Category Archive: Economics

  1. Why classical liberals need a research program

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    In my last post, I discussed several important moral features of classical liberalism; this time, I want to discuss classical liberalism as a research program.

    For thinkers like Ludwig von Mises and Friedrich Hayek, classical liberalism was first and foremost something to be studied and understood. The basic observation guiding their thinking is that the social world is incredibly complex yet also orderly. Furthermore, that order does not appear to be the product of some centralized coordinating authority. “Coordination without command” is the starting point of classical liberalism: how millions of individuals, each in possession of only a fraction of the knowledge necessary to create order in society, and each acting (generally) in the interests of themselves and their loved ones (rather than “society at large”), somehow produce social arrangements that exhibit a high degree of regularity and intelligibility.

    The market is the classic example of such “spontaneous orders.” There are groups that plan within markets: business firms and households. But no organization or group of organizations plans the market itself. Guided by the price system — itself underpinned by crucial institutions that protect private property rights, enforce contracts, and uphold a non-discriminatory rule of law — the groups that act within markets can “react” to each other’s wants and plans just by looking at market prices.

    If the price of oranges goes up, due to an unexpected frost killing off some of the orange crop, some households and firms will forego purchasing oranges and instead seek to fulfill their wants in other ways. The ones who still purchase oranges at the higher prices will be those who value oranges relatively more, such as hotels that can use orange juice as an input into a higher-price good, like mimosas.

    This give-and-take between buyers and sellers is the order of a market economy. Without a centralized commander, the tug-and-pull of freely adjusting market prices helps most everyone get what they want, in a way that minimizes frustrated plans and conflicts.

    To be sure, a positive appreciation for the complexities of markets and their role in human flourishing often yields a normative judgement that markets ought to be left as unimpeded as possible. Mises, famously, held a “rule utilitarian” ethical position: he favored the discovery and implementation of social rules that tended to maximize human well-being. But in order to discover these rules, he had to first “roll up his sleeves” and do the hard work of developing a rich body of social theory that could help him make sense out of the intricacies of the market and other orders, such as legal or constitutional order. Mises first and foremost was a social scientist devoted to understanding the extent to which human beings could live together peacefully, guided by forces other than sovereign fiat.

    Good classical liberals, then, can only responsibly engage the normative realm of classical liberalism if they appreciate how classically liberal institutions actually work — i.e., how real human beings relate to each other in societies not organized along the lines of a prison or army barracks. Even classical liberals who specialize in the normative aspects of the tradition must be familiar with the developments in market theory, legal theory, and constitutional theory as they have unfolded since the late 18th century.

    Classical liberals can and should be ideological. But they ought not be ideologues. For the former, an appreciation of the social world’s complexities and the institutions that govern it occupy center stage. In other words, human freedom is the conclusion written on the final line, not the assumption written on the first line.

  2. Want to help women? Lower marginal tax rates

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    This year April 17 is Tax Day.  Those who pay little tax count themselves as lucky winners.  Some of the biggest losers will be married, working women, who are being discouraged from working by high rates of tax.

    Higher marginal tax rates discourage married women from working.  When single women work and are considering marriage, higher rates discourage marriage.  Sometimes high tax rates result in women quitting the workforce altogether.

    Working women are disproportionately represented in the top fifth of the income distribution, where federal and state income tax rates can reach over 50 percent.  Frequently it is their work that pushes the family into the top brackets. After adding up costs of transportation, child care, and professional clothing, there is not much left.

    Taxes discourage married women not just from working, but also from striving for promotions, from pursuing upwardly-mobile careers.

    Mothers are more affected by the marriage penalty than other women because they are more likely to move out of the labor force to look after newborn children and toddlers, and then to return to work when their children are in school.

    On average, households in the top fifth of the income distribution have two earners.  In the middle fifth, it is 1.3 earners.  In the bottom fifth, it is half an earner.  That second earner pushes families into the top brackets.

    Census data show that men and women living alone are most likely to be poor. Over 70 percent of women and 60 percent of men living alone are in the bottom two fifths of the income distribution.

    Lowering the top individual income tax rate to 33 percent, as both House Speaker Ryan and President Trump have proposed, can reduce the marriage penalty.

    Many economists have shown that lowering individual and corporate income taxes is the key to increasing incentives for Americans to work and for businesses to invest.

    Nobel Prize winning economist Edward Prescott found that in the 1970s the labor supply of France, Germany, and the United Kingdom exceeded that of the United States. In the 1990s, Americans worked much more than Europeans. Controlling for other factors, he concluded that when tax rates of European countries and the United States were comparable, their labor supplies were comparable as well. Prescott concluded that the difference in the marginal tax rate accounts for the predominance of the differences at points in time and the large change in relative labor supply over time.

    Similarly, Professors William Gentry of Williams College and Glenn Hubbard of Columbia University found that higher marginal tax rates discourage entrepreneurship. Entrepreneurship involves risk-taking, and people are less willing to take risks when the rewards will be taxed away. A five-percentage-point reduction in tax progressivity would increase the entry rate by 25 percent.

    The increase in taxes in America in 1993, they found, lowered the probability of people becoming self-employed by 20 percent.  The ensuing period of high growth and low unemployment could have been even better.

    Professors Christina and David Romer, in a 2010 article in the American Economic Review, concluded that “a tax increase of 1 percent of GDP reduces output over the next three years by nearly three percent.” Romer and Romer say the effect is highly statistically significant. Furthermore, the effect is larger and more significant than if they had examined all legislated tax changes rather than just the ones they determined to be legitimate. The effect on output was smaller after 1980 than prior. The maximum output decline from 1950-1980 was 4.3 percent after seven quarters, compared to a 3.1 percent decline after eight quarters in 1980-2007.

    The majority of Americans are women. The majority of voters are women. Yet despite their political power, the federal government all too often ignores, or even worse, militates against the interests of women. This is particularly true of the economic interests of women. Especially in the details of tax codes, the economic interests of women are neglected.

    With high marginal tax rates, American women are shunted into higher tax brackets, discouraged from working, and given every incentive not to pursue advancement.  Let’s hope that things will be different in 2018 after President Trump and Congress modernize the tax code.

    This piece was originally published at Economics21.

  3. How regulations block economic progress

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    [This article is updated from one that originally appeared in the Mercury News.]

    Several years ago I participated in a colloquium whose title was something like “Advancing Technology: Thinking Outside the Box.” The presentations ranged from the ever-more imaginative uses of robots (fascinating!) to irrigating the Sahara Desert for growing crops that by mid-century could sustain the planet’s burgeoning population (unconvincing).

    My lecture was the most mundane: I proposed that better government regulation would act as what people in the military call a “force multiplier” (a tool that increases the effectiveness of your force) for technological advancement. I also argued that at present, excessively burdensome regulation blunts technological innovation.

    Progressive Policy Institute economists Michael Mandel and Diana Carew observed in a 2013 policy memo that “for each new regulation added to the existing pile, there is a greater possibility for … inefficient company resource allocation, and for reduced ability to invest in innovation.”

    The regulatory burden

    The economic burden of America’s accumulating mountain of regulatory requirements is almost unimaginable: According to a study from the Mercatus Center at George Mason University covering the years from 1977 through 2012, regulation’s drag on the US economy has made the economy a whopping $4 trillion smaller than it otherwise would have been.

