Category Archives: public choice

Teleological political theory

Posted on by

Timothy Taylor writes,

It can be hard for group with weak hierarchies to make decisions. Group members need to find a balance between making their own contributions in some areas but acquiescing to the group in others. To make this work, it takes a skilled political leadership with a combination of policy-related and hands-on managerial skills, together with group members who see themselves as acting in the context of a broader whole, not just as grandstanding individuals. The US political system seems lacking in these areas.

He is discussing Alan Blinder’s latest thoughts on political economy.

I think that Taylor (probably Blinder, also) starts with what I might call a teleological political theory. That is, the political process is trying to achieve some end. When you think of the desired end result as, say, the greater foodgood, then you wonder what sorts of individuals and reforms will best achieve that end.

An alternative perspective, which comes automatically to someone familiar with public choice theory or Austrian economics, is that markets and political processes produce outcomes on the basis of behavior. Behavior in turn is governed by incentives and cultural norms. Neither market processes nor political processes can be understood in teleological terms. You have to try to understand them as they are.

I think that the belief that we would have better political outcomes if we had “skilled political leadership with a combination of policy-related and hands-on managerial skills” is naive and dangerous.

High Fixed Costs and Public Goods

Posted on by

The June 2017 issue of Cato Unbound looks at how the private sector could provide public goods. It considers the idea of what Alex Tabarrok calls a Dominant Assurance Contract.

Alex writes,

The dominant assurance contract adds a simple twist to the crowdfunding contract. An entrepreneur commits to produce a valuable public good if and only if enough people donate, but if not enough donate, the entrepreneur commits not just to return the donor’s funds but to give each donor a refund bonus. To see how this solves the public good problem consider the simplest case. Suppose that there is a public good worth $100 to each of 10 people. The cost of the public good is $800. If each person paid $80, they all would be better off. Each person, however, may choose not to donate, perhaps because they think others will not donate, or perhaps because they think that they can free ride.

Now consider a dominant assurance contract. An entrepreneur agrees to produce the public good if and only if each of 10 people pay $80. If fewer than 10 people donate, the contract is said to fail and the entrepreneur agrees to give a refund bonus of $5 to each of the donors. Now imagine that potential donor A thinks that potential donor B will not donate. In that case, it makes sense for A to donate, because by doing so he will earn $5 at no cost. Thus any donor who thinks that the contract will fail has an incentive to donate. Doing so earns free money. As a result, it cannot be an equilibrium for more than one person to fail to donate. We have only one more point to consider. What if donor A thinks that every other donor will donate? In this case, A knows that if he donates he won’t get the refund bonus, since the contract will succeed. But he also knows that if he doesn’t donate he won’t get anything, but if does donate he will pay $80 and get a public good which is worth $100 to him, for a net gain of $20. Thus, A always has an incentive to donate. If others do not donate, he earns free money. If others do donate, he gets the value of the public good. Thus donating is a win-win, and the public good problem is solved.

I think of a public good as a special case of a more general problem, which is that it is often the case that average cost exceeds marginal cost. In fact, one of my main complaints about courses in basic microeconomics is that they focus on the opposite situation where marginal cost exceeds average cost, which is is not so often observed in reality.

For example, if you are building a cell phone network, the fixed cost of the infrastructure will be high. However, once you have the infrastructure, the marginal cost of transmitting a gigabyte of data will be low. If you charge this low marginal cost, you will never recover your fixed cost. Instead, you need customers to “donate” to pay for the infrastructure. The “donation” comes in the form of a monthly subscription fee.

In a typical cell phone pricing model, the charge for using data is zero until you reach your limit, and then it is ridiculously high. This model helps facilitate price discrimination. You pay a higher subscription fee to be in a higher data tier, meaning that you face the zero price at higher levels of data usage. Price discrimination of this sort helps the cell phone company recover fixed cost while making sure that most customers are charged low marginal costs most of the time.

The cell phone company has the ability to exclude non-subscribers from getting its service. With a public good, such as national defense, you no longer can exclude particular individuals. Either everybody gets it, or nobody gets it. Call this the non-excludability property.

Note: The textbook definition of a public good is one that is non-excludable and non-rivalrous. What I am suggesting here is any good that has very low marginal cost is “pretty close to” non-rivalrous. These “pretty close to” non-rivalrous situations are very common. {And with the Internet, they become more common. As maps turned into Google Maps, the marginal cost of producing a tryptich plummeted. As travel agents became TripAdvisor, the marginal cost of vacation planning services plummeted. etc.] Those that are also non-excludable, and therefore meet the textbook definition of public goods, are less common.

Governments, like private firms, can and do use price discrimination and bundling to cover fixed costs. People pay different tax amounts. People receive bundles of services–you pay for trash collection and government schools, even if you desire one but not the other.

