Category Archives: Culture

The unseen costs of Amazon’s HQ2 Site Selection

Earlier this year Amazon narrowed down the list of potential cities to site its second headquarters. Applicants are now waiting out the selection process. It’s unclear when Amazon will make its choice, but that hasn’t stopped many from speculating who the likely contenders are. Varying sources report Atlanta, Boston, and Washington D.C. at the top of the list. The cities that didn’t make the cut are no doubt envious of the finalists, having just missed out on the potential for a $5 billion facility and 50,000 jobs. The second HQ is supposed to be as significant for economic growth as the company’s first site, which according to Amazon’s calculations contributed an additional $38 billion to Seattle’s economy between 2010 and 2016. There is clearly a lot to be gained by the winner.  But there are also many costs. Whichever city ends up winning the bid will be changed forever. What’s left out of the discussion is how the bidding process and corporate incentives affect the country.

Although the details of the proposals are not made public, each finalist is likely offering some combination of tax breaks, subsidies, and other incentives in return for the company’s choice to locate in their city. The very bidding process necessitates a lot of time and effort by many parties. It will certainly seem “worth it” to the winning party, but the losers aren’t getting back the time and effort they spent.

This practice of offering incentives for businesses has been employed by states and localities for decades, with increased usage over time. Targeted economic development incentives can take the form of tax exemptions, abatements, regulatory relief, and taxpayer assistance. They are but one explicit cost paid by states and cities looking to secure business, and there is a growing literature that suggests these policies are more costly than meets the eye.

First, there’s the issue of economic freedom. Recent Mercatus research suggests that there may be a tradeoff to offering economic development incentives like the ones that Amazon is receiving. Economists John Dove and Daniel Sutter find that states that spend more on targeted development incentives as a percentage of gross state product also have less overall economic freedom. The theoretical reasoning behind this is not very clear, but Dove and Sutter propose that it could be because state governments that use more subsidies or tax breaks to attract businesses will also spend more or raise taxes for everyone else in their state, resulting in less equitable treatment of their citizens and reducing overall economic freedom.

The authors define an area as having more economic freedom if it has lower levels of government spending, taxation, and labor market restrictions. They use the Fraser Institute’s Economic Freedom of North America Index (EFNA) to measure this. Of the three areas within the EFNA index, labor market freedom is the most affected by targeted economic development incentives. This means that labor market regulation such as the minimum wage, government employment, and union density are all significantly related to the use of targeted incentives.

Economic freedom can be ambiguous, however, and it’s sometimes hard to really grasp its impact on our lives. It sounds nice in theory, but because of its vagueness, it may not seem as appealing as a tangible economic development incentive package and the corresponding business attached to it. Economic freedom is associated with a series of other, more tangible benefits, including higher levels of income and faster economic growth. There’s also evidence that greater economic freedom is associated with urban development.

Not only is the practice of offering targeted incentives associated with lower economic freedom, but it is also indicative of other issues. Economists Peter Calcagno and Frank Hefner have found that states with budget issues, high tax and regulatory burdens, and poorly trained labor forces are also more likely to offer targeted incentives as a way to offset costly economic conditions. Or, in other words, targeted development incentives can be – and often are – used to compensate for a less than ideal business climate. Rather than reform preexisting fiscal or regulatory issues within a state, the status quo and the use of targeted incentives is the more politically feasible option.

Perhaps the most concerning aspect of Amazon’s bidding process is the effect it has on our culture. Ideally, economic development policy should be determined by healthy economic competition between states. In practice, it has evolved into more of an unhealthy interaction between private interests and political favor. Economists Joshua Jansa and Virginia Gray refer to this as cultural capture. They find increases in business political contributions to be positively correlated with state subsidy spending. Additionally, they express concern over the types of firms that these subsidies attract. There is a selection bias for targeted incentives to systematically favor “flighty firms” or firms that will simply relocate if better subsidies are offered by another state, or potentially threaten to leave in an effort to extract more subsidies.

None of these concerns even address the question of whether targeted incentives actually achieve their intended goals.  The evidence does not look good. In a review of the literature by my colleague Matthew Mitchell, and me, we found that of the studies that evaluate the effect of targeted incentives on the broader economy, only one study found a positive effect, whereas four studies found unanimously negative effects. Thirteen studies (half of the sample) found no statistically significant effect, and the remaining papers found mixed results in which some companies or industries won, but at the expense of others.

