Category Archives: Government-Granted Privilege

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.

What is rent seeking? Ask the dino-hunters.

I haven’t had much time for blogging lately but I’m going to try to get back into the swing of things. Back in December, I had this to say in Real Clear Markets:

The eminent political economist (and my former professor) Gordon Tullock, passed away last month at the age of 92. His greatest contribution to economic understanding was a funny-sounding concept: “rent seeking.” Funny sounding or not, this idea-perhaps more than any other economic idea developed in the last century-explains what ails our moribund economy. And, as strange as this may sound, a pair of rock star dinosaur hunters form the 1880s can help us understand what exactly rent seeking is and why it’s such a problem.

You can read the rest here. FYI: I didn’t choose the title and am not crazy about it.  Dinosaur

The Sharing Economy and Consumer Protection

(It has been a busy few weeks and I haven’t had much time for blogging).

In early December, my colleagues Chris Koopman, Adam Thierer, and I published a piece on the sharing economy and consumer protection regulation. Here is a summary.

A few days later, I was on the Diane Rehm Show talking about the sharing economy with Alvaro Bedoya (@alvarombedoya) and Nancy Scola (@nancyscola). Alvaro is the executive director of the Center on Privacy and Technology at Georgetown University Law School and Nancy is a reporter covering the intersections of technology and public policy, politics, and governance for The Washington Post.

During the course of our conversation, Diane also spoke with Sunil Paul, the co-founder and CEO of Sidecar and with Donna Blythe-Shaw, the spokesperson for the Boston Taxi Drivers’ Association.

It was a great conversation and I very much enjoyed meeting Diane, Alvaro and Nancy.

You can listen to it here.

Also check out Adam’s comments on the sharing economy at a Congressional Internet Caucus Advisory Committee here.

An interesting development in state regulation of wine shipment

Can one state enforce another state’s laws that prohibit direct-to-consumer wine shipment from out-of-state retailers while allowing it by in-state retailers?  That’s the question posed in a recent New York case.

The New York State Liquor Authority has a rule that prohibits licensees from engaging in “improper conduct.”  The liquor regulator argues that direct shipments by retailers that violate other states’ laws constitute improper conduct.  It has fined, revoked licenses, and filed charges against New York retailers that it believes have shipped wine illegally to customers in other states. One retailer, Empire Wine, refused to settle and has sued the liquor authority in state court, claiming that the “improper conduct” rule is unconstitutionally vague and that the liquor authority cannot enforce other states’ laws that discriminate against interstate commerce.

Many states continue to prohibit direct shipment from out-of-state retailers. For example, 40 states do not allow New York retailers to ship directly to consumers.  This harms consumers, because it is usually out-of state-retailers, rather than wineries, that offer significant savings compared to in-state retailers. In a 2013 article published in the Journal of Empirical Legal Studies, Alan Wiseman and I identified two different anti-consumer effects of laws that allow out-of-state wineries to ship direct to consumer but prohibit out-of-state retailers from doing so. First, these laws deprive consumers of price savings from buying many bottles online: “Online retailers consistently offered price savings on much higher percentages of the bottles in each year—between 57 and 81 percent of the bottles when shipped via ground and between 32 and 48 percent when shipped via air. Excluding retailers from direct shipment thus substantially reduces—but does not completely eliminate—the price savings available from purchasing wine online.” Second, these laws reduce competitive pressure on bricks-and-mortar wine stores, since they exclude lower-priced out-of-state retailers from the local market. Thus, the laws likely harm consumers who buy from their local wine shops, not just consumers who want to buy online. (The published version of the paper is behind a paywall, but you can read the working paper version at SSRN.)

(Photo credit: http://srxawordonhealth.com/2011/07/11/exercise-in-a-bottle/)

 

The Sharing Economy

Over at the Tech Liberation Front, my colleague Adam Thierer has sketched out a few themes in the debate over the sharing economy. His discussion of leveling the regulatory playing field is particularly important. Here is my favorite part:

Alternative remedies exist: Accidents will always happen, of course. But insurance, contracts, product liability, and other legal remedies exist when things go wrong. The difference is that ex postremedies don’t discourage innovation and competition like ex ante regulation does. By trying to head off every hypothetical worst-case scenario, preemptive regulations actually discourage many best-case scenarios from ever coming about.

