Monthly Archives: November 2011

Why Do Some States Face Steep Borrowing Costs?

One of the interesting—and alarming—developments in state finance over the last few years is the spread between borrowing costs among the states. Unsurprisingly, the borrowing costs of all states jumped during the financial crisis and recession. But as the (anemic) recovery began, the borrowing costs of many states eased while those of some states like California and Illinois remained high.

A paper by Daniel Nadler and Sounman Hong of the Harvard Kennedy School offers one explanation:

Political-institutional factors—such as the political composition of state legislatures, and interstate variations in public sector labor environments, such as union strength, and collective bargaining rights—can explain a significant proportion of interstate variation in bankruptcy risk. We find that, controlling for multiple economic variables, states with weaker unions, weaker collective bargaining rights, and fewer Democratic state legislators pay less in borrowing costs absolutely, and less in borrowing costs at similar levels of unexpected budget deficits, than do states with stronger unions and a higher proportion of Democrats.

As this summary puts it:

According to the study, a 20 percentage point difference in the share of the public-sector workforce that is unionized is associated with an additional increase in state borrowing costs of 40.4 basis points.

Maybe We Need a Super Democrat?

The Super Committee has failed. What now?

As I have said before, it is very difficult to look at the long-run fiscal projections and conclude that the impending debt crisis is anything but a major spending problem. According to the CBO, when my daughter graduates from college, federal revenue will be right at its historical average of 18.4 percent of GDP. At the same time, federal spending will consume more than 35 percent of GDP—more than 15 percentage points above the 20 percent average that has prevailed my entire life.

So the long-run explosion in spending—which is driven almost entirely by entitlements and interest payments—must be arrested. How?

In my view, it takes a Democrat.

Only Nixon could go to China. Only Carter could deregulate. Only Reagan could sign the first arms reduction treaties. Only Clinton could sign welfare reform. Lasting and meaningful reforms often require politicians to cross the ideological divide. Given the partisan divide right now, it is very difficult for me to imagine that any Republican president would be successful in reducing entitlement spending. But a Democrat could do it.

And one piece of evidence for this is a 2004 paper in the Journal of Public Economics by the economist José Tavares. He writes:

In a panel of large fiscal adjustments in OECD countries during the last 40 years, we find evidence that left-wing and right-wing cabinets are partisan: the left tends to reduce the deficit by raising tax revenues while the right relies mostly on spending cuts. Our testable hypothesis is that cabinets can signal commitment by undertaking fiscal adjustments in ways that are not favored by their constituencies. In other words, the left gains credibility when it cuts spending while the right becomes more credible when it increases tax revenues. Probit estimates of the determinants of persistence in fiscal adjustments confirm that spending cuts by the left and tax increases by the right are associated with persistent adjustments.

So if it is spending cuts that we need, then these cuts are likely to be more sustainable (“persistent”) if they are executed by a left-leaning government.

Unfortunately, I don’t see much evidence that President Obama is keen to follow this course. His best shot at it came when his own deficit-reduction panel (the Bowles-Simpson Commission) endorsed a mostly-spending-cuts approach. He ignored them.

Property Rights and Coffee in El Salvador

In this week’s New Yorker,  Kelefa Sanneh details the work of Aida Batlle, a Salvadoran entrepreneur. (Unfortunately only part of the article is available online, but the entire story is a great read). Batlle is a pioneer in the world of high end coffee, growing beans that eventually go into cups of coffee that retail for up to $7 in Brooklyn. From an economics perspective, her story is interesting because she succeeds as an entrepreneur in the face of very poorly defined property rights.

Batlle grew up in the United States where she worked as a restaurant manager and caterer, developing insight into the demands of American foodies. Upon returning to El Salvador as an adult, she used this perspective to see the potential for a coffee crop that is treated with care typically reserved for heirloom tomatoes. Most coffee farmers send their entire harvest to be roasted and mixed in with other farmers’ yields, but she treated her crop more selectively. She accepts only properly ripened fruit and keeps the beans from all of her farms separate to preserve their unique flavors.

Sanneh explains the tacit knowledge that facilitates Batlle’s entrepreneurial awareness:

Plenty of farmers have great land and great cherry, but almost none of them share Batlle’s keen understanding of what her customers want to drink, what they want to hear, and what they’re willing to pay.

As she travels between her farms, Battle brings along two armed bodyguards at all times. This expense is a waste of resources; in an environment where Rule of Law prevails, spending money to protect against crime is unnecessary. An anecdote about one of Batlle’s farms brings to light the conditions under which entrepreneurs work in El Salvador:

The rising [price of coffee] has also made coffee more valuable to thieves. One day this spring, armed pickers arrived at Finca Kilimanjaro: they held the farm manager at gunpoint while they cleaned out the plants. “Kilimanjaro had the highest yield this year,” Batlle says. “But it turned out to be the lowest, because we had two days of non-stop theft. It was awful!” No doubt her beans were blended and sold as generic high-elevation coffee. To Batlle, the thought of this adulteration is more painful than the theft.

