Tag Archives: labor

The cost disease and the privatization of government services

Many US municipalities are facing budget problems (see here, here, and here). The real cost of providing traditional public services like police, fire protection, and education is increasing, often at a rate that exceeds revenue growth. The graph below shows the real per-capita expenditure increase in five US cities from 1951 to 2006. (Data are from the census file IndFin_1967-2012.zip and are adjusted for inflation using the US GDP chained price index.)

real per cap spend

In 1951 none of the cities were spending more than $1,000 per person. In 2006 every city was spending well over that amount, with Buffalo spending almost $5,000 per person. Even Fresno, which had the smallest increase, increased per capita spending from $480 to $1,461 – an increase of 204%. Expenditure growth that exceeds revenue growth leads to budget deficits and can eventually result in cuts in services. Economist William Baumol attributes city spending growth to what is known as the “cost disease”.

In his 1967 paper, Baumol argues that municipalities will face rising costs of providing “public” goods and services over time as the relative productivity of labor declines in the industries controlled by local governments versus those of the private sector. As labor in the private sector becomes more productive over time due to increases in capital, wages will increase. Goods and services traditionally supplied by local governments such as police, fire protection, and education have not experienced similar increases in capital or productivity. K-12 education is a particularly good example of stagnation – a teacher from the 1950s would not confront much of a learning curve if they had to teach in a 21st century classroom. However, in order to attract competent and productive teachers, for example, local governments must increase wages to levels that are competitive with the wages that teachers could earn in the private sector. When this occurs, teacher’s wages increase even though their productivity does not. As a result, cities end up paying more money for the same amount of work. Baumol sums up the effect:

“The bulk of municipal services is, in fact, of this general stamp [non-progressive] and our model tells us clearly what can be expected as a result…inexorably and cumulatively, whether or not there is inflation, administrative mismanagement or malfeasance, municipal budgets will almost certainly continue to mount in the future, just as they have been doing in the past. This is a trend for which no man and no group should be blamed, for there is nothing than can be done to stop it.” (Baumol, 1967 p.423)

But is there really nothing than can be done to cure the cost disease? Baumol himself later acknowledged that innovation may yet occur in the relatively stagnant sectors of the economy such as education:

“…an activity which is, say, relatively stagnant need not stay so forever. It may be replaced by a more progressive substitute, or it may undergo an outburst of innovation previous thought very unlikely.” (Baumol et al. 1985, p.807).

The cure for the cost disease is that the stagnant, increasing-cost sectors need to undergo “an outburst of innovation”. But this raises the question; what has prevented this innovation from occurring thus far?

One thing that Baumol’s story ignores is public choice. Specifically, is the lack of labor-augmenting technology in the public-sector industries a characteristic of the public sector? The primary public sector industries have high rates of unionization and the primary goal of a labor union is to protect its dues-paying members. The chart below provides the union affiliation of workers for several occupations in 2013 and 2014.

union membership chart

In 2014, the protective service occupations and education, training, and library occupations, e.g. police officers and teachers, had relatively high union membership rates of 35%. Conversely, other high-skilled occupations such as management, computer and mathematical occupations, architecture and engineering occupations, and sales and office occupations had relatively low rates, ranging from 4.2% to 6.5% in 2014. Installation, maintenance, and repair occupations were in the middle at 14.6%, down from 16.1% in 2013.

The bottom part of the table shows the union membership rate of the public sector in general and of each level of government: federal, state, and local. The highest rate of unionization was at the local level, where approximately 42% of workers were members of a union in 2014, up from 41% in 2013. This is about 14 percentage points higher than the federal level and 12 percentage points higher than the state level. The union membership rate of the private sector in 2014 was only 6.6%.

In addition to the apathetic and sometimes hostile view unions have towards technological advancement and competition, union membership is also associated with higher wages, particularly at the local-government level. Economists Maury Gittleman and Brooks Piece of the Bureau of Labor statistics found that local-government workers have compensation costs 10 – 19% larger than similar private sector workers.

