Archive for the ‘Regulation’ Category

Charting Regulation

Much of the work I do is in the area of regulation. It is always a challenge to convey how much the regulatory state has grown (yes, I know, we can count the pages in the Federal Register). Two scholars as the Mercatus Center (Patrick McLaughlin and Omar Al-Ubaydli) have developed RegData, a wonderful tool for measuring the size and scope of the regulatory state. The updated version of the program (currently in beta) allows one to chart the growth in regulatory restrictions between 1997 and 2012. For example, here is the chart representing the growth of regulations on an economy wide basis:


One can also examine regulations on specific industries and compare industries. For example, here is a chart on the growth of restrictions in (1) Primary and Secondary Education and (2) Scientific Research and Development Services.


As you will note, the charts do not include a legend—a flaw that I hope can be remedied. Here is a simple question on the above chart: which line represents education and which line represents scientific research and development? Hint: in one of these two sectors, the US a world leader. In the the other, it is a laggard. I wonder if we could move toward developing some testable hypotheses?

For a discussion of RegData 2.0, you can see a piece by Patrick McLaughlin at The Hill.

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The “license Raj” is an epithet often used for India’s byzantine code of rules and regulations on businesses under the central-planning system finally dismantled in part in the 1990s. The Economist applies the term to the United States, which buries entrepreneurs under layers of federal, state, and local red tape. According to the Competitive Enterprise Institute, the gross cost of federal regulations alone amounts to about $15,000 per household per year, and that doesn’t include the accumulated debt of lost growth due to regulation, which may be much higher. And none of that includes the costs of state and local regulations, such as occupational licensing, which has increased dramatically in the last 60 years, now covering up to 35% of the workforce.

The Economist cites thumbtack.com surveys showing that small business owners care more about the burden of regulation than taxation (about two-thirds of them say that they pay their “fair share” in taxes, as opposed to more or less than their fair share). This preference comes as no surprise to me. Apart from the soul-deadening effects of endlessly parsing legalese and filling out form after form, regulation also tends to substitute the grand (or petty) design of a bureaucrat or politician for the price signals the market provides. When regulation limits competition under the pretense of ensuring quality for the consumer, incumbent producers benefit, but potential upstarts lose, and so do consumers. There is a net cost to society. When local governments require construction companies to obtain permits for every little thing they do, rather than simply requiring them to post a bond and pay for any damage they may cause to local infrastructure or neighboring buildings, less desirable construction happens, and the costs of regulatory compliance are also pure loss.

The thumbtack.com ratings of state regulatory environment correlate highly with both Chief Executive magazine’s survey of CEOs on state regulation and with the regulatory index found in Freedom in the 50 States. CEOs of large companies and small-business owners really want the same thing: a streamlined government that works. We’re not as bad as Argentina or Belarus, but here in the U.S., we suffer from plenty of kludge, and everyone pays the price.

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In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.” Dodd-Frank was a massive piece of legislation (the Economist quipped that it was too big not to fail). One of the key criticisms was that so much of what Dodd-Frank aspired to do was delegated to rulemaking in the regulatory agencies. Ultimately, whether Dodd-Frank would prevent another financial crisis would depend on the quality and compatibility of some 398 rules.

One of the many targets of Dodd-Frank was the securitization process. In the days of traditional banking, banks financed their loans with deposits and then retained those loans until they matured (the “originate-to-hold” model). Because they had skin in the game, they had incentives to lend only to credit-worthy borrowers. But increasingly, this model was replaced by the “originate-to-distribute” model wherein banks would sell their loans to other parties that would, in turn, pool them and sell shares to investors (the securitization process). The securitization process changed the incentive structure. Lenders no longer had skin in the game and were thus far less interested in the question of whether borrowers could document their ability to meet their obligations. (more…)

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Roger Koppl argues this week at ThinkMarkets that “Income inequality matters.” He thinks it matters so much that he says it twice. He believes “Austrian,” pro-market, economic liberals should be speaking up more on this “central issue.” I think Koppl could not be more wrong. The issue deserves all the inattention we can muster for it.

The problem I think is not Koppl’s motives. He rightly says that we should “watch out for ways the state can be used to create unjust privileges for some at the expense of others.” He is certainly right about that. He argues that unjust state policies may be skewing market results in such a way as to increase inequality. He may be right about that. But he is wrong in suggesting that we ought therefore to be paying attention to income inequality. We ought therefore to be paying attention to those policies. Whether they produce greater inequality is neither here nor there.

Koppl gives four examples: (i) policies that privatize profits and socialize losses, (ii) bad regulation, (iii) collapse of the rule of law, and (iv) public schools. I can certainly join Koppl in a hearty wish that we not only attend to these unwarranted policies, programs, and tendencies, but that we do so with a degree of urgency prompted, in part, by their effects on the poorest and most vulnerable among us. But talking about inequality is precisely a distraction from doing so.

In a great paper of a few years ago, Harry Frankfurt argued that “Egalitarianism is harmful because it tends to distract those who are beguiled by it from their real interests.”* Frankfurt thought that focusing on equality was actually pernicious because it distracted us from attention to real harms, of which inequality is at most an indicator. And he was right. It may well be that, for example, the evisceration of the rule of law results in greater income inequality. But it also might not. Whether or not it does so, however, it is unjust, and it deserves our attention. Similarly for the increase in moral hazard and regulation, to say nothing of the deplorable system of public education. All of these need attention, and one prime reason they do so is because of their effects on those least capable of circumventing their evils. If we care about the poor, what we ought to care about is bad policy, not indicators that may or may not have anything to do with policies that are making people worse off. As long as we are worrying about income inequality, we are worrying about the wrong thing.

* In “The Moral Irrelevance of Equality,” Public Affairs Quarterly, April 2000.

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The standard account of regulation focuses on problems of market failure. One form of market failure stems from information scarcity or informational asymmetries. Regulations can deal with this kind of market failure by requiring information disclosure using standard metrics, often in a form that is assessable to relatively unsophisticated actors.  This form of regulation can be quite useful in promoting mutually beneficial exchanges between consenting adults.  Example: the Federal Trade Commission’s Used Car Rule requires dealers to post a buyers guide on used cars that inform the customer of basic information (e.g., is it being sold “as is” or is there a warranty). Presumably, this reduces informational asymmetries and facilitates exchanges.  Regulation by information can also reduce more intrusive expressions of government power. For example, the Securities and Exchange Commission requires firms to disclose their financials so that potential investors can make informed decisions. It does not, however, bar firms with a higher probability of bankruptcy from entering capital markets. Regulations facilitate exchanges and regulation by information does so with minimal state intrusion.

Paul Krugman has a piece today in the NYT (“Friends of Fraud”) decrying the GOP threats to block the confirmation of Richard Cordray as head of the Consumer Financial Protection Bureau created under Dodd-Frank.  Having lost the battle over Dodd-Frank, they want to strip the new bureau of its independence and are using the appointment to leverage the changes in question.  Krugman’s take:

What Republicans are demanding, basically, is that the protection bureau lose its independence. They want its actions subjected to a veto by other, bank-centered financial regulators, ensuring that consumers will once again be neglected, and they also want to take away its guaranteed funding, opening it to interest-group pressure. These changes would make the agency more or less worthless — but that, of course, is the point.

How can the G.O.P. be so determined to make America safe for financial fraud, with the 2008 crisis still so fresh in our memory? In part it’s because Republicans are deep in denial about what actually happened to our financial system and economy. On the right, it’s now complete orthodoxy that do-gooder liberals, especially former Representative Barney Frank, somehow caused the financial disaster by forcing helpless bankers to lend to Those People.

Elizabeth Warren (the policy entrepreneur who fought for a new consumer protection agency) was an expert in bankruptcy (before winning the Senate race) and she documented the large percentage of prime borrowers who were directed into subprime vehicles (I don’t recall the exact figure, but I believe it was around 25 percent). Others signed on to mortgages they didn’t understand, in part, because the terms of the agreement and the consequences were sufficiently obscured by the issuers. The problems of information asymmetry were significant, particularly for the less sophisticated borrower.

A few points of clarification: I think Dodd-Frank was bad legislation for a host of reasons that are beyond the scope of this posting. I do not think that the evil mortgage broker exploiting the hapless rube was the source of the financial crisis. Nor would I agree with Krugman’s portrayal of the crisis. There was so much more going on in this tale of crony capitalism, transfer-seeking, and failed regulation. But there is good evidence that many (not all) borrowers were exploited in ways that cost them dearly. I am at a loss to understand why the regulation of the kinds of mortgage instruments that are sold and the information provided to borrowers is so objectionable, particularly when (as noted above) it can facilitate functioning markets.

Quick question to the skeptics: when is the last time you read the information that was provided before you clicked “accept” and upgraded to the newest version of iTunes or installed the newest fix to whatever problem was discovered in your word processing or spread sheet program? Do you know what you agreed to? Now imagine a relatively unsophisticated borrower signing off on a 20-page document, having concluded that the mortgage broker told them all they needed to know about the agreement.

Bottom line: even those who support market governance can make  a compelling case for regulation, particularly when it involves the provision of information that facilitates voluntary exchanges.

Question: is there a credible argument to be made against the Consumer Financial Protection Bureau?  Note: the claim that all regulation is bad is not a credible argument.

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Regulating the Wrong Things?