If Batlle and coffee farmers like her could focus their energies into their business rather than loss prevention, high end coffee could perhaps be available to those of us who would never spend $7 on a cup of coffee. While trade is a positive-sum game for everyone involved, this type of plunder is a negative-sum game because it diverts productive resources toward defending against theft.

 

What Makes for a Good Balanced Budget Amendment?

Today, the U.S. House will begin debating a balanced budget amendment. This morning, the editorial board of the Wall Street Journal chastised Speaker Boehner for offering a “vanilla amendment that merely calls for a balanced budget, with no spending limitations or supermajority tax requirements.” Their worry is that, “Under Mr. Boehner’s amendment, spending could rise to 25% or 30% or more of GDP, so long as the budget is balanced.”

This is a misplaced worry. Right now, Congress is able to vote benefits for current voters while putting about 45 percent of the tab on non-voters (our posterity). It doesn’t take a complicated economic model to see that this arrangement systematically biases spending upward. And any amendment that requires current voters to pay for current spending will diminish that bias. As I told the House Judiciary Committee last month, in states where balanced budget requirements are stricter, spending is lower.

Moreover, the editors’ preferred amendment—one that includes some sort of spending limitation—is actually unlikely to achieve its goal. Last year, I examined the operation of various spending limits, using data from 49 states covering 30 years (I wrote about my research in an OpEd in the Journal). I found that those tax and expenditure limits “that limit budgets to some share of income had no statistically significant impact on either state-only spending or on combined state and local spending.” It may be that when states bind themselves with such limits, they make sure that the limit is set so high that it fails to actually constrain.

As far as supermajority requirements for tax increases are concerned, research does suggest that these can limit spending. I guess it is a political call as to whether such a requirement should be tied to a balanced budget amendment. In my view, a balanced budget amendment requires strong bipartisan support for it to be effective. But I don’t do politics.

I do agree with the editors in one regard. There is no need to settle for a “vanilla amendment.” There are many different varieties of balanced budget amendments and some of these have much stronger features than others. In my view, the most-effective amendments are those that:

  1. Require balance over some period longer than a year. This effectively disarms the strongest argument against a balanced budget amendment: namely, that it would force belt-tightening in the middle of a recession. In contrast, if budgets need to balance over a longer time period, then Congress is free to run deficits in particular years as long as they are countered by surpluses in others.
  2. Allow Congress some time to come into compliance. You don’t have to be a Keynesian to worry that a 45 percent reduction in the deficit overnight might be a shock to the system.
  3. Minimize the gamesmanship associated with revenue estimation: Across the country, states with balanced budget requirements have to estimate revenue throughout the year (I’m a member of Virginia’s Joint Advisory Board of Economists and our responsibility is to pass judgment on the validity of these estimates). But this invites all sorts of questions: what model to use for the economy, should revenue be scored dynamically or statically, etc. One way to sidestep all of these questions is to make the requirement retrospective: require that spending this year not exceed revenue from years past.

There are amendments that have these characteristics. For example, H.J. Res. 81 (which now has 54 cosponsors), has all three.

In other news, the amazing Cord Blomquist has managed to get my testimony on the YouTubes:

Is It Time to Privatize the Occupy Protests?

The aims of the “occupy” protesters are not always clear. But I think it is safe to say that a large number of them favor public policy solutions to our problems. If the top 1% is making too much money, they’d like politicians to raise the top marginal tax rate. If banks are taking on too much risk, they’d like politicians to regulate them. In essence, if the status quo is broken—and you don’t have to be an “occupier” to agree that it is—the occupy movement would like public policy to fix it.

In Zuccotti Park, public policy has just turned against the protesters: Mayor Michael Bloomberg has ordered the park cleared. The problem for the protestors is that they are on “privately owned public space” which means that public policy makers can decide what happens there (HT, @JoelWWood and @Cobrown).

This is a useful reminder that if you don’t like some outcome—be it the compensation package of a CEO, or the risk profile of a bank, or the way a piece of property is being used—then making it the purview of public policy doesn’t always guarantee your preferred outcome. In fact, as public choice teaches us, public policy often favors the entrenched special interests, not the little guy.

How might the occupiers keep their protest alive? I’d recommend that they privatize it. Take it to a private piece of property. I’m sure that there is some sympathetic property owner (maybe even someone in the top 1 percent?) who would be willing to donate their land. Better yet, they could pool together and buy some land themselves? A few thousand dollars would buy a few acres in many rural parts of the country.