In addition to these unseen costs on the economy, some critics are beginning to question whether being chosen by Amazon is even worth it. Amazon’s first headquarters has been considered a catalyst for the city’s tech industry, but local government and business leaders have raised concerns about other possibly related issues such as gentrification, rising housing prices, and persistent construction and traffic congestion. There is less research on this, but it is worth considering.

It is up to each city’s policymakers to decide whether these trade-offs are worth it. I would argue, however, that much of the evidence points to targeted incentives – like the ones that cities are using to attract Amazon’s business – as having more costs than benefits. Targeted economic development incentives may seem to offer a lot of tangible benefits, but their unseen costs should not be overlooked. From the perspective of how they benefit each state’s economy as a whole, targeted incentives are detrimental to economic freedom as well as our culture surrounding corporate handouts. Last but not least, they may often be an attempt to cover up other issues that are unattractive to businesses.

Does statehood trigger Leviathan? A case study of New Mexico and Arizona

I was recently asked to review, “The Fiscal Case Against Statehood: Accounting for Statehood in New Mexico and Arizona, by Dr. Stephanie Moussalli for EH.net (the Economic History Association).

I highly recommend the book for scholars of public choice, economic history and accounting/public finance.

As one who spends lots of time reading  state and local financial reports in the context of public choice, I was very impressed with Moussalli’s insights and tenacity. In her research she dives into the historical accounts of territorial New Mexico and Arizona to answer two questions.  Firstly, did statehood (which arrived in 1912) lead to a “Leviathan effect” causing government spending to grow. And secondly, as a result of statehood, did accounting improve?

The answer to these questions is yes. Statehood did trigger a Leviathan effect for these Southwestern states –  findings that have implications for current policy – in particular the sovereignty debates surrounding Puerto Rico and Quebec. And the accounts did improve as a result of statehood, an outcome that controls for the fact that this occurred during the height of the Progressive era and its drive for public accountability.

A provocative implication of her findings that cuts against the received wisdom:  Are the improved accounting techniques that come with statehood a necessary tool for more ambitious spending programs? Does accounting transparency come with a price?

What makes this an engaging study is Moussalli’s persistence and creativity in bringing light to a literature void. She stakes out new research territory, and brings a public choice-infused approach to what might otherwise be bland accounting records. She rightly sees in the historical ledgers the traces of the political and social choices of individuals; and the inescapable record of their decisions. In her words, “people say one thing and do another.” The accounts speak in a way that historical narrative does not.

For more read the review.

 

Birth control, keg stands, and moral hazard

A Colorado organization managed to produce ads promoting health insurance under the Affordable Care Act that are so goofy that some supporters thought they were a parody produced by over-caffeinated tea partiers. But the ads are more than just an unwitting parody. Some of them also unwittingly illustrate an economic principle that is crucial for understanding the cost of health insurance: moral hazard.

Two of the best examples are reproduced below.

lets get physical

keg stand

Source: www.doyougotinsurance.com

Contrary to what you might think after reading the ads, “moral hazard” does not mean health insurance is hazardous to your morals. (For some commentary on what these ads say about morality, look here.)

Moral hazard refers to an insured party’s incentive to take greater risk because the insurer will pay the costs if there is a loss. The two ads above pretty clearly say, “Go ahead and engage in risky behavior, because if there’s a cost, your health insurance will take care of it.”

In the health care context, moral hazard can also involve excessive use of health care services because the insurer is paying the bill. “Excessive,” in this context, means that the patient uses a service even though its cost exceeds the value to the patient.  For example, my Mercatus colleague Maurice McTigue tells me that before New Zealand reformed its health service, a lot of elderly people used to schedule monthly visits to the doctor’s office because it was free and provided a good opportunity to socialize with friends and neighbors. Visits dropped significantly after New Zealand’s health service instituted a $5 copay for doctor visits — which suggests that some of these visits were pretty unnecessary even from the patient’s perspective!

Moral hazard can have a big influence on the affordability of health insurance. Moral hazard losses in private insurance plans can equal about 10 percent of spending. Moral hazard losses in Medicare and Medicaid are much higher, equal to 28-41 percent of spending. (References for these figures are on page 8 of this paper.)

