Tag Archives: vote

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.

North Carolina Reconsiders its Rejection of Corporate Welfare

A couple of weeks ago, something surprising happened in North Carolina. As the Carolina Journal explained:

RALEIGH — Twenty-eight House Republicans bolted party ranks Tuesday, joining 26 Democrats to defeat an economic incentives program that some labeled “corporate welfare.” It was a rebuke to House Speaker Thom Tillis, R-Mecklenburg, Senate leader Phil Berger, R-Rockingham, and Gov. Pat McCrory, all of whom championed the legislation.

The 47-54 vote against House Bill 1224 signaled that the end of the meandering 2014 “short session” of the General Assembly could be nigh, arriving perhaps as early as today.

The move marked an unusual triumph of economic rationality over special-interest politics. As Brian Balfour explained it in the Civitas Review, the bill combined two unrelated policies: it capped local sales tax rates while expanding the state’s corporate welfare efforts. Now, however, the Washington Post is reporting that the governor is under intense pressure to call a special session so the legislature can reconsider the legislation.

If they do come back into session, legislators would be wise to study up on the issue before they reconsider their votes. A good place to start would be a recent Mercatus working paper by George Mason University Professor Christopher Coyne and GMU Ph.D. candidate Lotta Moberg. The paper explores the effects of targeted economic development incentives, stressing two under-appreciated downsides to the policies:

(1) they lead to a misallocation of resources, and (2) they encourage rent-seeking and thus cronyism. We argue that these costs, which are often longer-term and not readily observable at the time the targeted benefits are granted, may very well outweigh any possible short-term economic benefits.

To gain a better understanding of the effects of these policies, my colleague Olivia Gonzalez and I have begun looking at the empirical literature. While our results are still preliminary, what we have found so far should give Tar Heel legislators pause in re-thinking their decision. We found 26 peer-reviewed papers that assess the effect of targeted incentives on the broader economy (a surprisingly large number of studies only look at whether incentives help the privileged firms and sectors, ignoring how they affect the broader economy).

The pie chart below shows what we’ve found. Just 2 studies, constituting 8 percent of the sample, found that targeted incentives positively affect the economy-at-large. Four studies (15 percent of the sample) found that targeted incentives negatively affect the broader economy. Another 6 studies found that they produce some positive effects (such as higher employment) but also some negative effects (such as lower labor force participation). One study in the sample found a distinct group (manufacturers) benefited while others (finance, insurance, and real estate) lost. Thirteen studies (half the sample), simply found no statistically significant effect of targeted incentives.

Targeted incentives research pie chartOn balance, this is not a strong case for the effectiveness of targeted economic development incentives. It suggests that when states privilege particular firms or industries, they are wasting taxpayer resources, benefiting some at the expense of others, and potentially harming the broader economy. Of course, some pathologies of privilege such as long-term resource misallocation, rent-seeking waste, and corruption may not manifest themselves for years and are not likely to be picked up by these studies.

Delaware Senate votes to bail out three casinos

Delaware’s state senate has voted to redirect $10 billion in economic development funding to bail out three gambling casinos. The measure now goes to the House. Two reasons the casinos are failing: increased competition from Maryland and Pennsylvania and having to share a large chuck of revenue with the state. Lawmakers admit the bailout is only a “Band Aid,” and not enough to salvage the operations.

Supporters defend SB 220 as a jobs protection measure. But the real incentive is more likely the revenues involved. Lottery receipts are the fourth largest source of Delaware’s revenues at about 7 percent of the total bringing in $277 billion in 2013, right behind Income taxes, Franchise taxes, and Abandoned Property.

The casinos are certainly in trouble. According to Delaware Newszap.com Dover Downs Gaming & Entertainment saw a $1 million loss in Q1 2014 and is $46 million in debt. During that same first quarter the casino paid the state $16 million in revenue.

Revenue sharing between the state and the casinos has grown more onerous over the past 20 years. In 1997, the casino claimed 50.2 percent of the revenue and the state took 25.2 percent. In 2009, that split reversed, with the state claiming 43.5 percent of revenues and the casino keeping 37.8 percent.

The incentive for the bailout is fairly clear though the economic thinking is convoluted. Why not reduce the tax rate instead? Economist James Butkiewicz at the University of Delaware notes that as a voluntary tax it’s easy revenue and the state doesn’t have to raise taxes elsewhere.

