Tag Archives: FDA

More competition can lead to less inequality

Wealth inequality in the United States and many European countries, especially between the richest and the rest, has been a popular topic since Thomas Piketty’s Capital in the 21st Century was published. Piketty and others argue that tax data shows that wealth inequality has increased in the U.S. since the late 1970s, as seen in the figure below from a paper by Emmanuel Saez—Picketty’s frequent co-author— and Gabriel Zucman.

top-0-1-income-inequ

The figure shows the percentage of all U.S. household wealth that is owned by the top 0.1% of households, which as the note explains consists of about 160,000 families. The percentage fell from 25% in the late 1920s to about 7% in the late 1970s and then began to rise. Many people have used this and similar data to argue for higher marginal taxes on the rich and more income redistribution in order to close the wealth gap between the richest and the rest.

While politicians and pundits continue debating what should be done, if anything, about taxes and redistribution, many economists are trying to understand what factors can affect wealth and thus the wealth distribution over time. An important one that is not talked about enough is competition, specifically Joseph Schumpeter’s idea of creative destruction.

Charles Jones, a professor at Stanford, has discussed the connection between profits and creative destruction and their link with inequality. To help illustrate the connection, Mr. Jones uses the example of an entrepreneur who creates a new phone app. The app’s creator will earn profits over time as the app’s popularity and sales increase. However, her profits will eventually decline due to the process of creative destruction: a newer, better app will hit the market that pulls her customers away from her product, erodes her sales and forces her to adapt or fail. The longer she is able to differentiate her product from others, the longer she will be in business and the more money she will earn. This process is stylized in the figure below.

firm-life-and-profit2

If the app maintains its popularity for the duration of firm life 1, the entrepreneur will earn profits P1. After that the firm is replaced by a new firm that also exists for firm life 1 and earns profit P1. The longer a firm is able to maintain its product’s uniqueness, the more profit it will earn, as shown by firm life 2: In this case the firm earns profit P2. A lack of competition stretches out a firm’s life cycle since the paucity of substitutes makes it costlier for consumers to switch products if the value of the firm’s product declines.

Higher profits can translate into greater inequality as well, especially if we broaden the discussion to include wages and sole-proprietor income. Maintaining market power for a long period of time by restricting entry not only increases corporate profits, it also allows doctors, lawyers, opticians, and a host of other workers who operate under a licensing regime that restricts entry to earn higher wages than they otherwise would. The higher wages obtained due to state restrictions on healthcare provision, restrictions on providing legal services and state-level occupational licensing can exacerbate inequality at the lower levels of the income distribution as well as the higher levels.

Workers and sole proprietors in the U.S. have been using government to restrict entry into occupations since the country was founded. In the past such restrictions were often drawn on racial or ethnic lines. In their Pulitzer Prize-winning history of New York City, Gotham, historians Edwin G. Burrows and Mike Wallace write about New York City cartmen in the 1820s:

American-born carters complained to the city fathers that Irish immigrants, who had been licensed during the war [of 1812] while Anglo-Dutchmen were off soldiering, were undercutting established rates and stealing customers. Mayor Colden limited future alien licensing to dirt carting, a field the Irish quickly dominated. When they continued to challenge the Anglo-Americans in other areas, the Society of Cartmen petitioned the Common Council to reaffirm their “ancient privileges”. The municipal government agreed, rejecting calls for the decontrol of carting, as the business and trade of the city depended on in it, and in 1826 the council banned aliens from carting, pawnbroking, and hackney-coach driving; soon all licensed trades were closed to them.

Modern occupational licensing is the legacy of these earlier, successful efforts to protect profits by limiting entry, often of “undesirables”. Today’s occupational licensing is no longer a response to racial or ethnic prejudices, but it has similar results: It protects the earning power of established providers.

Throughout America’s history the economy has been relatively dynamic, and this dynamism has made it difficult for businesses to earn profits for long periods of time; only 12% of the companies on the Fortune 500 in 1955 were still on the list in 2015. In a properly functioning capitalist economy, newer, poorer firms will regularly supplant older, richer firms and this economic churn tempers inequality.