Adam asks for comments and additional reading suggestions. In that spirit, here are my own additional talking points on the issue:

  • Reviving dead capital: Something that Dan Rothschild has emphasized in a lot of his writings and that I’ve tried to stress when I can is that the “peer production economy” breathes life into otherwise dead capital. Cars, tools, apartments, planes, kitchens, and even dogs are now creating value for people when they otherwise would just be collecting dust (or fleas). This may help to explain the extraordinary value investors see in firms like Uber.
  • Exposing regulatory failure: Another—though not mutually-exclusive—view is that these new firms are making lots of money not because they are doing anything particularly revolutionary. Instead, they are doing well because they have found a way around traditional regulations which have rendered incumbent services truly abysmal and consumers are rewarding them for this. In this sense, Uber is profitable because it isn’t a cartelized taxi company. This is generally the view that Mike Munger expresses in his EconTalk with Russ Roberts. This is probably more applicable to Uber and Lyft than to AirBnB or 1000Tools.com since the ride-sharing firms compete with an industry that has obviously captured its regulator.
  • Transitional gains trap: The whole experience offers us an opportunity to illustrate one of Gordon Tullock’s most-valuable and least-appreciated points. When regulators contrive some artificial exclusivity, they allow incumbent firms to earn above-normal profits (rents). But often these firms are only able to earn above-normal profits for a time (a transitional period). That’s because eventually, the value of the rent is “capitalized” into whatever assets must be purchased in order to enter the industry. These assets may include taxi medallions, specially-outfitted cabs, well-connected lobbyists, or any other asset that is necessary to gain access to the exclusive club. This is important because it means that many of the current incumbents had to pay large sums of money for their exclusive position and, net of these payments, they really aren’t cleaning up. Just as Adam is right to say that “regulatory asymmetry is real” we should also acknowledge that, in many cases, taxi regulations that started out as privileges are now more like burdens.
  • Value is subjective: No two customers have the same values and interests. I may want the windows down on a hot day and you may want them up. It’s simply absurd to think that regulators could devise an objective quality-control checklist for firms to follow or that they could properly vet cab drivers better than consumers. Yet that is exactly the approach they’ve taken (see here for just how clumsy it’s been in VA). The customer rating systems are really revolutionary because they collapse these subjective, multidimensional quality scales down to one simple 5-point rating that captures a driver’s ability to tailor his or her services to the subjective needs of each customer. Your Uber ride begins with a conversation between you and your driver about what is important to you (music, temperature, windows, speed, route, etc.) and ends with a 1 to 5 rating. It’s as simple as that.
  • True competition is a discovery process: Regulations “lock in” the status quo technology (again, because they attempt to objectively state every possible quality that customers might care about). But this misses the whole point of competition. As Hayek taught us, true competition is about discovering things you never knew (and never knew you didn’t know), such as that customers like being able to order cars from their smartphones.
  • Empowering Diffuse Interests: Traditional public choice models predict that small, concentrated interests such as an incumbent taxi industry willtypically prevail in a political battle with a large, diffuse interest such as taxi customers. This time may be different though. Wherever it goes, the peer-production economy has quickly developed a large and happy base of tech-savvy customers. Since the firms themselves have tended to innovate without asking for permission, this has often meant that a city will have tens of thousands of loyal peer-production customers long before its regulators can say “cease and desist.” So in a number of places, we’ve seen regulators move to shut down the peer production economy, then we’ve seen customers protest en masse and regulators withdraw their proposals.
  • Safety: Uber and Lyft drivers carry no cash. Customers have an electronic record of the ride and their driver. Drivers have an electronic record of the customer. These simple solutions accomplish what reams of taxi regulations never could: they ensure that both the customer and the driver are as safe as possible.
  • Flexibility: Because they don’t work for the companies, Uber and Lyft drivers work when they want to. Most of them seem to report that this is one of the best features of the job.
  • Beware of Uber too!: As Milton Friedman put it, one must be careful to distinguish being “pro-free enterprise” from being “pro-business.” The goal here is not to allow Uber to be profitable but to allow competition which will enhance the customer experience. We have already seen that when given the chance, Uber—like most firms—will take an exclusive privilege when one is offered. We must be very careful that Uber isn’t let inside the regulatory velvet rope only to put it back up behind them.

North Carolina Reconsiders its Rejection of Corporate Welfare

A couple of weeks ago, something surprising happened in North Carolina. As the Carolina Journal explained:

RALEIGH — Twenty-eight House Republicans bolted party ranks Tuesday, joining 26 Democrats to defeat an economic incentives program that some labeled “corporate welfare.” It was a rebuke to House Speaker Thom Tillis, R-Mecklenburg, Senate leader Phil Berger, R-Rockingham, and Gov. Pat McCrory, all of whom championed the legislation.

The 47-54 vote against House Bill 1224 signaled that the end of the meandering 2014 “short session” of the General Assembly could be nigh, arriving perhaps as early as today.

The move marked an unusual triumph of economic rationality over special-interest politics. As Brian Balfour explained it in the Civitas Review, the bill combined two unrelated policies: it capped local sales tax rates while expanding the state’s corporate welfare efforts. Now, however, the Washington Post is reporting that the governor is under intense pressure to call a special session so the legislature can reconsider the legislation.

