Tag Archives: Mike Munger

The Sharing Economy

Over at the Tech Liberation Front, my colleague Adam Thierer has sketched out a few themes in the debate over the sharing economy. His discussion of leveling the regulatory playing field is particularly important. Here is my favorite part:

Alternative remedies exist: Accidents will always happen, of course. But insurance, contracts, product liability, and other legal remedies exist when things go wrong. The difference is that ex postremedies don’t discourage innovation and competition like ex ante regulation does. By trying to head off every hypothetical worst-case scenario, preemptive regulations actually discourage many best-case scenarios from ever coming about.

Adam asks for comments and additional reading suggestions. In that spirit, here are my own additional talking points on the issue:

  • Reviving dead capital: Something that Dan Rothschild has emphasized in a lot of his writings and that I’ve tried to stress when I can is that the “peer production economy” breathes life into otherwise dead capital. Cars, tools, apartments, planes, kitchens, and even dogs are now creating value for people when they otherwise would just be collecting dust (or fleas). This may help to explain the extraordinary value investors see in firms like Uber.
  • Exposing regulatory failure: Another—though not mutually-exclusive—view is that these new firms are making lots of money not because they are doing anything particularly revolutionary. Instead, they are doing well because they have found a way around traditional regulations which have rendered incumbent services truly abysmal and consumers are rewarding them for this. In this sense, Uber is profitable because it isn’t a cartelized taxi company. This is generally the view that Mike Munger expresses in his EconTalk with Russ Roberts. This is probably more applicable to Uber and Lyft than to AirBnB or 1000Tools.com since the ride-sharing firms compete with an industry that has obviously captured its regulator.
  • Transitional gains trap: The whole experience offers us an opportunity to illustrate one of Gordon Tullock’s most-valuable and least-appreciated points. When regulators contrive some artificial exclusivity, they allow incumbent firms to earn above-normal profits (rents). But often these firms are only able to earn above-normal profits for a time (a transitional period). That’s because eventually, the value of the rent is “capitalized” into whatever assets must be purchased in order to enter the industry. These assets may include taxi medallions, specially-outfitted cabs, well-connected lobbyists, or any other asset that is necessary to gain access to the exclusive club. This is important because it means that many of the current incumbents had to pay large sums of money for their exclusive position and, net of these payments, they really aren’t cleaning up. Just as Adam is right to say that “regulatory asymmetry is real” we should also acknowledge that, in many cases, taxi regulations that started out as privileges are now more like burdens.
  • Value is subjective: No two customers have the same values and interests. I may want the windows down on a hot day and you may want them up. It’s simply absurd to think that regulators could devise an objective quality-control checklist for firms to follow or that they could properly vet cab drivers better than consumers. Yet that is exactly the approach they’ve taken (see here for just how clumsy it’s been in VA). The customer rating systems are really revolutionary because they collapse these subjective, multidimensional quality scales down to one simple 5-point rating that captures a driver’s ability to tailor his or her services to the subjective needs of each customer. Your Uber ride begins with a conversation between you and your driver about what is important to you (music, temperature, windows, speed, route, etc.) and ends with a 1 to 5 rating. It’s as simple as that.
  • True competition is a discovery process: Regulations “lock in” the status quo technology (again, because they attempt to objectively state every possible quality that customers might care about). But this misses the whole point of competition. As Hayek taught us, true competition is about discovering things you never knew (and never knew you didn’t know), such as that customers like being able to order cars from their smartphones.
  • Empowering Diffuse Interests: Traditional public choice models predict that small, concentrated interests such as an incumbent taxi industry willtypically prevail in a political battle with a large, diffuse interest such as taxi customers. This time may be different though. Wherever it goes, the peer-production economy has quickly developed a large and happy base of tech-savvy customers. Since the firms themselves have tended to innovate without asking for permission, this has often meant that a city will have tens of thousands of loyal peer-production customers long before its regulators can say “cease and desist.” So in a number of places, we’ve seen regulators move to shut down the peer production economy, then we’ve seen customers protest en masse and regulators withdraw their proposals.
  • Safety: Uber and Lyft drivers carry no cash. Customers have an electronic record of the ride and their driver. Drivers have an electronic record of the customer. These simple solutions accomplish what reams of taxi regulations never could: they ensure that both the customer and the driver are as safe as possible.
  • Flexibility: Because they don’t work for the companies, Uber and Lyft drivers work when they want to. Most of them seem to report that this is one of the best features of the job.
  • Beware of Uber too!: As Milton Friedman put it, one must be careful to distinguish being “pro-free enterprise” from being “pro-business.” The goal here is not to allow Uber to be profitable but to allow competition which will enhance the customer experience. We have already seen that when given the chance, Uber—like most firms—will take an exclusive privilege when one is offered. We must be very careful that Uber isn’t let inside the regulatory velvet rope only to put it back up behind them.