But do casinos deliver for state coffers and economies?  Economists Douglas Walker (whose field is casino economics) and John Jackson find that while lotteries and horse racing tend to increase state revenues, casinos and greyhound racing tend to decrease it. Using recent data, Walker and Jackson find casinos have a positive economic impact. There are many other things to consider when thinking about the effects of casinos. As state creations there is ample opportunity for corruption and regulatory capture. Walker and Calcagno find just such a link in their paper in the journal Applied Economics (Dec 2013), “Casinos and Political Corruption in the United States: A Granger Causality Analysis.” And as a recent article by the WSJ notes oversaturation of casinos on the East Coast has also triggered an interstate “war” for revenues. Delaware’s gaming revenues are down 29 percent since 2011. A Delaware Casino Executive laments that the business model they are using is simply, “unworkable.”

 

 

 

The unseen costs of the Ex-Im bank

The great 19th Century French economist Frederic Bastiat had good advice when thinking about economics. Actions, habits, and laws, he said,

[produce] not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

The good economist, he said, “takes into account both the effect that can be seen and those effects that must be foreseen.”

So it is with the US Ex-Im bank.

The independent federal agency helps foreign firms finance the purchase of American-made products. They do this by selling insurance to these foreign purchasers, by directly loaning them money, and by guaranteeing loans that others like Goldman Sachs make to these firms.

Ex-Im’s activities produce some seen benefits and these are widely touted by the bank and it’s boosters, such as the National Association of Manufacturers. These seen benefits are:

The gains to foreign purchasers

Since most foreign purchasers are sub-prime borrowers (what could go wrong, right?), the bank’s assistance allows them to obtain credit that private lenders would otherwise be unwilling to extend. At least in the short run, this helps these foreign purchasers.

The gains to U.S. manufacturers

Ex-Im’s loans, loan guarantees and insurance all increase demand for some domestic manufacturers’ products. This allows them to sell more stuff and to sell it at higher prices than they otherwise would. The bank boasts that, on average, “87% of transactions benefit small business exporters of U.S.-made goods and services.” Note the use of the words “transactions” and “small.” The bank is slicing the data here in a way that isn’t entirely honest. More on which below.

But as Bastiat would tell us, these seen benefits are less than half the story. There are also a host of less-conspicuous effects, and all of them are bad. These include:

Excessive risk

Rational lenders are unwilling to finance risky bets unless they are compensated with higher rates of return. These higher interest rates, in turn, make risky borrowers think twice about undertaking bad investments. This is a feature of a well-functioning financial system, not a bug.

Like all goods, capital is scarce and this feature helps ensure it isn’t wasted, steering it to the projects where it can do the most good for people. Ex-Im’s activities, on the other hand, steer capital—at artificially low interest rates—to sub-prime borrowers so they can buy big, expensive products. This is bad for the world economy because it misallocates capital. But in the long run it’s bad for many of the borrowers themselves because it encourages them to take on risks they can ill-afford (which is why I hedged above when I said they gain “in the short run”). Another great French economist, Veronique de Rugy, highlighted this fact in a recent post. As she points out, this isn’t just a hypothetical concern:

In the 1990s, the Ex-Im Bank was so excited to “support” the people of the Republic of Nauru by extending financing assistance to Air Nauru to purchase some, you guessed it, Boeings. When Air Nauru defaulted in 2002, the Ex-Im Bank seized Nauru’s only jet straight off of the runway — leaving the country’s athletes stranded on the tarmac after the Micronesian Games.

Higher prices for manufactured products

Next consider the unseen effect on domestic purchasers. Like Air Nauru, domestic airlines such as Delta, United, Southwest, and dozens of others also buy Boeing aircraft. Unlike Air Nauru, these firms don’t receive loan subsidies. This hurts all of them once, and some of them twice.

First, the international carriers among this group like Delta lose market share to Ex-Im-privileged firms like Korean Air and Emirates Air. This explains why Delta has filed a lawsuit against Ex-Im.

Second, all US carriers—even those like Southwest that only serve the US market—end up paying higher prices for planes because Ex-Im privileges increase the demand for, and therefore the price of, airplanes. As Vero notes in this piece, this has many air carriers worried about a jet plane bubble. Simple economics, of course, predicts that some of this cost will be passed on to consumers in the form of higher ticket prices.

