Author Archives: Matt Mitchell

Economic Freedom, Growth, and What Might Have Been

Economists are obsessed with growth. And for good reason. Greater wealth doesn’t just buy us nicer vacations and fancier gadgets. It also buys longer life spans, better nutrition, and lower infant mortality. It buys more time with family, and less time at work. It buys greater self-reported happiness. And as Harvard economist Benjamin Friedman has argued, wealth even seems to make us better people:

Economic growth—meaning a rising standard of living for the clear majority of citizens—more often than not fosters greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy.

For much of my lifetime, brisk economic growth was the norm in the United States. From 1983 to 2000, annual growth in real (that is, inflation-adjusted) GDP averaged 3.67 percent. During this period, the U.S. experienced only one (short and mild) recession in the early ‘90s. The era was known among macroeconomists as the “great moderation.”

But starting around the turn of the millennium, things changed. Instead of averaging 3.67 percent growth, the U.S. economy grew at less than half that rate, 1.78 percent on average. To see the effect of this deceleration, consider the chart below (data are from the BEA). The blue line shows actual GDP growth (as measured in billions of chained 2009 dollars).

The red line shows what might have happened if we’d continued to grow at the 3.67 percent rate which prevailed for the two previous decades. At this rate, the economy would have been 30 percent larger in 2015 than it actually was.

This assumes that the Great Recession never happened. So to see what would have happened to GDP if the Great Recession had still occurred but if growth had resumed (as it has in every other post-WWII recession), I calculated a second hypothetical growth path. The green line shows the hypothetical path of GDP had the economy still gone through the Great Recession but then resumed its normal 3.67 percent rate of growth from 2010 onward. Under this scenario, the economy would have been fully 8 percent larger in 2015 than it actually was.

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(Click to enlarge)

So what happened to growth? One answer is economic freedom—or a lack thereof. Just yesterday, the Fraser Institute released its annual Economic Freedom of the World report. Authored by Professors James Gwartney of Florida State University, Robert Lawson of Southern Methodist University, and Joshua Hall of West Virginia University, the report assesses the degree to which people are free to exchange goods and services with one another without interference. As Adam Smith might have put it, it measures the degree to which we live under “a system of natural liberty.”

As the chart below shows, economic freedom was on the steady rise before 2000. This coincided with modest deregulation of a few industries under Carter and Reagan, tax cuts under Reagan and Clinton, free trade deals, and restrained growth in the size of government. But from 2000 onward, U.S. economic freedom has been in precipitous decline. This coincides with major new financial regulations under both Bush II and Obama, significant growth in government spending, and a steady erosion in measures of the rule of law.

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(Click to enlarge)

As I’ve noted before, the research on economic freedom is quite extensive (nearly 200 peer-reviewed academic studies use economic freedom as an explanatory variable). Moreover, meta-studies of that literature find “there is a solid finding of a direct positive association between economic freedom and economic growth.”

Perhaps the two charts have something to do with one another?

 

 

Why regulations that require cabs to be painted the same color are counterproductive

A few weeks ago, my colleagues Chris Koopman, Adam Thierer and I filed a comment with the FTC on the sharing economy. The comment coincided with a workshop that the FTC held at which Adam was invited to speak. Our comment, our earlier paper (forthcoming in the Pepperdine Journal of Business Entrepreneurship and the Law), and a superb piece that Adam and Chris wrote with MA fellows Anne Hobson and Chris Kuiper, have been getting a fair amount of press attention, most of it positive.

I want to highlight one piece that seems to have misunderstood us. I highlight it not because I blame the author, but because I assume we must not have described our point well. Paul Goddin of MobilityLab writes:

Their argument seems valid, but an example they use is New York City’s rule that taxicabs be painted the same color. They argue this regulation is a barrier to entry, yet neglect to mention that Uber also requires its drivers to adhere with automobile standards (although these standards have been loosened recently). As of this article, Uber’s drivers must possess a late-model 2005 sedan (2000 in some cities, 2007-08 in others), with specific color and make restrictions for those who operate the company’s Black car service.