Why We Need a Tax AND Spending Cut

Republicans are talking a lot about certainty. But even if they had won some sort of a victory where they got the current tax rates written in stone, spending is on such an unsustainable path in terms of entitlements, it really isn’t certain at all.

That is me in the NYT. If I had had more space and more eloquence, I might have said something similar to this:

If you hate taxes, cut spending! …Short-term, uncertain duration “tax cuts” are not tax cuts at all, but deficit-financed spending.

That’s Mike Munger, economist and political scientist from Duke University. There is more here and here

What is the economic logic behind this result? Why is it that a tax cut without a concomitant spending cut might not improve the economy? There are two economic models that predict just such an outcome:

Extreme Case:

In what might be called an “extreme case”, a tax cut without a spending cut has zero effect on the economy. This is an extreme case because it requires a rather generous view of humans: it assumes we are all super-logical forward-looking processing machines (all of us, of course, except for politicians; the model assumes they don’t have a clue). The model works something like this:

Step 1. Government cuts (lump-sum) taxes without cutting spending.

Step 2.  This requires an increase in government borrowing.

Step 3.  Forward-looking taxpayers recognize that deficits are future taxes (Munger uses the helpful acronym DAFT). Because of this, they reduce current consumption in order to save for the taxes.

Step 4.  The reduction in taxpayers’ consumption completely offsets the deficit-financed government consumption. And the increase in taxpayers’ savings completely offsets government’s increase in borrowing.

In the end, switching from taxes today to taxes in the future has no effect on interest rates, national savings, current consumption, exchange rates, future domestic production, or future national income.

Economists will recognize this as the Ricardian Equivalence theorem. Non-economists will likely find this a tad implausible.

But we don’t have to rely on such an extreme model to find that a tax cut without a spending cut might not be much help. Consider another, less-extreme, model:

The Less-Extreme Case:  

Step 1.  Government cuts (lump-sum) taxes without cutting spending.

Step 2.  This requires an increase in government borrowing.

Step 3.  Only some taxpayers recognize the deficits as future taxes. As a result, these taxpayers reduce their consumption and increase their savings. But these actions only partly offset government’s deficit-financed consumption.

Step 4.  Since the public’s increased appetite for savings isn’t enough to fully finance all of the extra government borrowing, government has to get its money from somewhere. It therefore draws on two sources:

  1. Government can borrow more domestically, but has to pay a higher price in the form of a higher interest rate (under the Ricardian model, the public wants to save more, so government doesn’t have to pay a higher price). Higher interest rates make it more difficult for private investors to fund their own projects (private investment is crowded-out), lowering the nation’s capital stock.
  2. Government borrows the money from foreigners. Under this scenario, interest rates may not rise, but future national income falls because of the burden of repaying the increased borrowing from abroad.

Step 5.  Because the nation’s capital stock shrinks, future growth suffers.

Under either scenario, a reduction in lump-sum taxes—unaccompanied by a reduction in spending—fails to jump-start the economy the way politicians hope that it might.

A Big Assumption:

There is one other assumption that I have smuggled into the analysis above. Note that “Step 1” under both scenarios is a reduction in “lump sum” taxes. A lump sum tax is a tax that everyone has to pay, regardless of how much they work or consume. Economists often use it as a benchmark for efficient taxation because if the tax isn’t associated with working or consuming, then it won’t affect peoples’ decisions to work or to consume, and therefore won’t do economic harm.

It is standard for economists to assume lump sum taxation when they are talking about deficits because it makes the analysis cleaner. But, of course, taxes are not lump sum. In the real world, most of government’s revenue is derived from income taxation.

And we know from theory and data that high marginal tax rates reduce the incentive to work, save, and invest, harming economic growth. Moreover, we have reason to believe the effect can be quite large.   

So in evaluating the recently-struck tax deal, we have to weigh the “tax increases harm economic growth” evidence against the “deficits harm economic growth” evidence. In the end, I suspect we are better-off in the short-run without a major tax increase in two weeks. But in the long-run we need to cut BOTH taxes and spending. As Professor Munger puts it, the alternative is “DAFT.”