Privileges for banks

Presumably, many of the legislators who routinely vote to reauthorize Ex-Im do so because they want to subsidize domestic manufacturers. Unfortunately, the laws of economics dictate that the actual beneficiaries of a subsidy need not be the intended beneficiaries.

In the case of Ex-Im, a large chunk of the benefit is captured by privileged banks instead of by manufacturers. Thanks to Ex-Im’s loan guarantees, banks are able to make loans to foreign buyers while unloading most of the risk. This is yet one more way in which banks, “privatize gains and socialize losses” (to borrow a phrase used by Nobelist Joseph Stiglitz at an Occupy Wall Street rally).

This privilege sits on top of a pile of other privileges. The IMF recently estimated that in most years the biggest of these privileges—the too big to fail subsidy—is larger than bank profits!

Few gain at the expense of the many

Consider, again, the bank’s assertion that 87 percent of its “transactions” benefit “small business” exporters. Why focus on transactions? Wouldn’t it be more transparent to focus on the size of these transactions? When you break it down this way, as Vero does in this piece, you see that 81 percent of the value of Ex-Im assistance goes to “big businesses” as the bank defines them.

And just how do they define big and small business? Answer: not in the same way others like the Small Business Administration do. Ex-Im’s definition of “small” manufacturers and wholesalers is three times larger (by number of employees) than the SBA’s definition and it includes firms with revenues as high as $21.5 million a year.

A host of pathologies

As I emphasize in the Pathology of Privilege, these favors to a select few domestic manufactures and banks come with a host of problems. In short, privilege “misdirects resources, impedes genuine economic progress, breeds corruption, and undermines the legitimacy of both the government and the private sector.”

But Ex-Im and its beneficiaries don’t want you to see that.

The farm bill: a lesson in government failure

As a consumer and as a taxpayer, the farm bill is a monstrosity. But as someone who teaches public finance and public choice economics, it is a great teaching tool.

Want to explain the concept of dead-weight loss? The farm bill’s insurance subsidies are a perfect illustration of the concept. They transfer resources from taxpayers to farm producers; but taxpayers lose more than producers gain.

Want to illustrate the folly of price controls? Sugar supports which force Americans to pay twice what global consumers pay are a fine illustration.

Want to explain Gordon Tullock’s transitional gains trap? Walk your students through the connection between subsidies and land prices: much of the value of the subsidy is “capitalized” into the price of farmland, meaning that new farmers have to pay exorbitant prices to buy an asset that entitles them to subsidies. This means new farmers are no better off as a result of the subsidies. As David Friedman puts it, “the government can’t even give anything away.” The only ones to gain are those who owned the land when the laws were created. But those who paid for the land with the expectation that it would entitle them to subsidies would howl if politicians tried to do right by consumers and taxpayers and get rid of the privileges.

Want to illustrate Mancur Olson’s theory of interest group formation? Look no further than sugar loans. Taxpayers loan about $1.1 billion to producers every year. Spread among 313 million of us, that is a cost of about $3.50 per taxpayer. And who benefits? Last year just three (!) firms received the bulk of these subsidies, each benefiting to the tune of $200 million. As Olson taught us long ago, the numerous and diffused losers face a significant obstacle in organizing in opposition to this while the small and concentrated winners have every incentive to get organized in support.

Want to show how a “legislative logroll” works? Explain to your students that members representing dairy and peanut interests are statistically significantly likely to vote in the interests of peanut farmers and vice versa.

Want to explain Bruce Yandle’s bootlegger and Baptist theory of regulation? Note that catfish farmers want inspection of “foreign” catfish in the name of safety (the Baptist rationale) when the real reason for supporting additional inspections is self-interested protectionism (the bootlegger motivation).

This week’s lesson is on the power of agenda setters to block even modest reforms. Buried in the dross of privileges to wealthy farmers, both the Senate and the House versions of the bill contained a small glimmer of reform. Both included language capping the amount of subsidies that farmers and their spouses receive at “only” $250,000 per year. Right now, House and Senate conferees are working to reconcile the two versions of the Farm Bill passed this summer. And according to the latest reports, they plan to strip these modest reforms that were agreed to by both chambers.

Unfortunately, kids, this is how modern democracy works.

