices, the socialists claimed, the market economy leads to abuse of workers by employers, tends toward monopoly manipulation of consumers, and results in a failure to produce the products and services people “really” need. Hence the necessity for the paternalistic interventionist-welfare state, with its massive growth in government spending and intrusiveness in society.

The second is pragmatism of everyday politics. After Keynesian Economics undermined the rationale for an annual balanced budget, politicians soon saw that they could justify offering voters “something for nothing” – government spending, programs, and interventions with a smaller price tag they the real cost – through the “miracle” of deficit spending.

As a result, modern government has become the Fiscal Leviathan State that is absorbing more and more of the society’s wealth and productive capability.

He concludes by arguing that there are few short-term solutions given the anti-capitalist ideology of our time, and the political pull of interventionist and redistributive paternalism that serves the interests of politicians and special interest groups.

The long run solution requires a change in the climate of ideas – and that requires setting the historical record straight on the achievements of free market capitalism, and articulating and defending the moral case for the free society and its smaller role for government.

The Latest Research on Economic "Growth"

2011-07-26T14:32:00.001-07:00

This is either a post about cutting-edge empirical growth research with extraordinarily delicate and difficult-to-implement policy implications OR a warning about how econometrics must be handled carefully.

Here's the paper; here's the abstract.

This paper explores the link between economic development and penile length between 1960 and 1985. It estimates an augmented Solow model utilizing the Mankiw-Romer-Weil 121 country dataset. The size of male organ is found to have an inverse U-shaped relationship with the level of GDP in 1985. It can alone explain over 15% of the variation in GDP. The GDP maximizing size is around 13.5 centimetres, and a collapse in economic development is identified as the size of male organ exceeds 16 centimetres. Economic growth between 1960 and 1985 is negatively associated with the size of male organ, and it alone explains 20% of the variation in GDP growth. With due reservations it is also found to be more important determinant of GDP growth than country's political regime type. Controlling for male organ slows convergence and mitigates the negative effect of population growth on economic development slightly. Although all evidence is suggestive at this stage, the `male organ hypothesis' put forward here is robust to exhaustive set of controls and rests on surprisingly strong correlations.

'Nuff said.

[HT to Eran Guse]

The Economics of Improv Comedy

2011-07-13T13:04:00.000-07:00

For fun today I attended a class on improv comedy at lunch time, and as I have heard many economists say there is economics in everything, improv is no exception. As the instructor explained to us how improv works my mind kept drifting to how a successful improv show is like a market economy. One of the most fundamental points that economists argue is that trade is mutually beneficial and that trade promotes cooperation between parties. In order to be successful in the market you have to use your resources to produce a product that consumers want and find worthwhile. Furthermore, Adam Smith's idea of the invisible hand tells us that if we follow our own self-interest we will also create a benefit for society.

Well I learned today that improv is all about cooperation. You have to offer the person you are working with something that they value and they in return will give you a line, information, character development that is beneficial to you. There are rules and you and your partner need to agree to these rules to get the best results. There is in fact a beneficial exchange of information between the two actors. It is in your self-interest to pay attention to the lines coming from the other actor to determine what it is they want. The invisible hand fits here nicely as the instructor explained that the purpose of improv is not to try and be funny, but to act and react to the actors around you. The comedy he explained is a by-product of a successful exchange between the actors. In other words if the actors listen to each other and engage in a beneficial exchange the audience will find it funny and be entertained. Yet another environment where the successful exchange between parties even without money or physical products being traded leads to the individuals improving themselves and the well-being of others.

Cannot wait for my next lesson ...

Surprise, Surprise! Folks in Highly Taxed Countries Are Happier than Americans!

2011-07-13T12:25:00.000-07:00

The Huffington Post recently had an article on how high tax countries are happier than the U.S. Surprise, Surprise! Folks in Highly Taxed Countries Are Happier Than Americans!: In the article Jane White writes "After the OECD created the Better Life Index to discern which are the happiest countries in the world an organization known as 24-7 Wall St. cherry-picked the list to narrow down those countries with the highest economic stability. Most likely, says MSNBC, 'the happiest people in the developed world get loads of social services without having to work too hard.' Or maybe these lucky folks not only don't have to pay for these services, more of them actually have jobs." White notes that the countries that have higher tax rates also have lower unemployment rates compared to the U.S. so she concludes that maybe higher taxes are not the job killers conservatives argue.

This could be true, but before we conclude this we should understand what the Better Life Index is about. According to the OECD Better Life Index web page the purpose is to ask whether "is wealth all that matters, or should we be looking at other things, like the balance between work and the rest of our lives? The Index aims to involve citizens in this debate, and to empower them to become more informed and engaged in the policy-making process that shapes all our lives." Do things besides wealth matter? I would argue yes, but does that mean we should ignore wealth? More importantly, wealth and a higher standard of living provides us the opportunity to pursue the other activities in our lives we value.

I decided to make some of my own comparisons. While the countries identified by 24-7 Wall Street have higher taxes and lower unemployment then the U.S., and are considered stable there are many countries in Europe many that we might consider stable that also have high tax rates and higher unemployment than the U.S. So why not combine another index the Economic Freedom of the World Index and see what we can learn when we combine well-being and economic freedom.

The countries highlighted in the article are Austria, Finland, Sweden, Netherlands, Australia, Norway and Denmark. I identified other Western European countries with high tax rates: Ireland, Germany, Hungary, France, Spain, Portugal, Greece, Italy, and Poland. What one can note is that the countries with higher tax rates and lower unemployment overall have a fair amount of economic freedom, ranking 40 or less out of 140 countries (lower numbers are better). While the countries I chose have high tax rates, and high unemployment are less economically free. The countries that are the most economically free in the index: Hong Kong, Singapore, New Zealand, Switzerland, Chile, United States, Canada, and Australia (one of the ones highlighted in the article). High rates can co-exist with economic freedom.

While the countries with higher tax rates noted in the article have lower unemployment than the U.S. the countries with the most economic freedom have lowest unemployment rates. Perhaps the most telling piece of information is economic growth. Many of the countries highlighted has being happier than the U.S. actually have economies that are shrinking (Norway, Denmark, and Australia) or are experiencing only modest growth. Again, the countries with the most economic freedom have the highest growth rates. What constitutes the well-being of a society may be open for debate and we might weigh different attributes more than other countries, but I personally would like to live in an economy that is experiencing economic growth and an increasingly higher standard of living. That does not imply low tax rates, but there is more to the story of well-being than merely the tax rates.

Sources: Economic Freedom of the world, http://www.taxrates.cc/, http://www.tradingeconomics.com/

Market Phenomena Blog

2011-07-11T09:14:00.000-07:00

We added a new blog to our Blog Roll today Market Phenomena. This blog is run by College of Charleston Economics graduate Jessie Saffron who graduated in 2009 and is now a law student at the University of Baltimore. He has some interesting thoughts and is worth a read.

Skeel on Bankruptcy and the Auto Industry Bailout

2011-07-07T11:07:00.000-07:00

On EconTalk today David Skeel of the University of Pennsylvania Law School talks about bankruptcy and the government bailout of the auto industry. This podcast is one that everyone needs to listen to as Professor Skeel explains all the costs associated with this bankruptcy, the lack of transparency in the process and the corners that were cut that jeopardize the rule of law going forward.

On the costs of the bailouts professor Skeel states "Well, if you start with the metric that the government wants to use, and that people often use--to what extent are taxpayers on the hook for this, what are they going to end up paying--what you would say is that it now looks like the car bailouts will cost about $14 billion. They'll be somewhere in the range of $14 billion; those numbers may change, but that will not end up getting repaid even after all the government's GM and Chrysler stock is sold; etc. To that, if you are trying to get an accurate number, you would need to add the other cost to taxpayers of the bailouts, that don't factor in the direct loans by the government. And the cost I have focused on in my work is that the Treasury basically adjusted the tax roles to give GM a special break with respect to its taxes. That is a break that could be worth as much as $45 billion in tax write-offs. When you run that through the 28% corporate-level tax it's probably in the $12 or $13 billion range. So basically what happened is, GM had a lot of tax losses, that, depending on how the transaction was structured might disappear, and depending on whether the government held onto its stock or sold its stock. Treasury essentially said: Don't worry about what you do; we are going to let you have these tax write-offs. Which ends up saving GM about $12 or $13 billion. So, you need to be taking into account those kinds of things as well--things that the government did that took money from the taxpayers, and essentially gave it to GM or Chrysler, even though it wasn't a direct loan; it was a regulatory intervention."

He goes on to note what this process does to traditional bankruptcy and its effect on the economic climate. "I really think as well that that feeds into the general impression that Wall Street has been bailed out, is being bailed out, and the little guy really isn't being helped. That's been an impression throughout the crisis, and I really think there's something to it. When you start suggesting that the rules apply differently for different people, I think it really erodes the economic morality, and erodes it in a way that really has affects everywhere. I think it's just terrible, that kind of behavior, and there has been a lot of it during the crisis."

The costs to these bailouts and government bankruptcy procedures will have large costs to taxpayers for years to come both monetarily and non-monetarily.

Unemployment, minimum wage, and the law of demand

2011-07-06T07:43:00.000-07:00

Approximately the third lecture of every semester is the topic of the law of demand. This idea is a crucial law in understanding economic theory and the world around us. The law of demand for those of you that need a refresher is that the price and quantity of a product are inversely related, ceteris paribus. That means demand curves slope downward. This idea is held with such certainty that Nobel Laureate George Stigler once quipped that any economist who could identify an upward sloping demand curve would be “assured of immortality, professionally speaking, and rapid promotion”*

My students often find this idea to be intuitive as most people do, if the price of a product increases we purchase less of it. However, there are clearly some people who still fail to understand this basic concept. The Wall Street Journal has a column on The Jobless Summer for teenagers. The article points out that the increase in the minimum wage in 2009 is major contributor to that situation. The minimum wage was raised creating a price floor and surplus i.e. unemployment. The wage rate was increased and employers purchase less labor, in other words the law of demand at work.

The article also notes that the individuals who work at the Center for American Progress do not believe in the law of demand. "The Center for American Progress ... recently recommended another increase to $8.25 an hour. Though the U.S. unemployment rate is 9.1%, the thinkers assert that a rising wage would 'stimulate economic growth to the tune of 50,000 new jobs.' So if the government orders employers to pay more to hire workers when they're already not hiring, they'll somehow hire more workers."

Raising the wage to increase employment seems like a similar argument that the stimulus was just not large enough. Both points seem to want to ignore the law of demand and the role of prices.

*Stigler, George J. The Theory of Price. 3d ed. New York: Macmillan, 1966 page 24.

Time to Kill the Michigan Alcohol Monopoly

2011-07-01T08:43:00.000-07:00

Michelle Minton has an article that demonstrates that George Stigler's idea of regulatory capture theory is alive and well in her article Time to Kill the Michigan Alcohol Monopoly. She writes "The wholesalers, rather than try to seek new growth opportunities in direct shipping, decided to squelch any new competition. In late 2008, Michigan lawmakers rushed through the Legislature a Michigan Beer and Wine Wholesalers Association (MBWWA)-endorsed bill (House Bill 6644) banning direct-to-consumer shipping of wine within the state. Legislators in Michigan, who collectively received almost $600,000 in campaign donations from MBWWA in 2008, introduced, voted on and enrolled the measure in a mere five legislative days. Before the shipping ban, retail liquor shops in Michigan, all of whom purchased their inventory from MBWWA members, could legally sell and ship those products directly to consumers. Rather than lose their monopoly control over the beer and wine market in Michigan, the MBWWA worked to end direct sales for everyone."

Time Inconsistency Overcome: What happens to your pets during the Rapture?

2011-06-29T14:05:00.000-07:00

I wonder if Tyler Cowen realizes how right he is when he says that there are markets in everything. I'm sure you've been concerned about what will become of your pets during the Rapture. Sure you're saved and will ascend to heaven directly. But what about poor fluffy?

Fluffy doesn't ascend with you, but you still love her don't you. Don't you want her to spend the rest of her days in comfort? If only there was a company that promised to look after your pets after you ascend to heaven? There is at least one http://eternal-earthbound-pets.com/

It's easy to make fun of this, but it is impressive that people have apparently solved the time inconsistency problem. You pay up front but they take care of your pet after you die. They have every incentive to let your poor pooch suffer while they spend their money on wickedness.

Perhaps you think that this isn't so different from regular life insurance. You pay premiums year after year hoping that the life insurance company will pay your beneficiaries. (Companies don't always look very hard for your beneficiaries.). But life insurance before the Rapture is different than life insurance afterwards. Without the Rapture insurance companies want to pay claims so that they can build an honest reputation and continue to get business. And of course the beneficiaries of most insurance policies can sue. Poor fluffy can't sue, and who knows what will happen to the legal system after the Rapture.

Apparently the companies spend resources making believers believe that the non-raptured are actually moral enough to take care of the pets once you've ascended. I think that's a great private sector response to a market failure.

Externalities solved by bees, Private Lighthouses providing public goods, Rapture Insurance; what can't markets solve?

U.S. Constitution Under Siege

2011-06-28T09:04:00.000-07:00

The most recent issue of Time Magazine has an article U.S. Constitution Under Siege over Libya, Taxes, Health Care. The article goes on to examine four issues that are raising constitutional questions: Libya, Obamacare, the debt ceiling and immigration. "Today's debates represent conflict, not crisis. Conflict is at the core of our politics, and the Constitution is designed to manage it. There have been few conflicts in American history greater than the internal debates the framers had about the Constitution. For better or for worse — and I would argue that it is for better — the Constitution allows and even encourages deep arguments about the most basic democratic issues. A crisis is when the Constitution breaks down. We're not in danger of that."

What is the origin of the constitution? Andréa Ford claims that the constitution was not established to limit government. "If the Constitution was intended to limit the federal government, it sure doesn't say so. Article I, Section 8, the longest section of the longest article of the Constitution, is a drumroll of congressional power. And it ends with the "necessary and proper" clause, which delegates to Congress the power "to make all laws which shall be necessary and proper for carrying into Execution the foregoing Powers, and all other powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof." Limited government indeed."

James Buchanan in his contribution to the economic discipline examines the issue of constitutional political economy. As Ed Younkins writes, "Buchanan distinguishes between two levels of public choice—the initial or first level sets the rules of the game through the choice of a constitution and the second or post-constitutional level involves playing the game within the rules. Different rules have different distributional consequences and the rules chosen are applicable into the future. Constitutional politics thus places boundaries over what ordinary politics is permitted to do. Ordinary political decisions are made often based on majority voting. One of Buchanan’s major contributions is bringing attention to the two-level structure of collective decision making.

