Tag Archives: community

Shortfalls in non-profit disaster rebuilding

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

After receiving years of praise for its work in post-Katrina recovery, Brad Pitt’s home building organization, Make It Right, is receiving some media criticism. At the New Republic, Lydia Depillis points out that the Make It Right homes built in the Lower Ninth Ward have resulted in scarce city dollars going to this neighborhood with questionable results. While some residents have been able to return to the Lower Ninth Ward through non-profit and private investment, the population hasn’t reached the level necessary to bring the commercial services to the neighborhood that it needs to be a comfortable place to live.

After Hurricane Katrina, the Mercatus Center conducted extensive field research in the Gulf Coast, interviewing people who decided to return and rebuild in the city and those who decided to permanently relocate. They discussed the events that unfolded immediately after the storm as well as the rebuilding process. They interviewed many people in the New Orleans neighborhood surrounding the Mary Queen of Vietnam Church. This neighborhood rebounded exceptionally well after Hurricane Katrina, despite experiencing some of the city’s worst flooding 5-12-feet-deep and being a low-income neighborhood. As Emily Chamlee-Wright and Virgil Storr found [pdf]:

Within a year of the storm, more than 3,000 residents had returned [of the neighborhood’s 4,000 residents when the storm hit]. By the summer of 2007, approximately 90% of the MQVN residents were back while the rate of return in New Orleans overall remained at only 45%. Further, within a year of the storm, 70 of the 75 Vietnamese-owned businesses in the MQVN neighborhood were up and running.

Virgil and Emily attribute some of MQVN’s rebuilding success to the club goods that neighborhood residents shared. Club goods share some characteristics with public goods in that they are non-rivalrous — one person using the pool at a swim club doesn’t impede others from doing so — but club goods are excludable, so that non-members can be banned from using them. Adam has written about club goods previously, using the example of mass transit. The turnstile acts as a method of exclusion, and one person riding the subway doesn’t prevent other passengers from doing so as well. In the diagram below, a subway would fall into the “Low-congestion Goods” category:

club goods

In the case of MQVN, the neighborhood’s sense of community and shared culture provided a club good that encouraged residents to return after the storm. The church provided food and supplies to the first neighborhood residents to return after the storm. Church leadership worked with Entergy, the city’s power company, to demonstrate that the neighborhood had 500 residents ready to pay their bills with the restoration of power, making them one of the city’s first outer neighborhoods to get power back after the storm.

While resources have poured into the Lower Ninth Ward from outside groups in the form of $400,000 homes from Make It Right $65 million  in city money for a school, police station, and recreation center, the neighborhood has not seen the success that MQVN achieved from the bottom up. This isn’t to say that large non-profits don’t have an important role to play in disaster recovery. Social entrepreneurs face strong incentives to work well toward their objectives because their donors hold them accountable and they typically are involved in a cause because of their passion for it. Large organizations from Wal-Mart to the American Red Cross provided key resources to New Orleans residents in the days and months after Hurricane Katrina.

The post-Katrina success of MQVN relative to many other neighborhoods in the city does demonstrates the effectiveness of voluntary cooperation at the community level and the importance of bottom-up participation for long-term neighborhood stability. While people throughout the city expressed their love for New Orleans and desire to return in their conversations with Mercatus interviewers, many faced coordination problems in their efforts to rebuild. In the case of MQVN, club goods and voluntary cooperation permitted the quick and near-complete return of residents.

Government shouldn’t pick winners either

Last week, Steven Mufson of the Washington Post reported:

The Energy Department gave $150 million in economic Recovery Act funds to a battery company, LG Chem Michigan, which has yet to manufacture cells used in any vehicles sold to the public and whose workers passed time watching movies, playing board, card and video games, or volunteering for animal shelters and community groups.

This week, Mufson’s colleague Thomas Heath reports about another firm that has received gov’t aide:

District-based daily-deal company LivingSocial has received a much-needed $110 million cash infusion from its investors, according to a memo the company sent to employees Wednesday.

“This investment is a tremendous vote of confidence in our business from the people who know us best, our current board members and investors,” LivingSocial chief executive Tim O’Shaughnessy said in the memo, which was obtained by The Washington Post.