Duke University health care economist Christopher Conover and I examined the eight major regulations rushed into place in 2010 to implement the first wave of Affordable Care Act mandates. The government’s analysis accompanying these regulations failed to take moral hazard into account. In other words, federal regulators extended insurance coverage to new classes of people (such as “children” aged 21-26) and required insurance plans to offer new benefits (such as a long list of preventive services), without bothering to figure out how much of the resulting new health care expenditures would be wasted due to moral hazard.

Is it any wonder that health insurance under the Affordable Care Act has turned out to be less affordable for many people? Makes me want to do a keg stand to forget about it. After all, if I fall down and get hurt, I’m covered!

Detroit’s Art is Not the Key to its Revival

This post originally appeared at Market Urbanism, a blog about free-market urban development.

Detroit’s art assets have made news as Emergency Manager Kevyn Orr is evaluating the city’s assets for a potential bankruptcy filing. Belle Isle, where Rod Lockwood recently proposed a free city-state may be on the chopping block, but according to a Detroit Free Press poll, residents are most concerned about the city auctioning pieces from the Detroit Institute of the Arts’ collection.

I’ve written previously about the downsides of publicly funding art from the perspective of free speech, but the Detroit case presents a new reason why cities are not the best keepers of artistic treasures. Pittsburgh’s Post-Gazette contrasts the Detroit Institute of Art’s situation with the benefits of a museum funded with an endowment:

As usual, Andrew Carnegie knew what he was doing.

The steel baron turned philanthropist put the City of Pittsburgh in charge of operating the library he gave it in 1895, but when he added an art museum to the Oakland facility just one year later, he kept it out of city hands.

“The city is not to maintain [the art gallery and museum],” Carnegie said in his dedication address. “These are to be regarded as wise extravagances, for which public revenues should not be given, not as necessaries. These are such gifts as a citizen may fitly bestow upon a community and endow, so that it will cost the city nothing.”

Museums and other cultural amenities  are a sign of a city’s success, not drivers of success itself. The correlation between culturally interesting cities and cities with strong economic opportunities is often mistakenly interpreted to demonstrate that if cities do more to build their cultural appeal from the top down, they will encourage job growth in the process. Rather, a productive and well-educated population both demand and supply these amenities. While an art museum may increase tourism on the margin, it is unlikely to draw additional firms or individuals away from other locations. Detroit is sitting on an estimated $2.5 billion in art, enough to put a dent in its $15 billion long-term obligations.

On a recent episode of Econtalk, Ed Glaeser explains that over investing in public amenities relative to demand is a sign of continued challenges for municipalities:

It is so natural and so attractive to plunk down a new skyscraper and declare Cleveland has ‘come back.’ Or to build a monorail and pretend you are going to be just as successful as Disney World, for some reason. You get short-term headlines even when this infrastructure is just totally ill-suited for the actual needs of the city. The hallmark of declining cities is to have over-funded infrastructure relative to the level of demand in that city.

Similarly, cities throwing resources at museums and other amenities designed to attract the “creative class” are highly likely to fail because bureaucrats are poorly-positioned to learn about and respond to their municipalities’ cultural demands. When cities do successfully provide cultural amenities, they are catering primarily to well-educated, high-income residents — not the groups that should be the targets of government programs.

I think it’s highly unlikely that Detroit will sell off any taxpayer-owned art to pay down its debts based on the media and political blow back the possibility has seen. However, seeing the city in a position where it owns enough art to cover a substantial portion of its unsustainable long-term debts demonstrates why municipalities should not be curators. Tying up municipal resources in art is irresponsible. The uncertainty that the city’s debt creates for future tax and service provision is clearly detrimental to economic growth. While assets like museums are nice for residents, they do not attract or keep residents or jobs.

Detroit does have an important asset; new ideas need cheap rent. Detroit’s affordable real estate is attracting start ups with five of the metro area’s young companies making Brand Innovator’s list of American brands to watch. While these budding businesses could be key players in the city’s economic recovery, top-down plans to preserve and increase cultural amenities for these firms’ employees will not.