Two types of analysis fall under the taxonomy of public choice—constitutional economics and operational public choice analysis. The purpose of constitutional economics is to legitimize the existence of a constitutionally circumscribed state and to discuss what type of constitutional rules could reasonably reach unanimous consent at the stage of constitutional choice. Buchanan’s primary interest lies in constitutional choice and constitutional reform. Operational public choice analysis deals with political processes within existing constitutional structures. Operational public choice analysis involves the study of a nexus of evolving exchanges, bargains, trades, agreements, contracts, and side payments."

For Buchanan the issues is one of pre and post constitutional political economy. The pre-constitutional idea was a contractual arrangement where individuals set and agreed on the rules. The post-constitutional world is one that each of us has an obligation to participate in the constitutional dialogue to insure that we maintain this contract. This a powerful idea and Public Choice theory provides us the tools to examine the political decision making in this post constitutional world, and can explain why we will violate the constitutional rules.

Buchanan also addressed the issue of anarchy and decided it could not work, but a group of young public choice scholars such as Edward Stringham, Benjamin Powell, Chis Coyne, and Peter Leeson are returning to this question. They argue that constitutional constraint cannot work as long as government is both rule maker and umpire.

The issues of constitutional crisis, reform, and anarchy are all ones we should be thinking about and participating in a dialogue about today.

Jerry O'Driscoll Sums up the Situation in Financial Markets

2011-06-27T06:08:00.000-07:00

Bob Higgs has a post on why hyperinflation hasn't occurred in the US.

Pete Boettke has a post on Bob Higg's post.

Jerry O'Driscoll made a comment on Pete's post.

Though two degrees removed from the initial commentary, Jerry's observations are spot-on and wonderfully succinct. I thought that they were worth repeating here.

Some of the reserve creation has supported lending overseas. And asset bubbles.

Banks are capital-constrained, which works on the supply side of credit. Individuals and companies are still deleveraging, which curtails demand for credit.

For two years, I have heard the same refrain from bankers. They have two types of customers: (1) those flush with cash who do not want to borrow; and (2) those who want to borrow, but who are poor credit risks.

The prime lending rate is not really a market rate. LIBOR is much more market-sensitive. Business loans are priced over LIBOR. That rate is still pretty low. Getting 25bp on reserves is a risk-free alternative to lending.

The near-zero Federal funds rate has torpedoed the interbank market. There is not enough return for the risk of lending to other banks.

For interested parties, going back to Higg's initial post is well worth the while.

Other Empirical Social Sciences

2011-06-26T08:05:00.000-07:00

I just got back from Spatial Stats camp at Penn State. The whole experience was fantastic and the teachers were even better. I also realized that there are other empirical social sciences. I'm well aware that poli sci is very empirical at many universities. There are also lots of empirical sociologists. I hadn't realized how empirical good geography-demography too. There are plenty of social science questions to ask that have a spatial component.

I have a project on non-profit rebuilding in New Orleans. There were geographers and sociologists working on similar projects in the rust belt. One woman was looking at the decision to abandon property in Cleveland. Another was looking at the spatial distribution of childhood poverty. I think there are plenty of economists who could find these questions interesting. If you were interested in poverty alleviation, empirical geography would give you the ability to assess different policies.

Naturally all sorts of environmental policy could be done in a geography department.

UNC, Penn State, and Wisconsin all seem to have strong programs.

Peter Boettke was my professor at George Mason and the main thing I took away from his was this idea that people make individual decision but the individuals are often in groups. The group has an influence on the individual's choice. In many econ departments you could say that as long as you said, Spencerian signaling immediately afterwards. Pete's perspective is that sometimes the way you interpret the world is influenced by the group you're in. I don't think a geography department would laugh at you for that.

Geography departments seem more willing to take a student who needs additional math and stats. My impression is also that there is less hazing in geography.

As for salaries, they are lower than economics. Much lower.
http://www.bls.gov/oes/current/oes251064.htm

Sociology might be better;
http://www.bls.gov/oes/current/oes251064.htm

My impression from talking to people is that the job market for empirical geographers and sociologists is much better than for other geographers and sociologists. If you study social theory and deconstruction your marketability is less than if you study something empirical.

I still think economics is the best field for studying social science, but I understand why people are interested in geography, sociology, demography, and of course political science.

Freedom: Where does South Carolina rank?

2011-06-24T07:10:00.000-07:00

Last week the Post and Courier, the local Charleston paper, reported on a story that surprised me Freedom: Where does South Carolina rank? The Mercatus Center at George Mason University has just released a new economic freedom of the state's index. This index joins others from the Fraser Institute and Pacific Research Institute. The reporter of the articles makes an important point in understanding what is at the heart of the issue for a state like South Carolina "There's a big difference between being conservative and being free. Actually, the most 'free' states are usually the moderately conservative states, according to the study." What distinguishes the Mercatus Index compared to the others is that is examines personal freedoms as well as purely economic freedoms. South Carolina scored 17 on economic freedom, but not surprisingly the state dipped to No. 40 on personal freedoms. Overall South Carolina ranked in the middle of the pack. So who is at the top and bottom? New Hampshire, South Dakota, and Indiana ranked in the top three. The bottom three were California, New Jersey, and New York.

That the index looks beyond pure economic freedom to issues of medical marijuana, gun control, and gambling makes it a welcome addition to this literature and one that we should all take a close look at to understand freedom.

Was the Glorious Revolution Glorious for Private Property?

2011-06-22T07:59:00.000-07:00

Douglass North brought institutions to the forefront of development economics. In doing so, he argued that the industrial revolution was largely the product of institutional improvement; that pre-industrial Europe was characterized by weak property rights; that, particularly in England following the Glorious Revolution, an improved private property rights regime set the stage for modern economic growth.

North's economic history (along with his collaborator Barry Weingast) inspired the modern empirical growth literature on the importance of institutionalized property rights. (The work of Daron Acemoglu and his coauthors exemplifies this literature.)

However, the latest issue of Kyklos features a fascinating article by Luis Angeles: "Institutions, Property Rights, and Economic Development in Historical Perspective". (Here's a gated and ungated link, respectively.) Angeles takes North to task on his history.

Throughout pre-industrial Europe low taxes were the nor given the significant limits on state capacity. England, for instance, was characterized by very low taxes from the thirteenth century until the Glorious Revolution: around 2% or less of national income if we count only the central government and up to 6% [...] if we include the Church. [...] From 1688 onwards we see the government's share in aggregate output increasing to levels never seen before (around 20% of national income by the end of the 18th century). [... Also] English Kings could not expropriate whoever they wanted whenever they wanted, and centuries of law and tradition supported the nobility in their rights to property. Clear evidence of this can be seen in the decision of some of England's most powerful monarchs, such as Elizabeth I or James I, to sell part of their lands in order to finance war efforts.

Angeles notes that the most cited cases of monarchical expropriation, e.g., Henry VIII seizing Roman Catholic Church lands or Edward I's expulsion of the Jews, "the victim was a particular social group that had fallen in disfavor and could not defend itself."

Perhaps more compelling is the harder evidence that Angeles brings to bear against North and Weingast.

North and Weingast's (1989) sole evidence for the improvement in England's institutions after 1688 is the falling rates on public debt. [... But] [i]f anything, falling interest rates on public debt could denote that the state can pay its debts easily by expropriating from its subjects. As it turns out, research has shown that the rates of return on private capital have been quite low in England since the late 14th century [...] and that their slowly decreasing trend suffered no notable alteration following the Glorious Revolution[.]

I found this article intriguing and not because I doubt the importance of property rights (for the industrial revolution or in contemporary settings) in the slightest. Rather, this article made me reconsider the basic historical yarn that I would spin (e.g., during an undergraduate class) in describing Western institutions and the dawn of modern economic growth (largely influenced by authors such as Douglass North). Perhaps some more detailed examination of institutional improvement in the 1700s would be useful.

Economics in Action-local edition

2011-06-17T13:54:00.000-07:00

This week I went to the Mid City Neighborhood Organization community-meeting in New Orleans. There were at least 80 people there and most seemed to be there to discuss a proposed development that would include a Winn Dixie grocery store and a 5 Guys Hamburger shop. It was interesting to hear about peoples’ concerns and what they were trying to do at the meeting.

Many of the people who spoke were concerned about rain runoff and drainage. That makes sense to me. Storm runoff is a type of externality.

In general the meeting was very Austrian and that was exciting.

There was quite a bit local knowledge prevalent in a very detailed discussion of traffic patterns. The developers knew the current traffic patterns, but meeting attendees tried to explain how people in New Orleans respond to changes in traffic patterns. They tried to argue that the developers hadn’t accounted for the way that locals respond traffic direction. This was a pretty cool example of local knowledge or tacit knowledge. There was no real good way for a traffic planner away from New Orleans to know how New Orleanians will respond to direction. Apparently they do not like to be told how to drive and ignore directions. But they also seem to ignore directions in a way that other New Orleanians can predict even if out of towners can’t.

I’m not sure if it was Coasian bargaining or regular bargaining, but several people in the audience were trying very hard to get some sort of concession from the developer. People wanted donations to the bike lane project, some sort of concession to bring in a certain number of local businesses, and some kind of unintelligible plan to do something for pets. That might seem like greedy people trying to get a handout from a developer who is helping the area recover from blight. But externalities are subjective. I see new competition and a 5 Guys as good things. That doesn’t mean everyone does. Some people may legitimately see this development as a negative externality and want compensation.

The conversation about local business was very interesting. Attendees did not consider a local franchise owner to be a local business. They wanted local funky stores that show New Orleans’ uniqueness. They couldn’t understand the developer’s perspective. The developer danced a bit not wanting to explicitly say, “Hey we want to make as much money as possible.” But he gave a good response. He didn’t know exactly what stores would end up being at the site. Different businesses will come and try to make a go of it. Some will make it some will fail. It depends on how well they serve local customers and what those customers want. If people say they want funky but only buy from national chains then national chains will be in the development. People then asked if the developers would be willing to talk to local businesses. The development had to try to explain that he wants as many businesses as possible to bid for space. That way he can get the most rent. All of this seemed very alien to attendees. No one offered to buy the site from the developer in order to build a better development with all funky stores.

The next day it was announced that the site had been approved. That made me wonder why we had the meeting at all.

Medicaid and Runaway Spending

2011-06-17T05:49:00.000-07:00

This morning I was obtaining background information on South Carolina’s Office of the State Auditor. On its webpage, at the bottom of the “Mission Statement” tab, the last paragraph notes that the Medicaid Audits Section of the State Auditor’s Office each year audits approximately 100 Medicaid contractors, using funding of over $230 million. As it was just after 5am when I read this, I did a quick and dirty calculation, assuming SC is the average spender, and multiplied this figure by the 50 states. The result of that crude calculation suggested to me that the US might spend $11.5 billion auditing Medicaid contractors in the United States. Don’t quote that number. The actual figure would deviate significantly from this calculation, but the obvious point is that billions of dollars are spent auditing Medicaid contractors in the US. This is mind-boggling and makes you wonder how much is spent just to provide Medicaid in the US. I checked on that. In 2009, total US spending on Medicaid was $366.4 billion. Therefore, $11.5 billion would only be 3.1% of the total spent. That makes it believable, but still mind-boggling. Check out other states

For those interested in learning more about issues concerning healthcare costs facing states, particularly Medicaid. Here is a preview of the type of information you will find; this about SC: “The state's Medicaid program is projected to cost $228 million more than lawmakers budgeted to spend on it this fiscal year. And the shortfall at the state Department of Health and Human Services is just a preview of the budget crisis awaiting the state in July. That is when the $1 billion in federal stimulus cash that's propping up this year's $5 billion spending plan runs out. ...”

If you want to know more about state and federal Medicaid spending, follow this link to Kaiser’s State Health Facts.

The end of crony capitalism

2011-06-17T05:31:00.001-07:00

It's a start! Yesterday the senate voted to end the tax breaks and federal subsidies for ethanol. See http://online.wsj.com/article/SB10001424052702304319804576389843694911096.html?KEYWORDS=ethanol. This may be a signal that the Senate will begin to examine all of the corporate welfare that it doles out each year. Crony capitalism as opposed to true capitalism occurs when businesses use the government to make rules or bestow benefits such that the business can become more profitable. Under true capitalism, businesses must add value to resources so that we the consumer are willing to pay more than the cost of production to purchase the product. In this case, both consumers and producers profit based on the values they place on the product. In free enterprise, businesses and consumers trade value for value. I bought the computer I am using to write this blog because I value it more than the price I paid for it. Toshiba sold it to me because they value the dollars I paid for it more than their costs of production.

In crony capitalism, firms use government mandates to block production or raise costs to other producers or they receive subsidies. In the first case, we saw that firms such as Archer Daniels Midland, ADM, benefited from the 54 cents per gallon tariff on imported ethanol. Ethanol is much cheaper to produce in Latin America, where it is made from sugar cane. This tariff increased the price of imported ethanol and also increased the demand for American (ADM) made ethanol which uses corn as the main ingredient. The consequence of this tariff is that the price of corn increased dramatically and over 40% of the corn produced in the U.S. was used for ethanol. This had huge secondary effects. The price of consumable corn increased as well as the price of all other products that use corn such as pork.

Making matters worse, the government subsidized gasoline blenders 45 cents per gallon of ethanol. This also increased the demand for corn ethanol, pushing up the price of corn.

Although the Senate has taken this first step to remove the crony capitalism, it does not remove the mandate that gasoline contain 10 percent ethanol. Thus ethanol producers are still the beneficiaries of crony capitalism. The result is that we will move to sugar ethanol increasing the price of sugar and reducing the price of corn.

Individualism and Worldwide Income Levels

2011-06-12T13:26:00.000-07:00

In the 2011 edition of the American Economic Review Papers and Proceedings, Yuriy Gorodnichenko and Gierard Roland present some evidence on the cultural determinants of 2000 income levels worldwide. They draw on various measures of cultural dimensions created by sociologist Geert Hofstede and psychologist Shalom Schwartz. I'll let the authors summarize in their own words.

Since research shows a powerful [positive] effect of individualism on long-run growth, the key question is what other dimensions of culture matter for long-run growth. In this paper, we look at the main existing cross-country measures of culture and analyze their effect on output per-capita. We find essentially that only individualism has a robust effect.

Individualism is the "extent to which it is believed that individuals are supposed to take care of themselves as opposed to being strongly integrated and loyal to a cohesive group." How Randian! Individualism, in the analysis, trumps egalitarianism, uncertainty avoidance, and harmony among other cultural dimensions.

Why Conservatives Can’t Stop the Growth of the State

2011-06-08T09:03:00.000-07:00

I recently attended the BB&T Program Chairs Conference at Clemson University where I was part of a panel on why conservatives cannot stop the growth of government. Here is a brief overview of some of the points I made.