Two States Are Cutting Back on Alcohol Regulations

Earlier this week, voters in the state of Washington passed Initiative 1183 which will close state-run liquor stores and allow for privately owned retail stores to sell liquor. This move effectively ends the state’s 78 year-old monopoly on the sale of alcohol. In a similar move this week, voters in Georgia showed an overwhelming support for repealing the state’s “blue laws” which prohibited the sale of liquor on Sunday.

With regards to Washington, the move to privatize the sale of liquor is certainly not a new idea. In fact, just last November, citizens in the state of Washington voted on two ballot initiatives, each attempting to end the state’s reign over the sale of alcohol.  However, neither ballot received enough votes to become law.

It is of no surprise that heated debates often arise when the state control of alcohol is questioned. Naturally, various questions arise in regard to liquor privatization. For instance, what will happen to the people currently employed in Washington’s state-run liquor stores? More importantly, though, what effects, if any, will privatization have on social outcome measures such as alcohol consumption and/or alcohol-related traffic fatalities?

These are precisely the questions that Mercatus scholars Antony Davies and John Pulito seek to address in their paper titled “Binge Thinking.”

In regards to job loss, the authors argue that although privatization may initially cause some job loss among individuals working in state-run liquor stores, it’s important to recognize that

many of the jobs will not disappear, but will merely shift from the public to private sector.

As Davies and Pulito further point out, one of the common arguments against the liberalization of alcohol control laws is the idea that

because state stores are not profit driven like private firms, privatization would result in increased alcohol consumption and problems associated with alcohol consumption, such as impaired driving.

However, the authors find evidence suggesting that

 States that recently privatized their liquor industries experienced a significant decline in per-capita alcohol consumption.

And

 States that have liquor controls experience significantly higher DUI-related fatality rates than states without controls.

Therefore, by liberalizing their alcohol control laws, Washington and Georgia may have created safer and more efficiently run alcohol industries. The other 17 “control states” should consider making similar moves.

Bankruptcy in Birmingham

Jefferson County, AL has filed for bankruptcy protection, joining the ranks of Vallejo, CA; Central Falls, RI; Boise, ID; and Harrisburg, PA. In this case, the debt that the county used to finance a new sewer system is the main driver of insolvency. The county currently owes about $4.15 billion on the sewer system.

The Associated Press reports:

The problems were years in the making.

Its debt ballooned after a federally mandated sewer project was beset with corruption, court rulings that didn’t go its way and rising interest rates when global markets struggled.

Since 2008, Jefferson County tried to save itself the cost and embarrassment of filing for bankruptcy. But after three years, commissioners voted 4-1 to bring the issue to an end.

“Jefferson County has, in effect, been in bankruptcy for three years,” said Commissioner Jimmie Stephens, who made the motion to file for protection in federal bankruptcy court in northern Alabama.

While the last few years have seen a few cases of municipalities filing for Chapter 9, Jefferson County’s case represents by far the largest. Unlike other recent bankruptcies that were a result of both poor financial management and the economic downturn, Jefferson County’s problems were in part a result of corrupt public officials. Twenty-two people have been convicted for illegally refinancing the sewer bonds to benefit local and Wall Street financiers. Residents in Alabama’s largest county will likely face higher sewer rates as a result.

But the biggest problem for residents when municipalities file for bankruptcy protection is the resulting policy uncertainty. Businesses are typically reluctant, with good reason, to move to a bankrupt municipality. The shadow of Chapter 9 means that for years, residents and businesses will be paying higher taxes in exchange for fewer services because of the remaining debt burden. This will put the county and even the state in a poor competitive standing for new jobs.

In 1994, Orange County, CA, filed for Chapter 9 protection on $1.7 billion in debt, and residents there are still paying taxes toward that debt today. In the short term, Jefferson County will face painful and immediate cuts. The Birmingham Business Journal spoke with Commissioner Jimmie Stephens on what the future holds for the county:

“We’re looking at all of these services that are not mandated by the constitution and, from there, we will begin the reductions and take it as far as we need to, keeping in mind the services that the citizens need,” he said.

 

Big Bank Profits and Government Intervention

Zachary Goldfarb had an interesting piece in the Washington Post this week. He writes:

President Obama has called people who work on Wall Street “fat-cat bankers,” and his reelection campaign has sought to harness public frustration with Wall Street. Financial executives retort that the president’s pursuit of financial regulations is punitive and that new rules may be “holding us back.”