The table below shows the median weekly earnings in 2013 and 2014 for workers in the two most heavily unionized occupational categories; education, training, and library occupations and protective service occupations. In both occupation groups there is a substantial difference between the union and non-union weekly earnings. From the taxpayer’s perspective, higher earnings mean higher costs.

union median wage chart

There needs to be an incentive to expend resources in labor-saving technology for it to occur and it is not clear that this incentive exists in the public sector. In the public sector, taxpayers ultimately pay for the services they receive but these services are provided by an agent – the local politician(s) – who is expected to act on the taxpayer’s behalf when it comes to spending tax dollars. But in the public sector the agent/politician is accountable to both his employees and the general taxpayer since both groups vote on his performance. The general taxpayer wants the politician to cut costs and invest in labor-augmenting technology while the public-employee taxpayer wants to keep his job and earn more income. Since the public-employee unions are well organized compared to the general taxpayers it is easier for them to lobby their politicians/bosses in order to get their desired outcome, which ultimately means higher costs for the general taxpayer.

If Baumol’s cost disease is the primary factor responsible for the increasing cost of municipal government then there is not an easy remedy in the current environment. If the policing, firefighting, and education industries are unreceptive to labor-augmenting technology due to their high levels of unionization and near-monopoly status, one potential way to cure municipalities of the cost disease is privatization. In their 1996 paper, The Cost Disease and Government Growth: Qualifications to Baumol, economists J. Ferris and Edwin West state “Privatization could lead to significant changes in the structure of supply that result in “genuine” reductions in real costs” (p. 48).

Schools, police, and fire services are not true public goods and thus economic efficiency does not dictate that they are provided by a government entity. Schools in particular have been successfully built and operated by private funds for thousands of years. While there are fewer modern examples of privately operated police and fire departments, in theory both could be successfully privatized and historically fire departments were, though not always with great success. However, the failures of past private fire departments in places like New York City in the 19th century appear to be largely due to political corruption, an increase in political patronage, poorly designed incentives, and the failure of the rule of law rather than an inherent flaw in privatization. And today, many volunteer fire departments still exist. In 2013 69% of all firefighters were volunteers and 66% of all fire departments were all-volunteer.

The near-monopoly status of government provided education in many places and the actual monopoly of government provided police and fire protection makes these industries less susceptible to innovation. The government providers face little to no competition from private-sector alternatives, they are highly unionized and thus have little incentive to invest in labor-saving technology, and the importance of their output along with the aforementioned lack of competition allows them to pass cost increases on to taxpayers.

Market competition, limited union membership, and the profit-incentive are features of the private sector that are lacking in the public sector. Together these features encourage the use of labor-augmenting technology, which ultimately lowers costs and frees up resources, most notably labor, that can then be used on producing other goods and services. The higher productivity and lower costs that result from investments in productive capital also free up consumer dollars that can then be used to purchase additional goods and services from other industries.

Privatization of basic city services may be a little unnerving to some people, but ultimately it may be the only way to significantly bring down costs without cutting services. There are over 19,000 municipal governments in the US, which means there are over 19,000 groups of citizens that are capable of looking for new and innovative ways to provide the goods and services they rely on. In the private sector entrepreneurs continue to invent new things and find ways to make old things better and cheaper. I believe that if we allow entrepreneurs to apply their creativity to the public sector we will get similar outcomes.

Grants to Puerto Rico haven’t helped much

Greece’s monetary and fiscal issues have overshadowed a similar situation right in America’s own back yard: Puerto Rico. Puerto Rico’s governor recently called the commonwealth’s $72 billion in debt “unpayable” and this has made Puerto Rico’s bondholders more nervous than they already were. Puerto Rico’s bonds were previously downgraded to junk by the credit rating agencies and there is a lot of uncertainty surrounding Puerto Rico’s ability to honor its obligations to both bond holders and its own workers, as the commonwealth’s pension system is drastically underfunded.   A major default would likely impact residents of the mainland U.S., since according to Morningstar most of the debt is owned by U.S. mutual funds, hedge funds, and mainland Americans.

So how did Puerto Rico get into this situation? Like many other places, including Greece and several U.S. cities, the government of Puerto Rico routinely spent more than it collected in revenue and then borrowed to fill the gap as shown in the graph below from Puerto Rico’s Office of Management and Budget. Over a recent 13 year period (2000 – 2012) Puerto Rico ran a deficit each year and accrued $23 billion in debt.