The philosophical arguments used by right are the same as the left:

Greed is dangerous and the cause of many of the crises we face
Altruism should guide us in our daily lives

Self-interest is considered to be a vice. One that capitalism promotes and the state can prevent.

These are the normative and philosophical arguments and while relevant and important to the discussion I want to address the economics of where this philosophy leads us and why these policies will continue to allow the growth of the state whether directed by the right or the left.

Public choice theory instructs us to look at the institutions that emerge once self-interest is the motivation and why in the public sector this will lead to institutional arrangements that will allow the state to grow. On the left the public interest theory leads politicians to argue that greed is the problem that free markets are the problem, and that government officials can solve all our problems.

So do conservatives have a public interest view of the world?

I think the answer is yes. They are willing to claim that markets work and that we are self-interested, but argue that our self-interest will create problems if wholly left unchecked. The issue of why the right cannot stop the growth of government is not merely a matter of scale or size, but of scope.I think that James Buchanan in his chapter Beyond Pragmatism in The Limits of Liberty: Between Anarchy and Leviathan states the problem quite effectively and simply. He writes:

“When something has gone wrong, our response is to fix it up with baling wire and to go on about our business. This baling-wire syndrome presumes, however, that the underlying structure or mechanism is sound and itself not in need of repair or replacement. But, eventually, baling-wire repairs fail, and more fundamental change becomes necessary. When such a stage is reached, continuation of the established response pattern may create more problems than it resolves.

"Politics," by which I mean governmental action, notably federal governmental action, has been the social analogue to baling wire. The identification of a "social need," whether this be real or manufactured, has come to suggest, almost simultaneously, a federal program. Social progress has been measured by the quantity of legislation, and our assemblies are deemed to be political failures when new programs are lacking. Properly interpreted, the succession of New Deal, Fair Deal, New Frontier, Great Society, and New Federalism formats represents the pragmatic and essentially nonideological working of American democratic process. Little or no attention has been paid to the possible interlinkage of program with program, to the ability of the underlying structural system to sustain the growing pressures put upon it, to the questions of aggregate size and scope for political activity.”

Conservatives have a hubris that they also can plan and are not afraid to use government action if it serves their purposes. F.A. Hayek in Why I am not a Conservative notes:

“The conservative feels safe and content only if he assured that some higher wisdom watches and supervises change, only if he knows that some authority is charged with keeping the change orderly. … In general it can probably be said that the conservative does not object to coercion or arbitrary power so long as it is used for what he regards as the right purpose”

The framers of the U.S. Constitution understood the importance of private property rights and self-interest in human nature. In a post constitutional world not having this correct view of human nature, of property rights and institutions explains why conservatives will continue to grow government.

Law versus legislation

2011-06-03T09:00:00.000-07:00

Hayek distinguishes between law - those rules that have evolved spontaneously and are unplanned and integrated into our expectations - and legislation - those rules designed by individuals or legislators and enforced through the threat of force. Similar to Don Boudreaux's lunch room example (listen at http://www.econtalk.org/archives/2006/12/boudreaux_on_la.html), I have noticed in my classrooms that after the first day of class, students almost always sit in the same seat. Thus the seat they choose on the first day, now becomes theirs. It's the law of the classroom, although there is no enforcement mechanism.

One difference is that we know law, but cannot possibly know all of the legislation that is continuously passed. Tennessee recently passed legislation that outlaws the sharing of internet passwords for Netflix and other sites.
http://latimesblogs.latimes.com/washington/2011/06/tennessee-outlaws-sharing-passwords-to-hulu-netflix-rhapsody-and-others.html

This type of legislation is unnecessary, since companies such as Netflix can determine whether I have shared my password with all of my friends. They can easily remove my account if too many people are using it. Netflix does not need the government to collect a $500 fine from me if I share my password. I have the contract with Netflix not the government. If I do share my password with all my friends, then and Netflix can either cancel my subscription or use the courts to sue me for breach of contract.

The question we need to ask is "Who benefits from this legislation?"

The Science of the Free Market

2011-05-28T04:39:00.000-07:00

The question of integrity concerning academic institutions’ involvement with outside donors seems to be a topic of interest these last couple of weeks. It has been suggested that academic institutions have sold out to outside donors and further that these donors have unprecedented and unwarranted involvement in the selection process of faculty. Of course the specific donors in question are the Koch brothers, or more accurately the Charles G. Koch Charitable Foundation, and the subject of the work they support is economic freedom.

I am an assistant professor of economics, and I have received a grant from the Koch Foundation. I have also participated in workshops on Koch’s Market-Based Management, a management philosophy based on the principles of a market economy and fully explained in Charles Koch’s book The Science of Success. This work is an important aspect of my professional development, and I am sharing my intellectual discoveries with my students, my colleagues and members of my community. I thought this was my job.

To that end, the Koch Foundation is interested in supporting teacher-scholars devoted to advancing individual well-being and in turn social progress by incorporating the principles of economic freedom in their work. It isn’t a big secret, and it shouldn’t be appalling. One can read about their mission right on the front page of their website.

I teach entrepreneurship in addition to economics. I use MBM in my classroom, by my own choice. It helps me drive home the relevance and linkages of individual integrity, value-creation for the customer and in turn the company, long-term profit maximization and the betterment of society in contrast to the short-sighted approach to business that is the focus of traditional business ethics education (I choose to let my students learn the habits and practices of winners rather than losers). For those not familiar with MBM, the five dimensions are:

1. Vision
2. Virtue and Talents
3. Knowledge Processes
4. Decision Rights
5. Incentives

Compare these five dimensions with the cornerstones of economic freedom:

1. Private ownership of resources or property
2. Personal choice
3. Voluntary exchange
4. Free entry into markets or competition.

An economist or a student at the introductory level immediately recognizes these four cornerstones of economic freedom as nothing more than underlying characteristics of a market economy, taught in every Principles textbook I have ever read. These are relatively simple, basic notions. Yet, society has managed to abstract from these basic principles, as success so often has the tendency to cause. Some argue of course, Joseph Stiglitz comes to mind, that we can’t assume these principles are strong enough to override the problem of imperfect information. Yet, technology is removing information barriers with amazing leaps, so much so that much of society is now more concerned with privacy rights than ever before – a recent WSJ article about researching human behavior through cell phone records comes to mind. Yet, looked at from another perspective, market innovations in science and technology are helping disseminate better, more complete information. On the basis of economic principles, this should suggest that the free market is becoming better able to deal with resource allocation and efficiency in production, not less able.

So in conclusion the Koch Foundation supports research and scholarship on economic freedom. I wonder if we would witness a media uproar over an energy firm, other than Koch of course – maybe BP before the big spill, supporting a chemistry department’s research into alternative fuels. Would there be outrage to find a Fortune 500 company supporting marketing research and learning activities? Would there be outrage to find that the EPA supports student competitions to come up with all the reasons regulation is good, which the EPA has actually done.

From the perspective of economic freedom, this is just more competition. But then, it shouldn’t be a surprise that opponents of the free market are opposed to competition.

Home Mortgage Interest: the most over-rated deduction

2011-05-25T05:32:00.000-07:00

My annual April op-ed piece on taxes...

It’s that time of the year again. Some people filed their 1040 tax forms last January, received their refunds and are excited that they let the government keep their money (interest-free) for months. Others have procrastinated and are filing their taxes at the last minute. Few taxpayers have noticed their “payroll tax” (FICA) - even though it probably takes more of their money (unless they earned a six-figure income). And most people believe that the world is a better place because of the Home Mortgage Interest Deduction (HMID).

Economists are interested in the distortions caused by subsidies in the tax code. Subsidies change incentives, so that people end up doing more of the activity being subsidized - whether it’s attending college, purchasing health insurance through one’s employer, or buying a bigger house. Such policies may be ultimately desirable. But they are “socially inefficient” - by definition - because they take resources from a more productive part of the economy and encourage people to do what has become “personally efficient.”

The HMID is projected to cost $132 billion next year. Even in years without budget concerns, that’s a lot of money. Now, some will say that this subsidy is important for the housing sector in particular and the economy in general. They point to the “multiplier effect” of jobs created by the housing sector - from construction workers to input suppliers, from those who earn the money to those who benefit when that money is saved, given away and spent on consumer goods.

But the same could be said of other ways to use $132 billion. For example, we could put the same money into infrastructure and create jobs, while improving roads and bridges. So, why would we think that spending the money for the HMID is better than alternative uses of the same money?

Aside from efficiency, there are also important questions of “equity” or fairness. One who receives a subsidy is likely to see that subsidy as “fair.” But if we’re trying to be more objective, what can be said about the fairness of the HMID?

Beyond its overall cost, the subsidy provides a disproportionate benefit to the wealthy. Intuitively, this is relatively easy to understand. One has to itemize deductions to get it. From there, the gain is only the amount of the itemized deduction over the standard deduction. In 2010, the standard deduction for married couples was $11,400. So, unless your mortgage interest and other deductions (most notably, charitable contributions, state-local income taxes and property taxes) exceed that amount, your mortgage interest does not reduce your taxable income at all.

For example, if a married couple has mortgage interest of $5,000 and total deductions of $12,000, then they only get the extra $600 over the $11,400 standard deduction. From there, you multiply the $600 reduction in taxable income by the relevant marginal tax rate (MTR). If they’re in the 15 percent tax bracket, then the extra $600 in deductions would be worth $90 in lower taxes. It’s difficult to get excited about saving $90 in taxes by giving a bank $5,000.

Both the amount of itemized deductions and the MTR typically increase with income. So it follows that the wealthier should be expected to benefit a lot, while the policy does little for the middle class and nothing for the poor.

Let’s look at the numbers. Some states benefit more than others. In 2008, 27 percent of Americans claimed the HMID for an average deduction of $3,279. But use of the HMID ranged between individual states, from Maryland’s 38 percent to North Dakota’s 15 percent. And average HMID deductions ranged from California’s $5,520 to North Dakota’s $1,222. (In Indiana, 33 percent claimed the HMID with an average deduction of $3,337.)

A recent study by the Urban Institute focused on the net tax benefit of the subsidy. Among Whites, 26.4 percent benefit from the HMID, by an average of $632. Among African-Americans, only 14 percent benefit from the subsidy, by an average of $277. Looking at income levels, the average annual benefit of the HMID is $4,466 for the top 5 percent of income earners; $2,639 for the top 20 percent; $215 for the middle 20 percent; and $2 for the lowest 20 percent.

It’s difficult to imagine why one would be really excited about this policy - rather than lower, overall taxes or lowering the deficit - unless one is wealthy and has a mortgage on an expensive home. But we should expect our politicians to rise above such selfish interest and to enact policies that are more efficient and more equitable.

the perils of direct democracy

2011-05-23T17:34:00.000-07:00

In political economy, Public Choice economists point to the foibles and failings of democracy: the disproportionate power of interest groups in some contexts (the tyranny of the minority); the unjust exercise of power by the general public (the tyranny of the majority); the problems caused by any system of government where people are fond of using power to take others' resources; and so on.

There's an old saying that democracy is the worst form of government, except for all of the others. Or putting it another way: the best form of government is the benevolent dictator; the trouble is finding the benevolent ones.

In April, in a special section, The Economist had some really nice articles on the impact of more direct democracy, as exercised (often famously) in California, starting 100 years ago.

Here's a general, introductory article...

as our special report this week argues, the main culprit has been direct democracy: recalls, in which Californians fire elected officials in mid-term; referendums, in which they can reject acts of their legislature; and especially initiatives, in which the voters write their own rules...This citizen legislature has caused chaos. Many initiatives have either limited taxes or mandated spending, making it even harder to balance the budget. Some are so ill-thought-out that they achieve the opposite of their intent...

Here's an essay on the history of California's democratic experiment...

In this [1911] Californian election voters had to decide on three new types of balloting: referendums, recalls and initiatives. They accepted them all with enthusiasm...Californians thus explicitly chose a path that diverged from the one America’s founders had taken...California is also unique, in America and the world, in treating every successful initiative as irreversible (unless the initiative itself says otherwise). The legislature cannot change it. In effect, this makes initiatives a higher class of law...Direct democracy in California is thus an aberration. It has no safeguards against Madison’s tyranny of the majority...it encourages special interests to wage war by ballot measure until one lobby prevails and imposes its will on all. Madison and Hamilton would have been horrified...

This essay applies the discussion to K-12 education...

And this essay lays out the extent to which voter knowledge (specifically in California) is limited or twisted...

Job Creation & Destruction and The Great Recession: Austrian Perspective

2011-05-18T09:48:00.000-07:00

Casey Mulligan from University of Chicago has a nice piece in today's New York Times online about job losses (and also job gains) during the Great Recession. His thesis: "Census Bureau data on employment by pay level cast doubt on credit-crunch and demand-based theories of the recession."

If cutting payroll spending [which would be the presumed motivation during a credit crunch] had been the primary motivation of employers, then they should have cut deepest among their most expensive employees. Firing one person making, say, $2,000 a week saves more than firing three people making $600 a week.

It is true that part-time employment, which is typically low-paying, increased significantly during the recession. However, last week I showed Census data suggesting that employment of people making more than $2,000 a week may have been greater in the 12 months after Lehman Brothers failed than it was before, even while employment of people making less than $2,000 a week fell several million.

Hiring more high-paid people is not a way to reduce payroll spending. Moreover, payroll spending now exceeds what it was when the recession began, yet employment remains millions lower. Apparently, payroll spending is not enough to bring those jobs back.

Another theory of the recession is that it was caused by a lack of demand — fewer employees were needed because employers were selling less to their customers. The low-demand theory is a good description of a couple of industries, like manufacturing and home construction, but if it described the economy as a whole we would have seen all types of employment cut, not just employment of people making less than $2,000 a week.

What seems to have occurred is a cut in personnel rather than payroll.

Another set of theories say that high-paid employees are replacing low- and middle-income employees. This replacement might come from employers’ attempts to cut personnel during the recession, rather than payroll spending. For example, employers might have worried about health insurance and other employment regulation whose costs are proportional to the number of employees they have. In this view, the bank bailout did little to prevent layoffs.

There may be an Austrian interpretation of this as well. The summary picture seems to be one where (1) relatively high-pay employees were substituted for low-pay employees while (2) within low-pay employment, there was a shift from full-time to part-time jobs. If the Great Recession was an Austrian business cycle theory (ABCT) type of bust, it should have been a period of reallocation following malinvestment. Labor would have been mismatched across heterogeneous capital types. During the reallocation one would have expected a bias towards more substitutable (i.e., mobile across job types). If higher levels of human capital (which typically correspond to higher pay) are more substitutable (or, using other economics terminology, if high-level human capital tends to have relatively low asset-specificity) then it would not be surprising to see a shift, for a given payroll, towards higher paying jobs. Also, low-paid workers may be more substitutable in the form of part-time jobs than full-time jobs.