But both sides face an inconvenient fact: During Obama’s tenure, Wall Street has roared back, even as the broader economy has struggled.…Wall Street firms — independent companies and the securities-trading arms of banks — are doing even better. They earned more in the first 21/ 2 years of the Obama administration than they did during the eight years of the George W. Bush administration, industry data show.…

Behind this turnaround, in significant measure, are government policies that helped the financial sector avert collapse and then gave financial firms huge benefits on the path to recovery. For example, the federal government invested hundreds of billions of taxpayer dollars in banks — low-cost money that the firms used for high-yielding investments on which they made big profits.

Later, Goldfarb was interviewed on NPR. Near the end of the interview, he says:

But the president has also refrained from taking some of the toughest actions that some economists and outside analysts would like him to have taken. For example, forcing banks or attempting to force banks to forgive the debts of homeowners, or partially forgive the debts of homeowners, or forcing banks to break up into pieces and end, definitively, the too-big-to-fail problem.

So in a sense, Obama has tried to strike a middle ground, harnessing frustration, sharing in frustration of the public regarding the financial sector, but not taking the fundamental actions that would radically restructure the financial industry and perhaps cause there to be more fairness across the country when it comes to the disparate treatment of Wall Street and the rest of the country.

In my view, a “middle ground” would be to a) not bail out banks, and b) not break them up or force them to forgive debts. Instead, the conventional wisdom holds that the moderate position is to a) bail out private firms and then b) force their hands.

Mayor-Elect Stanton Offers an Excellent Introduction to Public Choice

Tonight on Marketplace, Kai Ryssdal interviewed a handful of newly-elected and reelected mayors about their plans and priorities. Greg Stanton, the new mayor-elect of Phoenix, gave a surprisingly honest description of his aim:

In Phoenix, we really need to be working with local entrepreneurs, with local business — we need to be working with the federal government as well — to make sure that Phoenix and Arizona get more than our fair share of the jobs program that has been introduced through Congress.

Note that the Mayor-elect doesn’t want his fair share. He wants more than his fair share. Perhaps it was a Freudian slip? I suppose we can’t blame him. He is only responding to his incentives. Though they may not be as open about as Mr. Stanton, the unfortunate reality is that when the national government is doling out money to local governments, every other mayor in the country faces the same incentive.

As Bastiat put it some 150 years ago: “Government is the great fiction through which everybody endeavors to live at the expense of everybody else.”

Pension News From Around the Country

In California:

LOS ANGELES — Gov. Jerry Brown offered a far-reaching proposal on Thursday to reduce the cost to government of public pension programs, calling for an increase in the retirement age for new employees, higher contributions from workers to their own pensions and the elimination of what he termed abuses that have allowed retirees to inflate their pensions far beyond their annual salaries.

In Kansas:

TOPEKA — Kansas Gov. Sam Brownback and officials of the state’s public pension system aren’t saying publicly whether they favor issuing bonds to help close a close a long-term funding gap.

In Massachusetts:

The state House of Representatives today unanimously approved a plan to tighten the state’s pension provisions and raise the age that lawmakers and public employees are eligible for retirement. The move follows passage of a similar plan by the Senate earlier this fall. Both plans would only affect future hires, not current employees or retirees.

The House version passed today would boost the retirement age from 55 to 57 and could ultimately save $6.4 billion over 30 years, House lawmakers estimate. The Senate version went farther, raising the minimum age for retirement to 60.

In Mississippi:

JACKSON, Miss. (AP) — A group charged with studying the long-term viability of the state pension system is expected to release a formal report in two weeks.

During a meeting Monday, study commission chairman George Schloegel said he thinks several changes may be needed to shore up the Public Employees Retirement System.

The Clarion-Ledger reports…lawmakers alone can make changes, and it’s unclear whether they will make any radical alterations.

In North Carolina:

North Carolina is one state that’s planning to use a high-tech solution to look into the future and the present. The state’s Department of State Treasurer announced Thursday, Oct. 27, it will implement customized analytics software to better protect pensions for 850,000 state and local government employees….According to SAS, the customized software suite North Carolina will be using includes risk and performance measurement models for fixed-income equity, private markets and hedge funds.

And, in Rhode Island:

PROVIDENCE, R.I. — The General Assembly Joint Finance Committees will resume discussion of pension overhaul legislation Tuesday morning with a hearing on parts of the proposal that deal with municipal-run pension plans….Mayors have said they want the ability to make changes similar to what is proposed for state-run plans, such as suspending cost-of-living adjustments.

(here is Emily with more on RI)

Here, again, is Jeff Miron’s estimate of the date at which each state’s debt-to-GDP ratio will exceed 90 percent (the value at which economists believe debt tends to begin to hamper economic growth).

 

Unlike the calculations that the states themselves use, Miron’s calculations use the more-realistic discount rate assumptions of Novy-Marx and Rauh.

(HT to the National Association of State Budget Officers for their extremely helpful “state budget press clips”)