As the debates over regulating guns continue to gain speed in the wake of the mass shooting in Connecticut, attention has turned (as one might expect given the circumstances) to assault weapons. One problem is the difficulty on defining one’s terms. As Erica Goode explains in an enlightening piece in the NYT (“Even Defining ‘Assault Rifles’ is Complicated”).

There is general agreement that an assault rifle is a semi-automatic with a detachable magazine (for those who have not spent much time around firearms, semi-automatics fire one bullet per pull of the trigger. This distinguishes them from automatics or “machine guns,” which are illegal). But there is any number of semi-automatics with these features that would not fall into the category in question. Thus, we move to additional features:

Those could include features like a pistol grip, designed to allow a weapon to be fired from the hip; a collapsible or folding stock, which allows the weapon to be shortened and perhaps concealed; a flash suppressor, which keeps the gun’s user from being blinded by muzzle flashes; a muzzle brake, which helps decrease recoil; and a threaded barrel, which can accept a silencer or a suppressor. Bayonet lugs or grenade launchers are also sometimes included.

Of course, none of this addresses the action or the caliber of the cartridge, and thus does not speak to the killing capacity of the rifle. This small fact did not seem to bother the authors of the Public Safety and Recreational Firearms Use Protection Act of 1994, which defined an “assault weapon” as a semi-automatic rifle with a detachable magazine that had two or more of the above listed features.  As critics might note, this was regulation by cosmetics.

Last weekend, I attended my first gun show outside of Milwaukee (largely as an anthropological experience). There were several tables selling kits that would allow one to add some of the features described above. Many rifle owners like to customize their guns. I can’t imagine that anyone who bought an rifle without the features listed above would have any difficulty adding the desired components in his or her basement.  I would suspect that even if by some miracle Congress reinstated the 1994 legislation, it would not constitute much of a barrier to those who want to customize their firearms.

At the same time, I can’t believe that new regulations would have much of an impact on the murder rate given the simple fact that most firearm-related homicides are committed with handguns.

The FBI Uniform Crime Reports inform us that in 2011, there were 12,664 murders in the United States. Of this sum, 6,220 were committed with handguns and another 323 with rifles. By way of comparison, 1,694 were committed with knives, 496 with blunt objects, and 728 with “personal weapons” (a category that includes hands, fists, and feet). In case you are interested, 2011 was not anomalous. I took the FBI data from the past decade and produced the following graph:

Handguns v Rifles

Should there be stricter regulation of handguns? This is a difficult question to answer with precision for two reasons. First, the FBI (to my knowledge) does not report data on what percentage of the handgun-related murders were committed by individuals who had acquired their weapons legally. Second, the regulations vary dramatically by state. In Connecticut, one has to attend a handgun training course, get fingerprinted, and go through a rigorous background check before one can purchase a handgun (certain categories of individuals—felons, those who have been hospitalized for mental illnesses, are under restraining orders, or were received a less-than-honorable discharge from the armed forces—are automatically excluded). In other states, the regulations are far less demanding.

Bottom line: while the current debates have been animated by “assault weapons,” the empirical evidence suggests that rifles (regardless of their cosmetics) are not the core problem.  Of course, a cynic might suggest that this fact only increases the likelihood of a new assault weapon ban.

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I find this to be an interesting and frustrating topic. Let me take a somewhat different approach to it, one that I use when I engage the issue in a policy class I teach.

I begin with two assumptions.

  1. There is a universal desire for intoxication among human beings. This is clearly exhibited by the demand for intoxicants both cross nationally and over time.
  2. There is a justification for regulating access to intoxicants. Even “smoke em if you got em” libertarians do not condone distribution of intoxicants to minors (even if they might quibble over the precise age that prohibition should end).

From this point, I believe that one can make a strong case that regulations should be designed to channel the universal desire for intoxication toward those intoxicants that are the least harmful (and thus carry fewer negative externalities). One might imagine that this could be accomplished via taxation. This would be good news for those who enjoy  psilocybin mushrooms or marijuana; bad news for those who smoke cigarettes or crystal meth. One might assume that such a regime—rather than a blanket prohibition of anything other than alcohol and tobacco—would create incentives for those seeking intoxication to replace a more toxic drug with a less toxic drug.

As a generalization, I am far more comfortable with laws that focus on the activities one does while intoxicated rather than criminalizing the mere fact that one gets intoxicated or is in the possession of intoxicants.

For example, while I would not criminalize the possession or use of intoxicants, I would have no problem with a zero-tolerance policy on driving while intoxicated (or engaging in other activities that require sobriety) backed with significant criminal penalties.

One can also imagine that the market would come to play a significant role. Some private insurers already have risk-based schemes in place (for example, life insurance is more expensive for cigarette smokers—and yes, they will take a urine sample—than for non-smokers). Given that this is a private and voluntary transaction between adults, I have no problem with setting rates based on risk. One can imagine that if we had drug regulations that focused on the toxicity of intoxicants, insurers would follow suit.  Certainly, employers, landlords, car rental agencies…you name it…could adopt comparable schemes.  They are free to control their property and those wishing to engage in voluntary transactions with these firms are free to walk away from any arrangement they find overly invasive.

There are other unresolved questions. If we moved toward a harm-based regime for drug regulation, would the government or some third party need to assume a role in regulating or certifying the purity of the drugs in question? There is a strong case for this.

Let me give a brief anecdote. A few years ago, the price of cocaine had fallen dramatically. While demand was relatively stable, there was an oversupply (more evidence of our successful war on drugs). Dealers who could no longer make a profit selling cocaine, moved into heroin. Unfortunately, they did not have sufficient experience in cutting the heroin so there was both wild variability in the purity of the heroin and the stuff that was being used to cut it.  As one might predict, the end result was a spike in deaths due to overdoses in Connecticut and other states in the New York area. I knew one of the victims quite well.  Regulation of purity would have prevented such an occurrence. If we are intent on reducing harm, then regulation of drug purity would appear to be a necessity.

While I still mourn the death of the young man who died from a heroin overdose, I also mourn the deaths of several friends who died from consumption of legal intoxicants (for example, three of my friends have died of lung cancer in the past few years, aged 51, 60 and 64). There is strong statistical evidence that the legal intoxicants they consumed impose a far greater cost on society than many of the alternatives that are criminalized.

Bottom line: A harm-based regime that channeled the universal desire for intoxication into less toxic alternatives won’t solve all the problems. But it seems like a reason-based approach that would be a massive improvement over our pyrrhic war on drugs.

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As a resident of Connecticut, I have followed the events surrounding the Newtown shooting with great interest and sadness. By way of full disclosure, I am a hunter. When I was a child in Wisconsin, my father took his sons to gun safety classes taught in the basement of the local police department. Both of my sons went through hunter training courses before they joined me hunting pheasants (neither really liked hunting, but at least I knew that they understood to respect firearms, use them safely, and lock them up when not in use). I have never hunted with a semiautomatic weapon. I find it unsportsmanlike.

I am sympathetic to the claim that some may want firearms for home protection (although as a friend of mine—a Marine sharpshooter and Connecticut state trooper—notes, the best weapon for home defense is a shotgun, not a semiautomatic pistol or an assault rife. Unless one is trained for combat, one loses fine motor skills under stress and is likely incapable of using these weapons effectively or accurately).

With these disclosures in mind, what to make of Newtown?

John Kingdon’s classic work Agendas, Alternatives, and Public Policies made the case quite persuasively that in the world of public policy, there are many solutions waiting for a problem to happen.  Crises can open a window of opportunity for policy change. In Kingdon’s words:

“When a window opens, advocates of proposals sense their opportunity and rush to take advantage of it.”

Often, this occurs immediately. Policy advocates know that windows of opportunity open, but they can close rather quickly.

The tragic shooting in Newtown most certainly created a window of opportunity for policy change. One could have anticipated the political response ex ante, although there were a few surprises along the way.  On Sunday’s Meet the Press, for example, one commentator noted that the shooting should give anyone pause who wants to cut Medicare and Medicaid entitlements, given the funding they provide for mental health issues (the fact that the shooter was 20 from an affluent family seemed immaterial).

It is difficult to discern what lessons one should draw from the Newtown shooting. Those who want to use the shooting to make the case for more demanding gun regulations face the problem that Connecticut already has some of the most stringent gun controls in the country and the guns were purchased legally. Those who want to restrict interstate sales and the loopholes for gun shows face similar difficulties given that neither would have prevented the tragedy. Those who want to make the argument for greater public funding for mental health treatment face the problem that the shooter was from an affluent family; the lack of public funding was not an issue.

Advocates of an assault weapon ban (similar to that created under the Public Safety and Recreational Firearms Use Protection Act of 1994) may stand on firmer ground, given that the shooter used an assault rifle (a Bushmaster .223).  But the 1994 law did not ban semiautomatic rifles (automatic rifles are already illegal for all intents and purposes) nor did it ban the .223 Remington cartridge. It did ban the manufacturing of magazines that were capable of holding 10 or more rounds of ammunition (by comparison, semiautomatic big game rifles—unaffected by the assault rife ban—have clips that hold 5 cartridges). One wonders how great a barrier such a restriction would have posed, given that the shooter was armed with two semiautomatic pistols (legal under the assault rifle ban) and smaller clips could be ejected and replaced in a matter of seconds.

In my mind, the chief lesson of Newtown is a difficult one: even when you have strict gun laws (as Connecticut clearly has) and citizens abide by those laws (the owner of the guns reportedly purchased all guns legally), tragedies can nonetheless occur.