Furthermore, given the uncertainty associated with a macroeconomic reallocation, full-time jobs may be viewed as having more "putty-clay" characteristics. Benefits packages and longer-term employment contracts may be avoided during a time when the profitable directions of reallocation have yet to be discerned.

Counter-examples abound to some of my ramblings above. For example, a software programmer's human capital may well have higher asset-specificity than many manual laborers. On the other hand, I tend to think of white-collar workers generally as more easily changing industries at comparable pay than blue-collar workers are. Ultimately these are empirical questions.

Robert Frost

2011-05-17T20:54:00.001-07:00

I was reading Robert Frost and I saw this. He doesn't like government planners and do gooders. I especially like the term "beneficent beasts of prey." Robert Frost recognized the evils of government benefits and dependency.

It is in the news that all these pitiful kin
Are to be bought out and mercifully gathered in
To live in villages, next to the theatre and the store,
Where they won’t have to think for themselves anymore,
While greedy good-doers, beneficent beasts of prey,
Swarm over their lives enforcing benefits
That are calculated to soothe them out of their wits,
And by teaching them how to sleep they sleep all day,
Destroy their sleeping at night the ancient way.

From Roadside Stand

Academic Freedom and Private Donors

2011-05-17T16:45:00.000-07:00

Recently Florida State University has come under attack for accepting a donation from the Charles G. Koch Charitable Foundation for new faculty hires. The St. Petersburg Times reports that this is problematic because the Koch foundation will have some input into who is hired and this raises questions of academic freedom. Maybe I am naive and do not fully understand my rights related to academic freedom, but if FSU and Koch can agree on a candidate and that faculty member teaches in their area of expertise how is this a violation of academic freedom? However, just to be sure I recently reviewed the AAUP's statement on academic freedom and do not see any violations.

Perhaps I do not see an issue because I have been privy to responses from a variety of academics providing details of the FSU agreement that were not in the article. For instance Randy Holcombe, an FSU economics professor responded to the St. Petersburg Times article.

Holcombe writes "Here are some facts about our accepting this money. We recognized at the outset that we didn’t want an outside organization telling us who we could hire, and agreed we would only take the money if the Foundation agreed to support candidates we wanted to hire. If there were no mutually acceptable candidates, we would not take the money."

Others have responded as well Robert Lawson an FSU Ph.D. provides some additional background. Others such as Scott Beaulier have merely defended themselves from personal attacks by "journalists". Philosopher James Taylor examines the arguments point by point to determine if there is a violation of academic freedom.
Donor accountability does not seem unreasonable to me. I have seen donors provide funds to universities with no oversight only for those funds to be used in ways that the donor would have never intended.

Full disclosure: the Charles G. Koch Foundation provides the Initiative for Public Choice & Market Process a small grant that is used for a variety of student activities. I approached the Koch Foundation three years ago and in that time no one from the Koch foundation has ever suggested a speaker, a book, or a research topic to me. Apart from requiring an annual report on how I used the grant, the Foundation left me entirely to my own devices.

More professional sports arena madness

2011-05-11T07:58:00.000-07:00

Glendale, AZ has agreed to pay the NHL $25 million to keep the Coyotes there for one more year. Commenting on the city council's decision, Mayor Elaine Scruggs stated: "This is a payment for a service. This is not a subsidy. We are keeping our community arena open for business. We are keeping that arena generating revenue." Mayor Scruggs' comments just further emphasize why politicians are politicians and not businesspeople. The goal of a business is not to maximize revenue, but to maximize profit. Positive profits indicate that the use of the resources created more value than had the resources not been used in that manner. Negative profits (losses) indicate the resources were more valuable before being used up in the project. Positive revenues tell us nothing. Given all the discussion about the team leaving, I suspect that while the team generates positive revenues for the arena, I am quite certain it earns negative profits (particularly when accounting for the $25 million "payment for service").

As an aside: I am not clear how the Coyotes' use of the area is a service for the city. The customer in this transaction to use the arena is the Coyotes franchise; the producer is the arena owner (the city). Customers don't provide services for producers. Producers provide services for consumers. So, the mayor is wrong; it is a subsidy, and it certainly cannot be a payment for service.

Politicians: Surplus Killers

2011-05-11T07:24:00.000-07:00

Just this past fall South Carolina state legislators could regularly be found giving statements about not being able to come up with the funds to cover the state's $5.3 billion budget (FY 2011). However, with a stronger state economy than had been expected and greater cigarette tax revenue, the state now claims that it will be running a $110 million budget surplus. Story here.

So, what should the state do with that surplus? Given the nearly $40 billion state debt (23.5% of gross state product), a rational individual might think that the incentive might be to use the surplus to pay down the debt just a little--and it would be by just a little $110 million is a mere 0.275% of our state debt. What are our politicians planning to do with the surplus instead? Eliminate it, of course! How? As should be expected according to public choice theory, our politicians, in an effort to satisfy the politically organized, are going to give tax breaks to businesses who have argued that they have been over-burdened by the increased taxes to pay back the federal loans received to keep unemployment benefits flowing back in 2009.

The unfortunate reality is that the only legitimate way to get out of this problem of excessive federal and state debt is to cut spending and over-burden current tax-payers to pay off the federal and state loans taken out in the past to provide excessive benefits to past voters. We MUST run surpluses, not just balance the budget. I don't want to bear that cost, but we are past that now. It is wrong to further burden future generations with greater tax burden. This level of spending without taxation is not sustainable. The longer we put off the correction, the more painful that correction gets.

Toomer's for Tuscaloosa: Private vs. Public Disaster Relief

2011-05-10T20:51:00.000-07:00

Last fall a University of Alabama "fan" poisoned the 130 year old oak trees that help mark Toomer's Corner in Auburn. It's a tradition to roll these trees after a win. When the news was released that these trees were deliberately poisoned Alabama alumni created a Facebook page "Tide for Toomer's" and raised over $50,000 to help save the historic trees. On April 27th tornadoes devastated parts of Tuscaloosa and western Alabama. On April 28th a Facebook group was created "Toomer's for Tuscaloosa"

The coordination effort that has emerged to help the victims of the tornadoes is very impressive. Not only because they were probably there before FEMA, but the degree and depth of aid that is being coordinated. Here are a couple of sample posts that flood my news feed by the hour.

"Pass the word: a group from Troy will be feeding ANYONE and EVERYONE who needs it Sunday at the Lake Martin Baptist Church. If you know of surrounding areas in need, please pass the word. If we can, we will bring the food to those who can't get to us. Message me contacts or tell us where we are needed."

ESPN took notice of the group and reported on how this group had boots on the ground 24 hours after the storms.

The group not only posts what they are doing, but asks for requests for help and notifies people of what is needed and where the need is greatest. They posted to victims where FEMA would be providing generators and how people can contact the Red Cross. They have posted locations of where and how people can make donations or volunteer to help. The group has been reaching out to the local business community and they are responding as well.

"D and A Automotive from Montgomery, AL (drop off location) has their first truck loaded and ready to leave in a couple of hours. I called the CVS here on Zelda Road and spoke to the manager, Brooke. I told them I was coming with 100.00 to buy hygiene products and asked her if she could match it. She was pleased to do so. I just returned to work with my money's worth.. and almost $300.00 donated by CVS!" Piggly Wiggly and other business have contributed as well.

Aid is coming not just for the people, but for their pets. Auburn Vet School is holding a drive on May 14 to collect supplies for pets and livestock in the hard-hit areas of northern Alabama. The social network group is reaching beyond the borders of Alabama for help. In my home state of South Carolina they coordinated two drop offs in Charleston to take items to victims. They have reached out to Georgia and D.C.

Valuable information is being provided to people through this network in the form of public announcements such as how they can pay their bills using their cell phones. Where FEMA provides only the basic needs this group is working to provide for the more personal losses. A group of women organized a prom with donated dresses, and while that might seem trivial I am sure there are many high school students who are very appreciative that they will not miss out on this experience.

The group posted a letter to Alabama Governor Robert Bentley explaining how they created a supply chain network and that they are surprised by their impact. More importantly, they thanked the governor for minimizing the red tape.

The lesson here is that private aid can access and provide need to victims by having the knowledge of community and spontaneously emerge to coordinate efforts not just for their local community, but for the all the victims across the state. Few people could have predicted the way that social networking could coordinate such efforts. We should not underestimate how communities can and will pull together in times of crisis instead of relying on government aid.

Sweatshops and Human Trafficking

2011-05-08T15:33:00.000-07:00

Lots of interesting things came out of studying human trafficking in my international econ class. For one thing, women in Latin America sometimes get tricked into going with traffickers because the trafficker promises them a job in a sweatshop. Apparently women sometimes know that the sweatshop job may not be real, but the women risk it anyway.

This makes sweatshops sound really bad. Not only do they pay low wages, but the existence of sweatshops helps traffickers trick women.

Of course, a different way to look at this is to realize that people's lives are so bad in some developing countries that they will risk being trafficked for a sweatshop job. The sweatshop is a something that can really change someone's life.

In this interpretation the sweatshop job is a really good thing. If only we had more of them.

Are Market Processes Moral?

2011-05-06T14:47:00.000-07:00

A religion professor at my college recently gave a talk to economics seniors on the limitations of economics and the necessity of considering religious principles in determining what we should do. Economics, he said, has difficulty reconciling with the harsh criticism of market activity found in the Bible. There were, of course, other religions he could have considered, but Christianity was most common among these students.

One of his key points--that the economic way of thinking is not sufficient to understand the world around us--is valuable. An interdisciplinary approach to learning is indeed vital. However, I believe there are some problems with assertions that free markets and Christianity are incompatible.

The idea of free markets is about minimal intervention of the civil government into the marketplace. It is not about creating morality through markets. Neither is it an argument that people operating in a free market environment do not do bad things. It is true that markets sometimes produce things that should not be produced. For example, pornography, prostitution, and contract murder are provided in markets (and not always illegally). And people who produce good things sometimes do so while cheating, lying, and stealing. But no market-oriented economists I know would argue that markets are expected to stamp out all unsavory and destructive behavior. A market structure allows people to accomplish their goals, but is neutral about what those goals should be.

I think it's common for non-economists to create a bit of a caricature of capitalism--an image of a relentless search for financial gain, whatever the consequences for customers or bystanders. Yet free markets allow for the pursuit of multiple goals, not simply increasing the size of one’s bank account or even the size of corporate profits. Mother Teresa’s inclinations to help the lepers of Calcutta are no less consistent with the free market than a “greed is good” Gordon Gekko. Free markets are just that—free. A person in a free market has broad (not limitless) freedom to pursue their goals, goals which may be laudable or reprehensible.

Furthermore, it is a non sequitur to argue that all immoral acts must also be illegal acts. It may be wrong for a child to lie to his parents, but few would argue that the local sheriff should have jurisdiction in such matters. There are other social institutions besides the state, which can exercise influence to encourage moral behavior. The family and the church are two of these. I do not know of anyone who would argue that families and churches are incompatible with free markets. The existence of some immoral participants in the market, who produce evil things, does not imply that the state should intervene to deal with every form of immorality.

Neither markets nor governments do what we would like for them to do. Neither perform perfectly. Market institutions and coercive institutions (such as government) both are populated by imperfect human beings. One of the important questions, then, is whether markets or governments are least likely to produce the undesirable results we see. It seems that the recent financial crisis has been erroneously understood as the consequence of insufficient regulation. I recommend Tom Woods’ book Meltdown, Thomas Sowell’s The Housing Boom and Bust, and Peter Schweizer’s Architects of Ruin as readings on how government intervention contributed to the crisis. These tend to show that, far from being an example of “unfettered markets,” the financial crisis is an example of what regulation and monetary manipulation can do to an economy. While market processes suffer from greed, larceny, and deception, governments do as well. And the tendency is for greed, larceny, and deception to be worse where paired with coercive power. Markets can only entice cooperation, while the distinctive characteristic of government is its power to use force to accomplish its purposes.

Economic freedom

2011-05-06T11:35:00.000-07:00

I am on my way to the continent of big government - Europe. I saw this article in IBD and it made me think of how important economic freedom is to growth and also to reducing poverty.

Unfortunately, I cannot figure out how topmost text in this blog site directly. So I am pasting it from another program. Even though this technological, or maybe in my case, human problem is here, think about all of the great things that entrepreneurs have produced because they were environments where they were able to keep most of their profits.

I saw a study indicating that per capita, the US has more blockbuster drug patents and medical technology patents than Europe. Incentive do matter.

Regulation and Innovation

2011-05-04T08:50:00.000-07:00

A Mises Daily post today by Mark Thornton is entitled “The Attack on the Washing Machine.” I immediately thought of Jeffrey Tucker’s book, Bourbon for Breakfast. Later in the blog post there is an advertisement for Tucker’s book. I read the book last year at Christmas; it was a gift from my brother to our mother, who certainly does not follow Mises Daily.

Today, students in one of my senior undergraduate courses, the Economics of Entrepreneurship, are writing an essay on their final exam about one of the required readings, Baumol’s (1990) “Entrepreneurship: Productive, Unproductive and Destructive.” It struck me how effectively Tucker provides example upon example of how regulations affect innovation. Baumol focuses in general on the “rules of the game.” Admittedly many of my students struggle with the Baumol article. Tucker picks everyday things that almost all of us recognize and struggle with. The washing machine is but one example that a household member would identify with. The shower head is another great example in the book. The water heater is another. Students of economics would do well to read the Baumol article and Tucker’s book side by side.

Overselling Microfinance

2011-05-04T07:06:00.000-07:00

William Easterly reviews two recent books on development in the Wall Street Journal online: More than Good Intentions by Dean Karlan and Jacob Appel and Poor Economics by Abhijit V. Banerjee and Esther Duflo. Both books are authored by pioneers in the use of controled economic experiments to assess policies of development assistance.

Putting a good deal of stock in Easterly's (mostly positive) review, I've already ordered Poor Economics and am looking forward to giving it a read. However, here I only want to single out a bit of commentary from Easterly's review on what has been a development policy vogue for about a decade now: microfinance.

Targeted small loans to the poor have been oversold as a method of launching fledgling entrepreneurs into prosperity. Experiments showed that microcredit only nudged up the rate of new business-formation from 5% of households to 7%. Microloans are most often used for something else, such as financing the purchase of consumer durables or repaying debts to moneylenders. The problem is not that microcredit is a "failure" (both of the above are useful outcomes), but that its promises so often fall short. Messrs. Karlan and Appel note that in our own rich countries we don't expect that "every random man on the street" would be able "to conceive and manage a thriving small business." Nor would we "start lending money to random men on the street with that in mind." So why expect that with microcredit in poor countries?

