Tag Archives: Milton Friedman

Progressives and Libertarians Agree: Cronyism Stinks

Last week, I came across this photo. In my view, it succinctly and accurately sums up our greatest economic and social problem: government-granted privileges to the wealthy and well-connected.


Laura S., Movement To Strengthen Progressive Values

 

Brilliant though the point is, it is not novel. Market-oriented economists from Adam Smith to  Milton Friedman to Luigi Zingales have been making this point for decades (and in some cases, centuries). What is remarkable, however, is that the photo appeared on MoveOn.org’s website. They, in turn, attribute it to the Movement To Strengthen Progressive Values’ Facebook page. A similar sentiment was expressed by the left-of-center Nobel Laureate Joseph Stiglitz at an OWS rally several months ago.

It is heartening that self-described progressives and self-described libertarians can agree on matters so central to our political and economic ailments. My new paper explores these issues in greater depth. Here is the introduction (I plan to blog parts of the paper over the next few weeks):

Despite the ideological miles that separate them, activists in the Tea Party and Occupy Wall Street movements agree on one thing: both condemn the recent bailouts of wealthy and well-connected banks. To the Tea Partiers, these bailouts were an unwarranted federal intrusion into the free market; to the Occupiers, they were a taxpayer-financed gift to the wealthy executives whose malfeasance brought on the financial crisis. To both, the bailouts smacked of cronyism.

In this paper, I show that the financial bailouts of 2008 were but one example in a long list of privileges that governments occasionally bestow upon particular firms or particular industries. At various times and places, these privileges have included (among other things) monopoly status, favorable regulations, subsidies, bailouts, loan guarantees, targeted tax breaks, protection from foreign competition, and noncompetitive contracts. Whatever its guise, government-granted privilege is an extraordinarily destructive force. It misdirects resources, impedes genuine economic progress, breeds corruption, and undermines the legitimacy of both the government and the private sector.

Health Care and the Dynamics of Intervention

At the heart of the government’s defense of its health insurance mandate is the premise that, as Wall Street Journal reporter Jess Bravin puts it, “40 million uninsured Americans are distorting the health-care market by shifting costs of free emergency-room care to taxpayers and insurance ratepayers.”

In other words, the government believes that there is an externality problem with health insurance. If healthy people aren’t compelled by law to buy insurance, then they will drop out of the insurance pool. This will mean that the average health level of those who remain in the pool will decline. This, in turn, will raise the cost of insurance for all remaining members of the pool.

Of course, insurance companies have a way of dealing with this by attempting to charge people for the (statistical) cost that they impose on the pool. They can do this by charging higher rates for riskier people such as those who are overweight or those who are smokers (this, by the way, is why kids with bad grades pay higher rates for their auto insurance). But the government doesn’t like this solution because it means that some people who are higher risk through no fault of their own (for example, those with unlucky genetics), may end up paying higher rates. So the Patient Protection and Affordable Care Act made it more difficult for insurance companies to charge higher rates to higher risk customers (this is known as “community rating”). They also made it impossible for these companies to deny care to those with preexisting conditions.

According to the Journal, plaintiff’s attorney Michael Carvin doesn’t buy this reasoning. In yesterday’s oral argument he averred:

The failure to buy health insurance doesn’t affect anyone. Defaulting on your payments to your healthcare provider does. Congress chose for whatever reason not to regulate the harmful activity of defaulting on your health-care provider.

In other words, he agrees that there is an externality problem but it is entirely of the government’s making; it isn’t in any way inherent to the industry. There would be no externality if those who defaulted on their health care providers could be held liable.

Image by Duncan Lock

This is an example of what economists call the “dynamics of intervention.” Sanford Ikeda explores the concept in his 1997 book on the topic and credits Ludwig von Mises for its initial development. The basic idea is that one intervention often begets further interventions. Once government says that doctors can’t sue patients for defaulting on their bills and once government says that insurance companies can’t charge higher prices to riskier clients, then the argument for forcing everyone to buy insurance becomes stronger.