A time when politicians tried to coax ‘the opposition’ to their view

Rostenkowski,danOn May 28, 1986, Ronald Reagan delivered an Oval Office speech calling for tax reform: a revenue-neutral plan to reduce marginal tax rates and close scores of loopholes that privileged particular firms, industries, and individuals. The Great Communicator lived up to his reputation, delivering a flawless speech that somehow managed to evoke lofty images (“Two centuries later, a second American revolution for hope and opportunity is gathering force again”) and yet grounded these images in relatable prose (“No other issue will have more lasting impact on the well-being of your families and your future.”)

Democratic House Speaker Tip O’Neill asked Ways and Means Chairman Dan Rostenkowski to deliver the Democratic response. The choice was controversial. Over the previous five years, the Democrats had flopped in just about every one of their responses to the president. Rostenkowski, famous for his mumbled delivery and mixed metaphors, seemed unlikely to do any better. Here is what the congressman said:

Good evening, I’m Dan Rostenkowski from Chicago. Let me read you something that pretty well explains what tax reform is all about, and what Democrats are all about.

[Reading from a book] “The continued escape of privileged groups from taxation violates the fundamental democratic principle of fair treatment for all and undermines public confidence in the tax system.” That was Harry Truman’s message to Congress thirty-five years ago.

Trying to tax people fairly: That’s been the historic Democratic commitment. Our roots lie with working families all over the country, like the Polish neighborhood I grew up in on the northwest side of Chicago. Most of the people in my neighborhood worked hard in breweries, steel mills, packing houses; proud families who lived on their salaries. My parents and grandparents didn’t like to pay taxes. Who does? But like most Americans they were willing to pay their fair share as the price for a free country where everyone could make their own breaks.

Every year politicians promise to make the tax code fair and simple, but every year we seem to slip further behind. Now most of us pay taxes with bitterness and frustration. Working families file their tax forms with the nagging feeling that they’re the biggest suckers and chumps in the world. Their taxes are withheld at work, while the elite have enormous freedom to move their income from one tax shelter to another. That bitterness is about to boil over. And it’s time it did.

But this time there’s a difference in the push for tax reform. This time, it’s a Republican president who’s bucking his party’s tradition as protectors of big business and the wealthy. His words and feelings go back to Roosevelt and Truman and Kennedy. But the commitment comes from Ronald Reagan and that’s so important and so welcome.

Because, if the president’s plan is everything he says it is, he’ll have a great deal of Democratic support. That’s the real difference this time. A Republican president has joined the Democrats in Congress to try to redeem this long-standing commitment to a tax system that’s simple and fair. If we work together with good faith and determination, this time the people may win. This time I really think we can get tax reform.

Then, he asked the audience to send letters of support:

Even if you can’t spell Rostenkowski, put down what they used to call my father and grandfather—Rosty. Just address it to R-0-S-T-Y, Washington, D.C. The post office will get it to me. Better yet, write your representative and your senator. And stand up for fairness and lower taxes.

This account comes from Jeffrey Birnbaum and Alan Murray’s classic history of the 1986 tax reform, Showdown at Gucci Gulch. They write:

When the speech was over, and the microphones were turned off, the camera crew did something Rothstein [Rostenkowski’s media consultant] had not seen before: they broke into applause. “That was my first clue we hit it over the fence,” Rothstein says.

The second clue was an ecstatic call from the White House. The third was the incredible response from the American people who deluged Washington with more than seventy-five thousand supportive letters addressed to “Rosty.”

I’m not one for nostalgia. I think many humans have a tendency to look at history through sepia-colored glasses that idealize our own political and cultural past.

But it is hard to read Rostenkowski’s speech without seeing the glaring contrast with today’s political rhetoric. The speech is still partisan in a way: He makes it seem as if Democrats had always wanted a simpler and fairer code and he congratulates Reagan for coming around to their view. This is, of course, ahistorical as both parties were at fault for a tax code riddled with loopholes. But the whole thrust of the speech seems designed to make the other side feel safe about moving towards Rostenkowski’s position.

As an economist, I’m accustomed to thinking about human interaction as exchange: when two people meet, there is almost always an opportunity for mutually beneficial exchange (though transactions costs mean that many of these opportunities are unrealized). And the more different these people are in their tastes and in their productive abilities, the greater the opportunity for exchange.

It is interesting that more politicians don’t see their task as one of getting “the other side” to feel comfortable about abandoning its position and moving toward the middle. Instead, politicians seem to increasingly address themselves to their own base. Unfortunately, what draws the base in often pushes the other side away.