Pioneered by Nobel Peace Prize winner Muhammad Yunus in Bangladesh in the later 1970s, microfinance offers small, non-collateralized loans within an impovershed community and relies on peer-pressure within the community (i.e., bascially the threat of stigmitizing and/or ostracizing deadbeats) to overcome adverse selection and agency problems. (In the case of Grameen, borrowers were predominantly women.)

By most accounts, Grameen was - and is - a success. However, Easterly notes that the reviewed books are especially on point in "criticiz[ing] over-promising and generalizing in the aid business." A moment's consideration will suggest that microfinance is most likely to deliver (a) in small scale applications (b) in specific contexts.

Easterly (drawing on the authors' quotations) concisely drives point (a) home. Microfinance (as is any finance) requires complementary entrepreneurial capital. While the stock of per capita (raw, potential) entrepreneurs can likely be considered similar in both developed and developing nations (Baumol, 1990), it still is likely a small percent of the population.

On the second point ((b) - in specific contexts), Pete Boettke over at Coordination Problem also has a post on the Easterly review and I'll just borrow his commentary.

I am less persuaded than these authors that the poor are irrational and self-defeating, and instead think analysts have not completely identified the incentives that the poor face. The behavior is self-defeating, but the cause is to be found not in their inability to weigh costs and benefits, but the context they operate in that produces myopia and self-defeating strategies for poverty alleviation. Context matters; history matters; ideas and beliefs matter; institutions matter; INCENTIVES MATTER.

Why do Human Traffickers Send Money Home

2011-04-30T13:02:00.000-07:00

My international economics class just finished a week on human trafficking. Gruesome and horrible stuff. Some traffickers send money home or allow the people who are trafficked to send money home. This is strange because traffickers are not nice people and the victims have no choices in other matters.

Why do some traffickers allow people to send money home? Several points come to mind.

1) In some places there may be traffickers who build a reputation that lowers their costs. If you're going to sell your kids, sell them to Pete. He makes sure they send $10 a month back home.

2) Agency cost. It might be easier to make people do things if you use both the carrot (money sent home) and the stick (torture, disfigurement, murder, starvation).

2a) Tacit knowledge. It may be that some sorts of knowledge about customers and the best way to price discriminate are tacit. (It's easy to prevent resale on some of the things modern slaves provide to customers.) How does the modern trafficker or pimp get information that is very local and tough to see without being on the ground? She can arrange to send home money to slaves who communicate this type of information. Surprised that I said she? Lots of traffickers are women.

The Battle Continues: Round 2

2011-04-28T11:22:00.000-07:00

Russ Roberts Professor of Economics at George Mason University and John Papola former MTV, Nickelodeon and SpikeTV producer, creators of the Keynes and Hayek rap video Fear the Boom and Bust have delivered the next installment: The Fight of the Century.

An article in the Daily Caller states "On the surface, these videos might seem like they could only be interesting to political or economic wonks, but Russ Roberts’ and veteran TV producer John Papola’s witty lyrics, creativity and directorial vision bring the goods to make both videos entertaining and appealing to much wider audiences."

The lyrics are powerful and ring true to the economics theory. Just another medium to get across powerful ideas.

I am apparently not an economist. Who knew?

2011-04-28T08:17:00.000-07:00

Time and time again I read AP articles such as this one by Jeannine Aversa stating that economists--implying the whole profession or at least only those economists who actually matter--believe this and economists believed that. I honestly cannot recall the last time I agreed with what these group of people, referred to as economists, purported. As such, I have come to the realization that I, in fact, am not an economist, at least not in the eyes of the media or our policymakers at large. In order to be an economist to these individuals, I would have to be a blundering idiot, which I am not.

Let me dissect each of the unjustified claims of these acclaimed "economists" in Aversa's article:

1) "[Bernanke and other economists] generally agree that gas prices will stabilize and the economy will grow at a 3 percent pace in each of the next three quarters."

Nope, ain't happening. Inflation and the devaluation of the US dollar is accelerating at this point. That means imported goods, including oil, will continue to rise, not stabilize. Further, any recent gains in the unemployment rate which suggest a positive turn for the economy are only because of a falling labor force. The labor force participation rate (percentage of working aged population who either have a job or who are actively seeking employment) has fallen quite drastically recently (see this). I'd be very much surprised to see economic growth exceed 2.5% in any of the next three quarters and to see the average growth over that period exceed 2%.

2) Aversa (and economists) blame winter storms for lackluster construction expenditures.

Wow, what inconsistency in arguments. I can't count the number of times I have heard the following arguments by these very same "economists": heavy snow storms and destruction by high winds, tornadoes, hurricanes, etc. should spur spending as we must spend money to dig ourselves out and rebuild, creating jobs in the process, and when those people spend their incomes other jobs are created, and so on. The classic Broken Window Fallacy. But, I digress. The blame for lackluster construction expenditure should not be on unfavorable weather or on government not spending enough, but on the uncertainty and pessimism encouraged by our fiscal and monetary policy. Private sector decision-makers have less incentive to invest due to the uncertainty and pessimism created by public policy. That is the reason for the further slowdown of construction expenditures.

3) "Bernanke and other economists expect government defense spending and consumer spending will rebound in the next quarter."

Consumer spending is not going to rise, at least not by much in my opinion. Government defense spending? Let's just start another World War and the economy and unemployment will be just fine and we will all be better off according to these economists. Forget about the death and destruction--it's all about the aggregates. I certainly don't want any increases in government spending in any area, including defense spending.

4) "Economists in a new Associated Press survey predict the economy is growing at a 3.2 percent pace this quarter and that growth will steadily improve over the remainder of the year."

Again, growth will be nowhere near 3.2%. Any claims otherwise are irresponsible.

5) "But stripping out energy and food prices, inflation rose at a rate of 1.5 percent. That's at the low end of the range of inflation the Federal Reserve believes is needed for a healthy economy."

How is the continued devaluation of our currency a good thing? Inflation does not lead to growth. Quite the contrary. It leads to confounded information delivered to decision-makers due to uncertainty. This leads a good number of those decision-makers to expend many resources on the unproductive task of predicting inflation (and therefore predicting Fed policy). This slows growth. Again, claims otherwise are irresponsible, at best.

6) The esteemed economists referenced by our media continue to imply that the economy can be tinkered with to produce improved outcomes.

The economy is not an engine. It cannot be tinkered with. To quote Papova and Roberts newest video, Fight of the Century: "The economy's not a car, there's no engine to stall / no expert can fix it, there's not 'it' at all. / The economy's us, we don't need a mechanic / Put away the wrenches, the economy's organic" and "People aren't chessmen you can move on a board at your whim--their dreams and desires ignored...the market's a process where we can discover the most valuable ways to serve one another / we need stable rules and real market prices so prosperity emerges"

Price Gouging

2011-04-27T13:40:00.000-07:00

In this article in the Courier Journal http://www.courier-journal.com/apps/pbcs.dll/article?AID=2011304250118 Governor Beshear said, "If the flooding that we expect causes damage to agricultural lands in any significant way, we will be requesting a disaster declaration of the U.S. Department of Agriculture. … In addition, my office has conferred with Attorney General Jack Conway, and as a result of those conversations we will be issuing an order to prevent price gouging shortly."

Price gouging is great topic to think about. If a local hardware store raises the price of say sump pumps (generators during a power outage, snow shovels during a snow storm) during this flooding we could argue they are responding to supply and demand. My guess is not many of them will raise their prices because they are not in the market for the short run, but intend to have repeat customers. They would be foolish to take advantage of customers for these short run profits if they will potentially lose these customers in the future.

However, by enforcing this price gouging law, the governor de-incentivizes people from outside the flooded area from purchasing sump pumps at low prices in their towns, renting a truck to bring them to our flooded area, and then sell them for a profit. For this to happen, they have to be able to make enough money to justify the investment and risk. That is, they need to charge a higher price than the "store" price.

What's the result of enforcing the gouging law? Our local hardware stores will run out of sump pumps at the store price and no entrepreneurs will truck them in from other areas. So some of us will have flooded basements. The cost of this damage will be much higher than the "gouged" price someone might have to pay for the pump. Second, the sump pumps at the hardware store will go to the first customers who arrive there and often the price they pay will be the price of waiting for the store to open or a new shipment to come in. I know, I had to wait 8 hours to purchase a generator during an ice storm two years ago. If entrepreneurial "price gougers" are allowed to come in and sell their higher priced pumps, then some people who have a high opportunity cost of time will pay the higher price, install their pumps and go to work to earn some money. More people will have sump pumps and damage will be less.

The conclusion - although none of us like to pay above the market price for an item, during an emergency we will value it more and may be willing to pay more to solve our problem. If the government intervenes to "help us" by enforcing these price gouging laws, the government may actually be making us worse off. We will have fewer pumps and more damage.

Koppl on Method

2011-04-27T06:20:00.000-07:00

Pete Boettke, over at coordination problem, has a post about a Lant Pritchett commentary in The Economist. Pritchett argues (somewhat vaguely, I think) that formal methods in development economics can answer questions but cannot help determine what those questions are. I'm more bemused by Pritchett's comments than anything else, but Roger Koppl posted a comment below that nicely summarizes my own views on "formal method" (read, rigorous math and metrics) in economics. So here it is without further comment.

Method helps us to reaching some answers, but not always. For example, I don't think Akerlof was thinking about equations when he came out with his lemons argument. His discussion of his basic argument contained zero math. Once he'd explained the basic idea with his used car example, *then* out came the math. In other examples, the math comes first and the intuition second. I doubt there's much of a rule here. If we're tied up in a methodological straightjacket (of Bourbaki math or anti-math or whatever) then method can prevent us from finding potential answers to our questions.

Entrepreneurship and Real Estate

2011-04-26T08:07:00.000-07:00

Students in my senior research seminar in economics course are finishing a paper on residential real estate and government housing policy since 1934. It is a surprise to many people that homes used to be purchased with a 5-year balloon loan. That was when the homeownership rate was between 30 and 35 percent. In 1934 the government was determined to increase this rate. The government began its history of subsidizing home mortgages and partnered with banks to roll-out 20 and 30 year mortgages. By the 1960’s the rate had increased to 65 percent.

In this last housing boom, many people became familiar with “low-doc” and “no-doc” loans. Essentially you could borrow money for a home without proving all or any of your income. Another significant factor in the run-up in housing, and its weak foundation, was the moral hazard underlying the “originate and sell” model. Of course many banks would not have been willing to offer such mortgages without the government underwriting or the ability to sell the mortgages into a market rated by the government-approved ratings agencies.

My students focused on one particular aspect of the heavily subsidized real estate market, supply elasticity. Wheaton (2005) “Resort Real Estate: Does Supply Prevent Appreciation?” shows that real estate prices in Loon Mountain New Hampshire had little long-term nominal appreciation and no real long-term appreciation from 1980 through 2005. The explanation was extremely elastic supply relative to demand.

This extremely elastic supply can be viewed as an unintended consequence of government policies designed to increase the rate of homeownership. Easy credit not only increases buying power for potential homeowners in a real estate transaction; it also increases investors’ buying power. Furthermore, these investors are not necessarily all seasoned entrepreneurs. We are all likely familiar with HGTV’s “Flip this House” for example. We also probably know many people who profited handsomely by buying a lot or two in a resort or otherwise highly desirable area and selling it for double only a couple months later and sometimes even just weeks later. We also probably know many investors who were stuck with a few properties once the boom came to a halt. One can also see how the ranks of licensed real estate agents swelled throughout the housing boom, only to shrink after the collapse.

A phenomenon particularly unique to real estate investing is the ability of an investor to purchase more than one lot or home at a time, or at least over a short period of time, using leveraging with government subsidized financing instruments. It doesn’t take too much thought to see that eventually supply will outpace demand in a loose money boom environment, since the most stable fundamental underlying residential real estate is primary residential homeownership. Recreational homeownership adds a level of complexity to the dynamic, but the average person has little need for more than one home. Falling prices is the market adjustment to a high supply relative to demand. What was the extent of this market adjustment in many markets in the US? Horry County in Myrtle Beach currently has almost 18,000 vacant lots with infrastructure in place ready for building. Horry County only has approximately 265,000 people. Wake County (Raleigh), NC on the other hand has less than 16,000 such vacant lots for a population of approximately 900,000. Myrtle Beach is a tourist destination and its vacant lot to population rate is 3.8 times that of Raleigh’s. This year Realty Trac published the cities with the top 20 foreclosure rates in the country. All of the cities were in highly desirable, sunny places, except for #20 – Boise, ID, which is still a resort destination for its skiing and lower prices relative to Colorado. What does this say about supply? Many people became investors or “entrepreneurs” in these areas. Prices have plummeted in these areas because supply outpaced sustainable demand in the short-run. The “rules of the game” caused many people to become real estate investors and also influenced where their actions would take place geographically. The economic consequences have been dire for these regions and the nation, and the rate of homeownership has dropped. So much for good intentions.

Interested in Graduate School Read this Post

2011-04-25T18:15:00.000-07:00

Professor of Economics at George Mason University Peter Boettke who I think has been responsible for putting out some of the brightest young scholar in recent years posted on his Coordination Problem blog some advice for undergraduates interested in going to graduate school.

Academic Fame

2011-04-24T23:01:00.000-07:00

How much should an academic specialize? It depends on what you’re trying to maximize. But if you’re trying to maximize your citations there should be an optimal number of academic fields or even subfields. Citation count is one way to measure an academic’s fame. You might try to maximize your H-index, which is a metric of quantity and quality of scientific output. There are other metrics such as the g-index, which weights highly cited articles more. But the H-index is pretty well known.

You don’t want to be a dilettante where you never really master the topic. That’s not a good way to gain recognition. But overspecialization has costs too. You can over work a topic. You can keep working on the topic after it is dead.

A recent article in Frontiers in Ecology and the Environment (no ungated copy) confirmed that at least for ecologists and evolutionary biologists there is an optimum amount of specialization. That makes sense. Unfortunately, they don’t tell us how many topics to specialize in. They do tell us that it doesn’t seem to make much difference for people with fewer than 25 papers. Or at least we can’t tell because they don’t have enough fame to measure.

The more closely related the specializations are the easier it is to write in all of them. But portfolio theory suggests that they should be quite different. I would imagine that people who study radically different topics within economics will have more interesting insights. Part of your fame comes from how interesting you are. More interesting articles get into better journals and get cited more. Moreover, if your research topics are very different it is less likely that both topics will become passé during your career.

Alas, I also don’t know how many different subtopics in economics an academic should have to maximize fame. I don’t have 25 papers yet.