All votes are thrown away, so vote sincerely

Virginians go to the polls tomorrow to select a new governor. To be more precise: a modest minority of eligible voters—maybe about 35 percent—will go to the polls to select a new governor. The rest will stay at home, work late, or spend time with loved ones.

Seventh grade civics teachers and mothers everywhere wonder why more people don’t exercise their precious right to vote. Public choice economists wonder why anyone does.

Here is how I typically talk about the vote decision in my public choice classes. Perhaps it will help you think through how you’d like to spend your day tomorrow.

Let’s start with a simple model and add complexity as we go.

We are going to be “modeling” an individual’s decision to vote based on the idea that voting brings some satisfaction. We call this satisfaction “utility” and say that people will vote so long as the utility from voting is positive.

Utility from voting = a function of stuff

But what should we put on the right hand side? We know people vote so we know utility from voting is positive. What gives them this satisfaction from voting?

Let’s begin with the assumption that people vote because they want to affect the outcome, to make a difference. They derive some joy from the outcome of the election. Let’s call this joy B for benefit:

Utility from voting = B + other things

B is equal to the difference in benefits the voter obtains when one outcome beats another. B could be the benefit of a government job that the voter expects to have once his brother-in-law becomes mayor. Or it could be the benefit he expects to enjoy once the entire economy improves as a result of a candidate’s policies. It need not be personal benefits. It could also include the joy one might obtain from seeing more redistribution from one group to another. And, of course, it could be all of these. The point is that B captures the expected gain in utility from one outcome prevailing over the alternatives. Note that if you think that there is essentially no difference between the candidates, B will be zero since it represents the difference in benefits obtained from one outcome prevailing over the others.

We can say more. Voting is costly. When you vote, you have to give up time you could have spent working, reading public choice books, or playing with your children. Voting is also risky. You risk being selected for a boring jury pool, you risk getting your finger jammed in the voting machine, and you risk sustaining a life-threatening accident on the way to the polls. To account for these costs, we subtract a term called C:

Utility from voting = B – C + other things

But there is still more. Remember that the B term represents the difference in utility you obtain from seeing your preferred outcome prevail. But what if you expect to see your outcome prevail whether you vote or not (think: those who voted for Reagan in ’84)? Or what if you expect to see your outcome lose whether you vote or not (think: those who voted for Gary Johnson in 2012)? The point is that if you vote in order to make a difference, then your chance of making a difference is important in your decision to vote. So we should include that as part of the gross utility term. If P is the probability that your vote will make a difference then we can write:

Utility from voting = P*B – C

In words: the utility from voting is equal to the chance that one’s vote will make a difference, multiplied by the difference in benefits one expects to obtain from one outcome beating the others, minus whatever costs are incurred in the act of voting. So long as P*B > C, people will vote.

We call this the “instrumental theory of voting” because it describes a voter who uses her vote as an “instrument” to affect the outcome. Unfortunately, there is a problem with it.

It turns out that P is small, vanishingly small. By one estimate, the chance of casting a decisive vote in the 2008 presidential election was 1 in 60 million. Why so low? Your vote only makes a difference when the rest of the electorate is evenly split. In the case of a presidential election, you’d need your state to be the decisive state in the Electoral College and you’d need all the other citizens of your state to be exactly evenly divided. That’s not terribly likely. Of course, you have a greater chance of casting a decisive vote in a smaller election such as a governorship. But even in these cases, the probabilities are extraordinarily small. I estimate that there have been over 2,000 gubernatorial elections in the U.S. Not one has come down to a single vote (the closest was Washington state’s 2004 election which came down to 133 votes but even in this case no single vote could be said to have “made a difference”).

It turns out that the chance of sustaining a life-threatening accident on the way to the polls (an element of C) is actually greater than 1 in 60 million. So this leaves us with two conclusions:

  1. Perhaps B is so great that even when multiplied by a very tiny P, it is still enough to overcome C. In other words, perhaps people are willing to risk life and limb to obtain their preferred outcome in the election. This seems less than plausible.
  2. Perhaps people obtain some benefit from voting that has nothing to do with changing the outcome. In this case, we need to add something to our model, another gross benefits term that is not affected by P. Let’s call this “D”:

Utility from voting = P*B – C + D

Here, D represents some benefit from the act of voting that has nothing to do with changing the outcome. Different authors have suggested different ideas of what D might be. It might be the sense of pride one obtains in fulfilling one’s civic duty. Or it might be the joy one gets from “cheering” on one’s side even if it doesn’t make a difference. Think of fans at a football game. They “vote” by cheering even though they know that their own cheer won’t produce a victory. This is known as the “expressive theory of voting” since it captures the notion that people vote to express opinions, not necessarily to change the outcome.

