Tag Archives: energy

Should Regulation Prohibit Self-Penalizing Behavior?

Last weekend, a guy ordered the “Sourtoe Cocktail” at a hotel bar in Dawson City in the Yukon.  The drink is garnished with a real (preserved) human toe. The patron downed the drink, deliberately swallowed the toe, then paid the bar a $500 fine for swallowing the toe.

sour toe

Photo credit: Philippe Morin/CBC

This is the kind of anecdote that would prompt health and safety advocates in that less-civilized country south of the border (the United States) to call for a new regulation — probably one prohibiting the use of human body parts in cocktails. In my humble opinion, the story is a good example of why it’s a waste of government’s time to regulate against behavior that carries its own penalty.

In fact, there’s a double penalty in this case. First is the yuk factor.  I wouldn’t order a drink with a toe in it, much less swallow the garish garnish.  Second is the monetary fine imposed by the bar. And the bar subsequently raised the fine to $2500, since now the establishment has to pull a backup toe out of mothballs. (Presumably that’s the one on the plate of salt in the photo.)

That double-whammy already ensures that swallowing a toe in one’s drink will be a rare occurrence. Yet there is still some risk that it will happen again; a precautionary approach would suggest that a new regulation is indeed needed unless the drink can be proven absolutely safe.

The tale of the Sourtoe Cocktail is a fanciful (but real) example of self-penalizing behavior that is (apparently) not yet prohibited by the Canadian government. The U.S. government, however, has seen fit to enact regulations prohibiting much more mundane behavior that carries its own penalty.

For example, consider energy efficiency standards for appliances used by consumers and businesses. These standards effectively ban the sale of appliances that cost more to operate because they use more electricity or gas. Energy efficiency can have environmental benefits, but in many cases, most of the benefits the government claims for energy efficiency standards come in the form of lower energy bills for the users. In other words, the decision to buy a less-efficient washing machine, furnace, or refrigerator carries its own penalty in the form of higher energy costs.

The Department of Energy’s proferred justification for these regulations is that consumers harm themselves by placing too low a value on the future energy savings. That’s a debatable point that Ted Gayer and Kip Viscusi have amply dealt with in a recent study supported by the Mercatus Cetner and published in the Journal of Regulatory Economics. My colleague Sherzod Abdukadirov listed a bunch of regulations that employ similar logic in his recent post.

Even more questionable is the regulation regarding commercial washing machines that I reviewed for the Mercatus Regulatory Report Card. The Notice of Proposed Rulemaking for this regulation seriously argued that greedy, profit-oriented businesses would leave money on the table by refusing to invest in cost-saving, energy-efficient washing machines that would generate a high rate of return due to the energy savings!

With all the ways people find to harm each other, do we really need regulators to police behavior that carries its own penalty?

A government that hands out privileges can expect corruption

According to the Washington Post, the mafia is heavily involved in Italy’s renewable energy market. This is not particularly surprising given that firms in that market compete on a manifestly uneven playing field.

The Godfather Movie in TextIn a market characterized by a genuinely level playing field—one in which no firm or industry benefits from government-granted privilege—the only way to profit is to offer something of value to customers. If you fail to create value for voluntarily paying customers, they won’t volunteer their money. It’s that simple.

But things are different when the playing field can be tilted through government-granted privileges. This is because when the playing field can be tilted, firms have an incentive to find some way to persuade the government to tilt it their way. And the most persuasive techniques aren’t always above board.

The problem is that objective standards for playing favorites are hard to come by. This can corrupt even well-intentioned programs that privilege particular behavior in the name of serving the general good.

Imagine you are a politician and you want to reward firms that specialize in renewable energy. How do you determine who makes the cut? What if you want to reward companies that securitize mortgages for low-income households. How do you decide whom to reward? Or say you want to bailout “systemically important” banks. Where do you draw the line between systemically important and systemically unimportant?

Without objective guideposts, subjective factors loom large: whom do you interact with the most? Whom have you known the longest? Which firms share your ideological perspective? Which are headquartered in your hometown?

Even the most well-intentioned of politicians are susceptible to these considerations because all humans are susceptible to these considerations. That’s why a slew of research has found government-granted privileges are often associated with corruption. For example, in an examination of 450 firms in 35 countries, economists Mara Faccio, Ronald Masulis, and John McConnell found that politically connected firms are more likely to be bailed out than non-connected firms. It’s possible that more deserving firms just happen to be politically connected, but this strains credulity. A more plausible explanation is that in the absence of an objective standard for dispensing privileges, politicians reward those they know.

And when that is the case, firms make it their business to get to know politicians. Just ask Angelo Mozilo, the politically ensconced former head of Countrywide Financial. Countrywide supplied the loans that were repackaged by the federally backed Fannie Mae. And since Countrywide’s business model depended on the favor of politicians, Mozilo made sure he was in good standing with his benefactors. Under a program known internally as the “Friends of Angelo” program, Countrywide offered favorable mortgage financing to the likes of Senate Banking Committee Chairman Christopher Dodd and Senate Budget Committee Chairman Kent Conrad.

The conventional route to profit is to please one’s customers. But when firms are able to profit by pleasing politicians, they will do whatever it takes to please politicians. Which brings us back to Italy and renewables. The current investigation (known as operation Eolo after the Greek god of wind) first bore fruit in 2010 when eight people were arrested for bribing officials with cash and luxury cars. Armed with more evidence, officials have now arrested another dozen crime bosses.

It is good, of course, to have police who investigate these matters. But a far simpler, equitable, and efficient solution is to create a truly level playing field for business. When politicians cannot tilt the playing field in favor of particular firms or industries, businesses have nothing to gain from bribery and connections.

Put away the honey jar and you won’t have an ant problem.