Tag Archives: Century French

The unseen costs of the Ex-Im bank

The great 19th Century French economist Frederic Bastiat had good advice when thinking about economics. Actions, habits, and laws, he said,

[produce] not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

The good economist, he said, “takes into account both the effect that can be seen and those effects that must be foreseen.”

So it is with the US Ex-Im bank.

The independent federal agency helps foreign firms finance the purchase of American-made products. They do this by selling insurance to these foreign purchasers, by directly loaning them money, and by guaranteeing loans that others like Goldman Sachs make to these firms.

Ex-Im’s activities produce some seen benefits and these are widely touted by the bank and it’s boosters, such as the National Association of Manufacturers. These seen benefits are:

The gains to foreign purchasers

Since most foreign purchasers are sub-prime borrowers (what could go wrong, right?), the bank’s assistance allows them to obtain credit that private lenders would otherwise be unwilling to extend. At least in the short run, this helps these foreign purchasers.

The gains to U.S. manufacturers

Ex-Im’s loans, loan guarantees and insurance all increase demand for some domestic manufacturers’ products. This allows them to sell more stuff and to sell it at higher prices than they otherwise would. The bank boasts that, on average, “87% of transactions benefit small business exporters of U.S.-made goods and services.” Note the use of the words “transactions” and “small.” The bank is slicing the data here in a way that isn’t entirely honest. More on which below.

But as Bastiat would tell us, these seen benefits are less than half the story. There are also a host of less-conspicuous effects, and all of them are bad. These include:

Excessive risk

Rational lenders are unwilling to finance risky bets unless they are compensated with higher rates of return. These higher interest rates, in turn, make risky borrowers think twice about undertaking bad investments. This is a feature of a well-functioning financial system, not a bug.

Like all goods, capital is scarce and this feature helps ensure it isn’t wasted, steering it to the projects where it can do the most good for people. Ex-Im’s activities, on the other hand, steer capital—at artificially low interest rates—to sub-prime borrowers so they can buy big, expensive products. This is bad for the world economy because it misallocates capital. But in the long run it’s bad for many of the borrowers themselves because it encourages them to take on risks they can ill-afford (which is why I hedged above when I said they gain “in the short run”). Another great French economist, Veronique de Rugy, highlighted this fact in a recent post. As she points out, this isn’t just a hypothetical concern:

In the 1990s, the Ex-Im Bank was so excited to “support” the people of the Republic of Nauru by extending financing assistance to Air Nauru to purchase some, you guessed it, Boeings. When Air Nauru defaulted in 2002, the Ex-Im Bank seized Nauru’s only jet straight off of the runway — leaving the country’s athletes stranded on the tarmac after the Micronesian Games.

Higher prices for manufactured products

Next consider the unseen effect on domestic purchasers. Like Air Nauru, domestic airlines such as Delta, United, Southwest, and dozens of others also buy Boeing aircraft. Unlike Air Nauru, these firms don’t receive loan subsidies. This hurts all of them once, and some of them twice.

First, the international carriers among this group like Delta lose market share to Ex-Im-privileged firms like Korean Air and Emirates Air. This explains why Delta has filed a lawsuit against Ex-Im.

Second, all US carriers—even those like Southwest that only serve the US market—end up paying higher prices for planes because Ex-Im privileges increase the demand for, and therefore the price of, airplanes. As Vero notes in this piece, this has many air carriers worried about a jet plane bubble. Simple economics, of course, predicts that some of this cost will be passed on to consumers in the form of higher ticket prices.

Privileges for banks

Presumably, many of the legislators who routinely vote to reauthorize Ex-Im do so because they want to subsidize domestic manufacturers. Unfortunately, the laws of economics dictate that the actual beneficiaries of a subsidy need not be the intended beneficiaries.

In the case of Ex-Im, a large chunk of the benefit is captured by privileged banks instead of by manufacturers. Thanks to Ex-Im’s loan guarantees, banks are able to make loans to foreign buyers while unloading most of the risk. This is yet one more way in which banks, “privatize gains and socialize losses” (to borrow a phrase used by Nobelist Joseph Stiglitz at an Occupy Wall Street rally).