Non-excludability is a different issue. Governments typically solve the problem of non-excludability by using coercion–you are forced to “donate.” Coercion produces the “everybody gets it” outcome instead of the “nobody gets it” outcome.

Alex’s contract is an alternative to coercion. The idea is that a typical consumer will receive a small benefit in the “nobody gets it” outcome, but only if that consumer is willing to donate. With the “everybody gets it” outcome, the consumer gets a benefit above that consumer’s willingness to pay. That is the sense in which either outcome is a win for a consumer who is willing to donate, so that it is in the consumer’s interest to be willing to donate.

My problem is that I cannot see a way to combine Alex’s contract with price discrimination and bundling. And I think that price discrimination and bundling are very important for funding government in practice.

Title Insurance, Blockchain, and Reality

Posted on by

A reader points me to this report from Goldman Sachs, from last year, on applying Blockchain to title insurance.

We estimate that blockchain could drive cost savings of approximately $2 – $4bn as a result of reductions in headcount and actuarial risk. We believe blockchain could streamline the manually intensive process of property title search, introducing significant headcount cost savings into the system. In our base case, we estimate that blockchain could drive $2.3bn in headcount savings, primarily driven by a 30% reduction in fixed headcount personnel in search & examination as well as abstract and curative functions, combined with a 20% reduction in variable expenses from agent commissions and sales & marketing

The obstacles to a better title system have nothing at all to do with technology.

1. You could get most of these savings without any technology, just by switching to a Torrens title system.

2. The number of Congressmen willing to risk re-election to improve the title system in any way? 0

Restrict Supply, Subsidize Demand

Posted on by

The Los Angeles Times reports,

Home builders are not keeping up with demand for homes in California. There just aren’t enough homes being built relative to the growing number of households in California.

What is the “solution” to this supply problem? Subsidize demand:

a lot of local municipalities have first-time home buyer-assistance programs, and people should look at those programs in their area. You also may be able to qualify for additional assistance as a first-time home buyer based on your occupation, for folks like teachers, firefighters and law enforcement.

And people wonder why housing in California keeps getting less affordable.

Empirical Public Policy

Posted on by

James R. Barth and Stephen Matteo Miller write,

Testing whether it is good policy to increase bank capital requirements from 4 percent to 15 percent requires calculating and comparing the benefits and costs of such a change. Across all tested cases, it becomes clear that the benefits of increasing the capital ratio from 4 percent to 15 percent equal or exceed the costs.

This is an interesting example to discuss.

1. I am very confident that I could find problems with their methodology. This is an area in which empirical analysis is much less definitive than the authors suggest. I would say that their abstract is an example of lack of humility.

2. Nonetheless, I am very sympathetic to their conclusion.

3. In fact, many economists, left and right, are sympathetic to their conclusion. It would be hard to find a prestigious academic economist who is opposed to higher capital requirements for banks than what we have now. Unless these guys count.

4. But I bet that in fact capital requirements for banks will remain low, almost surely with obscure loopholes that make them even lower than the stated levels. It would not surprise me to find that capital requirements are so low that they are not binding, meaning that many banks will maintain capital ratios well above the minimum.

5. Speaking of my opinions, in Specialization and Trade I claim that government intervention in markets generally consists of subsidizing demand and restricting supply. This is inconsistent with any optimal intervention to address market failure.

6. Another presumption of mine is that housing policy will be dysfunctional. In addition to subsidizing demand and restricting supply, it will discourage saving and instead encourage indebtedness.

My claims in (4) -(6) might fall under the heading of “empirical public policy.” That is, what sorts of public policies can we expect? These questions are under-researched. On the other hand, economists over-research the topics of market failure and optimal policy solutions.

Implicit in this research imbalance is a very optimistic view of government intervention. It helps ingratiate economists with people in power. In effect, the economist says to the politician, “You are a wonderful public servant. I, the wise technocrat, am here to help you in your benevolent endeavors.”

Thus, the empirical policy economist is both obsequious and self-flattering. What gets lost is the opportunity to provide the public with a realistic comparison between the political process and the market process.

Sugar and the Kling Public Choice Theory

Posted on by

Glenn Reynolds writes,

Government policies promoting sugar, in no small part, got us into this mess. Without the government’s recommendations to avoid dietary fat that led to increased sugar consumption, many Americans would probably be thinner, or at least less obese. And then there are the subsidies.

The Kling theory of public choice is that government acts to subsidize demand and restrict supply. In this case, it subsidizes demand with food stamps and restricts supply with measures against imports.

Montgomery County (Md) Politics

Posted on by

A commenter asks,

You’ve mentioned many times that Montgomery is owned part and parcel by the teacher’s unions. . .what aspects of county government do they control, and how?

Don’t take my word for it. Take theirs.