Mr. O’Shaughnessy is putting a nice gloss on it. A LivingSocial “senior company insider” tells PrivCo:

We scrambled for cash quickly….we did receive one other funding offer, but the current investors’ terms were the least bad of two terrible proposals….which we had no choice but to take it or file for Chapter 11.

According to PrivCo, the company ended the year with just $76 million in cash and assets while it faces some $338 million in liabilities.

Readers will no doubt remember that just eight months ago, the D.C. Council unanimously voted to give LivingSocial a $32,500,000 get-out-of-tax-free card.

These stories (and the many, many more that could be told) suggest that President Obama’s former economic adviser  Larry Summers, was right to warn that government is a crappy venture capitalist. Milton and Rose Friedman’s simple explanation of the four ways money can be spent offers a nice explanation:

how to spend money

A private venture capitalist spends her own money to buy equity in a firm. And if that firm does well, she does well. Since she is spending her own money on herself, she has an incentive to both economize and seek the highest value.

But when government policymakers play venture capitalist, they are spending other peoples’ money on other people. They therefore have little incentive to either economize or seek high value. It is no wonder that they often make the wrong bets.

But the scandal has much more to do with a bad bet. Even if the bet pays off—which it sometimes does—there are problems associated with taxpayer support of private industry. There are more details in my paper, but just to name a few, government-supported industries will tend to:

  • Be cartelized, which means consumers are stuck with higher prices;
  • Use less-efficient productive techniques;
  • Offer lower-quality goods;
  • Waste resources in an effort to expand or maintain their government-granted privileges;
  • Innovate along the wrong margins by coming up with new ways to obtain favors rather than new ways to please customers.

Together, these costs can undermine long term growth and even short-term macroeconomic stability. And since the winners tend to be the wealthy and well-connected and the losers tend to be the relatively poor and unknown, privileges such as these undermine people’s faith in both government and markets.

We should be upset when governments sink money into firms that then go bankrupt. But it is no less scandalous when government sinks funds into firms that survive.

Governments should stay out of the business of picking winners or losers.

What the Mortgage Interest Deduction can Teach us About Government Failure

Is it hypocritical for a business or a politician to publicly oppose a government program only to turn around and ask for a share in it? Stephen Koff of the Cleveland Plain Dealer posed this question to me a few weeks ago. Likening it to the mortgage interest deduction, I said I didn’t think so.

I oppose the mortgage interest deduction. It pads the pockets of housing-industry special interests. It puts pressure on marginal tax rates to rise in order to make up for the lost revenue. And it likely has little impact on the incidence of home ownership since the value of the deduction is capitalized into the price of homes. (Even if it worked as intended and didn’t end up being capitalized into the value of home prices, it would be a regressive privilege for relatively wealthy home-mortgagers). For all these reasons, I—like most economists—oppose the mortgage interest deduction.

But come April 15, I take the deduction. And though I can’t say for certain, I suspect the same is true of most economists. Why?

The main reason is that not taking the deduction would have approximately zero impact on the problems I mentioned. Those problems only go away if the whole policy goes away. So, I do what I can to expose its faults when I talk to journalists but I don’t forgo it myself.

Whether or not you find this hypocritical, it is an empirical fact that lots of people see things this way. More importantly, this phenomenon is at the heart of the public choice critique of government failure. It explains why bad policy exists.  

Consider pork-barrel spending, as modeled in the prisoner’s dilemma (economists should skip the next two paragraphs). Imagine a community of two constituents. And imagine that each has the choice of two options: take pork or abstain from pork. Taking pork yields a private benefit of $10 for the taker. But because there are deadweight losses associated with taxation, $10 in pork will cost the community $12 in taxes and unrealized economic gain. If this cost is split evenly between the two constituents, and Constituent A is the only one who takes it, then he obtains $4 = $10 – 0.5*$12 (his gain, minus his share of the cost). Constituent B, however, only gets the cost of A’s pork: -$6 = -0.5*$12. The situation is reversed if B takes and A abstains. If both take, then each pays -$2 = $10 – 0.5*24 (the value of the pork minus the cost of paying for two peoples’ shares). Lastly, if both abstain, neither is taxed and neither obtains a benefit. The table below shows these outcomes. The first number indicates Constituent A’s payoff, while the second indicates Constituent B’s.