This privilege sits on top of a pile of other privileges. The IMF recently estimated that in most years the biggest of these privileges—the too big to fail subsidy—is larger than bank profits!

Few gain at the expense of the many

Consider, again, the bank’s assertion that 87 percent of its “transactions” benefit “small business” exporters. Why focus on transactions? Wouldn’t it be more transparent to focus on the size of these transactions? When you break it down this way, as Vero does in this piece, you see that 81 percent of the value of Ex-Im assistance goes to “big businesses” as the bank defines them.

And just how do they define big and small business? Answer: not in the same way others like the Small Business Administration do. Ex-Im’s definition of “small” manufacturers and wholesalers is three times larger (by number of employees) than the SBA’s definition and it includes firms with revenues as high as $21.5 million a year.

A host of pathologies

As I emphasize in the Pathology of Privilege, these favors to a select few domestic manufactures and banks come with a host of problems. In short, privilege “misdirects resources, impedes genuine economic progress, breeds corruption, and undermines the legitimacy of both the government and the private sector.”

But Ex-Im and its beneficiaries don’t want you to see that.

Why Matching Formulas Don’t Make Sense

Politico reports:

As part of the economic stimulus, the DOT allocated $3.3 billion to California’s planned high-speed rail line, which has become bogged down in a high-stakes fight over its price tag and location. California risks losing those federal funds if the state Legislature doesn’t approve $2.7 billion in bonds by mid-June.

To understand the incentives of a state legislator, consider a hypothetical example. Imagine there is a new restaurant in town. It is called “matching formula.” The restaurant has fifty tables and offers a special deal: no matter what you order, you get to split half of your bill with the rest of the restaurant’s patrons.

Now think about the value you would derive from a nice steak meal. Let’s say it is worth $26.00 to you. Unfortunately, at this restaurant, the meal costs $50.00.  Normally you wouldn’t pay that kind of money. But given the matching formula, it is only going to cost you $25.50 (that’s half the price, $25.00, plus one-fiftieth of the other half, $0.50). Since you derive $26.00 in value from the meal and since it only costs $25.50, you go ahead and order it.

But there’s more. The other patrons at the other 49 tables face the exact same incentive. If they too value the meal at $26.00, they too will order it. That’s another 49 meals, half the cost of which will be split 50 ways. Your share of their meals works out to $24.50 (that’s $25, times 49, divided by 50). So your final bill is $50.00 (that’s $25.50 for your meal, plus another $24.50 for everyone else’s).

Remember, you only valued it at $26. So on net, you are down $24 ($26 value, minus $50 cost). You might be thinking that it would be better to just order nothing. But if you do that, you still end up paying $24.50 for everyone else’s meal, but in this case you get nothing at all. It is better to be down $24 than $24.50.

Given the incentives of the restaurant, it is completely rational for you to order your meal and it is completely rational for everyone else to order theirs. The system as a whole, however, is nuts.

You could try convincing everyone else in the restaurant to order nothing. In that case, you would all be out $0. This is a winning strategy, but it can be very difficult to convince everyone. If 49 tables agree not to order anything, the 50th can get a GREAT deal: one steak valued at $26.00 that will cost them only $25.50. Once others see that the hold-out is profiting, they will refuse to abstain and the agreement will fall apart.

Strange as this story seems, this is exactly the way the federal government structures a number of federal-state programs. According to the story cited above, for example, California legislators can foist 55 percent of the cost of their high-speed rail on to federal taxpayers. And presumably other states’ legislators can do the same.

Under normal circumstances, the average state can export 58 percent of the cost of its Medicaid program on to federal taxpayers and some states can export up to 74 percent of the cost. But the stimulus bill temporarily enhanced these matching formulas so that now the average state can export 71 percent and some states can export up to 81 percent.

Notice that you don’t have to dislike steaks, trains, or Medicaid to find fault in these formulas. You just have to understand that there are costs and benefits to everything and recognize that these formulas bias cost/benefit calculations in favor of spending more than these things are worth.

The great 19th Century French economist Frédérick Bastiat once defined the state as, “that great fiction by which everyone tries to live at the expense of everyone else.”

Matching formulas institutionalize this fiction.

My apologies to Russ Roberts who once told a very similar story far better than I.