There is little question that gun violence is a problem in the US. Although violent crime has been in long-term decline in the US, the FBI reports there were 68,720 murders between 2007-2011. Of that number, 46,313  (67.4 percent) were committed with a firearm. But of this number, 1,874 murders were committed with rifles (in contrast, 2,945 were committed with blunt objects like clubs or hammers). Handguns were the weapons of choice. With respect to handguns, most were likely acquired illegally (my guess. I am not certain that the FBI publishes that data).

Some readers of Pileus may want to make the argument that any regulation of firearms is an infringement of our Second Amendment rights. Let the comments fly. When I used to take my sons hunting, I took some comfort in knowing that anyone we encountered in the field had undergone some training on the safe use of a firearm.

If President Obama and the Congress turn to gun control in the wake of the Newtown tragedy, one can only hope that they ground policy in a broader understanding of gun violence rather than searching the events of last week for lessons that may not exist.

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A casualty of “pro-consumer” financial regulation. John Stossel is on the story:

Today, Americans were told that they must close their Intrade.com accounts. That happened because the federal government agency known as the “Commodity Futures Trading Commission” (CFTC) today sued the prediction market, where people from all over the world bet about things like who will win elections.

Intrade decided all its U.S. customers must now close their accounts and withdraw their money from the site.

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There is an interesting piece by John Bresnahan (Politico) on Countrywide Financial’s VIP Program, which provided loans to members of Congress, staffers, and executive branch officials who were responsible for shaping regulatory legislation.

More than a half a dozen current and former lawmakers, including Senate Budget Committee Chairman Kent Conrad (D-N.D.) and House Armed Services Committee Chairman Buck McKeon (R-Calif.), obtained mortgages through the Countrywide VIP program, in some cases saving thousands of dollars, according to the Issa report, set for release Thursday….

Other lawmakers who received Countrwide VIP loans include former Sen. Christopher Dodd (D-Conn.), Rep. Edolphus Towns (D-N.Y.), Rep. Pete Sessions (R-Texas), Rep. Elton Gallegly (R-Calif.) and former Rep. Tom Campbell (R-Calif.). Dodd, who chaired the Senate Banking Committee, was identified as a Countrywide VIP going back to 1999, and he even referred an aide to a former GOP senator to the same program, Issa’s probe found.

No real surprises here for anyone acquainted with public choice, but the piece is nonetheless worth a read, particularly for those interested in how Countrywide worked with the GSEs to shape (and derail) reform legislation that might have limited the magnitude of the collapse and the subsequent contagion.

Thankfully, many of the recipients of Countrywide’s munificence were involved in framing Dodd-Frank.

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It seems that all we have heard of late is about the sharp partisan battles in Congress that have placed it in a gridlock and prevented it from working in a bipartisan fashion to “do the nation’s business.” Yes, the “do nothing Congress.”

But there are exceptions to this description.  Given the depth and severity of the financial collapse, it is good to see bipartisanship in addressing the issue of financial regulation, or more correctly, providing exemptions when there are mutually beneficial exchanges to be made.

As John Bresnahan reports, the prospects look good for a “one sentence bill worth $300 million to a bank owned by a politically connected family that has doled out hundreds of thousands of dollars in campaign donations.”

The bill would allow Emigrant Bank to avoid meeting the requirements for Tier 1 capital by allowing it to base capital requirements on what its assets were on March 31, 2010, before it broke the Dodd-Frank threshold of $15 billion. Of course, the argument is that the bank only broke the $15 billion mark for a brief period of time. By tweaking Dodd-Frank, Congress could allow the bank to free up funds, thereby allowing it to make additional loans, largely in New York.

Although the bill was sponsored by a Republican (Rep. Michael Grimm, R-NY), it has strong bipartisan support from members of the Financial Services Committee (success in the Senate remains uncertain). Why the support? Howard Milstein, owner of Emigrant Bank, was “a bundler for President Barack Obama’s 2008 campaign.”  Bresnahan provides some additional details on Milstein:

He is a force in New York state politics. Aside from his fundraising for Obama four years ago, Milstein has been a prominent financial backer of Gov. Andrew Cuomo. The Democrat tapped Milstein last year to head the New York State Thruway Authority despite complaints by watchdog groups that having a real estate mogul run the agency would be a conflict of interest.

Even Diana Cantor, wife of House Majority Leader Eric Cantor (R-Va.), worked for a Milstein-owned trust that catered to the needs of high-income customers.

The Milsteins, along with business associates and other family members, have donated hundreds of thousands of dollars to both GOP and Democratic lawmakers over the past decade. Along with Grimm, New York Democratic Reps. Carolyn Maloney, Carolyn McCarthy and Gregory Meeks — all co-sponsors of the bill — have received $11,500 in donations from the Milsteins this cycle.

According to a statement by Emigrant Bank, “H.R. 3128 is all about credit availability in underserved communities throughout New York City.” Perhaps. But one might also note that so many of the poor decisions leading up to the recent collapse (e.g., regarding relaxed underwriting standards, securitization, and the GSEs pumping liquidity into the low and moderate income segments of the market) were given the same justification, often by members of the House Financial Services Committee.

There is a powerful public choice argument regarding some of the factors that contributed to the financial collapse. In the election cycles leading up to the financial collapse, the securities and investment industry and real estate industry contributed tens of millions of dollars to the campaign chests of the Financial Services Committee and its Senate counterpart. Regardless of the party in control, the committee members prevented and/or gamed any attempts to impose regulatory reforms that might have had lessened the severity of the impending financial collapse. Certainly Congress responded in the aftermath of the collapse, albeit it ways that were far from sufficient.

But now that attention has turned elsewhere, normal practices appear to have resumed. The days of reform have run their course and Congress appears ready to return to its standard mud farming, imposing new regulations only to relax when a mutually advantageous deal can be struck.

At least we know that in 2012, gridlock has its limits and bipartisanship is still a possibility.

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Which public policies make an economy better for business? One way to answer this question is to ask businesspeople. Two recent surveys ask businesspeople to rank the American states on their friendliness toward business.

Now, libertarians often remind us that friendliness toward business is not the same as friendliness toward markets. Indeed, libertarians believe that many of their favored policies, such as abolishing trade protection, corporate welfare, and regulations that privilege big business, will redound to the benefit of workers and small business owners. What’s so interesting about these two surveys is that they are of different types of business owners: CEOs of large companies and small businesspeople. The first survey was conducted by Chief Executive magazine and the second by thumbtack.com in partnership with the Kauffman Foundation. By relating respondents’ views about the friendliness of their states to those states’ actual policies, we can see where big and small businesses agree and disagree about which policies are most important for their success.

My first step was to draw out of these survey data those numbers that relate specifically to different states’ policy environments, as opposed to other aspects of the economic climate. From the CEO survey, therefore, I took the taxation/regulation score given for each state (higher is better). From the small business survey, I took the “Regulations” component grades. Unfortunately, the small business survey does not include raw scores for each state, so I simply quantified the grades as follows: A+ = 0, A = 1, A- = 2, and so on, up to F = 11. The small business survey only covers 45 states, but for these states, the correlation between CEO and small business scores was -0.76. Since higher is better in the CEO survey and lower is better in the small business survey, that high correlation indicates a surprising degree of agreement between large and small businesses about states’ friendliness toward their businesses.

Nevertheless, there may remain some important differences in which policies large and small businesses prioritize. To get a handle on this question, (more…)

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The Institute for Justice has just released a new study of occupational licensing requirements in the 50 states and D.C. These requirements disproportionately harm low- and moderate-income people who are seeking to ply a trade.

License to Work finds that Louisiana licenses 71 of the 102 occupations, more than any other state, followed by Arizona (64), California (62) and Oregon (59). Wyoming, with a mere 24, licenses the fewest, followed by Vermont and Kentucky, each at 27. Hawaii has the most burdensome average requirements for the occupations it licenses, while Pennsylvania’s average requirements are the lightest.

Arizona leads the nation with the worst combination of number of licenses and burdensome requirements to secure those licenses, followed by California, Oregon, Nevada, Arkansas, Hawaii, Florida and Louisiana. In those eight states it takes on average a year-and-a-half of training, an exam and more than $300 to get a license, a tremendous burden for would-be entrepreneurs and workers.

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Interesting to see this come out of the center-left Brookings Institution:

Anti-density zoning — embodied in lot-size and density regulations–is an extractive institution par excellence. Through the political power of affluent homeowners and their zoning boards, it restricts private property rights — the civic privilege to freely buy, sell, or develop property — for narrow non-public gains. Property owners in a jurisdiction benefit from zoning through higher home prices (because supply is artificially low) and lower tax rates (because population density is kept down, as school age children are kept out), while everyone else loses.

Previously, my work has found that zoning laws inflate metro-wide housing costs, limit housing supply, and exacerbate segregation by income and race. Other work faults these laws for their damaging effect on the environment, since they make public transportation infeasible and extend commuting times. With a few possible exceptions…, it’s hard to think of an existing political institution in the United States that is more destructive of human and social capital.

Strong words!

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Regulatory Sprawl

The new edition of the Economist  has some rather entertaining articles on regulation in the US (the cover story: “Over-regulated America”). Little in the articles will come as a surprise to scholars of regulation. But there are many entertaining examples of regulatory sprawl and complexity. Some examples:

“The Federal Railroad Administration insists that all trains must be painted with an “F” at the front, so you can tell which end is which.”