Puerto rico govt spending

Puerto Rico has a lot in common with many struggling cities in the U.S. that followed a similar fiscal path, such as a high unemployment rate of 12.4%, a shrinking labor force, stagnant or declining median household income, population flight, and falling house prices. Only 46.1% of the population 16 and over was in the labor force in 2012 (compared to an average of nearly 64% in the US in 2012) and the population declined by 4.8% from 2010 to 2014. It is difficult to raise enough revenue to fund basic government services when less than half the population is employed and the most able-bodied workers are leaving the country.

Like other U.S. cities and states, Puerto Rico receives intergovernmental grants from the federal government. As I have explained before, these grants reduce the incentives for a local government to get its fiscal house in order and misallocate resources from relatively responsible, growing areas to less responsible, shrinking areas. As an example, since 1975 Puerto Rico has received nearly $2.7 billion in Community Development Block Grants (CDBG). San Juan, the capital of Puerto Rico, has received over $900 million. The graph below shows the total amount of CDBGs awarded to the major cities of Puerto Rico from 1975 – 2014.

Total CDBGs Puerto Rico

As shown in the graph San Juan has received the bulk of the grant dollars. The graph below shows the amount by year for various years between 1980 and 2014 for San Juan and Puerto Rico as a whole plotted on the left vertical axis (bar graphs). On the right vertical axis is the amount of CDBG dollars per capita (line graphs). San Juan is in orange and Puerto Rico is in blue.

CDBGs per capita, yr Puerto Rico

San Juan has consistently received more dollars per capita than the other areas of Puerto Rico. Both total dollars and dollars per capita have been declining since 1980, which is when the CDBG program was near its peak funding level. As part of the 2009 Recovery Act, San Juan received an additional $2.8 million dollars and Puerto Rico as a country received another $5.9 million on top of the $32 million already provided by the program (not shown on the graph).

It’s hard to look at all of this redistribution and not consider whether it did any good. After all, $2.7 billion later Puerto Rico’s economy is struggling and their fiscal situation looks grim. Grant dollars from programs like the CDBG program consistently fail to make a lasting impact on the recipient’s economy. There are structural problems holding Puerto Rico’s economy back, such as the Jones Act, which increases the costs of goods on the island by restricting intra-U.S.-shipping to U.S. ships, and the enforcement of the U.S. minimum wage, which is a significant cost to employers in a place where the median wage is much lower than on the mainland. Intergovernmental grants and transfers do nothing to solve these underlying structural problems. But despite this reality, millions of dollars are spent every year with no lasting benefit.

Local land-use restrictions harm everyone

In a recent NBER working paper, authors Enrico Moretti and Chang-Tai Hsieh analyze how the growth of cities determines the growth of nations. They use data on 220 MSAs from 1964 – 2009 to estimate the contribution of each city to US national GDP growth. They compare what they call the accounting estimate to the model-driven estimate. The accounting estimate is the simple way of attributing city nominal GDP growth to national GDP growth in that it doesn’t account for whether the increase in city GDP is due to higher nominal wages or increased output caused by an increase in local employment. The model-driven estimate that they compare it to distinguishes between these two factors.

Before I go any further it is important to explain the theory behind the author’s empirical findings. Suppose there is a productivity shock to City A such that workers in City A are more productive than they were previously. This productivity shock could be the result of a new method of production or a newly invented piece of equipment (capital) that helps workers make more stuff with a given amount of labor. This productivity shock will increase the local demand for labor which will increase the wage.

Now one of two things can happen and the diagram below depicts the two scenarios. The supply and demand lines are those for workers, with the wage on the Y-axis and the amount of workers on the X-axis. Since more workers lead to more output I also labeled labor as L = αY, where α is some fraction less than 1 to signify that each additional unit of labor doesn’t lead to a one unit increase in output, but rather some fraction of 1 unit (capital is needed too).

moretti, land use pic

City A can have a highly elastic supply of housing, meaning that it is easy to expand the number of housing units in that city and thus it is relatively easy for people to move there. This would mean that the supply of labor is like S-elastic in the diagram. Thus the number of workers that are able to migrate to City A after labor demand increases (D1 to D2) is large, local employment increases (Le > L*), and total output (GDP) increases. Wages only increase a little bit (We > W*). In this situation the productivity shock would have a relatively large effect on national GDP since it resulted in a large increase in local output as workers moved from relatively low-productivity cities to the relatively high-productivity City A.