If they do come back into session, legislators would be wise to study up on the issue before they reconsider their votes. A good place to start would be a recent Mercatus working paper by George Mason University Professor Christopher Coyne and GMU Ph.D. candidate Lotta Moberg. The paper explores the effects of targeted economic development incentives, stressing two under-appreciated downsides to the policies:

(1) they lead to a misallocation of resources, and (2) they encourage rent-seeking and thus cronyism. We argue that these costs, which are often longer-term and not readily observable at the time the targeted benefits are granted, may very well outweigh any possible short-term economic benefits.

To gain a better understanding of the effects of these policies, my colleague Olivia Gonzalez and I have begun looking at the empirical literature. While our results are still preliminary, what we have found so far should give Tar Heel legislators pause in re-thinking their decision. We found 26 peer-reviewed papers that assess the effect of targeted incentives on the broader economy (a surprisingly large number of studies only look at whether incentives help the privileged firms and sectors, ignoring how they affect the broader economy).

The pie chart below shows what we’ve found. Just 2 studies, constituting 8 percent of the sample, found that targeted incentives positively affect the economy-at-large. Four studies (15 percent of the sample) found that targeted incentives negatively affect the broader economy. Another 6 studies found that they produce some positive effects (such as higher employment) but also some negative effects (such as lower labor force participation). One study in the sample found a distinct group (manufacturers) benefited while others (finance, insurance, and real estate) lost. Thirteen studies (half the sample), simply found no statistically significant effect of targeted incentives.

Targeted incentives research pie chartOn balance, this is not a strong case for the effectiveness of targeted economic development incentives. It suggests that when states privilege particular firms or industries, they are wasting taxpayer resources, benefiting some at the expense of others, and potentially harming the broader economy. Of course, some pathologies of privilege such as long-term resource misallocation, rent-seeking waste, and corruption may not manifest themselves for years and are not likely to be picked up by these studies.

Ex-Im’s Deadweight Loss

To hear defenders of Ex-Im talk, you’d think that export subsidies are ALL upside and no downside. Economic theory suggests otherwise.

Clearly, some benefit from export subsidies. The most-obvious beneficiaries are the 10 or so U.S. manufacturers whose products capture the bulk of Ex-Im’s privileges (if they didn’t benefit, their “all hands on deck” public relations campaign to save the bank wouldn’t make a lot of sense).

Foreign purchasers who receive loans and loan guarantees from the bank in exchange for buying these products also clearly benefit.

The least-conspicuous beneficiaries are the private banks who finance these deals and get to offload up to 85 percent of the risk on to U.S. taxpayers. But they too clearly benefit.

Those are the upsides. But as economists are wont to say, “there is no such thing as a free lunch.”

Behind each of these beneficiaries is someone left holding the bag: there are taxpayers who bear risks that private lenders are unable or unwilling to bear. There are consumers who must pay higher prices for products that are made artificially expensive by Ex-Im subsidies. And there are other borrowers who lose out on capital because they aren’t lucky enough to have the full faith and credit of the U.S. taxpayer standing behind them.

One might be tempted to think that gains of the winners roughly offset the losses of the losers. But basic economic analysis suggests that the losses exceed the gains.

A few simple diagrams illustrate this point.

First consider any subsidy of a private (that is, excludable and rivalrous) good. Perhaps the most relevant example is a subsidy to private lenders. This is shown in the familiar supply and demand diagram shown below. The quantity of loanable funds is displayed along the horizontal axis and the price of a loan—the interest rate—is shown on the vertical axis.

People want loans to invest in their projects. We call this the “Demand for Investment.” It is shown as the blue, downward-sloping line. It is downward sloping because there are diminishing marginal returns to investment and because if you have to pay a higher interest rate, you will borrow less.

Other people have money to lend. We call this the “Supply of Savings.” It is depicted below as the solid red, upward-sloping line. It is upward sloping because there are increasing opportunity costs to lending out money and lenders must be enticed with higher and higher interest rates to lend more and more money.

The key to understanding this diagram—and this is a point that non-economists tend to find unintuitive—is that there is an optimal quantity of loans and it is not infinity. There is some point beyond which the marginal opportunity cost of further lending exceeds the marginal expected benefit from these investments.

Now consider what happens when the government guarantees the loans. Knowing that taxpayers will cover up to 85 percent of their losses, rational lenders will be willing to supply any given quantity of loans at a lower interest rate. Thus, the supply of savings shifts to the lower, dashed red line. But just because loan guarantees shield lenders from the true opportunity cost of these funds, it does not mean that the true opportunity cost goes away. In this case, taxpayers wear the risk. (For a dated but lucid explanation of the true opportunity cost associated with Ex-Im, see this Minneapolis Fed paper).