A rule that requires everyone in an industry to use the exact same equipment, branding and paint color is, I suppose, a barrier to entry. But that isn’t why we raised the issue. We raise it because—more importantly—it is a barrier to signaling quality.

It is a good thing that Uber and Lyft require their drivers to adhere to standards, just as it is a good thing that TGI Fridays and CocaCola set their own standards. Walk into a TGI Fridays anywhere in the world and you will encounter a familiar experience. That is because the company sets standards for its recipes, its decorations, its employee’s behavior, its uniforms, and much else. Similarly strict standards govern the way CocaCola is packaged, and marketed. Retailers that operate soda fountains are all supposed to combine the syrup and the carbonated water in the same way. If they don’t, they may find that CocaCola no longer wants to work with them.

These practices ensure quality. And they help overcome what would otherwise be a significant information asymmetry between the buyer and the seller. But notice that these signals only work because they are tied to the brands. Imagine what would happen if Chili’s, Outback Steakhouse, and Macaroni Grill were all required by law to adopt the same logos, the same decor, the same recipes, and the same uniforms as TGI Fridays. Customers would have no way of distinguishing between the brands, and therefore the companies would have little incentive to provide quality service in order to protect their reputations. Who cares about cooking a T Bone properly if the other guys are likely to get blamed for it?

So here in lies the problem with taxi regulations that require all cabs to offer the same sort of service, right down to the color of their cars: If every cab looks the same, no one cab company has an incentive to carefully guard its reputation.

Institutions matter, state legislative committee edition

Last week, Mercatus published a new working paper that I coauthored with Pavel Yakovlev of Duquesne University. It addresses an understudied institutional difference between states. Some state legislative chambers allow one committee to write both spending and taxing bills while others separate these functions into two separate committees.

This institutional difference first caught my eye a few years ago when Nick Tuszynski and I reviewed the literature on institutions and state spending. Among 16 different institutions that we looked at—from strict balanced budget requirements to term limits to “item reduction vetoes”—one stood out. Previous research by Mark Crain and Timothy Muris had found that states in which separate committees craft taxing and spending bills spend significantly less per capita than states in which a single committee was responsible for both kinds of bills. As you can see from the figure below (click to enlarge), the effect was estimated to be many times larger than that found for almost any other institution:

InstitutionsBut as large as this effect seems to be, the phenomenon has largely been ignored. To our knowledge, Crain and Muris are the only ones to have studied it. Their paper was now two decades old and was based on a relatively small sample of years from the 1980s.

As I wrote in yesterday’s Economics Intelligence column for US News:

To get a fresh look at the phenomenon, my colleagues and I consulted state statutes, legislative rules, committee websites and members’ offices. We created a unique data set that for some states spans 40 years. We took a cautious approach, coding taxing and spending functions as not separate in any chambers in which it was possible for a tax bill to come out of a spending committee and vice versa. We found that in 25 states, these functions are separate in both chambers, in 7 states they are separate in one chamber, and in the rest, these functions are separate in neither chamber.

To control for other confounding factors, we also gathered data on economic, demographic, and institutional differences between the states. Controlling for these factors, we found that separate taxing and spending committees are, indeed, associated with less spending. To be precise:

Other factors being equal, we find that those states with separate taxing and spending committees spend between $300 and $450 less per capita (between $790 and $1,200 less per household) than other states.

Our full paper is here, a summary is here, and my post at US News is here. Comments welcome.

State and local spending growth vs. GDP growth.

A few years ago, I produced a figure which showed inflation-adjusted state and local expenditures alongside inflation-adjusted private GDP.

It’s been some time since I made that chart and so I thought I might revisit the question. This time around, I compared state and local expenditures with overall GDP, not just private GDP.

The results are below (click to enlarge).