In a follow-up post, I’ll address some possible explanations for this.

Don’t make us drive these cattle over the cliff

First a brief note: I am now blogging at the American Spectator on economic issues. I invite you to visit the inaugural posts. Last week, I covered the fiscal cliff. Like many others, I also marvel at the audacity of the pork contained therein.

Lately the headlines have given me a flashback to 1990 and those first undergrad economics classes. And not just econ but also U.S. history and the American experience with price floors and ceilings. In this post I’ll discuss the floors.

As I note at The Spectacle one of the matters settled by the American Taxpayer Relief Act is the extension of dairy price supports from the 2008 farm bill. Now, Congress won’t be “forced to charge $8 gallon for milk.” To me, nothing screams government price-fixing more than this threat aimed to scare small children and the parents who buy their food.

Chris Edwards explains how America’s dairy subsidy programs work in Milk Madness. Since the 1930’s the federal government  has set the minimum price to be charged for dairy. A misguided idea from the start, the point of the program was to ensure that dairy farmers weren’t hurt by falling prices during the Great Depression. When market prices fall below the government set price the government agrees to buy up any excess butter, dry milk or cheese that is produced. Thusly, dairy prices are kept artificially high which stimulates more demand.

According to Edwards’ study, the OECD found that U.S. dairy policies create a 26 percent “implicit tax” on milk, a regressive tax that affects low-income families in particular. Taxpayers pay to keep food prices artificially high, generate waste, and prevent local farmers from entering a caretlized market.

Now for the cows. The recession revealed that the nation has an oversupply of them. The New York Times reports that rapid expansion in the U.S. dairy market driven by increased global demand for milk products came to a sudden halt in 2008. Farmers were left with cows that needed to be milked regardless of the slump in world prices. The excess dry milk was then sold to the government but only at a price that was set above what the market demanded.

In other words, in a world without price supports, farmers could have sold the milk for less at market and consumers would have enjoyed cheaper butter, cheese and baby formula. Instead, the government stepped in, bought $91 million in milk powder so the farmer could get an above-market price and keep supporting an excess of milk cows. Rather than downsize the dairy based on market signals (and sell part of the herd to other dairy farmers, or the butcher) farmers take the subsidy and keep one too many cows pumping out more milk than is demanded.

It turns out auctioning a herd is not something all farmers are anxious to do. Some may look for additional governmental assistance to keep their cattle fed in spite of dropping prices, increased feed costs, and bad weather. To be sure eliminating farm subsidies would produce a temporary shock (a windfall for farmers and sticker shock for consumers), but in the long run as markets adjust everyone benefits.Dairy cows in the sale ring at the Warragul cattle sales, Victoria, [2]

New Zealand did it. Thirty years later and costs are lower for consumers, farmers are thrivingenvironmental practices have improved, and organic farming is growing. While politicians and the farm lobby may continue pushing for inefficient agricultural policy in spite of the nation’s fiscal path,as Robert Samuelson at Real Clear Politics writes, “If we can’t kill farm subsidies, what can we kill?”

 

Contribute to a Public Good; Organize a Screening of “Honor Flight”

Most undergraduate economics majors learn that humans lack an incentive to contribute to so-called “public goods.” Experiments in the lab, however, show that this prediction of eliminatory theory doesn’t always describe real human behavior. Nor, as the late Elinor Ostrom showed, does it describe human behavior outside the lab. In the real world, it turns out that humans often do contribute to public goods.

These contributions are often facilitated by creative institutional arrangements. Kickstarter, for example, has allowed 2.5 million people to contribute over $350 million to creative projects. This year, people will voluntarily contribute more to the arts through Kickstarter than they will through the taxpayer-funded National Endowment for the Arts.

But let’s set aside numbers and theory. If you’d like to see a deeply moving example of how free people can come together to solve problems and do absolutely amazing things, see this movie.

I saw it this week and I can attest that it is one of the most powerful and moving films I have ever seen.

If you live in the Washington, D.C. area, you will have one more chance to see it this Friday night. If you live outside, D.C., go here to see if it is screening in your area. Now here is the cool part, if it isn’t playing in your area, an innovative service called Tugg, allows you to organize a screening in your own town (creative institutional arrangement, that).

So prove elementary economics wrong. Contribute to the public good and organize a screening. I guarantee you will find it deeply personally rewarding.