(Economists who aren’t familiar with Mises’s or Ikeda’s arguments will still recognize them as a version of “the theory of the second-best” BTW: read the link; it remains one of my favorite blog posts five years after first reading it).

The dynamics of intervention are strong enough to convince plenty of otherwise free-market advocates to countenance new government intervention in the marketplace. Milton Friedman, for example, famously said that as long as we have a welfare state, it makes sense to regulate the border. And a lot of free market advocates are willing to say that as long as we have Federal Deposit Insurance, the government should be allowed to regulate the risk profile of banks.

When PPACA was passed, self-described libertarian economist Kevin Grier found himself countenancing regulation of fast food, sugar, and even exercise (he also hated himself for thinking that way).

Of course, the other interpretation of the dynamics of intervention is that you shouldn’t start down the path to intervention in the first place because it will inevitably lead to much more intervention than you initially intended. That’s my take on it, at least.

I’ll end this already-long post by noting that Congress might have gone about this a different way and greatly reduced the dynamics of intervention problem. Instead of making it impossible to deny care to those with preexisting conditions, and instead of requiring community rating, and instead of requiring everyone to buy insurance, Congress might have left the insurance market alone and reformed Medicaid. It could have turned Medicaid into a voucher program that would allow qualifying recipients to use their voucher to either purchase insurance, or–in the event that no insurers will pick them up–to purchase health care services on the open market. If they were so inclined, Congress could have made the voucher more generous for those with pre-existing conditions (ideally, people wouldn’t be eligible for more generous benefits if they brought on the pre-existing condition themselves through their own health decisions). These reforms would best be coupled with other market-oriented reforms such as equalizing the tax treatment of employer-provided and individually-purchased insurance, legalizing the cross state purchase of insurance, and reforming medical malpractice laws.

My own view is that the most vulnerable in society would be best served by a robust private and charitable market (consider how well the poor are served by our mostly-private markets for necessities like food and clothing). The next best option would be for the states to develop their own safety nets. But the federal reforms in the preceding paragraph seem to me to be far superior to both the status quo and the mess that is PPACA.

Do More Revenues Lead to More or Less Spending?

This, I think, is (literally) the trillion dollar question.

As you can see from the animated chart below, ours really is a spending problem in the sense that revenue is set to remain fairly constant while non-interest spending is set to skyrocket.  That, in turn, causes interest payments to skyrocket, adding to the amount we spend and causing the whole thing to go to…you get the drift.

One hopes that at least some of the members of the Super-Committee recognize this. If so, they will draw a hard line in the sand demanding meaningful spending reforms in the entitlement programs that are at the heart of the long-term problem.

But a question remains: should they also draw a hard line in the sand against any and all revenue increases?  I believe this question turns on the one above: do more revenues lead to more spending?

If the answer is yes, then a hard line in the sand against revenue increases may be warranted.  But if the answer is no, then negotiators would be wise to focus all of their energies on reforming entitlement spending and should perhaps be willing to give some ground on revenue if it buys more support for spending cuts.  Interestingly, there are good “free market” economists on both sides of this debate.

Milton Friedman exemplifies the view that more revenue will only encourage more spending (see “The Limitations of Tax Limitation,” 1978; I wasn’t able to find a link).  Those who subscribe to his view may point to Reagan’s 1982 “TEFRA” deal with Democrats.  The president agreed to raise some tax revenue, mostly by closing loopholes, in exchange for spending cuts.  But, say critics, the tax increases materialized while the spending cuts never did.

On the other hand, James Buchanan, another Nobel-laureate with free market bona fides, takes the opposite view.  He argues that the ability to deficit spend biases policy makers to favor more spending.  He believes that if you make policy makers charge current taxpayers for what they spend, the current taxpayers will demand less spending.  Ironically, this leads to the conclusion that revenue increases will lead to less spending.  Advocates of this view might point to the 1990s.  Then, revenues as a share of GDP rose while spending as a share of GDP actually fell for the first time in post-WWII history.

As an empirical matter, I don’t think this is settled.  James Payne (2003) has studied the issue at the state level and has concluded that, at least in a plurality of states, spending does seem to respond to revenue, corroborating the Friedman view.  Thus, he concludes that, “any policy to reduce budget deficits via revenues may not result in deficit reduction.”