    One of the reasons for this massive effect is that, as regulations become more and more complex and burdensome, prospective entrepreneurs and managers must expend more resources on issues related to regulation and thus have less available for innovation and corporate growth.

    The Competitive Enterprise Institute’s report Ten Thousand Commandments 2016 examines many of the government’s own cost estimates (which are notoriously low, because bureaucrats tend to lowball the costs and overstate the benefits of their rules). Nevertheless, the study found that federal regulation alone costs consumers and businesses at least $1.9 trillion every year in compliance costs and lost economic productivity — more than 11 percent of current GDP. According to the author, federal regulation is, in effect, “a hidden tax that amounts to nearly $15,000 per U.S. household each year.”

    The “gatekeeper” regulatory agencies, whose affirmative approvals are necessary before new innovations can be commercialized, are the source of much of the massive burden of regulation. The Food and Drug Administration alone regulates products that account for more than a trillion dollars annually — 25 cents of every consumer dollar.

    The average cost to develop and bring a new drug to market is now about $2.6 billion, but many of the largest drug companies spend significantly more than that — for pharmaceutical giant AstraZeneca, the figure is almost $12 billion per drug, and for GlaxoSmithKline, Sanofi, and Roche, it is around $8 billion.

    It might seem counterintuitive that some of the behemoth companies spend the most per approved product; after all, they have the most experience with the processes of clinical testing and negotiating the regulatory maze. The reason is that the biggest companies take the most risks in drug development and, consequently, experience the most failures.

    Too few mistakes

    And that’s not a bad thing; as Phil Knight, the co-founder of Nike, put it, “The trouble in America is not that we are making too many mistakes, but that we are making too few.”

    What he meant is that to discover the Next Big Thing, you need to think outside the box — and inevitably, many of the projects attempted will fail, whether we’re talking about nuclear fusion, new pharmaceuticals, techniques for sequestering CO2, or software to assure the safety of self-driving cars.

    Much existing regulation is superfluous or fails to be cost-effective. In his excellent book Breaking the Vicious Circle, written shortly before he was appointed to the U.S. Supreme Court, Stephen Breyer cited an example of expensive, non-cost-effective regulation by the EPA: a ban on asbestos pipe, shingles, coating, and paper, which the most optimistic estimates suggested would prevent seven or eight premature deaths over 13 years — at a cost of approximately a quarter of a billion dollars.

    Breyer observed that such a vast expenditure on regulating uses of asbestos that confer such tiny risks would cause more deaths than it would prevent from the asbestos exposure, simply by reducing the resources available for other public amenities. Nevertheless, political pressures from environmental activists pushed the EPA into making a decision whose net effect was actually to increase health risks.

    Regulatory excesses make it less likely that in any of the sectors in which American scientists and companies have excelled — nanotechnology, materials science, nuclear power, pharmaceuticals, medical devices, biotech and agriculture, to name just a few — we will discover the Next Big Thing.

    The refinement of regulation to make it more evidence-based and cost-effective isn’t as sexy as growing crops in the Sahara, but it could yield tremendous humanitarian and economic benefits in the near-term and for generations to come.

    Regulators won’t do it without significant prodding, so maybe major health-related philanthropies like the Howard Hughes Medical Institute, Gates Foundation, and Chan-Zuckerberg Initiative should make it part of their agenda. As wealthy as they are, they and their grantees would benefit from the “force multiplier” effect of smarter, more streamlined, more efficient regulation.

  4. Famine is about freedom, not just food

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    Are famines just things of the past? In the ancient world, a bad harvest threatened lives. The agricultural output of the world has dramatically increased in the last couple hundred years, and today, the Earth supports billions of healthy people thanks to advances in farm technology and global trade. Where individuals are relatively free from violence and have access to global markets, widespread starvation is not a problem today. Healthy food staples are cheap. And, in an emergency, there is a lot of goodwill out there, such that a community with a free press and open markets will receive aid.

    Fortunately, most humans today do not live and die by whether rain happens to fall on their farm. Today, episodes of mass starvation only occur when people are oppressed by authoritarian government regimes or gang violence organized on a smaller scale.

    The latest tragedy is in South Sudan, which the U.N. has now officially declared to be a famine. In a Washington Post article on March 9, George Clooney declared the famine in South Sudan to be “government-made,” not only to distinguish it from natural causes such as the weather but squarely point the finger of blame at the administration in the capital of Juba.

    The Nobel Prize-winning economist Amartya Sen has pointed out that functioning democracies do not have famines. In free societies, a government so inept as to create mass starvation would be voted out. The accountability provided by a free electorate and free press incentivize politicians to respond to the needs of the people. The problem is not that authoritarian governments do too little to prevent famines, it’s that they do too much to cause famines.

    The famines of the 20th century dwarfed the infamous “Irish potato famine” of the mid-19th century. In China, tens of millions starved under the rule of Mao Zedong. The Communist regime in the Soviet Union oversaw several famines in which many millions starved, including the mass starvation known as the Holodomor in Ukraine. These famine events were sometimes associated with bad weather, but droughts do not cause famines. Only violence could cause a bad harvest to turn into mass starvation in the modern world.

    In 1931, there was a lot of food being grown in Ukraine, but the Soviet government took the food by force and left almost none behind to feed the farmers. Another kind of government oppression that made the situation worse, in this case, was the suppression of free speech and free press. The Soviets denied that anyone was starving and censored unfavorable reports, making it less likely that aid would come in from the international community. Aided by Western journalists friendly to Stalin, the Soviets effectively clouded the issue of famine in Ukraine.

    The most widespread famine to affect Ethiopia in the past century lasted from 1983 to 1985. The government at the time had violently attacked the people of Ethiopia and moved them around in collectivization schemes. An already poor country was rendered helpless through government intervention and corruption. A campaign of misinformation allowed government officials to profit from the international aid that was sent from rich countries, while the government withheld donated food from areas of the country where the people were not supportive of the regime.

    The most recent famine is now occurring in South Sudan. The people of South Sudan used to have productive resources with which to feed themselves, but soldiers representing both the government and rebel forces have raided villages and destroyed the means of production, such as cattle, leaving the people to starve. In his article, Clooney expresses cautious hope that foreign aid will be allowed to reach the victims of the famine, but he acknowledges that aid is a short-term fix. Famines will continue until the government is held accountable for corruption and abuse. Clooney is thinking like an economist, because he is talking about incentives, not intentions.

    Soon after the Western world was alerted to the severity of the famine in South Sudan, President Salva Kiir hiked the fee for work permits for foreign aid workers from $100 to $10,000. Perhaps that change is small in comparison with the violent attacks against aid workers perpetrated by government soldiers, but it does indicate how the government views the famine victims.

    Economic freedom for individuals and the protection of property rights is the reason that famines do not occur in democracies today, as Amartya Sen documented in his book Development as Freedom. Hunger isn’t just about food – it’s about freedom.

  5. The classical liberal case against nationalist immigration restrictions

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    If any part of liberalism needs revitalizing, it’s the case for liberalizing immigration.