“It was the Unions that put Duchy in office n it was the Unions that took her out. Justice served!” read a text message forwarded at 1:24 a.m. Wednesday by John Sparks, head of Montgomery’s firefighters union.

Trachtenberg netted support from public employee unions four years ago but later challenged what she considers unsustainable compensation packages. The cost of government salaries and benefits have soared over the past decade in Montgomery and are a key driver of ongoing budget problems in the wealthy county.

That was 2010 and it was the firefighters’ union that threw her out. But four years earlier, it was the teachers’ union that put her in.

Political observers say the incumbents could be facing tough reelection battles. Four — Floreen, Subin, Phil Andrews (D-Gaithersburg-Rockville) and Marilyn Praisner (D-Eastern County) — failed to capture endorsement from the county’s influential teachers union.

The candidates backed by the teachers’ union won, leading someone an observer to comment.

MCEA was upset that Floreen and Subin had supported delaying a 2003 cost-of-living increase that was due to teachers under their contract because of budget problems. As a result, Leventhal and challengers Elrich and Trachtenberg made the Apple Ballot, while incumbents Floreen and Subin were excluded. The Apple candidates won the top three slots, while Floreen earned the fourth seat and Subin lost. Subin’s loss was particularly notable because he was a 20-year council veteran and the long-time head of the council’s education committee.

The author concludes,

So what does the Teachers’ emergence as Montgomery County’s dominant political force mean for the future? With property tax growth slowing down, the next county council will face tough budgetary decisions. Public schools account for half of the county’s budget and would be an obvious location for cuts. But don’t expect any action there: the county’s politicians have learned that those who cross the Teachers Union once are unlikely to be given a second opportunity.

An increasing share of that budget is going to pensions and non-teaching staff who are union members. Actual classroom teachers are badly over-worked.

Because spending per student is by far the highest in the state, the WaPo constantly refers to Montgomery County as a high quality school system. However, the average outcomes in the County schools are mediocre. Students from the wealthiest parts of the County (three high schools in particular) produce good test scores, and the rest do not. Other school districts in Maryland get similar outcomes with students of similar backgrounds while spending much less money per student.

I know relatively little about Education Secretary Betsy DeVos. But I see the teachers’ union as an enemy, and they see her as an enemy. Ergo, I am inclined to view her in friendly terms.

The Economics of a Border-Adjustment Tax

Posted on by

Timothy Taylor writes,

Most countries around the world and all high-income countries other than the United States have “border adjustments” in their tax code, but a key point to recognize is that border adjustments are typically part of a value-added tax–not the corporate income tax.

. . .the Trump administration proposal for revising the corporate income tax is actually a first-cousin-once-removed of a value-added tax.

Taylor cites scholars of various political persuasions in support of this analysis. Greg Mankiw makes a similar point. If you prefer taxing consumption to taxing saving and labor, then you should get to know the economics of the border-adjustment tax in the context of a shift from taxing corporate profits to taxing corporate net revenue.

But John Cochrane points out

a tax system in which you tax $100 of sales, but offer $99 of deductions (costs, wages, earnings retained for investment), then tax only the last $1, then tax that $1 again as personal income, would seem to offer lots of room for shenanigans on just what gets deducted. Along with interesting financial engineering to “invest” more earnings and pay less dividends and interest.

The more radically you reform taxes, the more you risk creating new distortions, both foreseen and unforeseen.

Tyler Cowen has a point about politics.

I say anything complicated they will just screw up, and the lack of transparency in the plan means eventually it will lead to a tax hike and furthermore a good deal of favoritism and rent-seeking along the way. Best hope is simply that they cut the corporate tax rate and don’t do much else on that front.

It is true that lowering the corporate tax rate would reduce the malincentive effects of loopholes in the tax. Lowering the stakes involved would lower the rent-seeking. Also, simply lowering the rate seems less risky (see John Cochrane’s whole post.

The economic theory of how a border-adjustment tax should work is worth knowing. However, theory tends to apply to concepts in the abstract. In practice, a lot of tax policy turns on what gets defined as taxable and what does not. And those regulatory and legislative decisions are where the rent-seeking and the distortions kick in.

Noah Smith on Higher Education Policy

Posted on by

He writes,

As long as the number of available college spots remains roughly fixed, reducing the price of college will have only a very modest effect in creating broad-based economic opportunity.

My recommended solution is to focus on increasing the number of college spots available. Those could be four-year university slots, or vocational education — a mix of both would probably be best. But the key is that supply should go up.

Pointer from Mark Thoma.

Of course, from an economic point of view, Smith’s point is spot on. However, the Kling Theory of Public Choice is that public policy will always choose to subsidize demand and restrict supply. That is what is most in the interest of incumbent suppliers, who are the drivers of public policy.