“Every hour spent treating a patient in America creates at least 30 minutes of paperwork, and often a whole hour. Next year the number of federally mandated categories of illness and injury for which hospitals may claim reimbursement will rise from 18,000 to 140,000. There are nine codes relating to injuries caused by parrots, and three relating to burns from flaming water-skis.”

Or Dodd-Frank: “At 848 pages, it is 23 times longer than Glass-Steagall, the reform that followed the Wall Street crash of 1929. Worse, every other page demands that regulators fill in further detail. Some of these clarifications are hundreds of pages long. Just one bit, the “Volcker rule”, which aims to curb risky proprietary trading by banks, includes 383 questions that break down into 1,420 subquestions.”

The growth in regulation has been moderated in the past three decades, thanks in part to the introduction of cost-benefit-based regulatory review at the Office of Management and Budget’s Office of Information and Regulatory Affairs. OMB review has become far more rigorous and transparent overtime. In many cases, there is clear evidence that benefits exceed costs. However, the review process remains focused on “significant” regulations, ignoring the aggregate significance of seemingly insignificant regulations.  Moreover, there is little in the way of systematic analysis of existing regulations, many of which did not meet the significance criteria imposed under the prevailed executive orders (EO 12291 under Reagan-Bush, EO 12886 thereafter).

President Obama’s OMB has called, quite sensibly, for greater efforts at retrospective analysis (e.g., rather than relying solely on the analysis of significant regulations ex ante, when much of the analysis is based on sophisticated guesswork). But there is little to suggest that this will ever become a priority for agencies or that rule revocation—if taken seriously—would be tolerated by Congress, given that most regulations—even the most absurd—have constituencies.

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Here is a clip from Tuesday night’s “Freedom Watch” with Judge Andrew Napolitano. (Freedom Watch airs nightly on the Fox Business Network. If you don’t get FBN, contact your television provider!) The topic was a Reuters paper claiming that 14,215 new regulatory rules were put in place on businesses worldwide in 2012. I was one of three panelists discussing the issue with Judge Napolitano.

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The President has been providing moral support for the OWS protesters during his recent appearances.  How genuine is this support? One might take a clue from the Watergate era’s deep throat and “follow the money.” Thanks to a piece in today’s WaPo, this is not a difficult task. As Dan Eggen and T.W. Farnam report:

Obama has brought in more money from employees of banks, hedge funds and other financial service companies than all of the GOP candidates combined, according to a Washington Post analysis of contribution data….

Obama has raised a total of $15.6 million from employees in the industry, according to the Post analysis. Nearly $12 million of that went to the DNC, the analysis shows.

There are multiple ways of interpreting this. It could be the case that the financial community is simply hedging; even if they would prefer a Republican president, they will put some money down on the incumbent to ensure ongoing access.  But it may also be the case that they are relatively pleased with the return on their investments thus far. After all, things might have been far worse for the industry than Dodd-Frank. Yes, new regulatory legislation was passed, but without the kind of restrictions that Paul Volcker had demanded. Yes, there were verbal assaults on levels of compensation, but in the end, there were no restrictions and nothing more than a plea for voluntary restraint. Yes, there was a new financial consumer product safety unit created, but it was buried in the Fed–an agency that represents the industry–and Elizabeth Warren was thrown under the bus.

There has been a massive disjunction between the President’s rhetoric, on the one hand, and his public policies and fundraising activities on the other As one banking exec who raises funds for Obama noted in the piece, reports of dissatisfaction “are exaggerated and overblown.”  As for the rhetoric: “it probably helps from a political perspective if he’s not seen as a Wall Street guy.”

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I want to piggy-back here on Mark’s great post on urban planning and the poor. I’ve been playing around with some state-level data on local land-use regulations and cost of living. The last decade in the U.S. has been one of very slow productivity growth. As a result, fast-growing states tend to be those with low growth in cost of living. This explains not just states like Texas but North Dakota as well (and at the other end, California). Take a look at the list of states with highest annualized real personal income growth over 2000 to 2007 (the deflator, a state cost of living index, comes from the newest, 2009 Berry et al. data, which explains why the series ends at 2007):

1. Louisiana – 2.8%
2. Wyoming – 2.8%
3. North Dakota – 2.6%
4. South Dakota – 2.1%
5. Oklahoma – 1.9%
6. Arkansas – 1.8%
7. Mississippi – 1.5%
8. Nebraska – 1.5%
9. Montana – 1.5%
10. Kansas – 1.4%

Surprised? These are hardly “knowledge economies.” In some cases, mining or energy accounts for strong growth, and indeed in multiple regression mining share of GDP in 2000 does strongly explain subsequent real personal income growth (per capita or total). And in Louisiana’s case Hurricane Katrina chased away a lot of low-income people. But part of the story is elastic housing supply leading to low growth in house prices during the 2000-2007 bubble. A better measure of state economic success is arguably total rather than per capita income growth, which rewards states that attract people. Here are those numbers:

1. Wyoming – 3.6%
2. Nevada – 3.1%
3. Florida – 3.0%
4. South Dakota – 2.8%
5. Arizona – 2.8%
6. Arkansas – 2.6%
7. Texas – 2.6%
8. North Dakota – 2.6%
9. Oklahoma – 2.5%
10. Louisiana – 2.5%

Again, these states have in common slow growth in housing prices during the bubble. And what explains slow growth in housing prices? Land-use regulation. I use the Gyourko et al. land-use regulation variable to predict both cost of living in 2000 and growth in cost of living over 2000-2007. It is an extremely strong predictor of both (statistical significance>99.99%). When net 2000-2007 in-migration (% of 2000 population) is regressed on both 2000 cost of living and the land-use regulation index along with controls (economic and personal freedom, 2000 accommodations GDP per capita), both are highly statistically significant and negative. When total personal income growth is regressed on migration, controls, and the land-use regulation index, land-use regulation is insignificant while migration is highly significant and positive. No surprise there – land-use regulation doesn’t reduce total factor productivity, but it does discourage labor inflows.

So here’s the big story of growth in those states that have experienced it in the last decade: lack of land-use regulation –> slow growth in cost of living –> more in-migration –> more income growth. Highly regulated states like California (-0.4% annual growth), Oregon (0.1%), Massachusetts (0.1%), and New Jersey (0.3%) could learn something. If we are entering a “great stagnation,” we may have to squeeze increases in living standards out of lower prices rather than innovation for a while.

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Noel Johnson, Matt Mitchell, and Steve Yamarik have a new working paper answering that question in the affirmative. They look at state fiscal and regulatory policies and find that Democrats generally like to increase taxes and spending when in control of state houses and Republicans do the reverse. But when states have tough balanced-budget requirements called “no-carry rules,” Democrats and Republicans don’t differ much on fiscal policy. Instead they try to appeal to their constituencies by pursuing regulatory policies – in general, Democrats increasing regulation and Republicans cutting it. As the paper’s still in the working draft stage, they are looking for comments on it.

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Last year I had a little run-in with the town authorities over my garden. Fortunately, it ended well. However, for other people around the continent troubles with the local lawn nazis seem more severe, possibly involving jail time! Some of you may have heard of the woman in Oak Park, Michigan who faced jail time over her front-yard vegetable garden. (Charges were later dropped.) Now there’s a story out of Lantzville, British Columbia about a man who is also facing potential imprisonment over a two-and-a-half-acre organic farm in a residential area. This part of his account is particularly interesting:

The previous owner used an excavator and dump truck to mine and scrape the land bare. He had a soil screener set up on the property, selling the soil, then sand, then gravel, which resulted in lowering the level of the property by about four feet. When Dirk assumed ownership, all that remained was gravel. There were no worms, no grasshoppers, no birds, no butterflies; essentially – no living creatures!

Since 1999, Dirk has made a tremendous effort to heal the land, beginning slowly – one wheelbarrow at a time. Nicole joined him at the end of 2006. It has been a gradual, organic process from planting a few fruit trees and having a small growing area, to expanding with more hand-made soil using wood chips from local tree companies and a small amount of horse manure from local, Lantzville stables. Now we have four kinds of bees, several types of dragonflies, numerous types of butterflies, frogs, toads, snakes, hundreds of birds and much more!

To sum up: scraping your land bare, killing everything living there – totally OK. Growing vegetables and fruit trees – illegal.

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With the war in Europe between France and England intensifying, Americans found their rights as neutral traders regularly violated by both French and British navies, and French and British port restrictions further limited American opportunities for commerce. To make matters worse, on numerous occasions, English vessels had boarded American ships and “impressed” many of their crews into service as if they were British subjects. Such disregard for American sovereignty and rights was taken hard by the public, but America’s naval capacities were far from adequate to enforce a due respect on the high seas. Yet doing nothing was not a popular option.

President Jefferson attempted to draw a lesson from our colonial past and impose an embargo of American trade. The hope was that such an embargo would inconvenience European commerce to such a degree as to bring the powers, especially Britain, to that level of respect which American arms were insufficient to obtain. In 1807, the Embargo Act was imposed, interdicting all vessels from entering or exiting American ports. Trade was the life blood of New England, however, and the Embargo hit them especially hard. As weeks moved to months and months to a year, the suffering in the port cities became nearly unbearable. Numerous calls for lifting the interdiction were heard, but none of the offending powers seemed even remotely ready to bargain. Unwilling to surrender the point of honor or to risk outright war, Jefferson’s administration remained steadfast in its policy.