    Nationalists on the left and right argue that easing immigration restrictions would make Americans worse off. During the Democratic primaries, Bernie Sanders criticized open borders as a “right-wing proposal” that would “make everybody in America poorer.” And of course Donald Trump is calling for “an impenetrable physical wall on the southern border” to protect “the jobs, wages and security of the American people.” He has even floated the idea of an “ideological screening test” to ensure that the U.S. only admits those “who share our values and respect our people.” His executive orders banning citizens of five Muslim-majority countries from even setting foot in the U.S. seems to reflect this idea, and have met judicial resistance on the ironic grounds that they violate the values of the American people embodied in the constitutional guarantee of religion liberty.

    Trump’s stance on immigration exemplifies a broader cultural and economic nationalism. His chief strategist, Steve Bannon, has argued that capitalism and “the underpinnings of the Judeo-Christian west” are in crisis. According to this worldview, we have to build a wall around the American economy and culture as a matter of self-preservation. Congressman Steve King expressed this view recently in a controversial tweet:

    Trump, Bannon, and conservatives like King are wrong. We have overwhelming economic and cultural reasons to move toward a more open country. Indeed, some of Trump’s and Bannon’s own (professed) principles push in that direction. For instance, both tout lean government and robust capitalism. Trump says that “people flourish under a minimum government burden.” Bannon claims that “We are strong capitalists. And we believe in the benefits of capitalism. And, particularly, the harder-nosed the capitalism, the better.

    Yet restrictive immigration controls empower the state to suppress market competition and dictate how people may spend their money and allocate their labor. This is the opposite of capitalism. Literally.

    Immigration Restrictions Are an Attack on Economic Liberty

    Small-government, hard-nosed capitalism is flatly inconsistent with outlawing the buying and selling of labor. It shouldn’t matter where the laborer is born.

    For example, I’m a fan of the Philadelphia 76ers (unfortunately) and I’m eager to buy tickets to watch their rookie Ben Simmons play. And I’m sure that Simmons is equally eager to take my money. This is as capitalist as it gets: voluntary exchange for mutual benefit. Sure, Simmons is Australian, but so what? The free exchange of goods and services doesn’t suddenly become a bad idea because the provider moved across a border. Simmons plays in Philadelphia because it makes him better off, and fans pay to watch Simmons in Philadelphia because it makes them better off. That Simmons flew across an ocean to get there changes nothing of ethical or economic significance.

    Restricting Immigration Hurts the Economy and Is a Bad Way to Help Poorer Workers

    Maybe this is an unfair example. Simmons competes for a job with other millionaires, whereas Trump’s stated concern is immigration’s impact on poorer American workers. When immigrants enter the United States, they increase the supply of low-skilled labor and thus drive down the wages of low-skilled American workers.

    I’ll note up front that the extent to which immigrants directly compete with American workers is probably oversold. Immigrants tend to have different skill sets and job preferences than native-born Americans;  as such, they tend to complement rather than displace domestic workers. For instance, low-skilled immigrants are overrepresented in construction and agricultural work and underrepresented in government, education, and social services. As you’d expect, immigrants are less familiar with local languages and customs than native-born workers, giving the latter a leg up in competitions for jobs that require these skills.  Recent studies suggest that immigration even results in a small long-term increase in the wages of native-born workers.

    Still, it’s important to acknowledge the possibility that increased immigration will be bad for certain native-born American workers. In particular, those lower-skilled workers who do directly compete with immigrant labor can expect to see their wages drop by roughly 5%. But restricting immigration is the wrong way to solve this problem.

    Liberal Immigration Saves Millions from Desperate Poverty

    First, the benefits of liberalized immigration to the global poor are so overwhelming that it is flatly unethical to withhold them. Second, restricting immigration is a comparatively inefficient method of benefiting low-wage American workers.

    Philosopher Peter Singer explains that the world’s poorest people suffer from a deprivation far graver than anything experienced by even poor Americans:

    In wealthy societies, most poverty is relative. People feel poor because many of the good things they see advertised on television are beyond their budget — but they do have a television. In the United States, 97 percent of those classified by the Census Bureau as poor own a color TV. Three quarters of them own a car. Three quarters of them have air conditioning. Three quarters of them have a VCR or DVD player. All have access to health care. I am not quoting these figures in order to deny that the poor in the United States face genuine difficulties. Nevertheless, for most, these difficulties are of a different order than those of the world’s poorest people. The 1.4 billion people living in extreme poverty are poor by an absolute standard tied to the most basic human needs. They are likely to be hungry for at least part of each year. Even if they can get enough food to fill their stomachs, they will probably be malnourished because their diet lacks essential nutrients. In children, malnutrition stunts growth and can cause permanent brain damage. The poor may not be able to afford to send their children to school. Even minimal health care services are usually beyond their means.

    Only one policy has been shown to effectively bring the global poor up to the living standards of the global rich: allow them to move across borders, toward economic opportunity.

    The economist Michael Clemens writes, “Migrants from developing countries to the United States typically raise their real living standards by hundreds of percent, and by over 1,000 percent for the poorest people from the poorest countries. No other development policy realized within developing countries is able to generate anything close to this degree of convergence [between the earnings of people born in poor countries and those born in rich countries].”

    If someone is too poor to afford enough food to avert brain damage, it is morally indefensible to deprive them of the opportunity to increase their income by over 1,000%, especially when the cost of doing so is making someone hundreds of times richer about 5% poorer. That’s like cutting in front of someone dying of thirst because you want that last bottle of Aquafina to brush your teeth.

    Safety Nets Are a Better Way to Help Poorer Americans

    In any case, there are better ways to protect the economic well-being of poorer Americans than restricting immigration. A free market solution to a drop in wages or employment isn’t heavy-handed regulation of the labor market. Instead, let firms compete to figure out the most efficient ways of doing business and then directly compensate those workers who are made worse off. The compensation could take the form of government safety nets like unemployment benefits or the earned income tax credit.

    Trump’s first pick for labor secretary, Andy Puzder, is a fast-food executive who favors automation to keep production costs down. When McDonald’s installs automated kiosks, it worsens the labor market position of low-skilled American workers. But it also lowers the costs of a Big Mac, leaving consumers with more money to spend on other goods and services produced by other workers. Immigration has a similar economic effect. Insofar as immigration drives down production costs, Americans will have more disposable income to spend at Starbucks, where they’ll probably be served by a native-born barista with knowledge of the local language and customs.

    What’s more, the economic gains from immigration can be taxed to fund the safety net for displaced workers.

    Immigration Doesn’t Threaten American Values. Cultural Tests Do.

    But what if liberalizing immigration kills the goose that lays the golden egg? As Bannon might put it, we have to compromise pure capitalist principles in order to save the “the underpinnings of the Judeo-Christian west” that, in his view, make capitalism possible.

    One reason to be skeptical of this position is that American culture has allegedly been under siege by immigrants for decades (if not centuries), and the worry never seems to pan out.

    In fact, despite Bannon’s talk of the “Judeo-Christian west,” Americans haven’t always been keen on Jewish immigration. For instance, a 1940 proposal to resettle Jewish refugees in Alaska met with resistance in Congress because of the familiar-sounding fear that “these foreigners cannot be assimilated in Alaska, and will constitute a threat to our American civilization.” And in the 19th century, “many native-born Americans regarded Catholic immigrants as an ideological and racial threat.”