Player B
Abstain Take Pork
Player A Abstain 0.0 0.0 -6.0 4.0
Take Pork 4.0 -6.0 -2.0 -2.0

 

Irrespective of what Constituent B does, it always makes sense for Constituent A to take the pork. If B abstains, then A should take it because he gets $4.00 instead of $0. And if B takes, then A should also take because losing $2.00 is better than losing $6.00. Similarly, it is always in B’s interest to take. So the “equilibrium” of the game is for both A and B to take pork and for them both to be worse off than if neither took.

The point of the exercise is to show that the incentives of the system lead people to a socially suboptimal outcome. If they could somehow change the entire system—say by prohibiting taxes that fund special interests instead of general welfare—then they could get to the optimal outcome. But without changing the incentives of all players, it makes little sense for any one person to act against his or her interest.

MSNBC has lately taken to airing commercials that highlight federal funding for parochial projects. The commercials are apparently supposed to convince people that the federal government should fund all sorts of local project. As a one-time resident of Arizona I’m sure I benefited from the electricity generated at Hoover Dam. And whenever pork-barrel projects are considered, you can generally count on the local constituents who benefit from them to support them. But that doesn’t mean that the residents of the 48 states other than Arizona and Nevada should have had to pay for the Dam. In fact, the simple model of the prisoner’s dilemma teaches us that the incentives of such a system can lead to suboptimal outcomes.

I take the mortgage interest deduction. And the problem is that I—like every other homeowner—am incentivized to do so, even though the total costs outweigh the total benefits.

A Congressional Cookie Jar with Oak Tree Roots: The Economic Development Administration

David Bier of the Competitive Enterprise Institute makes the case in a recent paper for the abolition of the Economic Development Administration. The history of the EDA is tied into the programs of the Great Society which spawned many fiscal and programmatic connections between federal, state and local agencies with the ostensible aim of spurring local economic improvement (e.g.The Community Development Block Grant). Fifty years on and these programs haven’t lived up to the grandiose mission statements of their architects. The EDA is part of the framework through which stimulus dollars flowed and Bier’s article underscores the key objections to the application of federal dollars to local economic development.

Interestingly, the EDA has been the subject of several academic studies over the years. The classic public administration book, Implementation, by Jeffrey L. Pressman and Aaron Wildavsky undertook an early case study of the EDA in Oakland, California with its inaugural goal of hiring long-term unemployed minorities. They conclude that while advocates had “great expectations” the program produced meager results with impulsive project choices and cost overruns. The cause, the authors postulated, was a delay in implementation and cumbersome bureaucracy.

Pressman and Wildavsky seem to have documented a familiar tale of public choice theory: the malincentives present in bureaucracies and tendency toward inefficiency. Their classic book on programmatic breakdown has touched off another debate recently in the literature centered around the question, “What ever happened to the study of policy implementation?” An intellectual dead-end was encountered according to deLeon and deLeon which can be revitalized by considering policy implementation not from the top-down but from the ground-up.

Pressman and Wildavsky sliced into their analysis in keeping with the dominant theories of the time. They view the EDA in a top-down fashion – as a single federal programmatic entity acting on subordinate levels of state and local government. Since their 1973 classic, advances made by Vincent and Elinor Ostrom and others point to the fruitfulness of thinking in terms of polycentric rather than monocentric orders. That is, to consider policies in horizontal instead of vertical terms. Map out the multiple decision nodes that connect government, marketplace and community.

B. Guy Peters in his article, Implementation Structures as Institutions, notes that in the last decade, the public administration literature now strives to make just such connections in understanding how policies are implemented. It’s an important advance which allows for a more complex and nuanced picture of the effects of programs. Such analysis may help answer one perennial question: how is it that small-budget, experimental programs inspired by mid-century economic theories grow deep roots and resist any kind of reform, alteration or pruning for generations?

When we consider federal spending programs and trace their effects we often see the fleeting connections and feel a sense of unease. A former EDA administrator calls the program, “A Congressional Cookie Jar.” From his vantage point the program is an expense account for politicians to sprinkle federal dollars on their districts. But as EDA grants are scattered among municipal governments, what else happens along the way? How do constituencies coalesce? Who benefits and who loses? Where do the dollars go and how are connections forged between private, non-profit and public sector actors. Metaphorically speaking, how did a single-shot grant in the mid-1960s become an oak forest?