Expressive Voter

Expressive Voter

 

So what is the implication of all of this? Some say that the implication is that it is irrational to vote. It is costly and has almost no chance of making a difference, which gives voting about the same ROI as a sacrifice to the rain gods.

I disagree.

There’s nothing dumb about someone feeling that they have a civic duty. There’s nothing irrational about cheering on a cause even if you know it won’t make a difference. It is no more irrational to vote than it is to cheer for the Redskins (okay, so maybe it’s a little irrational).

It is irrational, however, for someone to believe that their vote makes a difference. Despite what MTV says, not every vote matters. In fact, the only time any one vote “matters” is when the electorate is perfectly split. And in that case, the only vote that really matters is Anthony Kennedy’s.

Some of you may find this depressing. It means you don’t matter. Worse, it means that you and your fellow voters have little incentive to gather or to process information about the issues, which means we are all destined to be uninformed and irrational when we step into that voting booth.

But there is some good news here: freed from any concerns that your miniscule vote will make a difference, you should feel free to vote your conscience. So if your conscience compels you to vote for a third (or fourth or fifth) party candidate, don’t listen to the nonsense that you are “throwing your vote away.” ALL votes (except for Anthony Kennedy’s) are thrown away. So, if you’d like to express your opinion, to cheer for a cause, then vote sincerely for the candidate that you think is best.

Then go home and spend time with your loved ones.

What would real reform in Virginia look like?

A couple of months ago, I blogged about Virginia Governor Bob McDonnell and the gifts he and his family have received from businessman Jonnie Williams, Jr. The comments were eventually picked up by journalist Katie Watson, first in a column and then in an interview with the local CBS affiliate. Eventually the Richmond Times Dispatch invited me to turn the blog into an OpEd and this last Sunday Bart Hinkle of the Dispatch elaborated on the point in an excellent post. I suspect many readers will agree that Hinkle made the point far more eloquently than I:

Many have wondered why McDonnell, otherwise a paragon of rectitude, would take such swag. But nobody has asked why Williams would give it — because the answer is obvious. Star Scientific has not made a profit in a decade. But it might, if the governor were to place the weight of the state on the economic scales.…Virginia’s governor has a lot of quo to give whether or not he takes a fistful of quid.

Image by hin255

Image by hin255

 

In my view, Virginians need to think as constructively as possible about the sorts of reforms that would prevent scandals like this from happening in the future. Unfortunately, my guess is that the political response will focus—to use Hinkle’s words—on the quid and not on the quo. I believe this would be a huge missed opportunity.

In Virginia, gifts to public officials valued at $50 or more are permitted but must be disclosed, while gifts of any value to family members of public officials are permitted and do not need to be disclosed at all. Just about every article I’ve read on the matter emphasizes this point and I’d guess that a number of legislators are busy drawing up bills to change these laws as I type. For his part, the governor himself has indicated an interest in changing the ethics laws, though he’s offered no specifics.

It’s understandable that this is peoples’ first instinct: If business owners are giving money to elected officials and their family members in return for special treatment from government, it seems only natural that there ought to be a law forbidding such gifts to elected officials and their families. I’m not opposed to such laws per se. But it would be a mistake to think that they are going to solve the problem.

Water flows downhill. And as long as elected officials are expected to dole out lucrative privileges to particular firms, particular firms will want to play in the political sandbox.

Even if Virginia adopted a complete ban on all gifts of any size to elected officials and their family members, I predict firms and their leaders would still donate to political action committees, they’d endorse candidates, they’d sponsor third-party political advertisements, they’d organize get-out-the-vote efforts, and they’d host fundraisers and campaign events. In an endless game of whack-a-mole, reformers could no doubt try to curtail these efforts too (with the First Amendment a likely casualty). But so long as businesses face such lucrative incentives to play politics, the reformers will always be one step behind.