    Those worries were clearly unfounded. And they’re equally unfounded today. Studies of today’s immigrants find that they too tend to adopt liberal political values.

    But suppose, for argument’s sake, that Bannon is right and the United States is facing a cultural crisis. There’s a bedrock moral issue at stake: how does a liberal society like the United States confront cultural and ideological challenges? Does it enlist the power of the state to forcibly exclude dissenting viewpoints or does it engage them?

    Historically at least, it’s been the latter. Dissent from liberal values needn’t come from across the border. We permit Nazis to march in Illinois and the Westboro Baptist Church to picket soldiers’ funerals. These are not groups “who share our values and respect our people.” Nevertheless, they’re free to speak, protest, and assemble within our borders. A command-and-control culture is as contrary to American values as a command-and-control economy.  It’s not the state’s job to regulate away bad ideas any more than it’s the state’s job to regulate away cassette tapes and Blockbuster videos. The American way is to defeat bad ideas in what Oliver Wendell Holmes called “the competition of the market.”

    Indeed, if the nationalist concern is to preserve “our values,” then I see no good reason to ignore homegrown cultural threats. If we’re going to start a program of ideological screening, why do it halfway? Let’s implement an ideological screening test for books to ensure that they contain only content that “shares our values and respects our people.” Parents influence their children’s values, so maybe you should be required to take the test before the state lets you become a parent. Presumably journalists, teachers, religious leaders, and voters will all need to be screened before they can get to work, too. After all, these people are at least as capable as immigrants of disrupting American culture.

    Yet we find the prospect of these ideological screening tests chilling. A liberal society worthy of the name refuses on principle to take illiberal means to liberal ends. And this means resisting the call to use armed guards, razor wire, and religious profiling to stop peaceful people from working toward a better life in our country.

    This piece was originally published at the Niskanen Center.

  6. Healthcare will never be affordable without action on prices

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    Republican reformers have repeatedly promised affordable healthcare for all Americans — doubly affordable, in fact. They promise sufficient subsidies to put premiums and out-of-pocket costs within reach of low- and middle-income consumers. At the same time, they promise that the plan will be affordable to the federal budget, even given the constraints their most conservative members would like to impose on federal spending.

    Unfortunately, the American Health Care Act (AHCA) now before Congress will make healthcare affordable in the budgetary sense only, by making it less affordable in the individual sense. According to analysis by the Congressional Budget Office, the AHCA will reduce the budget deficit by $337 billion over a ten-year period, but only at the expense of reducing the number of insured by 14 million in the near term and by 24 million after the full effects of the bill come into force. As the CBO points out, even many people who retain coverage will find it more expensive because the ACHA tax credits will be less than the subsidies available through exchanges under the current Affordable Care Act (ACA). For others, the only option that will become more “affordable” is that of going without insurance, due to the ACHA’s elimination of the ACA’s individual mandate.

    Under the ACHA or ACA, one uncomfortable fact remains unavoidable: There is no way to make healthcare affordable for either the budget or individuals without strong action to control prices for drugs, medical devices, hospitals, and doctors’ fees that are higher than in any other country. The current draft of the ACHA does nothing to deal with that critical problem.

    The Elephant In The Room

    Princeton economist Uwe Reinhardt calls high healthcare prices the “elephant in the room.” Yes, he says, there is waste at every level of the U.S. healthcare system. Yes, U.S. doctors and hospitals probably do overuse some procedures (C-sections) and tests (MRIs). Still, Reinhardt argues that by and large, it is the high price of care, not an excessive amount of care, that makes our healthcare so much more costly than that of any other advanced country. We don’t have more hospital beds per capita, or more doctors, or more births. We just pay more for each unit of service.

    Reinhardt cites data from the International Federation of Healthcare Plans to back up his claim. For example, in 2012, the average cost of an appendectomy in the United States was $13,851, compared to $5,467 in Australia, the country with the next highest price. For a normal delivery, the U.S. price was $9,775 compared to $6,846 in Australia. The range of prices charged within the United States was even more astonishing than the average. At the twenty-fifth price percentile, an appendectomy in the United States cost $8,156 — higher than Australia’s average. At the ninety-fifth percentile, the U.S. price was an astounding $29,426. A normal delivery in the United States raged from $7,282 to $16,653.

    What causes high prices and what can we do about them? Here is a list of some of the most common ideas. (Warning: Each of the following paragraphs would have to be expanded to its own long post — or even to a doctoral dissertation — for a complete treatment.)

    Lack of Transparency

    A lack of transparency helps keep prices high by discouraging consumers from shopping around for the best deal, even when their problem is not so acute that they have no time to shop. As Reinhardt puts it, “Fees in the private [healthcare] sector have been jealously guarded trade secrets among insurers and providers of health care.”

    Some reformers hope to encourage consumers to be smart comparison shoppers by imposing higher deductibles and copays and softening the blow with health savings accounts, which consumers can draw on to pay their out-of-pocket costs. However, those devices are useless if consumers cannot get price information in the first place.

    Some insurers are trying to combat the lack of transparency by providing comparative price information, but what they give is not always easy to understand, and many patients do not look at it. A 2015 poll by the Kaiser Family Foundation found that only 6 percent of patients had seen price information on hospitals and doctors, and only 2 to 3 percent had made use of it.

    There are plenty of ideas around to make price information more accessible and easier to use. For example, Jeffrey Kullgren, writing for the New England Journal of Medicine Catalyst, recommends bundling price quotes to show the sum of all fees that a consumer would face for a procedure, rather than separate fees for use of facilities, doctors’ services, supplies, and medications. He also recommends that providers have dedicated staff to provide price information to patients and explain what it means. Providers should also be willing to tell patients what services might not benefit them. For example, a $100 blood test might be essential for one patient but provide no useful information to another.

    Structural Incentives

    Even when price information is available to consumers, the structure of their insurance plan may not encourage them to use it. For example, if a plan covers whatever the provider charges, once a deductible has been satisfied, the consumer has no incentive to look for the best value for major procedures. In another article, Reinhardt  recommends “reference pricing,” a scheme under which an insurer pays only the price charged by a low-price provider in the area, leaving consumers to pay the balance if they choose a higher cost provider.

    Narrow network policies are a step in that direction of reference pricing, but they can meet resistance when patients have established relations with certain doctors and hospitals. Also, some consumers, to their sorrow, find that narrow networks can fail, leaving them with surprise bills from radiologists or anesthesiologists who are not network members, even though the hospitals where they work are.

    Individual consumers are not always the ones to blame for a failure to respond to incentives. Reinhardt notes that employers are also notoriously bad shoppers for low priced care. One reason may be that they think they can pass higher healthcare costs along to workers through lower wages — a hypothesis that many labor economists agree with.

    At a minimum, it is fair to say that a well-structured healthcare system should include some checkpoint in the chain between provider and patient where some party has an incentive to ask whether the product or procedure in question has a medical value that is commensurate with its cost. There is room for discussion as to who this should be or what standards should apply. The problem with the current U.S. system is that often no one at all has an incentive to address this question.