Strategy and politics in the of phrasing of bond referendum

How detailed should bond referendum be? The Arlington County Board heard comments from the public on the FY 2013 capital spending plan a few weeks ago. At issue was $153 million in local GO bond referendum that will be on the ballot on November 6th. The Arlington Sun Gazette reports there are four major “bundles.”

  • $31.946 million for Metro, neighborhood traffic calming, paving and other transportation projects
  • $50.533 million for parks, including the Long Bridge Park aquatics and fitness center and parkland acquisition
  • $28.306 million for Neighborhood Conservation and other “community infrastructure” projects
  • $42.62 million for design and construction of various school projects.

At issue was the language accompanying the bond packages. The Arlington County Civic Federation contends the $45 million dedicated to the acquatics center be listed as a separate item rather than bundled under the general category of park improvements.

Scott McCaffrey writes that the County Board has been bundling bonds under thematic groupings for many years as a strategy to lessen voter opposition, an interesting claim.

How explicit does language have to be in municipal General Obligation bond offerings? States typically require GO bond debt be subject to voter approval before issuance, but how does ballot language matter to the outcome?

While not addressing the matter specifically a few related questions have been pursued in the literature. Damore, Bowler and Nicholson in their paper, “Agenda Setting by Direct Democracy: Comparing the Initiative and the Referendum” (State Politics and Policy Quaterly, forthcoming) considers if agenda setters use the referendum process to extract greater spending than the median voter desires. Some of this research indicates that voters are less likely to support state referendum for tax increases but that between 1990 and 2008, 80 percent of bond referendum received voter approval.

As to the need for particular language, there are strategies. The Government Finance Officers Association (GFOA) lists six steps governments can take to improve their chances of getting a bond approved. This includes, “measure design” or “developing ballot language that appeals to voters and clearly explains how this measure addresses the particular issue targeted by the bonds meets the needs of the community.”

I did find anecdotal evidence that politicians struggle with language on ballot questions, in an effort to strike a balance between clarity and increased likelihood of passage. The Rockford Illinois School Board appears to be hemmed-in by how it phrases bond questions. The more detailed the questions the more legally-bound the board is to spend the money as specifically approved by voters.

Speaking of language, in writing this post I was unsure if I should be using”referenda” as the plural of “referendum”. “Referenda” sounds more natural to me but “referendum” appears to be used more often.

Given the difficulty of the original Latin grammar (referendum is a “gerund” and has no plural), it turns out there is an unsettled debate over this. Either is correct according to the Irish paper The Daily Edge. I felt better knowing that even The British Parliament debated over which plural form to use back in 1998. It turns out whether one uses the Latin “referenda” or the Anglicized “referendum” is purely a matter of taste.

Is the Localvore Movement a Folly?

Pierre Desrochers, Canadian economic geographer and Mercatus affiliated scholar makes the case that the Localvore’s drive to get people to “eat-locally” is based on fanciful notions of economics and agriculture, in his book, The Localvore’s Dilemma: In Praise of the 10,000-mile diet, co-authored with wife Hiroko Shimizu.

The book goes to the heart of an apparent motivation for food activists, that “sustainable farming” and “eating local” will help the planet. Desrochers and Shimizu disagree. They show that subsistence farming is unsustainable, back-breaking and not environmentally-superior to large-scale methods. Rather than reducing “food miles” (the distance the banana travelled into your cereal bowl) the authors instead make the case for eliminating ag-subsidies. The takeaway: eating globally gets you to a better place, environmentally, than limiting your consumption to the downtown farmer’s market.

I don’t disagree. But this review by Emily Badger at The Atlantic contains some food for thought. She suggests reading, Urban Farms, by Sarah Rich who went out and interviewed urban farmers to understand this growing movement. Here’s one of her findings, quoting Badger’s article:

Politics are all but absent from Rich’s interviews. She visits one urban farmer in Detroit who comes the closest to voicing revolutionary motives. He is concerned about a trash incinerator in his neighborhood, and he views his backyard farm partly as a defiant form of environmental remediation.

“That’s what he’s thinking about, his local garbage system and how messed up it is,” Rich says. “He wasn’t talking to me about Monsanto, or industrial agriculture.”

Throughout her 16 urban farm profiles, Rich found what she describes as very local initiatives, where agriculture just happened to be the medium for doing something positive in the city.

Rich documents many non-political motives for urban farming: a social anchor for the community, beautifying blight, jobs for the unemployed, places for children, opportunities for school kids to learn about plants and science, fresh produce in food deserts.