A better—more permanent, and more direct—reform would strike at the heart of the quid-pro-quo problem. It would limit the government’s ability to favor particular firms in the first place. This would require the elimination of all targeted tax exemptions and credits. The state could then use the extra money obtained from closing loopholes to lower its corporate and individual tax rates. The state would also need to eliminate all programs that make grants or loans to particular firms (you can see a listing of such programs here).

In one fell swoop, these types of reforms would instantly remove the incentive for firms to seek the favor of politicians. These reforms would also improve the economic climate of Virginia. Without government assistance, industries would be more competitive, lowering their prices and improving the quality of their products. Firms would pay more attention to trends in customer desires rather than political trends. This would help ensure that labor and capital would be allocated on the basis of genuine costs and benefits rather than political costs and benefits. And millions of dollars that are now wasted in seeking government-granted privilege could be put to more valuable uses.

This does not mean that the state would be powerless to entice firms to relocate here. Governors, legislators, and mayors across the state could and should work to make sure that Virginia’s tax and regulatory regimes are the least burdensome in the nation. Elected officials (and their spouses) could and should tout the state’s superior business climate.

And one of their talking points would be the fact that all businesses in Virginia get the same fair shake, whether they donate to politicians or not.

The farm bill vote gives credence to Democrats’ favorite ‘straw-man’ argument

“Republicans favor tax cuts because they want to give money to rich people.”

I’ve heard this argument, in various forms, for years. And I’ve always considered it one of the worst straw-men arguments in politics (right up there with “Democrats oppose foreign wars because they are anti-American”).

For one thing, there are plenty of good reasons for cutting taxes that do not rest on a desire to give money to rich people. Moreover, it’s a rather Orwellian twist of the English language to say that refraining from taking as much from high-earners is equivalent to handing them money taken from others. More fundamentally, though, I’ve always found it hard to believe that any serious person—Democrat or Republican—actually wants to transfer resources from middle and low-income taxpayers to upper-income taxpayers. This wouldn’t be justified on either efficiency grounds or on any standard theory of social justice.

Then came the July 11 House vote on the Farm Bill.

As I noted in my last post, U.S. Farm Policies—namely subsidies, price floors, and barriers to trade—are roundly opposed by economists of almost all stripes. The reason is that subsidies, price floors, and barriers to trade do exactly what the straw-man argument claims Republicans want to do: they transfer resources from middle-income consumers and taxpayers to upper-income farmers and landowners.

For years the issue has been clouded by the strange combination of food stamps and farm subsidies in a single “farm bill.” As Veronique explained a few weeks ago, this facilitated a logroll:

In their famous book published in 1962, “The Calculus of Consent: Logical Foundations of Constitutional Democracy,” Noble Prize Winner James Buchanan and his co-author Gordon Tullock identified this behavior as logrolling — an agreement between two or more lawmakers to support each other’s bill.

Normally, they wouldn’t support the other’s bill if it weren’t for the support of their own bill. The main consequence of this quid pro quo is more government spending across the board and in this particular case; more farms subsidies and more food stamps spending.

Then, on July 11, a funny thing happened. The Republican leadership split up the two portions of the farm bill and—shockingly, to me at least—put the farm subsidy portion of the bill up for a vote without any amendments.

Then, without the support of a single Democrat, 216 House Republicans voted to use government subsidies, price floors, and barriers to trade to transfer resources from middle income consumers and taxpayers to upper-income farmers and landowners.

I’m not sure what their motivations were, but the vote certainly makes it seem as though the Republicans in Congress who voted for it want to give money to rich people.

Burden of DC’s Wal-Mart Minimum Wage would be Borne by City’s Poor

Plans to bring six Wal-Marts to the District of Columbia may fall through over city requirements for the big box store to pay an hourly wage of $12.50, more than a 50-percent increase over the District’s $8.25 minimum wage. Yesterday, the DC City Council voted 8-5 to approve this higher minimum wage, creating a higher wage requirement for stores with over 75,000 square-feet and retailers that make over $1 billion annually.

The council passed Large Retailer Accountability Act under the rhetoric that raising the minimum wage would benefit the District’s workers and that Wal-Mart can afford to pay higher wages:

Vincent Orange was one of the most vocal supporters of the bill. “We don’t need Wal-Mart, Wal-Mart needs us,” he said. “The citizens of the District of Columbia demand that we stand up for them.”