    Fragmentation

    Insurance coverage in the United States is highly fragmented. In the private insurance market, there are many carriers. Small carriers, especially, have weak bargaining power compared to large hospital groups and drug companies. On the government side, coverage is divided among Medicaid, Medicare, and VA systems that have differing authority to negotiate for low prices — and sometimes none at all.

    In the private sector, insurers could be given the power to negotiate jointly with providers in their area. Government providers could also have a way to negotiate jointly for advantageous prices.

    The ultimate in bargaining power would be to have a single payer for all healthcare services. The bargaining power inherent in single-payer systems is one of the main reasons other advanced countries have lower healthcare costs and still manage to produce superior quality of care compared with the United States, where doctors remain in individual practices and hospitals are privately owned.

    Drug Prices

    The issue of pricing has nowhere received more attention than in the case of drug prices. Some observers think the advent of a million dollar pill is not far off. A recent commentary by Scott Alexander provides a good summary of the complexity of the issues involved.

    The central problem is that of balancing the high costs of research and testing against the relatively low costs of producing drugs, once they are in use. The current regime handles this by giving drug companies temporary monopoly rights through patents. During the patent period, producers can charge whatever prices they deem appropriate. After patents expire, competition from manufacturers of generics usually brings the price down toward production costs.

    This regime can have good outcomes or bad. The new generation of drugs to fight hepatitis C, which are very expensive but also very effective, appear to represent the good end of the spectrum. Research that, at vast expense, only fiddles with a molecule or two to produce a drug that prolongs a patent with no added medical benefit is the bad end.

    Price discrimination also contributes to high U.S. drug prices. A 2015 report from Bloomberg found that the prices of seven out of eight common medications cost less abroad than in the United States, even after taking into account the discounts negotiated behind closed doors with some insurers. The cholesterol lowering pill Crestor cost five times more in the United States than in the next-most-expensive country at list price, and more than twice as much even after discounts. The leukemia drug Gleevec cost four times more in the United States, and no discount was available.

    Economists do not universally condemn price discrimination. No one objects when theaters or theme parks charge reduced prices for children. Airlines use price discrimination to keep their airplanes filled — a practice that lowers average prices in the long run and increases the number of fights passengers can choose from. However, there are ways to keep price discrimination from getting out of control without undermining its usefulness in markets where fixed costs are high.

    High barriers to resale across markets are one factor that facilitates price discrimination. For that reason, many reformers suggest allowing consumers to purchase drugs online from retailers in Canada, Mexico, and other countries where prices are lower. Since the United States is the high-price consumer in most cases, moves to reduce price discrimination would probably lower prices here. However, the net gains would be less than suggested by the current cross-border price differential, since curbing price discrimination would probably raise drug prices abroad at the same time it lowered them in the United States.

    Mergers, Monopolies, and Entry Barrier

    Numerous studies (this one, for example) have found that mergers among hospitals tend to raise prices in the affected areas. Mergers between hospitals and physician groups can have a similar effect. During the Obama administration, the Federal Trade Commission began to push back against the wave of mergers. It is not yet clear whether such actions will continue under the Trump administration.

    Entry barriers are another factor that contributes to a lack of competition and higher prices. A recent study from the Mercatus Center notes that thirty-six states do not allow the entry of new hospitals without a certificate of need issued by a government agency. The ostensible purpose is to improve the quality of care by preventing excessive competition. The Mercatus study casts doubt on that claim, showing that by some measures, the quality of medical service is actually lower in states with certificate of need laws.

    Economists have also long argued that limits on admission to medical schools help to keep doctors’ salaries higher than in other equally wealthy countries. Observers on both the left and the right of the political spectrum complain that the American Medical Association acts as a cartel in resisting the expansion of medical schools even as the number of applicants rises.

    Administrative Costs

    The fragmented nature of U.S. healthcare produces higher administrative costs than other countries. Those costs ultimately work their way into the prices of hospital care, physician services, drugs, and every other area of care. A study from the Commonwealth Fund found that in 2014, administrative costs accounted for 25 percent of all hospital expenses—higher than any of eight other countries studied, and double the level of Canada. An earlier study from the Office of Technology Assessment found similar results for total administrative costs in the healthcare system.

    Single payer systems are inherently more efficient in terms of administrative costs. International experience shows that many savings can be realized within a unitary administrative framework without requiring that hospitals be owned and operated by the government or that all physicians become government employees.

    No Simple Answer But a Need for Action

    It should be clear from these examples that there is no single explanation for high U.S. healthcare prices, and no simple solution. Action is needed, but it needs to come across many fronts at once — against mergers, entry barriers, drug prices, lack of transparency, administrative fragmentation, and other problems. If each of these areas could eliminate a single percentage point of the gap between U.S. prices and those that prevail in our high-income peers, we could save billions of dollars a year.

    If the current draft of the AHCA is not revised to address the problem of excessive healthcare prices, it is likely to do little to improve affordability. Any savings it brings can come only from reducing the quantity or quality of care provided, not by reducing costs per unit of service.

    Paul Ryan, the most vocal backer of the bill, insists that this is only the first step. We have to understand, he says, that the AHCA is tailored to meet the arcane requirements of the Congressional reconciliation process, which limits changes to matters directly affecting taxes and spending. He promises a second wave of reforms to address cost controls and issues of efficiency.

    There is a huge danger in this approach, however: Every dollar saved in healthcare costs means a dollar less of revenue for some healthcare provider. Any proposals to cut drug prices, increase competition among hospitals, or squeeze out administrative costs in the insurance industry will face tooth-and-nail opposition from an army of lobbyists.

    The AHCA, if passed in its current form, will satisfy the potent symbolism of repealing Obamacare. Any Republican Senator or Congressman who votes against it will have broken an explicit campaign promise and will face a primary fight in the next election. But once a repeal bill passes — any bill — the political heat will be off. The motivation to tighten the screws on big pharma or the insurance industry, against the will of the lobbyists, will evaporate.

    At the same time, Democrats will dig in their heels against anything that might make the AHCA work better. At least a few Democratic votes will be needed for any further reforms that can’t squeeze through the eye of the reconciliation needle. But where is the political motivation to cooperate? Many Democrats may well prefer to see a half-baked GOP reform collapse in a death spiral, (as I predicted in an earlier post that it will do), and hope to pick up the pieces after the 2020 elections.

    In short, the two-part approach is unworkable. Sen. Tom Cotton was right when he tweeted to his colleagues in the House to “Pause, start over. Get it right.”

    This piece was originally published at the Niskanen Center.

  7. Entrepreneurs create value for disabled workers.

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    The numbers are alarming. Approximately 6.4% of America’s labor force is plagued with some form of physical or mental disability (U.S. Census). Only 1 out of 3 disabled persons is employed, and when they are employed they get on average only about 2/3rds the income of non-disabled workers.

    It may be tempting to blame this income discrepancy on prejudice or the selfishness of employers. And this attitude lies behind the push for legal minimum wage rates, which their promoters believe will improve the welfare of the low wage workers. This belief concerning minimum wage rates is at odds with economic forces that pervade society.

    In a competitive market, wages earned by labor tend to equal the value contributed to production by labor. In traditional microeconomic analysis, we refer to this as the marginal revenue product of labor. If the minimum wage is above the value contributed by a worker, employers are discouraged from employing that worker. Surprisingly, the federal minimum wage for disabled workers reflects this —it allows the payment of sub-minimum wages to workers whose disabilities inhibit their productivity.