Alternatively, the supply of housing in City A could be very inelastic; this would be like S-inelastic. If that is the case, then the productivity shock would still increase the wage in City A (Wi > W*), but it will be more difficult for new workers to move in since new housing cannot be built to shelter them. In this case wages increase but since total local employment stays fairly constant due to the restriction on available housing the increase in output is not as large (Li > L* but < Le). If City A output stays relatively constant and instead the productivity shock is expressed in higher nominal wages, then the resulting growth in City A nominal GDP will not have as large of an effect on national output growth.

As an example, Moretti and Hsieh calculate that the growth of New York City’s GDP was 12% of national GDP growth from 1964-2009. But when accounting for the change in wages, New York’s contribution to national output growth was only 5%: Most of New York’s GDP growth was manifested in higher nominal wages. This is not surprising as it is well known that New York has strict housing regulations that make it difficult to build new housing units (the recent extension of NYC rent-control laws won’t help). This makes it difficult for people to relocate from relatively low-productivity places to a high-productivity New York.

In three of the most intensely land-regulated cities: New York, San Francisco, and San Jose, the accounting contribution to national GDP growth was 19.3%. But these cities actual contribution to national output as estimated by the authors was only 6.1%. Contrast that with the Rust Belt cities (e.g. Detroit, Pittsburgh, Cleveland, etc.) which contributed -28.5% according to the accounting method but +6.1% according to the author’s model.

The authors conclude that less onerous land-use restrictions in high-productivity cities New York, Washington D.C., Boston, San Francisco, San Jose, and the rest of Silicon Valley could increase the nation’s output growth rate by making it easier for workers to migrate from low to high-productivity areas. In an extreme migration scenario where 52% of American workers in 2009 lived in a different city than they actually did, the author’s calculate that GDP per worker would have been $8,775 higher in 2009, or $6,345 per person. In a more realistic scenario (only 20% of workers lived in a different city) it would have been $3,055 more per person: That is a substantial increase.

While I agree with the author’s conclusion that less land-use restrictions would result in a more productive allocation of labor and thus more stuff for all of us, the author’s policy prescriptions at the end of the paper leave much to be desired.  They propose that the federal government constrain the ability of municipalities to set land-use restrictions since these restrictions impose negative externalities on the rest of the country if the form of lowering national output growth. They also support the use of government funded high-speed rail to link  low-productivity labor markets to high-productivity labor markets e.g. the current high-speed rail construction project taking place in California could help workers get form low productivity areas like Stockton, Fresno, and Modesto, to high productivity areas in Silicon Valley.

Land-use restrictions are a problem in many areas, but not a problem that warrants arbitrary federal involvement. If federal involvement simply meant the Supreme Court ruling that land-use regulations (or at least most of them) are unconstitutional then I think that would be beneficial; a broad removal of land-use restrictions would go a long way towards reinstituting the institution of private property. Unfortunately, I don’t think that is what Moretti and Hsieh had in mind.

Arbitrary federal involvement in striking down local land-use regulations would further infringe on federalism and create opportunities for political cronyism. Whatever federal bureaucracy was put in charge of monitoring land-use restrictions would have little local knowledge of the situation. The Environmental Protection Agency (EPA) already monitors some local land use and faulty information along with an expensive appeals process creates problems for residents simply trying to use their own property. Creating a whole federal bureaucracy tasked with picking and choosing which land-use restrictions are acceptable and which aren’t would no doubt lead to more of these types of situations as well as increase the opportunities for regulatory activism. Also, federal land-use regulators may target certain areas that have governors or mayors who don’t agree with them on other issues.

As for more public transportation spending, I think the record speaks for itself – see here, here, and here.

Municipalities in fiscal distress: state-based laws and remedies

The Great Recession of 2008 “stress tested” many policies and institutions including the effectiveness of laws meant to handle municipal fiscal crises. In new Mercatus research professor Eric Scorsone of Michigan State University assess the range and type of legal remedies offered by states to help local governments in financial trouble.