Society as a whole is made poorer because scarce resources are redirected from higher-valued uses toward lower-valued uses. In other words, those who lose end up losing more than the winners win. Economists call this “dead weight loss” (DWL). It is represented by the red triangle in the diagram below (click to enlarge).

DWL of a Subsidy

So far, this is the basic economic theory of a subsidy. But economists have developed more-specific models to understand subsidies in the context of international trade.

To get a handle on this, check out some videos by Professor Michael Moore of George Washington University. If international trade diagrams are new to you, I’d recommend looking at these diagrams before watching his videos. Then watch Professor Moore’s excellent illustration of an export subsidy in a small country, followed by the slightly more-complicated—but more relevant—case of export subsidies in a large country.

Small country case:

Large country case:

This is the basic case for free trade and it is widely accepted by economists. Some astute readers may know that there are some interesting theoretical exceptions to this rule. These exceptions derive from what are known as “strategic trade” models. They posit that in some situations—such as oligopolistic industries—governments can theoretically manage to use subsidies to make domestic firms win more than domestic consumers lose. The world is still poorer, but domestic winnings outweigh domestic losses.

These models are worth understanding. But the truth is they have not—and should not—undermine the basic economic case for free trade. The best exposition of this point is a classic piece by Paul Krugman called “Is Free Trade Passe?” In it, Krugman carefully walks the reader through the logic of these models. He then notes, quite rightly, that:

The normative conclusion that this justifies a greater degree of government intervention in trade, however, has met with sharp criticism and opposition—not least from some of the creators of the new theory themselves.

Krugman then ticks through the reasons why free trade should still be the reasonable rule of thumb. For one thing, since the strategic trade models seem to only work in oligopolistic industries, policy makers would need to know exactly how oligopolists will respond to these subsidies and the fact is “economists do not have reliable models of how oligopolists behave.” Then there is the problem of entry. Even if a government does solve the empirical problem of anticipating and accurately responding to oligopolists, it “may still not be able to raise national income if the benefits of its intervention are dissipated by entry of additional firms.”

Krugman’s final two critiques are fascinating because they are precisely the sorts of concerns a George Mason economist might raise. First, there is what Hayek might call the information problem:

[T]o pursue a strategic trade policy successfully, a government must not only understand the effects of its policy on the targeted industry, which is difficult enough, but must also understand all the industries in the economy well enough that it can judge that an advantage gained here is worth advantage lost elsewhere. Therefore, the information burden is increased even further.

And finally, there is the public choice problem. At the international level, “In many (though not all) cases, a trade war between two interventionist governments will leave both countries worse off than if a hands-off approach were adopted by both.” And at the domestic level:

Governments do not necessarily act in the national interest, especially when making detailed microeconomic interventions. Instead, they are influenced by interest group pressures. The kinds of interventions that new trade theory suggests can raise national income will typically raise the welfare of small, fortunate groups by large amounts, while imposing costs on larger, more diffuse groups. The result, as with any microeconomic policy, can easily be that excessive or misguided intervention takes place because the beneficiaries have more knowledge and influence than the losers.

To this, one could add a host of problems that arise when governments privilege particular firms or industries.

Which (finally) brings me to the bottom line: the economic case remains strong that export subsidies to domestic firms like Boeing and GE end up costing American consumers, borrowers, and taxpayers more than they end up benefiting the privileged firms.

Would cutting Ex-Im’s ties to the U.S. Treasury amount to “unilateral disarmament”?

Before winning this year’s World Cup championship, Germany faced a dilemma during its qualifying match against the United States. Both teams could ensure their advancement in the tournament by colluding to do nothing. If they tied, both would advance. If one of them won, the other might not advance. However, neither could ensure that the other would cooperate. And as a result, they were both forced to compete.

This situation, known a “prisoner’s dilemma,” is one that manifests itself in all sorts of situations, frombusiness to politics to World Cup qualifying games.

It also helps explain where we find ourselves with the Export-Import Bank,or “Ex-Im,” a federal agency tasked with subsidizing U.S. exports. The bank’s charter is set to expire in a few months, and some are making the case that it should be reauthorized to help U.S. manufacturers “compete internationally” by“leveling the playing field.” This is simply another prisoner’s dilemma playing out in the real world.

That is my latest, coauthored with Chris Koopman, at US News.

Are Uber and Lyft the next jitney?

This July marks the 100-year anniversary of the American Jitney. An early incarnation of Uber and Lyft, it was an enormously popular service that was at one point found in 175 U.S. cities. Haven’t heard of it? That’s because most major cities quickly regulated it out of existence.

My colleague, Michael Farren, and I explore the short life and death of the American jitney in tomorrow’s LA Times.