On the other hand, Andrew Young has studied the matter at the federal level and concludes:

Perhaps counter-intuitively, the findings suggest that tax increases—even temporary—may serve to decrease expenditures by forcing the public to reckon with the cost of government spending.  The findings suggest that the electorate has to be clearly presented with the bill to recognize the cost of government, rather than being allowed to run up a tab.

It makes some sense that the Friedman view would be corroborated at the state level while the Buchanan view would hold at the federal level.  Most states have an obligation to balance their books (more or less), while the Feds have no obligation whatsoever.  Thus, current state taxpayers tend to be the ones to pay for current state spending while current federal taxpayers can more-easily foist their costs onto the next generation.

If you do subscribe to the Buchanan view, what sort of revenue increases should be on the table?  The answer is almost certainly not rate increases on those who are current taxpayers.  They, presumably, are already resistant to more spending (we also know that these are the most inefficient sorts of tax increases).  Instead, revenue increases ought to be focused on closing loopholes and broadening the tax base (about half of all Americans have no income tax liability).  In a new Mercatus working paper, economists Jody Lipford and Bruce Yandle examine what happens to spending when large numbers of Americans have little or no income tax liability, leaving the rest (and future generations) to pick up the tab.

————–

Update: Josh Barro rightly noted that large numbers of Americans don’t have an income tax liability; they still pay other taxes including payroll taxes.

BP Now Breaking Windows?

The Wall Street Journal reminds us of the musical dénouement from The Life of Brian.

[In the] 1979 comedy from the Monty Python team, the hero ends up whistling the song “Always Look on the Bright Side of Life” despite having his hands nailed on each side of a cross.

It seems British Petroleum took that lesson to heart. Fortunately, the company found the bright side of the oil spill, which sounds a lot like Bastiat’s broken window fallacy. Planet BP, an online internal publication sent “reporters” to the gulf, and interviewed some locals who still love the big sunflower. From the WSJ:

“Much of the region’s [nonfishing boat] businesses — particularly the hotels — have been prospering because so many people have come here from BP and other oil emergency response teams,” another report says. Indeed, one tourist official in a local town makes it clear that “BP has always been a very great partner of ours here…We have always valued the business that BP sent us.”

Milton Friedman called this the most persistent economic fallacy in history. Moving money around isn’t the same as growing the economy. The broken window fallacy lauds simple currency exchanges to replace senseless destruction, instead of focusing on growing the total productivity. It’s like running in place, but believing you’ll win a race.

Seasteading, Tiebout, and Federalism

One of the most interesting things about state and local policy research is that localities are engaged in (admittedly imperfect) competition with one another. The Tiebout hypothesis, proffered by Charles Tiebout in his famous article “A Pure Theory of Local Expenditures,” suggests that in federal systems state and local governments compete with one another: if you don’t like the public services provided by your town or state, you can move to another one that provides a basket of public goods and services (and tax structures) more to your liking. People vote not only with ballots but with their feet.

It raises interesting questions for the future of the Tiebout model that sovereign nations may be forced at some point in the not-too-distant future to compete more for their citizens’ fealty.

The Seasteading Institute has been getting some significant attention recently, with a write-up in Wired magazine and an event next week at the Cato Institute. (The executive director of the Institute, Patri Friedman, will be speaking; Patri is the son of libertarian thinker David Friedman and grandson of Nobel laureate Milton Friedman, thus I suspect making the Friedmans the first family to have three generations speak at Cato.) The Institute proposes, in short, that in the near future it will be possible to create communities on the seas that are not the province of any (currently existing) sovereign country. (More on seasteading from Tim Lee at ArsTechnica.)

This has radical implications for governance and federalism. In our future life aquatic, to what extent will the Tiebout model begin to apply to nation-states? Will seasteading force countries to relax their own immigration standards? Will this increase the quality of national governments as competition increases?

Of course it’s impossible to predict, but it has interesting ramifications for the future of research on federalism and public policy.