The same churn occurs among the highest echelon of individuals as well. An increasing number of the Forbes 400 are self-made, often from humble beginnings. In 1984, 99 people on the list inherited their fortune and were not actively growing it. By 2014 only 28 people were in the same position. Meanwhile, the percentage of the Forbes 400 who are largely self-made increased from 43% to 69% over the same period.

But this dynamism may be abating and excessive regulation is likely a factor. For example, the rate of new-bank formation from 1990 – 2010 was about 100 banks per year. Since 2010, the rate has fallen to about three per year. Researchers have attributed some of the decline of small banks to the Dodd-Frank Wall Street Reform Act, which increased compliance costs that disproportionately harm small banks. Fewer banks means less competition and higher prices.

Another recent example of how a lack of competition can increase profits and inequality is EpiPen. The price of EpiPen—a medicine used to treat severe allergic reactions to things like peanuts—has increased dramatically since 2011. This price increase was possible because there are almost no good substitutes for EpiPen, and the lack of substitutes can be attributed to the FDA and other government policies that have insulated EpiPen’s maker, Mylan, from market competition. Meanwhile, the compensation of Mylan’s CEO Heather Bresch increased by 671% from 2007 to 2015. I doubt that Bresch’s compensation would have increased by such a large amount without the profits of EpiPen.

Letting firms and workers compete in the marketplace fosters economic growth and can help dampen inequality. To the extent that wealth inequality is an issue we don’t need more regulation and redistribution to fix it: We need more competition.

Why Mandating Higher Quality is Regressive

Lately, a lot of attention has been given to the fact that millions of Americans are seeing their health insurance plans cancelled as a result of the Patient Protection and Affordable Care Act (aka Obamacare). Some pundits have gone so far as to argue this is a good thing. The cancelled plans, the logic goes, were lower in quality than the plans being offered in the new government health insurance exchanges. Many people will end up paying more for the replacement plans, but since the new plans cover a wider variety of health services, they are better off, right?

Actually, no. Imagine if the same logic were applied to automobiles. I drive a 2003 Toyota Matrix. Would I be better off if my current model was banned and I was forced to buy a brand new Ferrari instead? The President made a similar comparison in a recent press conference when he said:

We made a decision as a society that every car has to have a seat belt or air bags. And so you pass a regulation. And there’s some additional cost, particularly at the start, of increasing the safety and protections, but we make a decision as a society that the costs are outweighed by the benefits of all the lives that are saved. So what we’re saying now is if you’re buying a new car, you got to have a seat belt.

If the President’s comparison were appropriate, people would be able to keep their current plans, and might only have to add a new feature or two when they buy a new plan. Instead, people are being dumped from their current coverage and forced into the government run exchanges where they are being forced to buy all kinds of options they don’t want or need. Some might get a subsidy to help with the purchase, but this is still like forcing everyone to buy a Ferrari when all they really want is their trusty old Honda Accord.

Sure, if I had to buy a new Ferrari, it might have all kinds of amazing features that my current car lacks. But I would also have a lot less money to spend on other things that I value a lot more, like my monthly gym membership, or taking my girlfriend out to a nice restaurant on occasion. If banning low quality goods and services is so good for consumers, why not extend this logic even further? Why not ban row boats and force people to buy yachts instead? Imagine how much better dressed Americans would be if we banned all of the clothes sold at Target and Walmart and only allowed people to purchase Christian Dior or Armani!

The problem with this logic is that quality is what economists call a “normal” good. A normal good is something people demand more of when their income rises. By contrast, an “inferior” good is something we demand more of when our income falls. Think macaroni and cheese dinners or sneakers from Payless, for example.