At a certain point, the states began to question not only the efficacy of the measure, but its justice. Should not the risks of trade be borne by the traders themselves? Why a general restriction? If families and communities are ruined, is this not an indication of a policy gone too far? Indeed, so far that it might conflict with a vital principle of constitutional government? The national authority was to engage in defensive action in support of the states and their communities, not in their strangulation. If it could not live up to its military obligations, this was no excuse for an imposition of a total ban on trade, a power not contemplated in the original design.

In the earliest resolutions of Massachusetts, Connecticut, and Rhode Island the hue and cry was again heard. Massachusetts’ legislature, as Thomas Woods noted in his collection of sources, sought only formal political means, and counseled patience on the part of its citizenry as it pursued these avenues of redress. Rhode Island observed that it was “the duty of this general Assembly, while cautious not to infringe upon the constitution and delegated powers and rights of the General Government, to be vigilant in guarding from usurpation and violation, those powers and rights which the good people of this state have expressly reserved to themselves…” Here were the states as Sentinels calling out their warning.

But Connecticut, first through its governor and then its legislature went further still, openly and officially “declining to designate persons to carry into effect, by the aid of military power, the act of the United States, enforcing the Embargo.” And “that the persons holding executive offices under this state, are restrained by the duties which they owe this State, from affording any official aid or cooperation in the execution of the act aforesaid.”

This action went the further step of embracing the idea of non-cooperation, and its precedent went back to colonial legislatures that had refused to cooperate with the enforcement of the Imperial Stamp Act. No force would be applied directly to interdicting federal officials, but no cooperation would be accorded them either. They could do their work on their own, but in the absence of active assistance or support from state institutions, they would find that task far more difficult. No power of the federal government could compel action on the part of the states in this regard.

And here New England’s civil society operated in yet a further way to exert force against the centralized exercise of power, again, much like what had happened in earlier colonial protests. While not directly engaged in administering smuggling, the governments of New England gave tacit affirmation of private actions through their resolutions. New England’s merchants were long practiced in the arts of running goods around imperial restrictions. Now they would do the same with respect to national ones. And the general government found its resources stretched to the breaking point.

Remarkably, Jefferson himself later reflected on this opposition of local authorities. He recalled this episode as a powerful illustration of why local governance is so critically important to the maintenance of a free society! No longer president, he could reflect with some approval on the nature of the opposition he had then faced. (more…)

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Ronald Coase is one of my favourite living economists (he is now 100 years old). His work on the significance of transactions costs and dealing with problems that these costs raise is fundamental to a proper understanding of the market economy and the institutions that support it.  Alas, though his work was recognised with the receipt of the Nobel Prize in 1991 the implications of Coase’s ideas are not widely understood by contemporary economists and indeed they are often completely misrepresented by those who should know better (in my book Robust Political Economy I target Joseph Stiglitz as being particularly guilty of this charge).

One of the most interesting but neglected of Coase’s ideas is presented in a brief essay on ‘The Market For Goods and the Market For Ideas’ , originally published in the American Economic Review in 1974. In this essay, Coase points out the inconsistency of those who cite ‘imperfect’ and ‘asymmetric information’ as constituting a case for government regulation in markets for private goods and services, while remaining steadfast in their support for free speech in the political market for ideas. For its proponents though the ‘free market in ideas’ is plagued with various ‘imperfections’ – such as deception, misrepresentation and downright lying by politicians and pressure groups, coupled with the ignorance of the general public (i.e. voters), over time free speech and the competition it engenders offers the best prospect of ensuring that good ideas prevail over the bad. Attempts to regulate political speech to ensure that only ‘accurate’ and ‘truthful’ information is presented to the public are doomed to fail. Who would decide what is to count as ‘accurate’ and ‘truthful’, and who would ‘guard the guardians’ of public truth should they seek to abuse their authority?

If the above argument holds in the market for political ideas, however, then it is equally if not more valid in markets for private goods and services. As Coase notes,   ‘It is hard to believe that the general public is in a better position to evaluate competing views on economic and social policy than to choose between different kinds of food’. Although consumer goods markets are plagued by imperfect information, misleading advertising and the existence of fraud, competition remains the best protector of consumer interests. Indeed, competition is likely to be more effective in the market for most goods and services because the costs of failing to be adequately informed are more likely to be concentrated on those who actually make bad choices– thus incentivising the critical scrutiny of advertising claims. In the market for ideas by contrast, failure to be adequately informed has externality characteristics – the decision to vote for a bad idea has consequences not only for the individual concerned but for the wider society at large. By making this point, Coase anticipated the argument made by Brennan and Lomasky (Democracy and Decision, Cambridge University Press, 1993) and more recently by Bryan Caplan (The Myth of the Rational Voter, Princeton University Press, 2007) that democratic politics is afflicted with the problem of ‘rational irrationality’ and that the ‘market for ideas’ is more likely to ‘fail’ than is the market for private goods.

What though is the best way of resolving the theoretical inconsistencies that Coase exposes? In his 1974 essay the man himself challenges economists and public policy analysts to choose one of the following options. The first would be to abandon free speech and concede the case for ‘expert rule’ in all spheres of life. In contemporary politics, this approach seems to be favoured by the acolytes of Cass Sunstein with their desire to regulate for ‘balance’ on the internet and other public media (no place for climate change sceptics etc.) – yet this approach has no answer to the question of ‘who should guard the guardians’. A second option attractive to many classical liberals would maintain the case for free speech in the market for ideas but would recognise that the argument for ‘de-regulation’ is equally if not more valid in the market for private goods and services. The third and final approach would recognise that ‘market failure’ in the realm of ideas is indeed more likely than in the sphere of private consumer choice and would thus argue for the de-regulation of economic markets, and increased regulation of free speech. He does not endorse this view per se, but the latter position might be implied by Bryan Caplan’s suggestion that greater influence should be given to economists in determining the contours of public policy. 

That Ronald Coase was able to anticipate these issues in the early 70s is proof enough of the relevance of his work today. How though would Pileus readers answer Coase’s challenge?

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When it comes to supposed threats to Americans’ freedoms originating in academe, conservatives often like to point out the mouldering Marxists in various humanities departments around the country. I am largely unconcerned, except to the extent that these professors impose ideological orthodoxy on their students or erode academic standards. No, a far larger and more imminent threat comes from the inherently politicized discipline of “public health.”

Formerly a discipline devoted to research on sanitation and epidemiology, public health is now more or less an explicitly ideological field devoted to ginning up panic over freely chosen, private behaviors and to cheerleading for paternalist government action to prohibit or discourage them. Take any fun activity enjoyed by those who are not urbanized, (generally) white, middle-aged, highly educated professionals – smoking, shooting, drinking, eating tasty food, calling a friend in the car, generally exercising “personal freedoms” – “public health advocates” are agin’ it. (Of course, you don’t see them agitating against marathon running or rock climbing or bungee-jumping or long-distance hiking or extramarital sex. Fun, risky things that urbanized, highly educated professionals like.)

The question the public-healthies (for short) never think to ask is: Does maximum health make people better off? If people are aware of the risks of an activity, and do it anyway, doesn’t that very fact show that they are better off being permitted to do it? Why is there a need to tax or regulate them into compliance with your preferences? If you think that people are not aware of the risks, why not restrict yourselves to educating them – in a sane, reasoned, non-hysterical way?

The new public-healthery has (more…)

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President Obama has made a striking 180 degree pivot in the weeks since the 2010 midterm. We all recall the extension of the Bush tax cuts. Many interpreted this as a pragmatic decision given that it was tied to an extension of unemployment benefits. But in recent weeks, several decisions seem to mark a potential shift in orientation:

January 6, 2011: the appointment of William M. Daley, Clinton Secretary of Commerce and executive at JP Morgan Chase as the new Chief of Staff. Daley had been an opponent of some of the central achievements of the first two years of the Obama administration (health care and the new consumer protection agency for financial services).

January 7, 2011: The appointment of Gene Sperling as director of the National Economic Council. Sperling was director of the NEC during Clinton’s second term, where he helped negotiate the Gramm-Leach-Bliley Financial Modernization Act (1999). He subsequently assumed a position Goldman Sachs.

January 18, 2011: President Obama issued an Executive Order mandating (in his words via a WSJ op-ed) “a government-wide review of the rules already on the books to remove outdated regulations that stifle job creation and make our economy less competitive. It’s a review that will help bring order to regulations that have become a patchwork of overlapping rules, the result of tinkering by administrations and legislators of both parties and the influence of special interests in Washington over decades.”

January 20, 2011: The appointment of GE CEO Jeffery Immelt to chair a new Council on Jobs and Competitiveness. Michael O’Brien (The Hill) notes:

The move appears to be another step by Obama to address tensions between his administration and the business community, a relationship that’s been strained during his first two years in office…. Immelt’s appointment can also be seen as an overture, to a degree, to Republicans. The GE CEO has donated thousands to Republican candidates and committees over the years, though he’s helped fund some Democrat campaigns as well.

An administration that began with a green industrial policy to promote recovery (remember the “green shoots” that were supposed to arise during Recovery Summer?) seems to be embracing tax cuts, regulatory review, and Clintonian partnerships with business. Is this the beginning of a significant shift in economic policy or mere symbolic action?

A few weeks back, I had a posting on the states and bankruptcy. Interesting piece by Mary Williams Walsh in today’s NYT on this very issue.

Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Obviously, there will be fierce union opposition to these proposals. Walsh quotes Charles M. Loveless, legislative director of the American Federation of State, County and Municipal Employees: “They are readying a massive assault on us…We’re taking this very seriously.” The article suggests (perhaps correctly) that some advocates of state bankruptcy want to use the current financial problems—a product of recession, not the long-term structural deficits—as a means of getting at their long-term liabilities (read: unfunded pension and health care commitments to AFSCME members).

Extended tax cuts, regulatory review, the appointment of business executives and former Clinton “third way” veterans to key economic advisory positions, efforts to scale back on state commitments to unions…the times they are a changing. Of course, only time will tell whether these changes mark a permanent shift in economic policy or a temporary expedient.

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At the NY Times‘ Economix blog, Ed Glaeser takes up explanations for the relative population growth enjoyed by Texas, Florida, Georgia, Arizona, and Nevada, compared to relative decline in New York, Massachusetts, and Connecticut. If we ignore international migration, which tends to increase the population of Mexican border states especially, and natural increase, then the population shift is really the result of inter-state migration. So why have people been leaving most of the Northeast and fleeing to the South and Southwest?

Glaeser notes two explanations: sunshine and public policy. People tend to leave cold states for warm states. But that fact alone can’t explain all or even most of the migration that we see. Here’s Glaeser on the policy explanation: (more…)

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Avik Roy has an interesting piece in National Review on how conservatives (really, free-marketeers) should approach the policy and politics of health care in the age of PPACA. I largely agree with his policy prescriptions, somewhat vaguely stated as they are:

First, Republicans must foster a truly free market for health insurance by eliminating the differing tax treatment of employer-sponsored and individually purchased insurance. Second, Republicans must make dramatic improvements to Medicaid, using Mitch Daniels’s impressive reforms in Indiana as a template. Third, Republicans must move Medicare onto a sustainable path that puts financial control in the hands of seniors themselves rather than central planners.

I would also argue for repealing state-level health insurance mandates, but that is properly the role of state governments. (As noted in this blog, allowing purchase of health insurance under other states’ laws would achieve more or less the same end.)

Roy’s analysis of the political situation is insightful. Republicans and conservative Democrats are very unlikely to achieve a filibuster-proof majority after the 2012 elections. Therefore, repeal of PPACA will have to be passed through reconciliation. But since the CBO scored PPACA as reducing the deficit, a simple repeal cannot pass through reconciliation.Thus, whether they like it or not, Republicans will have to take on new spending cuts to any repeal.

And this on the presidential race is spot on:

This means that influential Republican activists must — must — coalesce around the most electable Republican presidential candidate who can articulate conservative health-care principles. This is no time for single-issue small-ball or personal score-settling. A GOP nominee who passes all the litmus tests but can’t win in November would only succeed in making Obamacare permanent. One who can win but isn’t capable of pushing for real health-care reform wouldn’t be much better.

The first criterion rules out Palin and Gingrich (and let’s be honest, Paul and Johnson too). The second rules out Huckabee and Romney. Who’s left? Mitch Daniels?

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Police are using regulatory inspections as a pretext for warrantless, apparently racially biased searches. If you’re going to support occupational and business licensing, you’re going to have to accept a hobbled Fourth Amendment.

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I was ever so briefly at a conference on pricing carbon this weekend at Wesleyan (I was a moderator for a session). The panelists were committed to the same goal (reduced CO2 emissions) so the discussion focused on the issue of regulatory design and policy instruments. Of the competing approaches—cap-and-trade, cap-and-dividend, and a straight carbon tax—the carbon tax, in my opinion, makes the most sense.

By way of background, I find the data on global climate change pretty persuasive even if we accept that there is a fair amount of uncertainty.  Given the benefits of reducing CO2 emissions, reducing dependency of foreign oil, etc., a transition to less carbon-intensive fuels and processes makes sense even if we determine at some point in the future that the environmental risks of climate change were less than we currently believe them to be.

Given the impossibility of establishing property rights over climate stability, the kinds of free-market environmentalist approaches that many find appealing would seem inapplicable. Thus we turn to other kinds of policy interventions.

Cap-and-trade worked quite well for acid rain. There is little question that Title IV of the Clean Air Act Amendments of 1990 created an amazingly cost-beneficial approach to the problem. But CO2 is far more complicated for a number of reasons and it is questionable that caps could function without offsets, which open the door to endless gaming.  The carbon tax, in contrast, is a simple and transparent means of managing a negative externality.

A carbon tax would gradually increase the tax per ton of CO2, thereby making less carbon-intensive forms of fuel and processes more price competitive.  Current proposals require revenue neutrality. Some suggest returning 100% of the revenues on a per capita basis via electronic transfers, thereby limiting the opportunities for transfer seeking and gaming the system (both of which would be ubiquitous in a cap scheme with offsets or any efforts to divert some of the funds to a green industrial policy). Others make the case for “tax shifting” (e.g., using the projected $500 billion in carbon revenues to eliminate those that create disincentives to investment or are overly regressive).  Obviously, one could combine dividends and tax shifting. It would be prudent to combine the carbon tax with the immediate elimination of all subsidies for fossil fuel production. Of course, it would be a major innovation for US government to stop subsidizing the very activities we are trying to regulate….but I digress.

Regardless of how one uses the resources, there is a major hurdle: taxes are taxes (even if we call them “fees”) and in this political environment one might suppose that any proposal for new taxes would be DOA.

But not necessarily.

There is growing recognition of the huge fiscal crisis on the horizon. There is literally no hope of avoiding it through attacks on “waste, fraud and abuse,” earmarks, and domestic discretionary spending.  Yes, any of us could make the intellectual case for massive entitlement cuts or restructuring. But there is little evidence that a majority of either party will ever make the case and endure the political costs associated with substantial revisions in Social Security and Medicare.  So we turn, necessarily, to revenues.  Why not frame a carbon tax as a means of shoring up the unfunded portion of Social Security and Medicare without significant cuts—and thereby avoiding an eminent fiscal collapse.

We know that existing federal trust funds are not a store of wealth. The trick would be to assure that 100% of the revenues were placed in a real trust fund with real assets until the unfunded liabilities were reduced to manageable levels.  At that point—assuming that point ever arrived—decisions could be make to pay down the debt. None of this would preclude future reforms (indeed, they would likely remain necessary given the magnitude of the gap).

As a means of protecting existing entitlements, it might be attractive to the AARP and members of both parties who would like to find some means of avoiding the difficult decisions before us. As a means of reducing CO2 emissions, it would be attractive to environmentalists and younger voters (who would also be attracted by the beneficial impacts on entitlements they may never see under current conditions)?

Could the carbon tax provide a foundation for a potent grey-green coalition committed to fiscal and environmental sustainability?


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The Treasury has been spinning TARP as a victory in the months leading up to midterm elections. I have a lot of respect for Elizabeth Warren (former Chair of the Congressional Oversight Panel for TARP, currently helping in the early work for the Consumer Finance Protection Agency she promoted) and the work she has done on bankruptcy.

As John Maggs reports in Politico, it appears that Elizabeth Warren is not too cheery on TARP’s performance.

Money quote:

“The rescue of AIG continues to have a poisonous effect on the marketplace,” said one critic recently. “By providing a complete rescue that called for no shared sacrifice on the part of AIG and its creditors, the government fundamentally changed the rules of the game on Wall Street. As long as the biggest companies in America believe that you and I will bail them out, the worst effects of the AIG rescue will linger.”

The critic was not a Republican politician or some conservative think tank. It was Elizabeth Warren, President Barack Obama’s choice to set up a new agency that will protect consumers from financial system abuses, and her blunt assessment is shared, to some extent, by critics on the left and the right.

Of course, Warren is correct, particularly in her observation: “The greatest consequence of TARP may be that the government has lost some of its ability to respond to future crises.”

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The health care reforms were designed to expand coverage and “bend the cost curve.” Did no one suspect that insurers would muster a proactive response to changes in policy?

In Connecticut: “Health insurers are asking for immediate rate hikes of more than 20 percent in Connecticut for some plans, citing rising medical costs and federal health reform laws as reasons.” This same story is playing out across the country.

The reforms prevent insurance companies from denying individual policies for children with preexisting conditions. In Colorado:

at least six major companies — including Anthem, Aetna, Cigna, and Humana — have said they will stop writing new policies for individual children” in Colorado. The companies “blamed health reform mandates taking effect Thursday requiring companies that write such policies as of that date to also cover sick children up to age 19,” the paper said.

Much of this seems quite predictable. One wonders what other changes the next few years will witness as the provisions of the reforms are enacted.

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Another bizarre case of town government versus the property owner.

DEKALB COUNTY, Ga. — DeKalb County is suing a local farmer for growing too many vegetables, but he said he will fight the charges in the ongoing battle neighbors call “Cabbagegate.”

Fig trees, broccoli and cabbages are among the many greens that line the soil on Steve Miller’s more than two acres in Clarkston, who said he has spent fifteen years growing crops to give away and sell at local farmers markets.

For my own, briefer and less stressful encounter with town government, see here, here, and here.

HT: Our esteemed ringleader, Grover Cleveland.

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I’m a native plant gardener. I’ve removed all of my back lawn and replaced it with native trees, shrubs, vines, wildflowers, ferns, and grass and grass-like species, and I’ve removed most of my front lawn and done the same, apart from some mown paths. Why? Because native plants are better for the environment. Our wildlife, from insects to birds, coevolved with these plants and are well adapted to using them for survival. Alien plants often require special help to survive (watering, fertilizing, spraying with pesticides, none of which I do), or else they take over because they lack their natural predators to keep them in check. My native garden has attracted many species of birds, including things like flycatchers that one rarely sees in cities. The garden is awash in bees, moths, and butterflies the entire summer. Here are some pictures of the gardens:

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Today I received a notice of code violations. Supposedly someone complained about my front yard, and now the town is giving me two days (!) to remedy the violations, or the town will come and mow the garden down and bill me for the pleasure.