“Municipal Fiscal Emergency Laws: Background and Guide to State-Based Approaches,” begins with some brief context. Most municipal fiscal laws trace their lineage through the 1975 New York City fiscal crisis, the Great Depression and the 19th century railroad bankruptcies. Writing in 1935, attorney Edward Dimock articulated three pieces to addressing municipal insolvency:  1) oversight of the municipality’s financial management 2) stop individual creditors from undermining the distressed entity and 3) put together a plan of adjustment for meeting the creditor’s needs.

These general parameters are at work in state laws today. The details vary. Some states are passive and others much more “hands-on” in dealing with local financial troubles. Scorsone documents these approach with a focus on the “triggers” states use to identify a crisis, the remedies permitted (e.g. can a municipality amend a collective bargaining agreement?), and the exit strategies offered. Maine has the most “Spartan” of fiscal triggers. A Maine municipality that fails to redistribute state taxes, or misses a bond payment triggers the state government’s attention. Michigan also has very strong municipal distress laws which create, “almost a form of quasi-bankruptcy” allowing the state emergency manager to break existing contracts. Texas and Tennessee, by contrast, are relatively hands-off.

How well these laws work is a live issue in many places, including Pennsylvania. In 1987 the state passed Act 47 to identify distressed municipalities. While Act 47 appears to have diagnosed dozens of faltering local governments, the law has proven ineffective in helping municipalities right course. Many cities have remained on the distressed list for 20 years. Recent legislation proposes to allow a municipality that can’t “exit Act 47” the option of disincorporating. Is there a middle ground? As the PA State Association of Town Supervisors put it, “If we can’t address the labor issues, if we can’t address the mandates, if we can’t address the tax exempt properties, we go nowhere.”

Municipalities end up in distress for a complex set of reasons: self-inflicted policy and governance failures, uncontrollable social and economic shifts, and external shocks. Unwinding the effects of decades of interlocking problems isn’t a neat and easy undertaking. The purpose of the paper isn’t to evaluate the effectiveness various approaches to helping municipalities out of distress, it is instead a much-needed guide to help navigate and compare the states’ legal frameworks in which municipal leaders make decisions.

 

 

 

The first lesson in economics is a lesson in English

Professor Newton: Okay class. Today we are going to talk about my 3rd law. Imagine I am standing on a small, unmoored boat. I am about to step off on to a dock. What advice do you have for me?  

Susie: Be careful. Every action has an equal and opposite reaction. As you step off of the boat, you might push it out from under you and end up in the water.

Professor Newton: Bravo. Any other thoughts or questions? [Pointing to Bobby] Yes, Bobby? 

Bobby: It’s clear that Susie doesn’t like you because she wants you to be marooned on the boat.

Professor Newton: How did you get into this school anyway, Bobby?   

Bobby’s error is elementary. He has misunderstood Susie to be making a statement about what she wants to see happen–what economists call a “normative” statement. In fact, Susie intends her comment as a “positive” statement about what she thinks will happen. 

His mistake is uncharitable and illogical. 

Regarding charity: There is no need to impugn Susie’s intentions. Until there is evidence to the contrary, he owes her the respect of assuming her intentions are good.

Regarding logic: His statement is a non-sequitur. There would have been nothing illogical if he had questioned the validity of her analysis; perhaps the boat bottom is resting in the mud below, creating enough friction to make her concern unfounded. But in questioning Susie’s motives rather than the soundness of her analysis, Bobby robs himself of the chance to gain better understanding of the world. And he makes himself a fool. 

Though it might have been a common reaction in Galileo’s time, Bobby’s error is unusual today. When it comes to the physical world, people rarely mistake positive statements for normative statements.

Unfortunately, when it comes to the social world, Bobby’s mistake is incredibly common. I’m amazed at how many college educated people make it. I’m amazed at how many nationally syndicated columnists make it.

Though it is really more of an English lesson, I’ve come to believe that the first lesson every economics student needs to learn is the difference between a normative and a positive statement.

Consider this exchange, which seems to play out every day on some editorial page or on some talking-head show:

Ms. A: A minimum wage raises the price of labor. Since most demand curves slope downward, theory predicts that if the minimum wage is set above the market equilibrium wage, a smaller quantity of labor will be demanded than supplied. In other words, a minimum wage may exacerbate unemployment, harming the very people it was intended to help. Those especially likely to be harmed are those with few skills such as the young and uneducated.    