While supporters of higher minimum wages say that they are helping their least well-off constituents, in fact raising the minimum wage for Wal-Mart will hurt the very members of the city’s labor force that  council members say they are trying to help. That raising a minimum wage raises unemployment is uncontroversial among most economists. When the employment rate falls with a higher minimum wage, those left without a job will be lowest-skilled workers with the fewest job choices. While a higher minimum wage will benefit a group of employees who keep their jobs and otherwise would have made the lower minimum wage, policymakers must acknowledge the tradeoffs involved in a minimum wage law and that by supporting a minimum wage, they are hurting society’s least well-off members.

Furthermore, by discouraging Wal-Mart from opening stores, DC’s council is doing another disservice to residents by reducing availability of low-cost goods. Again, the burden of this policy decision falls hardest on the city’s lowest-income residents. Because those with lower incomes tend to spend a higher percentage of their income on food and other basic goods sold at Walmart, discouraging the company from opening DC locations is a regressive policy. Even for those who don’t choose to shop at Wal-Mart, the retailer’s low prices create pressure for other city stores to reduce their own prices to compete, benefiting an even wider net of consumers.

Mayor Vincent Gray has the option to veto the bill, which would require a ninth vote from the Council to overturn. If the DC City Council actually wants to benefit the city’s low-income residents, allowing Wal-Mart to provide jobs and affordable goods would create broader, lasting benefits to the community than a restrictive minimum wage. Requiring large stores to pay a higher minimum wage than other retailers would limit consumer choice, especially for consumers who have few choices, and it would eliminate job opportunities for the least-skilled workers.

Government shouldn’t pick winners either

Last week, Steven Mufson of the Washington Post reported:

The Energy Department gave $150 million in economic Recovery Act funds to a battery company, LG Chem Michigan, which has yet to manufacture cells used in any vehicles sold to the public and whose workers passed time watching movies, playing board, card and video games, or volunteering for animal shelters and community groups.

This week, Mufson’s colleague Thomas Heath reports about another firm that has received gov’t aide:

District-based daily-deal company LivingSocial has received a much-needed $110 million cash infusion from its investors, according to a memo the company sent to employees Wednesday.

“This investment is a tremendous vote of confidence in our business from the people who know us best, our current board members and investors,” LivingSocial chief executive Tim O’Shaughnessy said in the memo, which was obtained by The Washington Post.

Mr. O’Shaughnessy is putting a nice gloss on it. A LivingSocial “senior company insider” tells PrivCo:

We scrambled for cash quickly….we did receive one other funding offer, but the current investors’ terms were the least bad of two terrible proposals….which we had no choice but to take it or file for Chapter 11.

According to PrivCo, the company ended the year with just $76 million in cash and assets while it faces some $338 million in liabilities.

Readers will no doubt remember that just eight months ago, the D.C. Council unanimously voted to give LivingSocial a $32,500,000 get-out-of-tax-free card.

These stories (and the many, many more that could be told) suggest that President Obama’s former economic adviser  Larry Summers, was right to warn that government is a crappy venture capitalist. Milton and Rose Friedman’s simple explanation of the four ways money can be spent offers a nice explanation:

how to spend money

A private venture capitalist spends her own money to buy equity in a firm. And if that firm does well, she does well. Since she is spending her own money on herself, she has an incentive to both economize and seek the highest value.

But when government policymakers play venture capitalist, they are spending other peoples’ money on other people. They therefore have little incentive to either economize or seek high value. It is no wonder that they often make the wrong bets.

But the scandal has much more to do with a bad bet. Even if the bet pays off—which it sometimes does—there are problems associated with taxpayer support of private industry. There are more details in my paper, but just to name a few, government-supported industries will tend to:

  • Be cartelized, which means consumers are stuck with higher prices;
  • Use less-efficient productive techniques;
  • Offer lower-quality goods;
  • Waste resources in an effort to expand or maintain their government-granted privileges;
  • Innovate along the wrong margins by coming up with new ways to obtain favors rather than new ways to please customers.

Together, these costs can undermine long term growth and even short-term macroeconomic stability. And since the winners tend to be the wealthy and well-connected and the losers tend to be the relatively poor and unknown, privileges such as these undermine people’s faith in both government and markets.

We should be upset when governments sink money into firms that then go bankrupt. But it is no less scandalous when government sinks funds into firms that survive.

Governments should stay out of the business of picking winners or losers.