Does the Localvore movement have to be an either/or proposition? I’m intrigued that Rich went into the field and talked to urban gardeners to see what is driving them. Based on Ms. Badger’s article it isn’t green ideology or government subsidies, but something much more ‘organic and human.’

The pleasures and rewards of a backyard garden.

I think the policy problem Desrochers and Shimizu identify is a real one.  The more idealistic members of the “Food Activist” movement assert that local farms can (at least partially) replace global production to sustain the current population. They insist that large-scale food production is bad for the environment and take an overly romantic view of small-scale subsistence farming. That is folly. But free trade in food should not imply that urban gardening doesn’t have virtues of its own.

I confess my prejudice. Growing up in suburban north Jersey we benefitted from a subdivided acre of land that we shared with my grandmother. My siblings and I helped tend a large vegetable garden, fruit trees, berry brambles and my mother’s ever-expanding herb garden. For a period my father experimented with growing grapes for wine (a project he abandoned upon sampling the results). We learned how to grow, care for, and cook the fruit of our labors.

There is an indescribable gulf between the Jersey tomatoes we grew and the tasteless rubber ball I reluctantly buy in the grocery. We canned, froze and shared the yield of our garden with neighbors. I learned to appreciate food (i.e., not waste it), how to recycle (compost), how to cook, how to propagate raspberries, currants and gooseberries; and for a few summers to stomp on grapes.

Before I was born, my grandmother (who was raised on a farm in Białystok, Poland) kept two chicken coops. I imagine that turned into more trouble that it was worth but nevertheless it was the source of my grandparents’ dinner for a brief time. The exercise of gardening not only taught basic science and refined our palates, but imparted lessons in self-sufficiency, responsibility, stewardship, familial cooperation, gave us spells of serenity, a place of respite and imagination, and the opportunity for generosity. Non-quantifiable.

We managed to grow enough to eat well during the summer and have some to spare for the winter. It would have been tough (impossible) to survive on it alone. And, we made frequent trips to the grocery store for everything else: to buy food that was produced everywhere else. We tended to skip over the produce section between June and September and never bought a tomato.

So, yes to the economics of global food production and subsidy-free agriculture. And yes to the non-quantifiable benefits of working the land no matter how modest the effort.

 

 

 

 

Proposed changes to Illinois’ pension benefits

Illinois Governor Pat Quinn proposed several changes to the state’s pension plan last week designed to shore up the state’s fund that has one of the nation’s largest unfunded liabilities. The Chicago Tribune summarizes the potential changes:

Illinois’ unfunded pension liability has grown to a huge $83 billion after the state skimped on funding for years. In fiscal 2013, which begins July 1, the state’s payment into the pension system will hit $5.2 billion, or 15 percent of general revenue spending – up substantially from 6 percent in 2008, according to the governor’s office.

Quinn, a Democrat, said his plan would leave the system, which covers state, local school, university and community college employees, 100 percent funded by 2042. Without it, he said Illinois will have expected payments totaling nearly $310 billion between 2012 and 2045, when a $32.7 billion unfunded liability would still remain.

“This plan rescues our pension system and allows public employees who have faithfully contributed to the system to continue to receive pension benefits,” he said.

Under the proposal, workers’ pension contributions would increase by 3 percent, while cost-of-living adjustments would be reduced. A retirement age of 67 would also be phased in.

Governor Quinn says that these changes will save state taxpayers between $65 and $85 billion in the next 30 years. The plan would also take steps to try to reduce abuse of the public sector pension system on the part of union employees that the Tribune exposed this fall.

The reforms are designed to bring the Illinois pension fund in line with the practices that the Governmental Accounting Standards Board advocates. While these reforms are marginal improvements toward putting the pension fund on a sustainable trajectory, they do not address the fundamental problem with the GASB standards. Public pensions are guaranteed benefits, so they should be valued at the risk free discount rate and invested in safe assets like US Treasury bonds. The unfunded liability is, in reality, much larger than what GASB standards suggest because they do not require the use of the risk free discount rate.

Furthermore, the reforms would do nothing to ensure that future politicians do not continue the decades of irresponsible practices that have gotten the state’s fund to where it is today. While the plan says that going forward the state will make the required contributions, we know that current legislators cannot tie the hands of future legislators. Future policymakers could easily return to skipping pension fund payments and painting a rosy picture of the funds assets with accounting gimmicks.