A vaguely related paper on academic specialization:

http://www.iq.harvard.edu/blog/sss/archives/2009/12/academic_specia.shtml

"Specialization and the road to academic success" Belmaker, Cooper, Lee, and Wilman. Frontiers in Ecology and the Environment. 10:8 (Dec.) 2010

Innovative Price Adjustment

2011-04-22T17:00:00.001-07:00

I'm presently revising a paper (written with Daniel Levy) that argues that an implicit contract is important for understanding why 6.5 ounces of Coca-Cola - in the bottle or at the fountain - was exactly 5 cents from 1886 into the 1950s. (We also have a JMCB paper on the subject.) Going through some of our documents gathered from the Coca-Cola archives in Atlanta, I came upon this absolutely brilliant - though ultimately ill-fated - attempt to deal with the fact that, in 1951, inflation and the nickel Coke were not going to work out together. The following was developed by one Eugene Kelley of the Coca-Cola Company and entitled the "Single Coin Plan".

Coin operated bottle coolers for Coca-Cola were originally designed to sell a bottle of Coca-Cola for a nickel. Due to increased costs, to our regret, we can no longer sell a bottle of Coca-Cola for 5 [cents]. Coin mechanisms that operate with a nickel and a penny (6 [cents] total) are much more complicated and less satisfactory to you than mechanisms that operate with a nickel, so instead of offering one 'Coke' for 6 [cents] the coin cooler offers 8 'Cokes' for 45 [cents] which is only 5.625 [cents] per bottle. This is accomplished by adjusting the coin cooler to deliver either an empty bottle or no bottle at all for one nickel in every nine deposited. This absence of 'Coke' is called an official blank. Please be warned that, if you fail to deposit nine nickels, at worst you will strike blank and have to deposit another nickel for your 'Coke.' At best you will miss the blank (8 times out of 9) and your 'Coke' will cost only a nickel, but as stated, your average 'Coke' sells for 5.625 [cents] per bottle[.]

Prices sometimes are rigid. In this case a nominal price was rigid for many decades. One concern about adjusting the price in 1951 was that doing so would impose additional transaction costs on consumers by forcing them to use multiple coins rather than just the nickel. This may seem trivial, but the management of one of the most successful American corporations thought it was important enough to entertain a scheme like the above.

Unions II

2011-04-21T06:25:00.000-07:00

In Investors Business Daily today the following editorial appeared http://www.investors.com/NewsAndAnalysis/Article/569811/201104201922/Teachers-Pet.htm. Ths article describes how the California Federation of Teachers passed a resolution praising cop killer Abu-Jamal. Abu-Jamal killed police office Daniel Faulkner in Philadelphia in 1981. It is not clear to me what this cop killer has to do with teaching children in California. Anyhow, the editorial shows how union leaders (not necessarily the teachers who pay their salaries) often are out of line with reality.

Unions

2011-04-21T06:19:00.000-07:00

I heard a report on "Morning Edition" today http://www.npr.org/templates/story/story.php?storyId=135576309 telling how the Association of Machinists and Aerospace Workers has filed a complaint with the National Labor Relations Board stating that Boeing is engaging in unfair labor practices by moving work to their non-unionized South Carolina plant. The fact that this union has any say in the operation of a private business shows how the power of government and rent seeking union reduces efficiency, job opportunities for non-union workers and hurts society as a whole. I hope the NLRB changes its ways soon so that ALL workers can have a chance at jobs instead of those privileged union workers.

Federal Government Default? Unlikely but I'm Hopeful.

2011-04-19T06:01:00.000-07:00

According to the Wall Street Journal "the [federal] government could default on its debt by July 8." S&P, one the big three of the credit rating oligopoly (along with Moody's and Fitch), has changed its outlook on US Treasuries from "stable" to negative".

Treasuries actually rallied on this news, investors being hopeful that it will force bipartisan compromise on the federal budget and, more importantly, raising the debt ceiling. That ceiling stands at $14.294 trillion and the US debt is $14.219.

I'm hopeful in more of a let the bodies hit the floor sense.

Now, I do not think that default is at all likely, and investors probably rallied with a rational expectation of a Oh Gawd, no! response from Washington politcians. However, I think that default is exactly what the US needs from its federal government right now.

Two economic principles that I have come to believe firmly in are, first, the ratchet effect elaborated most thoroughly by Robert Higgs in Crisis and Leviathan and, second, fiscal illusion, an idea that I most closely associate with James Buchanan and Richard Wagner.

The ratchet effect describes the observation that government powers (and spending) sprawl during a crisis and then recede once the crisis has passed, though not to pre-crisis levels. (Think of using a socket wrench. Your arm motion is forth and then back; forth and then back; etc. However, the bolt is proceding clockwise and deeper throughout.) We're certainly at that point now, in terms of both new regulatory powers and spending following the 2007-2009 financial crisis and recession.

The increased federal spending has not been funded from current revenues and this year's deficit will be about 10 percent of GDP (or about $1.6 trillion). If running a tab rather than paying-as-we-go causes people to underestimate the costs of increased spending, then we have a case of fiscal illusion. Fiscal illusion can be contrasted with the Ricardian equilivalence described by Robert Barro in his classic 1974 Journal of Political Economy article, "Are Government Bonds Net Wealth". In the world described by Barro, homo economicus does not view government bonds (i.e., goods provided by government issuing debt) was wealth because he realizes that the liabilities have the same present value as the taxes he doesn't have to pay today.

However, do you know someone with a credit card who doesn't behave as Barro describes? Someone who treats consumption financed by 20 percent interest rate debt as real increases in living standards? If you do know someone like that, do you think there's a good chance he or she is the median voter? I do, so also think that the median voter does not correctly perceive the costs of the expanding government. Of course, the tab will come do someday, but in the meantime the expanded government becomes institutionalized: new regulations become "just part of life"; the new goods provided by the government become "entitlements". The government has not only expanded but also ratcheted into place so that it will be unlikely to recede.

Whatever the real short-run costs (which uneniably may be large), I say concerning the possibility of federal default: the sooner the better!

Remembering the Real Ayn Rand

2011-04-18T19:47:00.000-07:00

Last week Donald Luskin a chief investment officer at Trend Macrolytics LLC and the co-author with Andrew Greta of "I Am John Galt" wrote in the WSJ Remembering the Real Ayn Rand. What Luskin points out is a point that many people forget when they think about Rand and Atlas Shrugged that all not all business men are heroes. Luster notes "it's a misreading of "Atlas" to claim that it is simply an antigovernment tract or an uncritical celebration of big business. In fact, the real villain of "Atlas" is a big businessman, railroad CEO James Taggart, whose crony capitalism does more to bring down the economy than all of Mouch's regulations." Today with crony capitalism all around us Rand's work continues to be relevant.

Q&A with a Bahmian Entrepreneur

2011-04-18T05:38:00.000-07:00

I just returned from the Bahamas where I consumed massive amounts of grouper, lobster, and conch. It was a beautiful thing. Me, my wife, and various other APEE attendees spent a whole lot of time in wonderful little fish fry shacks like this.

Well, on the final night there I decided to ask the proprietor of not one but four of such restaurants a couple of questions. (While we did get a chance to visit the above-pictured fish fry, it is not one of the four belonging to the gentleman in question.) Let's call this Bahamian entrepreneur "Mr. Bob".

ME: Mr. Bob, how easy is it to open a business in the Bahamas?

MR. BOB: Very easy! Very easy! You just call me and Mr. Bob will make it happen!

ME: Ok. Well, let's say that I didn't know you. How hard would it be then?

MR. BOB: Very hard! Very hard! You have to call me and I know people.

After that last part, Mr. Bob made some allusions to parliament members and made a hand motion that could only be interpreted as, um, having someone by the ... well, you get the point. Later on one of our WVU grad students, Travis, asked similar questions of a taxi driver. The answers were similar to the extent that they involved tales of bribes and "knowing the right people".

Apparently the Bahamian economy is an unfortunate example of one where institutions (i.e., the "rules of the game") are such that a lot of effort gets channeled into unproductive rent-seeking (even if the ultimate aim is to be able to pursue productive entrepreneurial activities).

One is reminded of Hernando de Soto's The Mystery of Capital. Very few economists spend time "in the field" documenting how difficult it is to pursue productive entrepreneurship around the globe. When de Soto did so for a handful of countries, just looking at his book's diagrams of contorted, years-long paths to start businesses is shocking to the American eye. Sadly, this is the reality for most of the world's economies.

Three Tier System

2011-04-15T08:19:00.000-07:00

The next time you are in another state and want to buy a microbrew beer that you get at home good luck. If you wonder why, blame it on the three tier system. Since prohibition, each state has set up such a system where breweries can only sell to distributors who then sell to retailers (bars, liquor stores) and then finally to you the consumer. This legal monopoly that distributors have makes it difficult for people who like quality microbrew beer to purchase it. The big distributors worry more about selling their Bud and Coors and often will not carry microbrew brands. I can get Jolly Pumpkin in my hometown in Indiana, but when I cross the river to one of the better beer stores in Louisville, they don't have it. None of the distributors in Kentucky carry it. A free market where brewers and distributors could sell across state lines would solve this problem.

The Grinch Who Stole My Booze

2011-04-14T16:10:00.000-07:00

SC legislature seeks to ban the sale of alcohol on Thanksgiving and Christmas.

Adam Smith Pro-Market?

2011-03-21T10:58:00.000-07:00

Donald J. Boudreaux has a post on Cafe Hayek on Adam Smith and his view as commentator writes "Reviewing Nicholas Phillipson’s new biography of Adam Smith, George Scialabba portrays Smith as having been less a proto-Milton Friedman and more a proto-Paul Krugman (“Das Capitalist,” March)." This is a recent view of Smith and during Adam Smith week this question will be discussed. Scholars James Otteson and Spencer Pack offer different views of Smith. Come to these events to hear these different views.

defining Libertarian (vs. Conservative or Liberal) Morality

2011-03-17T16:03:00.001-07:00

Excerpts from a long and interesting article by Ronald Bailey in Reason...

When it comes to morality, libertarians are often typecast as immoral calculating rationalists who also have a somewhat unseemly hedonistic bent. Now new social science research shows that libertarians are quite moral, just not in the same way that conservatives and liberals are.

University of Virginia social psychologist Jonathan Haidt has done considerable previous work probing the moral differences between American liberals and conservatives, but came to recognize that a significant proportion of Americans did not fit the simplistic left/right ideological dichotomy that dominates so much of our political and social discourse. Instead of ignoring outliers, Haidt and his colleagues chose instead to dig deeper.

The result: A fascinating new study, “Understanding Libertarian Morality: The psychological roots of an individualist ideology”...involving moral surveys of more than 10,000 self-identified libertarians gathered online at the website yourmorals.org...

So what did the study find to be the basis of libertarian moral thinking? It will not surprise Reason readers that the study found that libertarians show (1) stronger endorsement of individual liberty as their foremost guiding principle and correspondingly weaker endorsement of other moral principles, (2) a relatively cerebral as opposed to emotional intellectual style, and (3) lower interdependence and social relatedness....

In his earlier work, Haidt surveyed the attitudes of conservatives and liberals using what he calls the Moral Foundations Questionnaire which measures how much a person relies on each of five different moral foundations: Harm/Care, Fairness/Reciprocity, Ingroup/Loyalty, Authority/Respect, and Purity/Sanctity. Typically, conservatives scored lower than liberals on the Harm and Fairness scales and much higher on Ingroup, Authority, and Purity scales. In this case, libertarians scored low on all five surveyed moral dimensions....

The Schwartz Value scale measures the degree to which participants regard 10 values as guiding principles for their lives. Libertarians put higher value on Hedonism, Self-Direction, and Stimulation than either liberals or conservatives and they put less value than either on Benevolence, Conformity, Security, and Tradition. Like liberals, libertarians put less value on Power, but like conservatives they value Universalism less....Haidt and his colleagues eventually recognized that their Moral Foundations Questionnaire was blinkered by liberal academic bias by failing to include a sixth moral foundation, Liberty. They developed a liberty scale to probe this moral dimension....And guess what? The researchers found that libertarians dramatically outscored liberals and conservatives when it came to putting a high value on both economic and lifestyle liberty. Most dishearteningly, liberals scored two full standard deviations below libertarians on economic liberty....

Clearly, libertarians are not amoral. Rather, standard morality scales do a poor job of measuring their one central and overriding moral commitment.”...

Lack of consistency in claim of "pro-choice" among officials

2011-03-10T13:59:00.000-08:00

Whether you agree that conservation is good or not is beside the point. As Sen. Paul argues, the way to encourage conservation (if that is what is best for society) is to logically convince others to voluntarily choose to conserve, rather than to force your opinions on others. Claiming outright that you know better and forcing others to act in a certain way or limiting their choices is degrading (and very costly).

Happy Birthday Economics

2011-03-09T19:58:00.000-08:00

Two hundred and thirty-five years ago today (March 9th) Adam Smith published An Inquiry into the Nature and Causes of the Wealth of Nations. Russell Roberts post on Cafe Hayek some commentary on the importance and relevance of this classic work.

Adam Smith was not the first to write about economics, but was the first to write a formal treatise and was a great systematizer of the field. In less than two weeks (March 21-25) the Initiative for Public Choice & Market Process will celebrate with our third annual Adam Smith Week.

Speakers will include James Otteson and Russell Roberts.

On the looming NFL lockout...

2011-03-08T09:18:00.000-08:00

The looming possibility of a NFL lock-out has garnered much attention in the sports world over the past couple of months, and nearly every sports analyst has shared his or her opinion on the matter. Some chastise the NFL Players Association (NFLPA) while many others rip the NFL owners. While I could easily dissect the arguments of any number of analysts, I want to comment on just one: Rick Reilly of ESPN wrote this piece appearing on ESPN.com.

In that article, Reilly calls the NFL owners greedy and then goes on to provide examples of how the owners are not in need as they live their lives in luxury. He explains that with so many people unemployed in our economy and the growing depression that that can cause, all that many people have to look forward to is NFL football on Sundays.

My major issue with Reilly's argument is that he assumes that people are entitled to the NFL. It is this sense of entitlement that is plaguing our society most. The NFL owners, regardless of how wealthy they are and how poor other people are, are not obliged to produce the games for us to watch. The owners have any number of options for how they can employ their resources. To demand that they employ them in a way that suits our desires but offering what the owners perceive as a lower rate of return is to demand that they sacrifice of themselves in favor of our desires. To demand others sacrifice themselves for you and then chastise them for not doing so is hypocritical and immoral.

I do not intend to argue that the NFL owners are necessarily correct in their arguments. Indeed, both sides have what I believe to be unrealistic expectations in this negotiation. The true problem is that we have two cartels in the NFL: the NFLPA and the NFL owners. Collective bargaining is the source of the issues. If individual teams were able negotiate with individual players, I suspect that both sides would be much happier with the arrangements. Unfortunately, we have one cartel negotiating with another cartel. Two wrongs do not make a right, and the NFL will continue having labor disputes as long as these cartels exist.

my two recent papers on health care

2011-03-07T07:09:00.001-08:00

The first just came out in Cato Journal-- Envisioning a Free Market in Health Care.