Ms. B: Ms. A doesn’t really care about poor people. She just cares about the wealthy and that’s why she opposes a minimum wage.

Note that it would be completely legitimate for B to challenge A’s positive analysis. Maybe there are good reasons to believe that her theory fails to capture the complexity of the issue. Or maybe B believes the evidence is just too mixed to make any definitive conclusions. These are legitimate responses.

But to impugn A’s intentions is both uncharitable and illogical. Nothing of what A said suggests she wants anything but the best for low-income earners. B is robbing herself of the opportunity to gain a better understanding of the world. And she makes herself a fool.

The mistake is not unique to any particular ideology or worldview. Consider this exchange, some version of which I’ve heard many times over the past 13 years:

Mr. Dove: U.S. foreign policy–including the support of regimes that are unpopular with their own people–angered antagonists and made the U.S. more susceptible to attack on 9/11. 

Ms. Hawk: Dove thinks that America got what it deserved on that horrible September day.

Note that it would be completely legitimate for Hawk to challenge Dove on either his theory or his facts. But to impart normative meaning to what is essentially a positive statement is uncharitable and illogical. Assume for the moment that Dove’s assessment is correct (though, of course, it would be difficult to ‘test’ it). This does not change the fact that attacking innocent civilians is normatively reprehensible and nothing in Dove’s statement suggests he believes otherwise.

But because Hawk jumps to impugn Dove’s normative beliefs, he deprives himself of the opportunity to gain a better understanding of the world. And in so doing he makes himself a fool.    

Science is all about positive claims. But it’s also about normative claims; the only reason to study unemployment or terrorism is because–as human beings–we have strong normative beliefs about the desirability of these things.

The next time you hear a positive claim–especially an unsettling one that challenges your belief system–think twice before you assume the claim says anything about what its speaker believes normatively. You don’t want want to be uncharitable or foolish.

Embrace Change

Kaiserin_Maria_Theresia_(HRR)Whenever someone suggested a new innovation or an improvement, Empress Maria Theresa had a favorite response: “Leave everything as it is.” As the sovereign of most of central Europe during the 18th Century, the Habsburg Empress epitomized absolutist rule, claiming that her powers had no limit.

But as her statement demonstrates, she clearly understood that her powers were limited by new and disruptive innovations. Her husband, Holy Roman Emperor Francis I understood this as well. Daron Acemoglu and James Robinson relate that when an English philanthropist suggested some social reforms for the benefit of Austria’s poorest, one of Francis’s assistants replied: “We do not desire at all that the great masses shall become well off and independent….How could we otherwise rule over them?” (A&R, 224).

This is why these Habsburg rulers did everything they could to stand athwart innovation. As Acemoglu and Robinson put it:

In addition to serfdom, which completely blocked the emergence of a labor market and removed the economic incentives or initiative from the mass of the rural population, Habsburg absolutism thrived on monopolies and other restrictions on trade. The urban economy was dominated by guilds, which restricted entry into professions. (A&R, 224).

Francis went so far as to block new technologies. For instance, he banned the adoption of new industrial machinery until 1811. He also refused to permit the building of steam railroads. Acemoglu and Robinson inform us that:

[T]he first railway built in the empire had to use horse-drawn carriages. The line…was built with gradients and corners, which meant that it was impossible subsequently to convert it to steam engines. So it continued with horse power until the 1860s. (A&R, 226).

Unfortunately, history is replete with examples of despots who stood in the way of innovation. In Russia, Nicholas I enacted laws restricting the number of factories and “forbade the opening of any new cotton or woolen spinning mills and iron foundries.” (A&R, 229). And in the Ottoman Empire, sultans banned the use of printing. So stultifying was the effect that “well into the second half of the nineteenth century, book production in the Ottoman Empire was still primarily undertaken by scribes hand-copying existing books.” (A&R, 214).