There’s nothing inherently “inferior” about an inferior good. Rather, people with lower incomes often prefer to trade off quality in exchange for a lower price. This is a perfectly rational decision. Since people demand more quality as income rises, banning lower quality products, like catastrophic only health insurance coverage, is actually banning the products that lower income people prefer. And it’s not just the poor who make tradeoffs between price and quality. (For example, I know for a fact that one of my more senior colleagues at the Mercatus Center buys most of his clothes at Walmart!). When prices rise in response to the mandated improvement in quality, the preferences of the poor are ignored and their options limited. As such, each individual must decide for him or herself what the right balance is between quality and price.

Once this becomes clear, one has to wonder who a lot of regulations are really designed to serve. For example, the FDA recently announced it will be setting standards for the production of pet food. Are regulations like this designed to cater to the preferences of the poor, who probably opt for the 79 cent can of cat food? Or are they more in line with the preferences of people who already buy organic food for their cats, people who might not mind paying a little extra to ensure that their pet food has met the new standards set by the FDA?

Mandating rearview cameras in automobiles is regressive for the same reason. This item was originally found mostly in luxury cars, but, thanks to market innovation, these cameras are rapidly becoming commonplace features in cars, all without government regulation.

One of the benefits of the market system is that when a new product is first introduced, the wealthy often pay a lot for it. Over time, the kinks in the product are worked out, and prices fall as the new technology becomes more affordable. Eventually, low income people can afford the product as well, but each consumer must decide for herself when the price has fallen sufficiently to make the purchase worthwhile.

Banning low quality items may seem like a noble way to protect consumers, but not when that removes lower-priced options for those consumers who have the fewest resources to spare. Rather than forcing consumers to buy luxury items, regulatory agencies should respect consumer preferences, especially the preferences of the poor.

The Precautionary Principle vs. Glow in the Dark Plants

http://www.thecroodsmovie.com

In “The Croods,” a box office hit cartoon showing a family of cavemen, the father issues daily warnings to his family that everything new is bad. He explains to his inquisitive daughter that they have survived for so long in their dangerous world by doing exactly the same thing every day and eschewing innovation. In our times, we would call his approach “the precautionary principle.”

The precautionary principle was on display when environmental activists petitioned a startup fundraiser Kickstarter to shut down the Glowing Plant Project, calling it “a new biotech threat coming from Silicon Valley.”  As its name suggests, the project aims to create plants that will glow in the dark using synthetic biology. And while the idea may sound like a fad, it may have practical applications, e.g. living streetlights that would use their own energy to illuminate our cities.

Under pressure, Kickstarter amended its rules to ban startups from rewarding their donors with genetically modified products. The environmental activists further called on the regulators to subject similar projects to independent risk assessments. So far various agencies claimed that the issue is outside their jurisdiction.

The idea of making organisms glow is not new. A few years ago, FDA certified that there was no evidence that the Glofish, produced using similar technology, “pose any more threat to the environment than their unmodified counterparts.” But this will hardly satisfy the environmental groups who believe synthetic biology poses a major threat to conservation and sustainability of biological diversity.

There is logic to the precautionary principle. Innovation can and often does bring new risks. There were no driving related fatalities before the invention of cars and certainly fewer greenhouse gas emissions. And it would take a lightening strike to get a fatal electric shock before the invention of powerful electricity generators. Cars, electricity, vaccines and many other innovations came with substantial risks. But just imagine how riskier and poorer the world would be if we had used a precautionary principle to stifle innovation in those technologies.

My colleague Adam Thierer writes in his recent law review article:

New technologies help society address problems that are associated with older technologies and practices, but also carry risks of their own. A new drug, for example, might cure an old malady while also having side effects. We accept such risks because they typically pale in comparison with the diseases new medicines help to cure. While every technology, new or old, has some risks associated with it, new technologies almost always make us safer, healthier, and smarter, because through constant experimentation we discover better ways of doing things.

He further notes:

The precautionary principle destroys social and economic dynamism. It stifles experimentation and the resulting opportunities for learning and innovation. While some steps to anticipate or to control unforeseen circumstances and “to plan for the worse” are sensible, going overboard with precaution forecloses opportunities and experiences that offer valuable lessons for individuals and society.