    A worker’s wage reflects the value derived from a time unit of labor. If, on average, a worker creates $30 worth of value for his employer in an hour of work, his wage will tend to be higher than if his labor contributes $20 of value per hour of work. The laborer who is paid only $20 per hour when he creates $30 of value in an hour can advertise his service to other employers. The famed economist John Bates Clark reflects on this in his book The Distribution of Wealth,

    There is a general rate of wages; and employers in this group can have laborers for what it costs to get them out of the other groups, in which their productive power is smaller. By doing this, they can make a profit. For an interval they can hold the difference between the pay of labor in the general market and its earning power in the industry into which they bring it. This is, however, a vanishing difference; for, as competition does its work, it slips through the employers’ fingers.

    If the employer who employs the worker whose labor, on average, creates $30 of value per hour wants to keep his service, the wage paid to him must rise closer to $30 per hour. When labor utilizes capital (like power tools or factory machines), the productivity of that labor is increased. Part of this value is itself received by the capital in the form of a rent, but so too is part derived from labor that uses it. Labor that is more productive receives a higher wage. Accountants that use accounting software will be more productive than those who use typewriters or pen and paper. Farmers that use tractors and combines are more productive than subsistence farmers who lack these means. The cost-reducing technology embodied in capital makes its users and the consumers served by it wealthier.

    Alleviating disabilities is profitable.

    The same logic holds for disabled workers. A labor-inhibiting disability increase the costs of the worker to produce the same amount of product as a person who is otherwise the same but lacks the disability.

    Where there are costs that can be reduced, there is a profit opportunity. Any entrepreneur who succeeds in reducing costs faced by a laborer who suffers from a disability can earn a profit while also improving the lives of the disabled.

    Consider a disability that can now be largely disregarded in terms of its economic effects: vision impairment. According to data aggregated by the Center for Disease Control and Prevention, “14 million Americans aged 12 years and older have self-reported visual impairment defined as distance visual acuity of 20/50 or worse.” 11 million of these are able to correct their vision to 20/40 or better with glasses and other visual aids.

    In a world without this technology, the ability of these persons to function would be greatly inhibited. Both the quality of their lives and the value of their labor would deteriorate. Today, success in overcoming vision ailments is so widespread that it is easy to ignore the poverty that would exist absent this technology.

    But what about those who suffer from extreme blindness? A report from the Wall Street Journal has shown that even many who suffer from blindness can now see with the help of eSight. The product is a visor that uses video technology that, according to the company, allows 3 out of 4 persons who suffer from blindness to see. An eSight visor sells for around $10,000.

    Or consider the development of exoskeletons. An exoskeleton from SuitX allows those who are paralyzed to walk. Another company, Ekso Bionics, even promotes exoskeletons as labor-augmenting devices. These exoskeletons can be purchased at a price starting around $40,000. Entrepreneurs are working to lower these costs, however the process is a slow one. They must bear the costs of the FDA approval process, because the exoskeleton is considered a medical device.

    Entrepreneurs act as first responders for helping a significant proportion of disabled persons. They stand to gain by offering these technologies on the market. The person who purchases it makes an investment. Not only do she directly enhance her own quality of life, she can augment her labor and, therefore, income.

     

  8. Why libertarians should oppose the Universal Basic Income

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    Here’s my opening statement for my Students for Liberty debate with Will Wilkinson.  Enjoy.


    Libertarians have a standard set of fundamental criticisms of the welfare state.

    1. Forced charity is unjust. Individuals have a moral right to decide if and when they want to help others.
    2. Forced charity is unnecessary. In a free market, voluntary donations are enough to provide for the truly poor.
    3. Forced charity gives recipients bad incentives. If the government takes care of you, you’re less likely to take care of yourself by work and saving.
    4. The cost of forced charity is high and growing rapidly, leading to a future of exorbitant taxes or financial crisis.

    Taken together, I think these criticisms justify the radical libertarian view that the welfare state should be abolished.   But this is an extremely unpopular view, so it’s natural for libertarians to consider more moderate reforms like the Universal Basic Income.  And when you’re considering moderate reforms, the right question to ask isn’t: “Is it ideal?” but “Is it better than the status quo?”

    My claim: the Universal Basic Income is indeed worse than the status quo.  In fact, all the fundamental criticisms of the welfare state apply with even greater force.

    1. Some forced charity is more unjust than other forced charity. Forcing people to help others who can’t help themselves – like kids from poor families or the severely disabled – is at least defensible. Forcing people to help everyone is not. And for all its faults, at least the status quo makes some effort to target people who can’t help themselves.  The whole idea of the Universal Basic Income, in contrast, is to give money to everyone whether they need it or not.  Of course, the UBI formula normally reduces the net payment as income rises; but if a perfectly able-bodied person chooses never to work, the UBI gravy train never stops.
    2. The UBI is an extremely wasteful form of forced charity. Helping the small minority of people who can’t help themselves doesn’t cost much. Giving an unconditional grant to every citizen wastes an enormous amount of money.  If you were running a private charity, it would never even occur to you to “help everyone,” because it’s such a frivolous use of scarce charitable resources. Instead, you’d target spending to do the most good.  And unlike the UBI, the status quo makes some effort to so target its resources.
    3. Overall, the UBI probably gives even worse incentives than the status quo.Defenders of the UBI correctly point out that it might improve incentives for people who are already on welfare. Under the status quo, earning another $1 of legal income can easily reduce your welfare by a $1, implying a marginal tax rate of 100%.  But under the status quo, vast populations are ineligible for most programs.  Such as?  You guys!  If you’re an able-bodied adult, aged 18-64, who doesn’t have custody of any minor children, the current system doesn’t give you much.  Switching to a UBI would expand the familiar perverse effects of the welfare state to the entire population – including you.  And if taxes rise to pay for the UBI, the population-wide disincentives are even worse.
    4. A politically acceptable UBI would be insanely expensive. Libertarian economist and UBI advocate Ed Dolan has a detailed, fiscally viable plan to provide a UBI of $4452 per person per year. But every non-libertarian I’ve queried thinks it should be at least $10,000 per person per year.  Even with a one-third flat tax, that implies that a family of four would have to make $120,000 a year before it paid $1 of taxes.  This is pie in the sky.

    But doesn’t the UBI give people their freedom?  In some socialist sense, sure.  But libertarianism isn’t about the freedom to be coercively supported by strangers. It’s about the freedom to be left alone by strangers.

    If abolition of the welfare state is extremely unlikely and the UBI is worse than the status quo, does this mean libertarians should accept the welfare state as it is?  Not at all.  There’s a straightforward moderate path to a freer world: AUSTERITY.  Cut benefits.  Restrict eligibility.  Remind the world of the great Forgotten Man: the taxpayer.  We probably can’t convince the majority to end the welfare state.  But “Welfare should be limited to genuinely poor people who can’t help themselves” has broad appeal – and unlike the UBI, it’s a clear step in the libertarian direction.

    This piece was originally published at Econlog on February 20, 2017.