The centuries and the miles that separate us from these episodes give us some objectivity and allow us to see them for what they are: the naked exercise of government force to obstruct innovation for the benefit of a few entrenched interests. But how different are these episodes, really, from the stories we read in today’s newspapers? Are they all that different from New Jersey’s refusal to allow car companies to sell directly to consumers? Are they any less silly than the anti-Uber laws cooked up by a dozen U.S. cities? We like to think that our own political process is more enlightened but right now, federal, state and city policy makers are working to block the development of promising innovations such as wearable technologies, 3D printing, smart cars, and autonomous vehicles.

book-cover-smallFor a thoughtful and forceful discussion of what might be called the anti-Maria Theresa view, everyone should read Permissionless Innovation by my colleague Adam Thierer. It is a well-researched and well-argued defense of the proposition that our default policy should be “innovation allowed.” You can find Kindle and paperback versions on Amazon. Or you can check out the free PDF version at the Mercatus Center. For a nice overview of his book, see Adam’s post (and video) here. Please read it and send (free) copies to any modern-day Maria Theresas you may know.

Does an income tax make people work less?

Harry Truman famously asked for a one-handed economist since all of his seemed reluctant to decisively answer anything: “on the one hand,” they’d tell him, but “on the other…”

When asked whether an income tax makes people work more or less, the typical economist gives the sort of answer that would have grated on Truman like a bad music critic.

If, however, we change the question slightly and make it more realistic, it’s possible to give a decisive answer to the question. Income taxes do reduce overall labor supply. This is something that economists James Gwartney and Richard Stroup explained in the pages of the American Economic Review some 30 years ago. And last week, the CBO’s much-discussed report on the ACA and labor-force participation illustrated their point nicely.

Continue reading

The minimum wage and slower job growth

In my December post on Willie Lyons I linked to a new article on the minimum wage by Jonathan Meer and Jeremy West, both of Texas A&M.

The paper merits a closer look as it points to a more nuanced minimum wage / unemployment relationship than you typically see in public policy debates. Namely, the authors find that a minimum wage reduces employment growth rather than employment levels.

This insight is inspired by the work of Nobel laureate Peter Diamond who analyzed employment as a searching and matching-type game between employers and employees (Diamond argued that unemployment insurance can make workers more selective in the jobs that they take, improving the “match” between employer and employee). As a number of subsequent authors have emphasized, this means that the transition to a new employment equilibrium can take time. “In this case,” Meer and West write, “the effects of the policy [minimum wage] may be more evident in net job creation.” (7)

The theoretical prediction, however, is ambiguous. On the one hand, a minimum wage reduces employer demand for labor by raising the cost of employment. On the other, it induces greater search effort among potential employees.

To resolve this theoretical ambiguity the authors consult the data. They study the problem by looking at three different datasets that encompass all fifty states, plus DC and cover the years 1975-2012. What did they find? First:

Our findings are consistent across all three data sets, indicating that job growth declines significantly in response to increases in the minimum wage. (2)

To be precise, they find:

a ten percent increase in the minimum wage results in a reduction of approximately one-quarter of the net job growth rate. (19)

To gain a better understanding of whether this happens because a minimum wage retards job creation or because it accelerates job destruction, the authors then look at each of these factors separately and conclude that the minimum wage mostly seems to retard creation of new jobs in expanding firms.

Lastly, they find that “the effect on job growth is concentrated in lower-wage industries and among younger workers.”

Not so incidentally, my colleague Keith Hall (a former Bureau of Labor Statistics commissioner) calculates that the latest seasonally-adjusted unemployment rate among the 18-24 age group is 12.4 percent. This is nearly twice the national average.

Credit Warnings, Debt Financing and Dipping into Cash Reserves

As 2013 comes to an end recent news brings attention to the structural budgetary problems and worsening fiscal picture facing several governments: New Jersey, New York City, Puerto Rico and Maryland.

First there was a warning from Moody’s for the Garden State. On Monday New Jersey’s credit outlook was changed to negative. The ratings agency cited rising public employee benefit costs and insufficient revenues. New Jersey is alongside Illinois for the state with the shortest time horizon until the system is Pay-As-You-Go. On a risk-free basis the gap between pension assets and liabilities is roughly $171 billion according to State Budget Solutions, leaving the system only 33 percent funded. This year the New Jersey contributed $1.7 billion to the system. But previous analysis suggests New Jersey will need to pay out $10 billion annually in a few years representing one-third of the current budget.