The first violation is straightforward and easily dealt with. The town prohibits trees and shrubs from obstructing vision from private driveways and requires them to be no more than three feet in height. No problem – I try to keep the shrubs by the sidewalk trimmed for public convenience, but some of them are as tall as five feet. I’ll give them a bad haircut now, and then in the fall, as per usual, I will cut them to the ground (these species respond well to this kind of hard pruning).

It’s the next citation that I find very troubling:

According to the notice, “weed and plant growth” in excess of 10 inches is prohibited. Well, that would prohibit pretty much any garden, wouldn’t it? But they clearly misrepresented the text of the ordinance, the definitions in which read as follows:

All grasses, annual plants, trees or vegetation that are harmful to the public welfare, including stumps, roots, filth, garbage, or trash. The term “grass, weeds and plant growth” shall not include cultivated flowers, healthy trees, shrubs, or gardens.

Plant growth deemed by the Town of Tonawanda Code Enforcement Officer as potentially dangerous to the public welfare, or such plant growth that is an unattractive public nuisance or grows in an undesirable location.

In short, my garden is fully exempted from this ordinance. Furthermore, the code enforcement officer followed the wrong procedure in citing my property. From the ordinance:

B. Written notice may be given by registered mail addressed to the owner of the parcel of real property in question together with posting at the parcel of real property in question or by personal delivery to the owner. Service shall be deemed complete upon the deposit of the registered mailing in a postpaid envelope and the posting at the real property in question and, if by personal delivery, upon the delivery of notice in person to the owner of the parcel of real property.

C. Such notice shall specify the violation(s) as determined by the Code Enforcement Officer and shall direct the owner of the parcel of real property in question to remedy the violation(s) and bring the parcel of real property into compliance with the provisions of this chapter within 10 calendar days of service of notice.

The notice did not come by registered mail; it came by regular mail. The letter does not give me 10 days from the date of service; it gives me 7 days from the date on the letter (just 2 days from the date I received it).

I believe I am on firm legal ground. The concern, however, is that the town will come and mow down my gardens without due process. This has happened all over the country and in Canada. Here’s one example from Illinois, and here’s another from Toronto. The Environmental Protection Agency even provides advice to homeowners on fighting their town governments!

From a utilitarian perspective, government should probably be subsidizing my work rather than prohibiting it. I’m providing benefits to the community and the environment. I’m still optimistic that this will end well, that I’ll be able to get in touch with either the inspector or the mayor, and the town will come to their senses. If not… watch this space.

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When Reform Isn’t Reform

In the months leading up to the passage of the financial reform legislation, Congress decided to segregate the issues of financial regulation and the government sponsored enterprises (GSEs) that were central to the collapse. Now that Dodd-Frank is in the bank, Congress and the White House are turning to Freddie and Fannie, the two GSEs that have already  sopped up $150 billion in taxpayer money. Will this process lead to meaningful reforms?  An article by Binyamin Appelbaum in yesterday’s NYT does not give me much hope.

The financial crisis came in the aftermath of the collapse in the real estate bubble. The bubble was created, in part, by government efforts to promote high levels of home ownership, particularly among low income citizens. This was justified in the 1990s through evidence suggesting racial discrimination in credit markets; during the Bush presidency it was promoted as part of the effort to create the so-called “ownership society.”

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 mandated that the Department of Housing and Urban Development set quantitative targets for GSE purchases of mortgages serving a low and moderate-income clientele.  Between 1993 and 2007, the target increased from 30 percent to 55 percent.  Even if we stipulate arguendo that the goal of extending home ownership to low income borrowers was laudable, it was nonetheless the case that this population—and the speculators that moved in to take advantage of liberalized underwriting standards—were highly vulnerable to economic fluctuations.

Let me be clear: I am not claiming that the housing policy of the Clinton and Bush administrations and Congress was the sole source of the financial crisis. But without the bubble it created (facilitated by a number of other factors, including the Taxpayer Relief Act of 1997, the Fed’s policies, and private sector chicanery), the crisis would not have occurred.  Clinton, Bush, and congressional majorities of both parties embraced a set of social goals and decided to use the GSEs as the instruments of choice in realizing these goals.

The NYT article contains some quotes that should disturb anyone hoping for genuine reform.  Appelbaum reports:

Mr. Geithner said continued government support was important “to make sure that Americans can borrow at reasonable interest rates to buy a house even in a downturn.”

While a range of options are on the table, Appelbaum notes:

The choice will reflect in large part a judgment about how hard the government should try to increase homeownership. Broader guarantees create greater risks for taxpayers, but also lower interest rates, bringing ownership within reach for more families. Shaun Donovan, the housing secretary and a host of the conference with Mr. Geithner, said that the administration remained committed to “broad access to homeownership, including options for those families who have historically been shut out of these markets.”

The conclusion: clear evidence that efforts to use the GSEs to engineer a predefined level of home ownership has had no discernable impact on policymakers’ desire to continue using the GSEs for this purpose.

I can imagine a principled argument from the Right that the level of home ownership is an emergent property of incomes and preferences. Rather than trying to achieve some politically-defined level of ownership, we should create the preconditions for growth and make certain that lenders bear the risk for the loans they make, even if this results in more stringent underwriting standards.

I can imagine a principled argument from the Left that the real problem has been the nation’s failure to invest in public housing for low-income households. Under the sway of neoliberalism, Democrats and Republicans alike gravitated toward “third way” solutions that effectively allowed them to move their responsibility to the poor off budget.

What I cannot imagine is a principled argument for a continuation of the status quo.

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Freddie and Fannie are in the news again.

Freddie is currently seeking an additional $1.8 billion in funding (to be added to the $160 billion that has already been spent on the two government sponsored enterprises or GSEs). This recent news has led me to pose an account of how a standard political choice story of political exchange evolved into one of state vampirism. Let us review some of the facts.

The financial collapse revealed the weakness of many institutions, much to the surprise of regulators. No one in government fully appreciated the fragility of AIG or Lehman, for example.  But the same cannot be said of the GSEs. A partial accounting of the warning signs:

  • When accounting scandals led to the collapse of Enron in 2001 and WorldCom a year later, attention turned to the misapplication of accounting standards in other large firms. In January of 2003, Freddie Mac admitted that it had engaged in creative accounting to “smooth out” its earnings growth and mask underlying volatility.
  • That same year, the IMF  identified a host of problems at the GSEs including the “systemic risks inherent in the agencies’ large mortgage portfolios and their hedging operations” and the “lack of transparency.”
  • In 2004, the OMB warned: “The GSEs are highly leveraged, holding much less capital in relation to their assets than similarly sized financial institutions….a misjudgment or unexpected economic event could quickly deplete this capital, potentially making it difficult for a GSE to meet its debt obligations. Given the very large size of each enterprise, even a small mistake by a GSE could have consequences throughout the economy.”
  • Congress held hearings over the course of the next several years to consider strengthening the oversight of the GSEs  and limiting the size of their portfolios. Greenspan—usually skeptical of regulation—testified that the GSEs should be forced to reduce their trillion dollar portfolios to $100 or $200 billion, a position echoed by Treasury officials. Although proposals to create a new agency to oversee the GSEs were introduced in both chambers, Republicans and Democrats blocked reforms—refusing to place restrictions on the size of their portfolios, preventing the regulator from considering systemic risk, or tying passage to the creation of an affordable housing fund to make grants to advocacy groups.

The GSEs avoided the kinds of regulations that, if introduced early enough, might have limited the extent of the crisis.

Making Sense of Nonsense

The above pattern might not seem to make sense until once considers it through the lens of public choice.   The GSEs, although private in the pre-crash days, benefitted dramatically from the implied backing of the US government. They were able to attract capital more cheaply because investors believed that their debt was as good as T-bills.

The GSEs preserved their status by funneling large amounts of money into politics. As Open Secrets noted in a brief 2008 piece on Freddie, Fannie, and political giving:

Fifteen of the 25 lawmakers who have received the most from the two companies combined since the 1990 election sit on either the House Financial Services Committee; the Senate Banking, Housing & Urban Affairs Committee; or the Senate Finance Committee. The others have seats on the powerful Appropriations or Ways & Means committees, are members of the congressional leadership or have run for president.

During the 1989-2008 period, Open Secrets reported that “Current members of Congress have received [as of 2008] a total of $4.8 million from Fannie Mae and Freddie Mac, with Democrats collecting 57 percent of that.” Top recipients of GSE largess for the period 1989-2008:

  1. Christopher Dodd (D-CT)
  2. John Kerry (D-MA)
  3. Barack Obama (D-IL)
  4. Hilary Clinton (D-NY)
  5. Paul Kanjorski (D-PA)

Obama’s performance is pretty amazing given his short tenure in the Senate. In case your are wondering, the top 25 also included Barney Frank (D-MA), Rahm Emaunuel (D-IL), Nancy Pelosi (D-CA), and Steny Hoyer (D-MD) were also in the top 25. And even if the top of this list was full of Democrats, Republicans were recipients of GSE funds as well, claiming a majority in 2006.