As Eileen and Ben point out in their paper “Illinois’s Fiscal Breaking Points,” the state needs larger institutional reforms to achieve fiscal stability and improve its bond rating. These changes could include a constitutional cap on the unfunded liability, or, better, a transition away from defined benefit public pensions to a defined contribution system.

Fiscal Tactics and the Columbia Pike Trolley

The Columbia Pike Trolley does not have a reputation for popularity among some local residents of Arlington County, VA. In a previous post, I noted the concerns voiced on local blogs and community boards that the $261 million trolley is several times more expensive than the alternatives. In addition, it is feared the trolley will not relieve congestion but will interrupt spontaneous economic development. The Green Party calls it, “the urban renewal trolley for the rich.” Part of the economic development plan involves demolishing older apartment buildings, raising rents.

How will officials try to finance the streetcar?  The plan requires the majority of funds come from local sources (seed money is being provided by a federal program). One possibility is they will dodge voter approval by raising revenue bonds instead of general obligation bonds (GO bonds). The reason is that in order to issue GO debt (which is backed by the full faith and credit of the government), the County would need to put the bond issue on the ballot. But they are worried about voters rejecting it. Revenue bonds don’t require voter approval since they are backed by an independent revenue stream; in this case, future revenues from the government’s surcharge on commercial real estate.

Locals may not have their chance to approve or reject the project, however. The Arlington Sun Gazettte reports that according to Virginia law Arlington as a county – not a city – government, “does not have the power to have a referendum on a topic or subject matter, like cities [do].” The decision to move forward or stop the project thus rests with the County Board.

Map of proposed Columbia Pike streetcar system

The plan is an example of what I define as “fiscal evasion.” These are maneuvers governments employ to defer or obscure the full costs of spending by evading rules or constructing loopholes. Not to be confused with venal gimmicks, fiscal evasion is often built into the rules. It is undertaken by, “circumventing statutory or constitutional budget rules, or through the weak design of such rules.”  In other words this approach is perfectly legal. Since revenue bonds don’t need voter approval revenue bonds present the “funding path of least resistance,” from the viewpoint of trolley advocates.

 

 

When Taxpayer Dollars Are Used to Advocate for More…Taxpayer Dollars

Back in 2010, I noted that government spending can beget further spending. I cited research by Russell Sobel and George Crowley which shows that when the federal government transfers money to the states (as the stimulus bill did), the states tend to increase their own future taxes after the federal money goes away. They found that for every $1.00 the feds send to the states, states increase their own future taxes between $0.33 and $0.42.

Image by scottchan

It recently came to my attention, however, that little-noticed aspects of the 2009 Stimulus and the 2010 Affordable Care Act go even further: they fund advocacy on behalf of further state and local government spending.

Here is the story:

The stimulus bill set aside $650 million for the Department of Health and Human Services to spend on “evidence-based clinical and community-based prevention and wellness strategies.” The idea was to encourage state and local governments to adopt policies that get people to stop smoking, to eat better, and to get exercise.

HHS used the money to create a new grant program called Communities Putting Prevention to Work (CPPW). According to the CPPW website, it features “a strong emphasis on policy and environmental change at both the state and local levels.” (emphasis added).

Grants can go to local governments or to non-profits. You can see a list of approved grantee strategies here. Many of the strategies seem to be regulatory in scope (e.g. media and advertising bans for cigarettes, bans on branded promotional items, etc.). A number are also focused on getting state and local governments to spend more money. For example, they suggest efforts to get money for “hard-hitting counter-advertising” against tobacco. Or for “safe, attractive accessible places for activity” such as “recreation facilities, [and] enhance[d] bicycling and walking infrastructure.” They also call for “Reduced price[s] for park/facility use” (which, of course, means increased taxpayer support).

Interestingly, the Affordable Care Act doubled down on these activities. “Phase Two Funding” for CPPW was buried in the ACA.

It seems more than a little unseemly to have federal taxpayers bankroll an advocacy campaign like this. How would progressives feel if federal tax dollars were spent on a campaign to get state governments to cut taxes and regulations? Or how about a taxpayer-financed campaign to promote awareness of the Economic Freedom of the World index or the Freedom in the 50 States Index? Studies suggest, by the way, that economic freedom is associated with improved health outcomes (see Exhibit 1.16 of the EFW on p. 24). So maybe such a campaign would qualify for a grant under the program?