So take it from the Croods – if we didn’t take risks and innovate, we’d still be living in caves.

FDA is Finally Gluten-Free

by OngjulianBrady Dennis reported in the Washington Post that after nine excruciating years FDA finally came up with a “gluten-free” standard. It took so long for the usual reasons, as Dennis explains in his article:

Alessio Fasano, director of the Center for Celiac Research at Massachusetts General Hospital, said the FDA took an “excruciating” amount of time to finalize its gluten-free definition in part because it had to consider a massive amount of research on celiac disease as well as varying opinions from activists who wanted even more stringent standards and industry officials who argued for more lenient requirements. In the end, he said, the agency struck the right balance.

The question that the article failed to ask was whether the FDA standard was even necessary. As Dennis points out, there are several independent private organizations that certify gluten-free products. Thus, not only do markets provide gluten-free certification, they also give consumers a choice on the standard’s stringency. Consumers who are highly sensitive to gluten can pick the labels that impose more stringent standards. Less sensitive consumers could choose products with higher gluten content.

Instead of fighting for nine long years for a single government imposed standard, why not let markets do what they do best – offer consumers better choices at lower prices?

Political espionage and government intervention

“To govern is to choose,” John F. Kennedy famously declared. And when governments intervene in markets, they inevitably choose to favor some business forms over others.

Sometimes this is obvious, as when a local government considers a regulation which conspicuously privileges one type of operator at the expense of another. Sometimes this is less-obvious, as when a licensing regime raises barriers to entry, privileging incumbent firms at the expense of those that might enter the market.

Sometimes the privilege is nearly hidden. Last year, I wrote about laws banning old-fashioned incandescent light bulbs. NPR’s Peter Overby had reported that major light bulb manufacturers actually liked the ban and spent money lobbying to maintain it. Why would a firm possibly want to limit its options? After all, it can make curly-Q light bulbs whether the old kind are legal or not. The answer seems to be that the ban benefited large, established firms because it kept customers from buying the older, cheaper alternative bulbs from rivals who weren’t as good at making the newfangled kind.

The point is that it is nearly impossible to formulate an intervention that treats all firms equally. Even a flat rate tax will fall more heavily on small firms because they lack the compliance resources that the big ones have. It goes without saying that this tendency is even greater when interventions violate generality.

When government policy can make or break a business, you can bet that the business will take an interest in policy. Very large sums of money are at stake when a city council considers a new regulation, when Congress considers requiring customers to buy a certain product, or when the FDA considers approving a new drug. It should come as no surprise, then, that some enterprising folks have set up firms that specialize in reading the tea leaves of government policy. These firms help their clients predict what new rules, regulations, taxes, subsidies, etc. might be coming down the pike. And firms are willing to pay pretty hefty sums for these prognostications, especially when policy is difficult to predict (as, for example, when it turns on the arbitrary beliefs of certain regulators).

Brody Mullins and Susan Pulliam write about just such a firm in a fascinating article in yesterday’s Wall Street Journal.

Naturally, lawmakers take a dim view of this activity. Senator Charles Grassley (R-IA) wants these “political intelligence specialists” to disclose their clients, activities, and fees: “We ought to know who these people are that seek political and economic espionage,” he says.

I have another idea. Rather than regulate the firms that are trying to figure out whom government is going to punish and whom it is going to privilege, why not eliminate discriminatory government policy? Why not limit government intervention in the market? And why not ensure that policy turns on predictable rules rather than arbitrary decisions?

If government cannot privilege some and punish others, then insider information will be worth next to nothing. If government interventions are limited, then firms will not live or die at the whim of politicians and regulators. And if policy is predictable and rational, share prices will reflect policy expectations, and there will be no way to profit from insider information.

If to govern is to choose some business forms over others, then sometimes the best option is not to govern and to let people choose for themselves.