New Jersey isn’t alone. The biggest structural threat to government budgets is the unrecognized risk in employee pension plans and the purely unfunded status of health care benefits. Mayor Michael Bloomberg, in his final speech as New York City’s Mayor, pointed to the “labor-electoral complex” which prevents employee benefit reform as the single greatest threat to the city’s financial health. In 12 years the cost of employee benefits has increased 500 percent from $1.5 billion to $8.2 billion. Those costs are certain to grow presenting the next generation with a massive debt that will siphon money away from city services.

Public employee pensions and debt are also crippling Puerto Rico which has dipped into cash reserves to repay a $400 million short-term loan. The Wall Street Journal reports that the government planned to sell bonds, but retreated since the island’s bond values have, “plunged in value,” due to investor fears over economic malaise and the territory’s existing large debt load which stands at $87 billion, or $23,000 per resident.

This should serve as a warning to other states that continue to finance budget growth with debt while understating employee benefit costs. Maryland’s Spending Affordability Committee is recommending a 4 percent budget increase and a hike in the state’s debt limit from $75 million to 1.16 billion in 2014. Early estimates by the legislative fiscal office anticipate structural deficits of $300 million over the next two years – a situation that has plagued Maryland for well over a decade. The fiscal office has advised against increased debt, noting that over the last five years, GO bonds have been, “used as a source of replacement funding for transfers of cash” from dedicated funds projects such as the Chesapeake Bay Restoration Fund.

 

Do Energy Efficiency Regulations Create Jobs?

Earlier this year, the Department of Energy (DOE) finalized a regulation setting energy efficiency standards for microwave ovens. At the time, Heather Zichal, the Deputy Assistant to the President for Energy and Climate Change, had this to say about the regulation:

…in his State of the Union Address this year, the President set a bold new goal: to cut in half the energy wasted in our homes and businesses over the next 20 years. Part of how we will achieve that goal is by making appliances more energy efficient. Not only will that help Americans keep more money in their pockets, it will also curb pollution and spark innovation that creates jobs and ultimately brings better products to the marketplace. That’s why we are proud to announce today that the Department of Energy has finalized new energy efficiency standards for microwaves… (emphasis added)

I’ve written elsewhere about why Americans should be skeptical of the environmental benefits from this regulation, as well as other energy efficiency regulations emanating from the Department of Energy. Putting that aside for a moment, I’d like to focus on the last part of Ms. Zichal’s comment, that energy efficiency regulations will create jobs.

As an example, let’s look at the microwave oven regulation that Ms. Zichal cites in her blog post. According to the Department of Energy’s own employment analysis, the employment effects of this regulation are negligible. Since American consumers import roughly 99% of microwaves purchased, the DOE expects that effects on domestic production jobs will be virtually zero.

In addition, DOE models indirect employment effects on other industries as a result of changes in consumer behavior and investment decisions resulting from the regulation. While these numbers are highly uncertain given the inherent difficulty in predicting these things, the DOE estimated the rule will probably eliminate jobs in the short term, estimating between 551 jobs destroyed and 17 jobs created by 2016. In the long run, employment effects may be positive, with the regulation potentially creating between 153 and 697 jobs by 2020. However, the DOE notes there are limitations inherent in its model when calculating these effects, especially when trying to predict jobs created years in the future. For example, the DOE states:

Because [the agency’s model] does not incorporate price changes, the employment impacts predicted by [the model] would over-estimate the magnitude of actual job impacts over the long run for this rule.

The DOE goes on:

…in long-run equilibrium there is no net effect on total employment since wages adjust to bring the labor market into equilibrium. Nonetheless, even to the extent that markets are slow to adjust, DOE anticipates that net labor market impacts will be negligible over time due to the small magnitude of the short-term effects.

Creating jobs should never be the primary reason for justifying a regulation.  In most cases, jobs created by regulations are compliance jobs, which constitute a cost of regulating, not a benefit. More importantly, these types of predictions about jobs created and destroyed ignore the true employment costs of regulation that occur when individuals lose their jobs because of a rule. These costs include things like lost earnings, loss of health insurance, stress, additional health effects, etc. Despite this, by the DOE’s own estimates job creation does not appear to be a solid justification for this particular energy efficiency standard.