I'm still shopping the second paper around-- The Economics of Health Care and Health Insurance.

No surprise here...study finds government waste

2011-03-02T02:00:00.000-08:00

A new study by a government watchdog group finds evidence federal waste due to redundant and over-lapping programs (story here).

Wait, isn't the term "government waste" a redundancy itself?

Keeping the streets safe

2011-03-01T07:23:00.000-08:00

After watching this clip, I have to wonder whether there is a better way to license drivers. The public sector apparently does not adequately measure whether or not an individual can responsibly handle a motor vehicle. Might a private market--with numerous competing licensing companies--work at least as well as the public system we have now. How might this work? I honestly have yet to think through it fully. But, I would have to think that in a market where reputation matters--low percentage of licensed drivers being cited in an accident--the situation would have to be better, right?

By the way, while the clip is about female drivers, I would argue there are likely just as many bad male drivers on the streets as female drivers.

Stimulus Two Years Later

2011-02-23T12:29:00.000-08:00

Two years ago the federal government injected an unprecedented amount of money into the economy in an effort to solve the current economic crisis. So what was the result? Economist Russell Roberts in this video gives his expert testimony before a Senate Committee on the stimulus. Dr. Roberts is a professor of economics at George Mason University and will be in Charleston next month as part of the Initiative for Public Choice and; Market Process' Adam Smith Week.

Democrats taking their balls and going home...

2011-02-22T13:43:00.000-08:00

Like many of my free-market friends and colleagues, I would be happier if more politicians more often did not show up to work--this way, they get less done and therefore do less harm.

With this said, let me approach this issue slightly differently: By participating in the election process, those running for office not only agreed to the validity of the election process in regards to who wins the job for which he or she is competing but also in regards to who wins the other seats for which the individual is not running. Thus, by participating in the election each member of the legislature agreed to participate in good faith in that legislative process regardless of which party holds the majority. By now refusing to participate in the process (because they are upset that the Republican majority is going to get their way) I would argue that the Democrats in WI and IN are in breach of contract. In the private sector any individual who does not show up for work is penalized and often loses his or her job fairly quickly. Only in the public sector could not showing up to do your job be an accepted and (to some) laudable strategy.

I haven't used this sort of strategy since I was a kid when I got upset over the outcome of a backyard game of football. My solution: I took my ball and went home....and then pouted for a while.

Creating criminals of all of us

2011-02-22T06:17:00.000-08:00

The passage of a whole host of new regulations, bans, and taxes--each of which are difficult to abide by and/or create an environment in which citizens are better off not abiding by them--remind me of the following quote from Ayn Rand's Atlas Shrugged:

"'Do you really think we want those laws to be observed?' said Dr. Ferris 'We want them broken.... When there aren't enough criminals one makes them. One declares many things to be a crime that it becomes impossible for men to live without breaking laws.... just pass the kind of laws that can neither be observed nor enforced, you create a nation of law breakers and then you cash in on guilt.'"

Here are two examples:

New York City recently passed a smoking ban that applies to beaches, parks, and even Times Square.

The sale of children's toys and clothing, including second-hand items, must meet new lead standards; this includes thrift stores and porch/garage sales.

What other policies would fit this billing? Post your suggestions as a comment below.

Explore the Ideas of Liberty

2011-02-18T14:35:00.000-08:00

The Institute for Humane Studies (IHS) introduces a new resource for learning about the ideas of a free society. A You Tube channel to provide a starting point for conversations on important questions:

• What is the nature of man and society?
• What are the best ways to organize human society?
• What is the proper role for government?

Explore the videos many of the faculty featured on this channel are speakers at IHS seminars for college students and recent graduates.

To learn more about LearnLiberty, visit http://www.LearnLiberty.org

Entrepreneurship as a Market Process

2011-02-17T15:30:00.000-08:00

Austrian economists Ludwig von Mises, Friedrich A. Hayek, and Israel Kirzner have argued that the market is a process. More specifically it is a process of entrepreneurial alertness and discovery. The role of the entrepreneur is anticipating what it is that consumers will desire, and coordinating the use of the means of production towards that end.

Today President Obama is meeting with three well known entrepreneurs Steve Jobs of Apple, Eric Schmidt of Google, and Mark Zuckerberg of Facebook. According to Bloomberg "The president will discuss the U.S. economy and job creation with the executives as he promotes the $3.7 trillion budget he released this week that aims to keep up government funding for education and research."

I am not sure what these men will tell President Obama about his budget, but I find it interesting that these are now all successful private companies that innovated and used their entrepreneurial abilities to get ahead and it was the private market that adopted and made their products successful not government.

why do liberals want to hurt the poor (revisited)? the case of Wal-Mart in NYC

2011-02-15T15:38:00.001-08:00

Liberals advocate a number of policies that inadvertently harm the poor-- as use government policy to help favored interest groups (e.g., K-12 education and the case below). This is somewhere between repugnant and regrettable.

Liberals advocate policies that are a decidedly mixed bag in terms of helping the poor (e.g., welfare policies). This is understandable but unfortunate.

Liberals often miss ignore policies that hammer the poor directly (e.g., Social Security and payroll taxes)-- out of ignorance, crass politics, or statist impulses. This is somewhere between sad and ridiculous.

But on occasion, liberals go out of their way to support policies that directly harm the poor-- as in the following case. What can one say about such people?

Here's Charles Fishman in the WSJ...

Last year, New York City residents spent $196 million at Wal-Mart—enough shopping to support three of the company's Supercenters. Manhattanites alone dropped $1 million a week at America's biggest store. That's a pretty remarkable sum, given that there isn't a single Wal-Mart in New York City. It turns out that while city politicians and labor unions have successfully, indeed proudly, kept Wal-Mart out of the five boroughs, they haven't been able to keep New Yorkers out of Wal-Mart stores in New Jersey and Long Island.

The big-box retailer is making a major push to end that inconvenience. Having made an unsuccessful bid five years ago, this time the company is mounting a sophisticated campaign. It features a new website (www.walmartnyc.com), direct mail brochures, radio and newspaper ads, opinion polls, and the consulting savvy of New York Mayor Michael Bloomberg's former campaign manager and his former pollster.

Wal-Mart's poll shows that 71% of New Yorkers want the store to open. Even in Manhattan, where the prospect of Wal-Mart was least popular, 58% still favor it...

The question, though, is why in capitalist democracy those fears of competition should determine public policy. New York is famous as the center of the nation's media business. But the city didn't step in and ban the Internet 15 years ago out of fear that the city's magazines, ad agencies, TV networks and music recording would be devastated by the new media. And many were.

The city's small groceries, diners, coffee shops, food trucks and boutiques also aren't quite as fragile as the Wal-Mart critics would have us believe. They've already survived the big-box, national-chain onslaught.

Home Depot first came to New York City in 1994. It now has 21 locations, including two in Manhattan. Target first opened in New York in 1998, and now has 10 stores, including one in Harlem. New York has Kohl's and Best Buy, Costco and Ikea, Olive Garden and McDonalds. For those worried about low-priced competition, the city already has 50 Family Dollar outlets....Yes, Wal-Mart is nonunion, but Target and Home Depot and Starbucks are all nonunion as well, as are most mom-and-pop stores.

Perhaps most importantly, it's puzzling why elected officials would oppose a store that, everyone agrees, brings low prices to working-class consumers who need those low prices more than ever....

education vouchers (to join food stamps) in Indiana?

2011-02-15T15:07:00.000-08:00

Gov. Daniels is proposing educational vouchers (see: food stamps) for lower-income and middle-income families-- with the support of legislators, a national foundation for school choice centered in Indiana, and public support...if not some powerful interest groups.

This would allow them (far) more choice among educational service options. Of course, people have education options, on paper, independent of income. But in practice, access to alternatives is highly restricted for people with fewer means. This policy would inject competition into an arena where the government has tremendous monopoly power.

Opposition to vouchers comes from:
-self-interested government suppliers who want to continue with their monopoly power (can't blame them)
-those with wrong-headed and simplistic arguments about church/state (it's common to fall for "good stories")
-statists who value government, even at the expense of the poor and middle class (this is different from other "liberals" who value the well-being of the poor rather than the expansion of government as an end)
-those who generally embrace markets, but worry that onerous regulations would accompany the monies (this is a reasonable concern, but does not necessarily follow)
-those who avidly embrace markets, are deeply concerned about this form of govt intervention, and will hold out for a pure, non-govt reform

It's common for people to worry about adding competition to highly-regulated markets. Part of this is the abstract thinking required to imagine an unseen outcome. For example, people imagine a great expansion of religious education. But more likely, those willing to provide religiously-based education are already in the market, willing to self-subsidize their views. With government subsidies available, a wide variety of (secular) providers would move strongly into the market.

In any case, the status quo is clearly troubling and more spending certainly hasn't helped. At the end of the day, the question is whether this reform would improve things-- not whether it allow us to reach some utopia.

Project Labor Agreements

2011-02-15T15:06:00.001-08:00

I testified before the relevant committee of the Indiana Senate a few weeks ago-- and before the House committee today. It passed in both places.

Here's the follow-up article I wrote for papers across Indiana-- on PLA's ("project labor agreements")...

An Economist’s View of Project Labor Agreements

Project Labor Agreements (PLAs) are collective bargaining agreements that establish terms of employment for a specific project. PLAs typically require a contractor to hire workers through union halls and follow union rules on pensions, working conditions, and conflict resolution. Non-union workers are usually required to pay union dues during the project. Obviously, PLAs make it more difficult and costly for non-union contractors to bid on such projects.

At the federal level, the use of PLAs has varied with the party of the president. Democrats Clinton and Obama have supported such arrangements; both Bush presidencies opposed them. In Indiana, state legislators are considering a prohibition on PLAs for state and local government projects (SB333 sponsored by Sen. Greg Walker; HB1067 sponsored by Rep. Phil Hinkle).

Restrictive contract provisions and government regulations often result in unintended but perverse consequences. In this case, the most troubling result of PLAs is probably that union workers from other states are favored over non-union workers from Indiana.

What are some other concerns?

The most notable is that PLAs will reduce bidding competition and increase costs. Particularly as consumers, we realize that competition is helpful. If I were to arrange laws so that you could only shop at WalMart or eat out at McDonalds, you’d be upset. But for producers, limited competition is quite attractive. In the public sector, higher costs result in higher taxes or reduced spending in other areas. This is especially troubling with tight budgets in a rough economy.

Proponents of restrictions can point to certain efficiencies that come from monopoly power. For example, imagine a law that required you to deal with a single home builder. He might say that he could avoid the cost of bidding and pass those savings to you. Similarly, if we gave them monopoly power, McDonalds could reduce costs by eliminating advertising. Likewise, we could avoid campaign spending if we got rid of elections or held them once a decade.

The question is not whether monopolies have some efficiencies, but whether monopolies are a net improvement. The efficiency of monopolies is difficult to imagine. Beyond that, studies show that costs for public-sector projects with PLAs were 12-20% higher.

Second, note that the proposed legislation only speaks to PLAs in the public sector. Interestingly, we observe some PLAs in the private sector. The difference is a company would negotiate its own PLA. In the public sector, politicians vote to fund a project, but political appointees later negotiate the PLA (with different ends in mind). The bottom line is that, with the looser budget constraints and deeper pockets of government, one would expect PLA inefficiencies to be magnified in the public sector.

Third, from the field of “Public Choice” economics, we know that political intervention is attractive when there are concentrated and obvious benefits for one group—and diffuse and subtle costs for another group. The recipients are excited while those bearing the costs don’t notice. The recipients lobby for such restrictions and tell us why the legislation is good for us. Those in the general public are busy mowing their lawns and raising their kids—and won’t pay attention.

Likewise, we know that suppliers (of labor or product) have an incentive to restrict their competition with laws that prevent them from participating in the market—or indirectly, by increasing their costs and making it more difficult for them to compete.

These are especially important considerations because labor unions are famous for using public policy to reduce competition in labor markets (for example, through “prevailing wage” laws) and product markets (most notably, with respect to international trade). And by definition, unions are cartels in labor markets—groups of (labor) suppliers who collude to extend their market power. Putting it more succinctly: if PLAs are not to their advantage, why would they avidly advocate their use?

Indiana’s state politicians are left with a difficult choice. Will they benefit union construction workers (who are fewer but better-organized politically) over non-union construction workers (who are more numerous but less-organized)? And will they benefit union construction workers at the expense of taxpayers?

Delta Improves Efficiency of Bumping Passengers

2011-02-15T11:52:00.000-08:00

If you have ever traveled than chances are you have head the following: “Ladies and gentlemen, today’s flight is going to be very full. If you have flexible travel plans and would be willing to take another flight, please come see us at the desk.” Delta airlines has started a new system to find these volunteers in a more economically efficient way. Quite simply Delta airlines wants to know your willingness to pay for your seat. Now when you check in if the flight is overbooked they tell you and ask if you are willing to give up your seat and if so how much it will cost for you to give up your seat. This way Delta can knows sooner which passengers have the lowest opportunity cost of travel and those who value the seats more will remain on the flight. (HT: Steven Horowitz)

The Economics of Valentine's Day

2011-02-14T12:01:00.000-08:00

Who says economists are not romantic. In this video Professor Christopher Coyne explains the economics behind giving the right gift on Valentine's day.

Undergraduate Research Journal

2011-02-03T11:55:00.000-08:00

Students, if you working in the area of free-enterprise and market related research you have an outlet for your work. The Journal of Liberty and Society is a peer-reviewed undergraduate journal. The Journal of Liberty and Society is Students For Liberty’s annual academic journal for students interested in the intellectual underpinnings of a free society. The purpose of this journal is to encourage academic work surrounding the topic of liberty and its role in society for students everywhere. Want to learn more check out the call for papers.

President Obama and the Median Voter Model

2011-01-31T12:35:00.000-08:00

In 1957 Anthony Downs wrote An Economic Theory of Democracy which became a seminal work in the area of Public Choice Economics. In that book he expanded on the median voter model, which became an important model for examining candidate decision making. The model suggests that the median voter is the one who's preferences will be recognized and candidates will move to the middle to win this individual's vote. In other words candidates race to the middle in an effort to win the most votes and the election since there are thought to be more voters at the median then on the fringe.

One week before the president's state of the union address he wrote in the Wall Street Journal Toward a 21st-Century Regulatory System. In which he outlined that the federal government needs to cut regulation and make smart decisions about the costs of regulation. Economist Diana Furchtgott-Roth with Real Clear Markets recently wrote in her blog Obama Approaches Regulations Backwards:

"After two years of issuing regulations that have exacerbated recession-induced unemployment by discouraging job creation, President Obama has issued an executive order to evaluate whether rules and regulations have benefits that exceed costs. This backwards process-backwards because the benefit-cost calculus should have been applied first-does not inspire confidence."