  9. Trump, Trade, and Great Power War

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    One of the signature features of President Donald Trump’s campaign was his hostility to free trade. Then-candidate Trump repeatedly denigrated various multilateral trade pacts as bad deals for the United States. Pulling out of the Trans-Pacific Partnership, appointing opponents of free trade—such as Steve Bannon and Peter Navarro—into key positions, and promises of tariffs that are likely to produce retaliatory measures, all demonstrated that Trump was planning on following through on his protectionist campaign rhetoric.

    While Trump’s attack on free trade has important implications for American and global economies, it will also have an impact on the likelihood of war between the great powers.

    As discussed here previously, President Trump sees the world in zero sum terms. Absent disproportionate economic gains for the United States, international agreements cannot be considered successful. However beneficial such arrangements prove to be for all involved, Trump’s mercantilist outlook sees them as a raw deal for Americans.

    It is not surprising therefore, that U.S. Treasury Secretary Steve Mnuchin nixed attempts to include language supporting free trade in a statement from a G-20 meeting in Baden-Baden, Germany. As CNN reported, while the statement included some positive words on trade, “conspicuous by its absence was the phrase ‘we will resist all forms of protectionism’ that was contained in the communiqué from the last meeting of the group in China, July 2016.” Mnuchin rejected the idea that the omission was meaningful, but the unwillingness to reaffirm American opposition to protectionism ignores that trade provides benefits beyond the global economy. Specifically, the expectation of future trade affects the likelihood of war and peace.

    The connection between trade and conflict has never been as simple as early liberal theorists suggested. The idea, wrongly attributed to the nineteenth century French economist Frederic Bastiat, that “when goods don’t cross borders, soldiers will” still offers a good summation of the longstanding position that trade has pacifying effects on international politics. The logic behind the argument is compelling: the greater the extent of commercial relations between states, the less likely there will be conflict because the economic cost of war (and the lost benefits of trade) will be too high. However, history has shown that states still sometimes go to war despite high levels of economic interdependence at the time of the conflict.

    In his book Economic Interdependence and War, political scientist Dale Copeland explained that it is not the current level of trade that is important to the likelihood of conflict. Rather, Copeland argues, it is the expectation of future trade that determines a state’s willingness to go to war. He writes,

    In a very real way, it does not matter in the least whether past and current levels of trade and investment have been low, as long as leaders have strongly positive expectations of for the future. It is their future orientation and expectations of a future stream of benefits that will likely make the leaders incline to peace. Likewise, it does not matter whether past and current levels of commerce have been high if leaders believe they are going to be cut off tomorrow or in the near future. It is their pessimism about the future that will probably drive these leaders to consider hard-line measures and even war to safeguard the long-term security of the state.

    Multilateral trade has been a feature of the liberal international order developed after World War II for a reason. Postwar policymakers feared a return to the closed economic blocs of the 1930s that helped drive the world to war. It is entirely possible that the norms in favor of free trade are robust enough to withstand the absence of routine language from a statement by a meeting of the world’s finance ministers. But groups like the G-20 help set expectations about the future. Given the connection between those expectations and conflict, failing to reaffirm America’s opposition to protectionism could put the world on a dangerous path.

    This piece was originally published at the Niskanen Center.

  10. Defense spending: Why we pay for the permanent war economy

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    Since 1996, the Pentagon has lost track of $8.5 trillion — it simply doesn’t know what the money was spent on. That doesn’t even include the billions lost to known waste and abuse.

    But despite that troubled budgetary record, the government is preparing this month to increase defense spending.

    On March 8, the U.S. House of Representatives passed the defense spending bill for fiscal year 2017, providing $516.1 billion in the “base budget” and $61.8 billion for “Overseas Contingency Operations” (OCO) — i.e., wars. While the budget must still pass the Senate, this represents an increase of $5.2 billion over the last fiscal year. Adding in the $5.8 billion in supplemental funding provided by December’s Continuing Resolution, the current budget comes to a total of $583.7 billion for the year. Still outstanding is a supplemental budget request that is expected to add $30 billion to the OCO, which would raise that number significantly.

    Though some members of the House have hailed the new bill as a pivot from defense spending cuts and a necessary step toward increasing national security, it is useful to put this budget in context. While the current bill does not bring military spending entirely up to its 20111 peak, much of the difference comes from a reduction in spending on the Iraq and Afghanistan wars, rather than from the Pentagon’s base budget.

    Despite the sequestration in 2013, the base budget has continued to rise once again, and though the active military engagements in Iraq and Afghanistan have been reduced, continued military action there and elsewhere has kept the OCO account open.

    The International Institute for Strategic Studies provides detailed calculations of total world defense spending that shed light on how the United States compares to the rest of the world. By the Institute’s calculations, the United States in 2016 spent 39 percent of total world defense spending, only 2 percent less than the next 15 countries — including China (10 percent) and Russia (4 percent) — combined.

    Source: The International Institute for Strategic Studies, The Military Balance 2017

    Those percentages are a function of other nations’ spending decisions, as well as those of the United States, but you might think that if security was the main driver of defense spending, spending as much as the next 15 nations combined should be enough to provide a reasonably secure environment. An increase in spending for 2017 may seem excessive.

    Troubled projects

    As Politico notes, the current House bill contains $6.8 billion more in additional procurement funding than even the original 2017 request from the Obama administration, including “$750 million for six additional Navy and Marine Corps F-35 Joint Strike Fighters and $495 million for five extra Air Force F-35s,” as well as adding “$433 million for the DDG-51 destroyer program, a third Littoral Combat Ship and $150 million in advance procurement for a new polar icebreaker.”

    Both the F-35 Joint Strike Fighter and the Littoral Combat Ship are produced by Lockheed Martin, and both have been plagued by cost overruns and technical problems. Yet even with the overruns and the verbal sparring regarding the continued budgetary issues surrounding the programs, the current bill still increases spending for these projects.

    Lest you think that Lockheed Martin is alone, it should be noted that these are only two programs in a general pattern of behavior within the defense sector.

    Consider the $31 to $60 billion lost due to waste in Iraq and Afghanistan or the potential misuse of the OCO “slush fund” since the conclusion of those wars.

    Or consider the known cases of waste and abuse, such as spending $1 billion to destroy $16 billion in ammunition, or $1 billion for shoddy airplane maintenance.2 And, of course, there is that missing $8.5 trillion.

    How does such behavior persist in the defense sector, and even seem to be rewarded with additional spending? The answer is straightforward: it may be that military spending, rather than being purely about security, has a political component as well.

    Political budgets

    The political nature of defense spending comes about in two interrelated ways.

    First, the nature of the budgetary process, financed through a system of generalized taxation, erodes the link between decision-making and those who bear the full cost of the decision. In fact, rather than being faced with the full cost of decisions, agencies in the defense sector face a perverse incentive. When a private firm makes budget errors, it risks losing shareholder value.

    However, if a defense agency does not spend its entire budget, that money will be cut and given somewhere else. Rather than being punished for overspending, agencies are punished for saving money. The Department of Defense does not have shareholders, and there is no real recourse for taxpayers to sanction egregious misuse of resources.

    Second, defense spending decisions are made through a political process that requires agreements between the Pentagon, the president, and Congress. The current defense bill has only passed through the House. It has to jump further political hurdles as it moves through the Senate. Firms that want to succeed in this process need someone politically connected and skilled at navigating the system on their payroll, and they need to use those skilled and connected people in lobbying to keep the defense budgets high.