Health Care and the Dynamics of Intervention

At the heart of the government’s defense of its health insurance mandate is the premise that, as Wall Street Journal reporter Jess Bravin puts it, “40 million uninsured Americans are distorting the health-care market by shifting costs of free emergency-room care to taxpayers and insurance ratepayers.”

In other words, the government believes that there is an externality problem with health insurance. If healthy people aren’t compelled by law to buy insurance, then they will drop out of the insurance pool. This will mean that the average health level of those who remain in the pool will decline. This, in turn, will raise the cost of insurance for all remaining members of the pool.

Of course, insurance companies have a way of dealing with this by attempting to charge people for the (statistical) cost that they impose on the pool. They can do this by charging higher rates for riskier people such as those who are overweight or those who are smokers (this, by the way, is why kids with bad grades pay higher rates for their auto insurance). But the government doesn’t like this solution because it means that some people who are higher risk through no fault of their own (for example, those with unlucky genetics), may end up paying higher rates. So the Patient Protection and Affordable Care Act made it more difficult for insurance companies to charge higher rates to higher risk customers (this is known as “community rating”). They also made it impossible for these companies to deny care to those with preexisting conditions.

According to the Journal, plaintiff’s attorney Michael Carvin doesn’t buy this reasoning. In yesterday’s oral argument he averred:

The failure to buy health insurance doesn’t affect anyone. Defaulting on your payments to your healthcare provider does. Congress chose for whatever reason not to regulate the harmful activity of defaulting on your health-care provider.

In other words, he agrees that there is an externality problem but it is entirely of the government’s making; it isn’t in any way inherent to the industry. There would be no externality if those who defaulted on their health care providers could be held liable.

Image by Duncan Lock

This is an example of what economists call the “dynamics of intervention.” Sanford Ikeda explores the concept in his 1997 book on the topic and credits Ludwig von Mises for its initial development. The basic idea is that one intervention often begets further interventions. Once government says that doctors can’t sue patients for defaulting on their bills and once government says that insurance companies can’t charge higher prices to riskier clients, then the argument for forcing everyone to buy insurance becomes stronger.

(Economists who aren’t familiar with Mises’s or Ikeda’s arguments will still recognize them as a version of “the theory of the second-best” BTW: read the link; it remains one of my favorite blog posts five years after first reading it).

The dynamics of intervention are strong enough to convince plenty of otherwise free-market advocates to countenance new government intervention in the marketplace. Milton Friedman, for example, famously said that as long as we have a welfare state, it makes sense to regulate the border. And a lot of free market advocates are willing to say that as long as we have Federal Deposit Insurance, the government should be allowed to regulate the risk profile of banks.

When PPACA was passed, self-described libertarian economist Kevin Grier found himself countenancing regulation of fast food, sugar, and even exercise (he also hated himself for thinking that way).

Of course, the other interpretation of the dynamics of intervention is that you shouldn’t start down the path to intervention in the first place because it will inevitably lead to much more intervention than you initially intended. That’s my take on it, at least.

I’ll end this already-long post by noting that Congress might have gone about this a different way and greatly reduced the dynamics of intervention problem. Instead of making it impossible to deny care to those with preexisting conditions, and instead of requiring community rating, and instead of requiring everyone to buy insurance, Congress might have left the insurance market alone and reformed Medicaid. It could have turned Medicaid into a voucher program that would allow qualifying recipients to use their voucher to either purchase insurance, or–in the event that no insurers will pick them up–to purchase health care services on the open market. If they were so inclined, Congress could have made the voucher more generous for those with pre-existing conditions (ideally, people wouldn’t be eligible for more generous benefits if they brought on the pre-existing condition themselves through their own health decisions). These reforms would best be coupled with other market-oriented reforms such as equalizing the tax treatment of employer-provided and individually-purchased insurance, legalizing the cross state purchase of insurance, and reforming medical malpractice laws.

My own view is that the most vulnerable in society would be best served by a robust private and charitable market (consider how well the poor are served by our mostly-private markets for necessities like food and clothing). The next best option would be for the states to develop their own safety nets. But the federal reforms in the preceding paragraph seem to me to be far superior to both the status quo and the mess that is PPACA.