State and Local expenditures vs. GDPAfter adjusting for inflation, the economy is about 5.79 times its 1950 size. This is a good thing. It means more is being produced and more is available for consumption. And since the population has only doubled over this period, it means that per capita production is way up.

Over the same time period, however, state and local government expenditures have not just gone up 5 or 6 or even 8 times. Instead, after adjusting for inflation, state and local governments are spending about 12.79 times as much as they spent in 1950.

State and local governments, of course, depend entirely on the economy for their resources. As I put it when I produced the original chart, this is like a household whose income has grown about 6-fold but whose spending habits have grown nearly 13-fold.

No, bailouts are not something to celebrate

Robert Samuelson at the Washington Post is celebrating the auto bailout.

Last December I had a piece in the Post in which I argued that “pro-business” policies like bailouts are actually bad for business. I offered five reasons:

  1. Pro-business policies undermine competition.
  2. They retard innovation
  3. They sucker workers into unsustainable careers.
  4. They encourage wasteful privilege seeking.
  5. They undermine the legitimacy of government and business.

Read my piece for the full argument.

But aren’t things different in the midst of a major economic and financial crisis? Shouldn’t we have more leeway for bailouts in exigent circumstances?

No. Here is why:

First, we should always remember that the concentrated beneficiaries of a bailout have every incentive to overstate its necessity while the diffuse interests that pay for it (other borrowers, taxpayers, un-favored competitors, and the future inheritors of a less dynamic and less competitive economy) have almost no incentive or ability to get organized and lobby against it.

Bailout proponents talk as if they know bailouts avert certain calamity. But the truth is that we can never know exactly what would have happened without a bailout. We can, however, draw on both economic theory and past experience. And both suggest that the macroeconomy of a world without bailouts is actually more stable than one with bailouts. This is because bailouts incentivize excessive risk (and, importantly, correlated risk taking). Moreover, because the bailout vs. no bailout call is inherently arbitrary, bailouts generate uncertainty.

Todd Zywicki at GMU law argues convincingly that normal bankruptcy proceedings would have worked just fine in the case of the autos.

Moreover, as Garett Jones and Katelyn Christ explain, alternative options like “speed bankruptcy” (aka debt-to-equity swaps) offer better ways to improve the health of institutions without completely letting creditors off the hook. This isn’t just blind speculation. The EU used this approach in its “bail in” of Cyprus and it seems to have worked pretty well.

Ironically, one can make a reasonable case that many (most?) bailouts are themselves the result of previous bailouts. The 1979 bailout of Chrysler taught a valuable lesson to the big 3 automakers and their creditors. It showed them that Washington would do whatever it took to save them. That, and decades of other privileges allowed the auto makers to ignore both customers and market realities.

Indeed, at least some of the blame for the entire 2008 debacle falls on the ‘too big to fail’ expectation that systematically encouraged most large financial firms to leverage up. While it was hardly the only factor, the successive bailouts of Continental Illinois (1984), the S&Ls (1990s), the implicit guarantee of the GSEs, etc., likely exacerbated the severity of the 2008 financial crisis. So a good cost-benefit analysis of any bailout should include some probability that it will encourage future excessive risk taking, and future calls for more bailouts. Once these additional costs are accounted for, bailouts look like significantly worse deals.

Adherence to the “rule of law” is more important in a crisis than it is in normal times. Constitutional prohibitions, statutory limits, and even political taboos are typically not needed in “easy cases.” It is the hard cases that make for bad precedent.

Boom towns and bust policies

Stephen Walters, Professor of Economics at Loyola University Maryland, has written a new book called Boom Towns. I’ve written a review for the Library of Law and Liberty. Here is the beginning:

Capital, in the 21st century, has a bad rap. Many say that because it is the source of “passive income,” it does nothing but pad the pockets of the idle rich, driving a wedge between the haves and the have-nots. It’s helpful, then, to be reminded that capital in all its forms is the source of human betterment. Capital is the accumulated stock of stuff (financial assets, physical equipment, human knowhow, even social connections) that helps us make and do more stuff. So policies that drain capital from a community or discourage its formation in the first place are likely to leave a trail of destruction. This is the central lesson of Stephen J.K. Walters’ Boom Towns: Restoring the Urban American Dream.