However, I think she is missing a bigger point. He is not approaching this backwards, but rather like any good politician should approach the situation. With the midterm elections sending a signal that voters have moved to the right of President Obama he is doing what any good public choice scholar would expect he is trying to move toward the median voter. With two years until the next presidential elections and candidates starting to announce exploratory committees to run it is not too soon for President Obama to be looking for ways to move to the middle and try and win the vote of the median voter and a second term in office.

Great Decisions

2011-01-25T17:27:00.001-08:00

Harvard Economist Ben Friedman speaking this evening says jobs are not the problem with the economy. Differences between demand and supply of skilled workers is the problem and our K-12 system is at fault.

What to do? Greater choice in the public education system is the solution. Additionally, the earlier we train people, the more effective and successful the training. The problem is it's costly to provide training at lower levels. He sights HeadStart as an example of great success.

According to Dr. Friedman, allocation of capital stock is our second problem. The role of the financial system is to allocate financial capital. The question is, does the system work?

Dr. Friedman implies the answer is no but refocuses the argument. Losses by homeowners and stockholders are not the issue. The issue is the misallocation of scarce resources. In this case, capital stock was misallocated to the housing market.

These are the issues policy makers should be focused on right now, according to Dr. Friedman.

- Posted using BlogPress from my iPhone

Location:Wooster, OH

Public Choice readings list

2011-01-20T08:52:00.000-08:00

For those who have yet to see Tyler Cowen's list of recommended readings in Public Choice, you can view it here. I highly recommend it; Cowen has put together an excellent list of readings.

"Cut and Cap" solution to rein in federal spending?

2011-01-18T11:10:00.000-08:00

Chris Edwards, Director of Tax Policy Studies at the Cato Institute, proposes a "Cut and Cap" plan to help control Federal spending in lieu of any debt limit plan. He suggests that the GOP promised $100 billion cuts--chump change relative to the size of the budget and more symbolic than anything else--still be honored. Then, place a cap on the growth of annual federal spending equal to inflation plus population growth.

While this plan, if followed, may slow the growth of the debt it does not prevent it from growing nor does it do anything to ensure that it begins to shrink over time. In order for the debt to fall over time, the cap would have to be less than inflation plus population growth (say, 2% rather than the 3% Edwards proposes). Even then we likely would not see any reductions in the debt for years to come given how far beyond its means the Federal government is currently spending.

The Economics of the BCS

2011-01-16T14:46:00.000-08:00

Anyone who knows me well would know that I was very happy with how the BCS system worked out this year with Auburn going to the BCS Championship game. However, if you know me well you also know that I have for years complained about the system and think that it is a flawed. I have been a strong proponent of a playoff or +1 system since 2004 when an undefeated Auburn team did not get a shot at the title game. This year TCU fans may think they were shut out of the big game. The bowl system is however entrenched in the university system with the proliferation of games providing serious funding to athletic and academic programs.

The complaint about the BCS system have come from many group including coaches, fans and most importantly legislators. Yes, legislators have proposed laws to reform the BCS. In the end it may be simple economics that may change the system. As ESPN reports, fan apathy a threat to BCS, this year the television viewer's and ticket sales of BCS bowls (the Orange, Sugar, Rose, Fiesta bowls, and the BCS National title game) were down. Maybe what screaming fans, coaches and legislators could not the market system will accomplish. When demand declines for a good then producers have to find a way to attract customers, which in this case could mean a new system for determining the National champion.

National Cyberspace ID Numbers

2011-01-10T08:25:00.000-08:00

Once again we see another example of this administration skirting Congress when it comes to creating new programs/regulations/laws. In this case, the Commerce Department is on track to be granted the authority to establish unique cyberspace identifications for each one of us. Of course, supporters argue that this is in our best interest as it will "reduce the need for people to memorize dozens of passwords." I think I'd prefer my freedom, thank you very much. I can remember my passwords just fine.

Barack Obama on Debt Limits

2011-01-05T22:33:00.000-08:00

Thanks to Mish for reprinting this quote from Senator Obama in 2006, explaining why he planned on voting against that year's debt limit increase:

“The fact that we are here today to debate raising America's debt limit is a sign of leadership failure. It is a sign that the U.S. Government can't pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government's reckless fiscal policies. … Increasing America's debt weakens us domestically and internationally. Leadership means that ‘the buck stops here. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.”

Yes, I’ll Take That Bet

2010-12-28T08:17:00.000-08:00

Five years ago, New York Times columnist John Tierney bet Matthew R. Simmons $5000 that oil prices would not triple by the end of 2010. To Simmons, this result, or something close to it, was inevitable, given increasing global demand for scarce resources, and especially because of the prospect of Peak Oil. One can assume his beliefs were bolstered by sophisticated econometric models with predictions that seemed so strong that the five grand looked like easy money.

But Tierney, a friend and student of the late Julian Simon, knew something about the Law of Supply and its role in causing Malthusian predictions to almost always turn out wrong. With this in mind, and knowing well the results of Simon's similar bet with Paul Ehrlich, Tierney felt safe betting against another Chicken Little.

Tierney writes about his experience in this morning's Times.

The Story of Spending

2010-12-24T09:22:00.000-08:00

Public choice economics has often been accused of being politically conservative, and one can understand that conclusion given that the conclusion of the theory tends to favor free-markets. However, the one of the points of public choice theory is too highlight that if market failures exists government failure also exists. This is not a right or a left issue. The problem is not democrats or republicans the problem is government i.e. politicians period.

James Buchanan in "The Ethics of Debt Default" wrote “The most elementary prediction from public choice theory is that in the absence of moral or constitutional constraints democracies will finance some share of current public consumption from debt issue rather than from taxation and that, in consequence, spending rates will be higher than would accrue under budget balance.”

I think the video above makes the point quite well that the issue of debt and deficits is not new and is not an ideological issue.

Christmas and Capitalism

2010-12-23T15:23:00.000-08:00

One of my favorite things about Christmas is watching the old movies. White Christmas, It's a Wonderful Life (one of my all time favorites), and Miracle on 34th Street (the original of course). Miracle on 34th Street has a few capitalism themes in it that I personally enjoy.

Free Market economists talk about the virtues of markets recognizing the preferences of consumers and that they must serve the desires of consumers or be driven out of competition by other entrepreneurs who will. Profits are the reward for offering products consumers want. More importantly, making profits does not mean taking advantage of customers or engaging in activities that many would consider beneficial to others.

This quote from the actor who played R. H. Macy demonstrates exactly this point when he state to his executives:

"Never in my entire career have I seen such a tremendous and immediate response to a merchandising policy. And I'm positive, Frank, if we expand our policy we'll expand our results as well. Therefore, from now on not only will our Santa Claus continue in this manner but I want every salesperson in this store to do precisely the same thing. If we haven't got exactly what the customer wants we'll send him where he can get it. No high pressuring and forcing a customer to take something he doesn't really want. We'll be known as the helpful store, the friendly store, the store with a heart, the store that places public service ahead of profits. And, consequently, we'll make more profits than ever before."

By offering customers great customer service and providing them with information on where to buy their goods an apparently "self-less" act Macy profits. Is this the type of service that individuals who fear business making profits and taking advantage of customers are concerned with? The writer's of Miracle on 34th Street seemed to understand that how markets work.

Divided We Vote

2010-12-13T20:57:00.000-08:00

The recent midterm elections indicate that it is often the case that the party of the executive branch loses seats in the legislature. Why do citizens favor gridlock or divided government? My paper with Edward Lopez, "Divided We Vote," is now forthcoming at Public Choice and examines this question at the state level.

Abstract: Divided government is known to correlate with limited government, but less is understood about the empirical conditions that lead to divided government. This paper estimates the determinants of continuous and categorical measures of divided government in an empirical macro political economy model using 30 years of data from the American states. Voters support more divided government after increased government spending per dollar of tax revenues, but more unified government after worsening incomes and unemployment rates. Only conditional support is found for the strategic-moderating theory (Alesina and Rosenthal 1996) that focuses purely on midterm cycles and split-ticket voting absent economic conditions.

You can download a freshly revised copy at SSRN.

abolish drunk-driving laws?

2010-12-07T09:41:00.001-08:00

A provocative piece by Radley Balko in Reason...

Among other things, Balko's essay underlines the importance of considering unintended consequences, particularly in government policy.

Last week Austin Police Chief Art Acevedo advocated creating a new criminal offense: "driving while ability impaired." The problem with the current Texas law prohibiting "driving while intoxicated" (DWI), Acevedo explained, is that it doesn't allow him to arrest a driver whose blood-alcohol content (BAC) is below 0.08 percent without additional evidence of impairment...

People do react to alcohol differently...A person's impairment may also depend on variables such as the medications he is taking and the amount of sleep he got the night before. Acevedo et al.'s objections to the legal definition of intoxication highlight the absurdity of drawing an arbitrary, breathalyzer-based line between sobriety and criminal intoxication.

The right solution, however, is not to push the artificial line back farther. Instead we should get rid of it entirely by repealing drunk driving laws.

Consider the 2000 federal law that pressured states to lower their BAC standards to 0.08 from 0.10. At the time, the average BAC in alcohol-related fatal accidents was 0.17, and two-thirds of such accidents involved drivers with BACs of 0.14 or higher. In fact, drivers with BACs between 0.01 and 0.03 were involved in more fatal accidents than drivers with BACs between 0.08 and 0.10....In 1995 the National Highway Traffic Safety Administration studied traffic data in 30 safety categories from the first five states to adopt the new DWI standard. In 21 of the 30 categories, those states were either no different from or less safe than the rest of the country.

Once the 0.08 standard took effect nationwide in 2000, a curious thing happened: Alcohol-related traffic fatalities increased, following a 20-year decline. Critics of the 0.08 standard predicted this would happen. The problem is that most people with a BAC between 0.08 and 0.10 don't drive erratically enough to be noticed by police officers in patrol cars. So police began setting up roadblocks to catch them. But every cop manning a roadblock aimed at catching motorists violating the new law is a cop not on the highways looking for more seriously impaired motorists....

Several studies have found that talking on a cell phone, even with a hands-free device, causes more driver impairment than a 0.08 BAC. A 2001 American Automobile Association study found several other in-car distractions that also caused more impairment, including eating, adjusting a radio or CD player, and having kids in the backseat (for more on such studies, see the 2005 paper I wrote on alcohol policy for the Cato Institute).

If our ultimate goals are to reduce driver impairment and maximize highway safety, we should be punishing reckless driving. It shouldn't matter if it's caused by alcohol, sleep deprivation, prescription medication, text messaging, or road rage...

Doing away with the specific charge of drunk driving sounds radical at first blush, but it would put the focus back on impairment, where it belongs. It might repair some of the civil-liberties damage done by the invasive powers the government says it needs to catch and convict drunk drivers....

Gilder in World on Ayn Rand, capitalism and self-interests

2010-12-07T08:53:00.000-08:00

Interviewed by Marvin Olasky...

Ayn Rand, in her last public speech in 1982, just before she died, attacked you furiously. What got her goat? Altruism. She thought I was ascribing altruism to capitalism. Altruism in her theory is the foundation of socialism, and she thought capitalism is supported by egoism or by individual fulfillment above all. She was blinded in part by her atheism. If you read her books, her characters lead sacrificial lives in order to serve others in many instances. But her objectivist philosophy denies the existence of God, and she found my Christian orientation obnoxious. I said businesses succeed by serving others.

Many on the left also equate capitalism with egoism, and for that reason hate it. Capitalists do not get to follow their own dreams, whatever they may be. Academic intellectuals can propagate their ideas whether anyone wants to hear them or not. They can enforce their whims if they join the government—but capitalists cannot succeed without serving others....

Why does the left associate self-interest with capitalism rather than socialism? Self-interest is an all-purpose agency. To say it drives capitalism: How does that distinguish capitalism from any other system? Self-interest certainly could be said to drive socialism as well, because what a greedy, self-interested person wants is guaranteed returns....

macroeconomic modeling, going forward...

2010-12-07T08:52:00.000-08:00

An interesting article from Mark Whitehouse in the WSJ on post-crash macro-economic modeling...

Of course, the quick response here is to look at Austrian Economics which has had a lot to offer on macro policy, especially over the last three years. But their work is not formalized/math-heavy enough to count, here, as "models".

In any case, this points to the inherent difficulties in trying to model something as complex as a macro-economy with equations. Such modeling is helpful, but limited. And keep in mind, that we're talking about macro vs. micro (which is a lot clearer and less complex)!

Physicist Doyne Farmer thinks we should analyze the economy the way we do epidemics and traffic.

Psychoanalyst David Tuckett believes the key to markets' gyrations can be found in the works of Sigmund Freud.

Economist Roman Frydman thinks we can never forecast the economy with any accuracy.

Disparate as their ideas may seem, all three are grappling with a riddle that they hope will catalyze a revolution in economics: How can we understand a world that has proven far more complex than the most advanced economic models assumed?...

The problem, says Mr. Farmer, is that the models bear too little relation to reality. People aren't quite as rational as models assume, he says. Advocates of traditional economics acknowledge that not all decisions are driven by pure reason.

Mr. Farmer sees a perhaps greater flaw in the models' mathematical structure. A typical "dynamic stochastic general equilibrium" model—so called for its efforts to incorporate time and random change—consists of anywhere from a few to dozens of interlinked equations, which must agree before the model can spit out a solution. If the equations get too complex, or if there are too many elements, the models have a hard time finding the point at which all the players' preferences meet.

To keep things simple, economists leave out large chunks of reality...

Mr. Farmer says he thinks the traditional models will always be useful for certain types of analysis, but isn't optimistic they'll provide the whole solution. "Economic forecasts have never been very good, and it's not clear that if we stick with the methods we're pursuing we'll do any better," he says. "We need to try something new."

“Wow, I’m kind of stunned, I’m thinking Sputnik”

2010-12-07T03:03:00.000-08:00

That's Chester Finn's quote from this morning's New York Times, reacting to the news that students in Shanghai vastly outscored their counterparts in international standardized educational testing.

Finn seems to view this news as Sputnik-like, in that he sees it as an event that would galvanize support for even broader federal control of education (if that is even possible in the United States). But in 1994, Charlotte Twight demonstrated that Sputnik was actually a false crisis manipulated by those parties that long-wanted to expand federal control of education, while even the Times article lists several reasons why the testing results coming out of China are severely high-balled.

It makes one wonder: Is Finn participating in the same form of deception today? Given the role played by DC conservatives in federalizing education, I wish I was more stunned.