Tag Archives: Douglass North

Farm bill replaces conspicuous subsidies with inconspicuous subsidies

From consumers and taxpayers, the farm bill taketh. But to economics teachers, it continues to giveth.

The latest lesson comes courtesy of Ailsa Chang of NPR:

Also getting criticism is the newly-reformed crop insurance program. Now the idea was to protect farmers during bad seasons. The new bill expands that program with money saved from ending a system of direct cash payments to farmers. These are payments farmers would get regardless of their actual profits or even if they planted any crops. The payments amounted to about $5 billion a year. Democrat Debbie Stabenow who chairs the Sen. Agriculture Committee says now farmers will have to first incur losses before they get paid.

“With crop insurance, farmers don’t get a check. They get a bill. They may pay tens of thousands of dollars in premiums and never get a check in a year.”

But critics say farmers are just getting subsidized in a different way.

Ms. Chang is absolutely right to call crop insurance a subsidy in disguise.

Think of it this way:

Imagine that you make donuts and that in order for you to make donuts, you need to buy sprinkles. Now imagine that the government tells you that they will pick up 60 percent of your sprinkle bill. Yes, you still get a bill for sprinkles, but it is a much smaller bill than you would otherwise get. A normal person would call that a subsidy. Similarly, it only seems reasonable to say that when the government picks up 62 percent of a farmer’s insurance premium bill, it offers him (and his insurer!) a generous subsidy.

In many respects, however, crop insurance premium subsidies are worse than donut sprinkle subsidies because they encourage risk; they incentivize farmers to plant crops in flood or drought-prone fields. This is a lesson in moral hazard.

It’s also a lesson in political economy. Why are farm bill authors phasing out direct payments in favor of insurance subsidies and other complicated schemes like the “shallow loss” subsidy program that Professor Vincent Smith writes about? The answer is that direct payments are too conspicuous.

Nobel Prize winning economist Douglass North explained the logic in this piece from 1990:

[T]ransfer payments aside, unabashed redistribution is rare precisely because of its transparency. Farm price support bills in the US policy that simply paid the farmer not to produce never succeeded for just the reason that they were too transparent. And most legislation is not of this type. In most legislation redistribution is either concealed or a by-product of other objectives. In either case, not even the bill’s author may know all the consequences; much less the constituents.

 

What is Economic Freedom and What Can it Say About Prosperity?

My post in the NYT’s Room for Debate blog elicited a good number of comments and questions. So today I thought I might elaborate on the most-important of these questions: What exactly is economic freedom and what do we know about the way it affects prosperity?

First, its impact. The economists Chris Doucouliagos and Mehmet Ali Ulubqasoglu recently reviewed 45 studies examining the freedom-growth relationship. They concluded:

[R]egardless of the sample of countries, the measure of economic freedom and the level of aggregation, there is a solid finding of a direct positive association between economic freedom and economic growth.

Studies also find that economic freedom tends to be associated with a whole host of other factors that humans tend to value such as:

  • Higher income levels: Faria and Montesinos (2009) Dawson (1998), De Haan and Siermann (1998), De Haan and Sturm (2000), Cole (2003), Gwartney et al. (2004) and Weede (2006);
  • Lower poverty levels: Norton (2003);
  • Less volatility in the business cycle: Dawson (2010);
  • Better environmental outcomes: Norton (1998), ch. 2);

even:

  • Fewer homicides: Stringham and Levendis (2010); and 
  • Greater levels of reported happiness: Ovaska and Takashima (2006)

But what is economic freedom?

The concept is quite old, dating back to well-before Adam Smith. For his part, he called it “a system of natural liberty” and gave us a view of what he meant by it when he wrote:

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.

This, however, is still pretty vague.

So in the last quarter-century, a number of economists have focused on defining and—importantly—measuring economic freedom. There are now a number indices of economic freedom at both the national and sub-national levels. Among academics, the most-widely cited of these is the Economic Freedom of the World index, the latest of which is authored by Professors James Gwartney, Joshua Hall, and Robert Lawson. This index grew out of a series of conferences initiated by (Nobel Laureate) Milton Friedman and the Fraser Institute’s Michael Walker in the mid-1980s to early 1990s. Other attendees included economic luminaries such as “Lord Peter Bauer, Gary Becker, Douglass North, Armen Alchian, Arnold Harberger, Alvin Rabushka, Walter Block, Gordon Tullock, and Sir Alan Walters” (a number of whom have either won Nobel prizes in own their right or are likely to in the years that come). Out of these conferences, a consensus began to emerge that the four cornerstones of economic freedom were:

  • Personal choice,
  • Voluntary exchange coordinated by markets,
  • Freedom to enter and compete in markets, and
  • Protection of persons and their property from aggression by others.

From these conceptual cornerstones, the authors of the index began to gather data with an eye toward objectively measuring the degree to which the laws of different nations permit (or don’t) the exercise of economic freedom. Their index includes factors such as government consumption spending as a share of total consumption, top marginal income tax rates, the degree of judicial independence, growth in the money supply, taxes on international trade, and regulation of private sector credit (among 17 other components). The index now covers more than 140 countries, with data on many going back to 1970. And now there are literally hundreds of peer-reviewed articles that are based on this index or one of many others like it.

Since the publication of this index, a number of others have gotten in on the game. There are now indices that measure freedom at the sub-national level, the most-recent of which is Sorens and Ruger’s Freedom in the 50 States, published by Mercatus (the next addition of which is coming out soon). 

As I have recently noted, these state level indices suggest that economic freedom is a powerful predictor of prosperity.

So that, in a nutshell, is economic freedom.