Here is another excerpt:

In some cases, reformers’ cures for urban decay have been worse than the disease. Title I of the Housing Act of 1949 is a case in point. It made federal dollars available to cities that bulldozed property in blighted areas and turned it over to private developers. While earlier reforms had sought to replace tenements with public housing, Title I allowed funds to be used for “shiny new office towers, upscale apartments, convention centers, or hotels.” By 1967, some 400,000 housing units had been razed, but only 10,760 low-rent dwellings had been built to replace them. The result was “an intra-urban diaspora” as about two million, mostly Black, residents were displaced. Though it is impossible to quantify precisely, Walters rightly emphasizes the significance of this unfathomable loss in social capital as people were driven from the communities that had sustained them for generations.

After I wrote this, a friend pointed me to this moving Reason video, written and produced by Jim Epstein and narrated by Nick Gillespie:

Corporate welfare spending is not transparent

Over a century ago, the Italian political economist Amilcare Puviani suggested that policy makers have a strong incentive to obscure the cost of government. Known as “fiscal illusion,” the idea is that voters will be willing to spend more money on government if they think its costs is lower than it actually is. Fiscal illusion explains a great deal of public choices, including the popularity of deficit spending.

It also explains why the public knows the least about some of the most controversial items in the public budget such as corporate welfare. But some would like to change this. Here are Jess Fields and Tom “Smitty” Smith, writing in the (subscription required) Austin-American Statesman:

Texans believe in government transparency and accountability. For this reason, we have some of the most advanced open-government initiatives in the nation. Yet one policy area remains outside the view of the general public: economic development.

When local governments cut deals that result in millions in incentives, they can do it behind closed doors in “executive session” — legally — thanks to exceptions to the Open Meetings and Public Information Acts for “economic development negotiations.”

Fields is a senior policy analyst at the free enterprise Texas Public Policy Foundation, while Smith is the director of the Texas office of Public Citizen, a progressive consumer advocacy group started by Ralph Nader in the ‘70s.

Texans aren’t the only ones interested in making corporate welfare more transparent. The Government Accounting Standards Board (GASB) is considering rules that would require governments to report the tax privileges that they hand out to businesses. Here is Liz Farmer, writing in Governing Magazine:

Specifically, GASB is proposing that state and local governments disclose information about property and other tax abatement agreements in their annual financial statements. If approved, the new disclosures could shed light on an area of government finance and provide hard data on information that is assembled sporadically, if at all. Scores of public and private groups support the proposal and it has proven to be one of GASB’s most debated topic yet, as nearly 300 groups or individuals submitted comment letters to the board. But many still say the requirements don’t go far enough.

She notes that the proposal misses a number of tax privileges including:

  • Tax increment financing (TIF),
  • Agreements to discount personal income taxes,
  • “[P]rograms that reduce the tax liabilities of businesses or similar classes of taxpayers.”

Because of these omissions the new GASB rules may only capture about one-third of all tax expenditures.

Puviani would have predicted that.

Three ways states can improve their health care markets

I have a new essay, coauthored with two of my former students, Anna Mills and Dana Williams. We just published a piece in Real Clear Policy summarizing it. Here is a selection of the OpEd:

Liberals, conservative, and libertarians agree on the goals: Patients should have access to innovative, low-cost, and high-quality care. And though another round of federal reform may be years off, a number of state-level changes can move us closer to a competitive and patient-centered health-care market, making it possible to realize these shared aspirations.

In a new paper published by the Mercatus Center at George Mason University, we identify three areas for reform: States can eliminate certificate-of-need laws, liberalize scope-of-practice regulations, and end the regulatory barriers to telemedicine.

And here is our longer essay.