    This year’s budget cycle is no different. To see how this works, return to Lockheed’s troubled F-35 program. According to the Center for Responsive Politics, in 2016 “70 representatives signed a letter to the leadership of the House Defense Appropriations subcommittee urging continued support for the program. In the 2016 cycle, those 70 lawmakers received nearly $3.5 million from the defense sector” and “collectively received a total of almost $578,000 from Lockheed Martin in the 2016 cycle, nearly 17 percent of their defense dollars.”

    It does not take much imagination to envision a relationship between campaign contributions, letters, and increases in spending for the program. Again, Lockheed is not the only player in this game. It is simply one illustration of the phenomenon.

    It is not difficult to see why these dynamics in national defense create what is sometimes referred to as the “permanent war economy.”

    While it may not be possible to completely remove politics from such decisions, these dynamics should not go unnoticed when the U.S. taxpayer and voter are offered the rationale of national strength and security as the primary reason for increased spending. That rationale is not the only incentive that policymakers face when engaging in public sector budget decisions.


    1This year and all those listed in the article are fiscal years.
    2For a full report of these numbers, see here.

  11. It’s never worth playing the Olympic game

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    Budapest has done the sensible thing and withdrawn from the competition to host the 2024 Summer Olympics. Finally a refutation of the standard point about economists – that the more united their view on a subject the less attention anyone else pays to them. For the truth about the Olympics is that they are a potential financial disaster which no sensible person would wish to host or subsidize.

    No, really, 85 per cent of surveyed economists think that subsidies to professional sports teams should cease – and Olympic athletes these days are professional. All that guff about the games causing job creation, economic development, urban renewal and all that, just guff. Even rugby stadia in New Zealand, the place which takes sport seriously, aren’t worth the outlay.

    Back in 2004, the Athens games contributed to the entire country going bust. It only contributed, but even so. Now, not even a year after, and the Rio stadia are already rotting away. As for our own attempt, it was going to cost £2 billion at the outset (a figure arrived at by government deciding not to include charging itself for VAT in the calculations) and ended up somewhere north of £20 billion.

    The numbers will never stack up. The future value of velodromes, rowing lakes, athletics tracks and diving pools is not up to the costs of creating them. These are, quite simply, a collective money pit.

    The same goes for all those other arguments rattled out in defence of the games; they don’t add up. Certainly, there’s a burst of tourism from those desperate to come see the a runnin’an’ a jumpin’. But as London found out, that burst was neatly offset by all those people who would have liked to come to visit at that time – but didn’t because of the crowds. It was all rather Yogi Berra: no one goes there anymore because it’s too busy. He was right, in this instance.

    To the economist, though, it’s the regeneration argument which is the most insane. Sure, various nasty areas in east London were spruced up, this happens in every Olympic location. But let’s look at the opportunity costs. The price of something is not what you spend upon it, nor is it the benefit you get from having spent it. It’s what you have given up in order to gain it. That’s the true price.

    So, if we were to have spent £20 billion tidying up London, would we have got more of it tidied up if we hadn’t had to host a sporting bacchanal at the same time? Most assuredly, we would have got a lot more done for that money without all the interruption. So even though it might have been fun to see whiff whaff come home, it certainly wasn’t worth it.

    That’s why I have only praise for the good sense of the Burghers of Budapest. The local establishment was all in favour of the games – after all, there would be billions raised in taxes to be spent and who wouldn’t love to be a part of that?

    But those being taxed had a rather different view and started a petition to call for a referendum. On 17 Feb they handed that in with 40 per cent more signatures than were needed to set the process in motion. On the 22 of this month the bid organisers folded and withdrew, following Hamburg in 2015 and Rome in September. Now only Los Angeles and Paris are left in the race.

    If only we had been able to do the same and phone Paris to see if they still wanted it before we blew £20 million large.

    The truth is that if the lycra-clad superjocks want to have a jamboree that’s their right and privilege, of course it is. But there’s absolutely no reason why we should pay for it – we being the taxpayers of whichever urb is mad enough to agree upon hosting.

    The Olympics: Just Say No.

    This piece was originally published at CapX.

  12. Airport economics: The tragedy of the overhead bins

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    While I was traveling recently, I noticed a number of economic principles at work. Economics is everywhere, of course, but sometimes it’s easier to see when you step out of your routine. With spring break and summer vacation rapidly approaching, here are a few things to think about as you hustle through the airport.

    1. The Water Bottle Racket

    It can be frustrating to have to leave your bottled beverage at security, especially since you know it’s going to cost you quite a bit more at the shop by the gate than it did at your local grocery store. Why are airport concessions able to charge a premium for their products? Well, there aren’t a lot of options to choose from. You can stay thirsty, wait for the small beverage provided by the airline, or drink from a water fountain while you’re still in the terminal.

    With limited choices, you are more likely to pay higher prices than you otherwise would. This is a concept known as price elasticity of demand. The less sensitive you are to price, the more inelastic your demand is said to be.

    2. One Plane, Many Prices

    How much did you pay for your ticket? If you’re feeling bold, ask the people around you how much they paid. It’s likely everyone will have a different answer! Since you’re already being nosy, you might as well ask a few follow up questions. When did they buy their ticket? Will they be traveling over a weekend?

    Airlines consider this information when quoting prices to potential customers. If I am booking a business trip that’s a couple weeks away, I am probably willing to pay more for a ticket than someone who is planning out a vacation months ahead of time. There will be fewer options available, my dates may be less flexible, and the ticket will often be purchased from a corporate account that is much larger than your average vacation goer’s budget. Because customers have different price elasticities (and there are restrictions on reselling airline tickets), airlines can charge customers different prices based on their willingness to pay.

    3. The Tragedy of the Overhead Bins

    Have you noticed that it seems very desirable to be one of the first passengers to board the plane? Some passengers are willing to pay extra for this service (their demand for this perk is more inelastic). Others wait as close to the gate as they can and jump in line as soon as their boarding group is called (their demand is more elastic).

    Why? Flights are long, the seats aren’t all that comfortable, and legroom is sparse. Why in the world would you go through so much effort to make sure you could sit in cramped conditions for an additional 15 minutes or so? It turns out that it has less to do with wanting extra time to enjoy your luxurious 31 inches of legroom and more to do with ensuring your luggage has a spot nearby. Most airlines assign specific seats, but they do not assign a particular space in the overhead bin. That space is a common resource; whoever gets there first gets to claim it.

    The informal rule is the first person to put their stuff in the bin has claim to that space for the duration of the flight. As with many common resources, this can lead to overuse, or what economists call a “tragedy of the commons.” Have you ever been the unfortunate one at the end of the line trying to find a place for your rolling bag, while passing bin after bin filled with jackets and small purses that could easily be stored under seats instead of overhead? The reason is that there is little incentive to conserve the space for other uses. What would happen if airlines charged for and assigned bin space like they do seats? I predict you would rarely encounter a coat or small bag in the bin.

    These are just a couple examples to get you started. What other Econ 101 principles have you seen at work on the road? While you’re pondering that, see if you can devise a rational answer to this puzzler: why don’t airlines assign overhead bin space? Leave a comment below!