So, we have profit-maximizing firms (in this case the GSEs) investing in vote-maximizing politicians (see above) and receiving special regulatory treatment. The costs were borne by consumers and taxpayers. Many members of Congress undoubtedly thought they were doing good while doing well. By requiring via statute that the GSEs make 55 percent of their mortgage purchases from low and moderate income borrowers, they were furthering pressing social goals and contributing to the creation of an ownership society.

From Political Exchange to Political Vampirism

As we know, in 2007-2008, many of the misguided policies interacted to produce a daunting financial crisis and the largest issuance of debt relative to GDP since World War II.  Freddie and Fannie, carrying large portfolios that had been politically insulated by Congress, all but collapsed, forcing a government bailout that has cost, to date, $160 billion.

In 2010, Congress passed the financial reform legislation (formally, the Dodd-Frank Wall Street Reform and Consumer Protection Act).  As noted in a previous posting, Dodd-Frank was expansive enough to cover everything from conflict metals to the racial composition of financial institutions. What was left out? The provisions of the act did NOT cover the GSEs.

One reason for leaving the GSEs alone may have been their continued utility as instruments of social policy.  As Zachary Goldfarb notes in today’s WaPo:

Since then [the collapse], they have been run by government overseers who have told the companies to help carry out the Obama administration’s housing policy. They have focused on continuing to guarantee mortgages to keep interest rates low and on reworking unaffordable home loans so borrowers can avoid foreclosure. The federal government has pledged to keep the companies solvent.

One might be surprised that the administration is using the GSEs to promote the same kind of credit policies that contributed to the housing bubble—on second thought, who would be surprised, since the clownish and melodramatic explanations of the collapse are the ones that have prevailed politically.

Some things did change with the collapse of the GSEs. When the government stepped in with a bailout, new bans were placed on campaign donations. Amazingly enough, Congress believed that once it owned an entity, it might be somewhat unseemly for it to extract donations from it.  Some predicted that after decades of Freddie and Fannie dominance of housing policy, this would have some profound implications. As the WaPo noted on August 7: “now Fannie Mae and Freddie Mac, titans of the mortgage finance industry, are wards of the state, bailed out by Washington to the tune of $160 billion and banned from political activity.”

But even if political donations are temporarily off the table, there are other ways to extract blood from Freddie and Fannie.  From today’s WaPo:

The firms are also paying steep dividends to the government in return for the aid. The dividend rate, 10 percent, is far more than the companies would pay to raise money in the capital markets. After the latest round of assistance, Freddie will be required to pay $6.4 billion in annual dividends to the government. “This dividend amount exceeds the company’s annual historical earnings in most periods,” Freddie said in a statement. “Freddie Mac expects to request additional draws under the Purchase Agreement in future periods.”

So let us review the key facts: Initially, Congress provides the GSEs with an implicit guarantee in exchange for a steady flow of donations and lax oversight. That equilibrium proved quite stable for decades and delivered the goods for legislators regardless of their political stripe. However, exogenous and endogenous shocks punctuated this equilibrium and gave rise to the political vampirism witnessed today. The GSEs are given a lease on life, but a life that might feel more like a slow death as its resources are being drained away.

How are things working out? In Goldfarb’s words: “Now, it is government decisions that are driving a good bit of the companies’ losses.”  How great are these losses? Since the collapse, Freddie has received over $60 billion from the public coffers, and now it is approaching Congress for an additional  $1.8 billion in government aid.  The combined GSE bailout has cost a mere $160 billion, as if anyone other than bondholders are counting.

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Senate Majority Leader Reid has declared cap-and-trade dead (for now). As the Christian Science Monitor notes:

In a bid to win Republican support, Democrats will drop proposed controls on greenhouse gas emissions in favor of more limited measures that have attracted bipartisan support in the past. These include: lifting the liability cap to hold BP accountable for the Gulf oil spill, decreasing dependence on foreign oil, boosting incentives to create up to 400,000 green jobs, and expanding funding for land and water conservation.

If Reid can’t get sufficient support now, one can imagine that it won’t be forthcoming after the mid-term elections (assuming that the GOP doesn’t snatch defeat from the jaws of victory).

But wait!

As Daniel Foster (National Review) and John Fund (WSJ ) suggest, there might be another strategy at work: pass a scaled down energy bill now (loaded up with enough green pork to attract a majority) and postpone the conference report until after the November elections, at which time there will be an opportunity during the lame duck session to  slip cap-and-trade into a conference report.

An interesting question to ponder this weekend: Is cap-and-trade DOA, or will it rise from its  grave in the waning days of the Congress?

The answer may be more complicated than one might suppose. There is an assumption here that Democrats would support cap-and-trade as the preferable response to global climate change. In reality, many on the Left have never been all that happy with cap-and-trade when compared to a carbon tax or more statist alternatives. For many, there is an elemental abhorrence to market mechanisms at the core of cap-and-trade and various plans seem to provide far too many concessions to corporations (e.g., in the distribution of credits, the cost containment components, the definitions of what constitute offsets).

As Jesse Jenkins (Huffington Post) suggest, we should be happy to see cap-and trade die for some of these reasons.  In his words:

the proposed cap and trade bill was riddled with so many loopholes and cost containment mechanisms–most notably the availability of up to 2 billion dubious carbon offsets–that the effective price on carbon was too low to effectively spur clean energy innovation and adoption and the “cap” on carbon was rendered effectively non-binding.

Far preferable for many is a green industrial policy focusing on clean energy.  In Jenkins words: “the most reliably successful driver of new innovation and transformative technology changes has been an active partnership between private-sector entrepreneurs and innovators and a public sector acting as both an initial funder and demanding customer of new, cutting-edge technologies.”

My guess is that some form of cap-and-trade remains the most likely scenario, although less likely than in the early days of the 111th Congress.

Update: A further complication emerges…Obama would likely veto legislation promoted by coal state Dems limiting the EPA’s authority to promulgate climate rules. (For anyone who is familiar with the politics of acid rain as they evolved in the 1970s and 1980s, this has a familiar feel). http://www.politico.com/news/stories/0710/40174.html

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Is Network Neutrality a racist policy?  At least one prominent Chicago politician seems to think so. Cook County Commissioner Robert Steele recently voiced his objections to the FCC’s proposed regulatory attempts to achieve Net Neutrality. The principle of network neutrality asserts that broadband providers should not be able to block or limit use of their networks in order to impose a tiered service model of access, or to hinder competitors.

Steele sees net neutrality as furthering the interests of an “elitist agenda.” In his Huffington Post piece, Steele argues:

[T]here is very real concern among communities of color that the FCC’s planned “third way” for new regulations would discourage investment in sorely needed broadband infrastructure, stifle innovation, and kill job growth that stems from the wide availability of broadband services. Anyone can tell you that the current Internet we enjoy today was built on the investment of private companies, companies that provide jobs and companies that continue to build out the needed access to broadband infrastructure, both wireless and wired. While I would love to be able to tell you that the public sector has been able to invest just as much, that is unfortunately not the reality. Furthermore, we need to ask what do these government regulations really do for us in terms of increasing adoption of broadband technology, and also accessibility across America.

Steele goes on to argue that proponents of net neutrality rely

. . . on the assumption that without FCC oversight the internet providers would have “free rein to prioritize, block or slow access to content on the web.” These claims are boldly passed off as fact without recognizing the record on these matters — since the original four net neutrality principles were enacted in 2005, there have been only three instances that required intervention, and these isolated incidents were handled quickly and without much fanfare. As a matter of fact, in a decision by liberal Judge David Tatel, a three-judge panel of the D.C. Circuit of the U.S. Court of Appeals has come down on the side of those against further Net Neutrality regulations in the Comcast v. FCC case.

What is interesting about Steele’s position is that it recognizes the role of private investment in internet infrastructure. He also makes the connection between the regulatory barriers and the incentives for private investors to expand broadband access.

Proponents of ever more regulation often assume quiet compliance from minority and underprivileged communities, whose interests they either ignore or simply do not bother to understand. It is refreshing to see a grass roots politician thoughtfully question the benefits of regulation.


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The president will address the nation tonight from the Oval Office to discuss the BP/Deepwater Horizon fiasco. The New York Times reports: “It is Mr. Obama’s goal… to acknowledge the uncertainties and what one called “the new reality,” allay people’s fears and give reason to hope,” drawing parallels to FDR’s fireside chats.

One wonders: will there will be more in store this evening? Candidate Obama made a series of campaign promises about charting a course to a new green economy, reducing our reliance on carbon-based fuels through what amounted to a green industrial policy.

As political scientist John Kingdon reminded us in his classic Agendas, Alternatives, and Public Policies: “people in and around government sometimes do not solve problems. Instead, they become advocates for solutions and look for current problems to which to attach their pet solutions.”

What kinds of solutions can be attached to this problem? A new carbon tax? Increased CAFE standards? New investments in the “green technologies of the future” that will create “green jobs?” Cap-and-trade?

My best guess is that advocates in the administration, Congress, and the larger interest group universe are actively searching for means of coupling their favored solutions to the problem in the Gulf. A window of opportunity has opened, and as we know, a crisis is a terrible thing to waste.

Unfortunately, crises may result in good politics, but they rarely result in good public policies. More often than not, they also result in an expansion of the public sector often with minimal attention to whether the resulting policies will have the intended impact on the problems in question.

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When and Why We Regulate

Regulation has attracted more than a few posts as of late, and with good reason. The last few years have brought one of the greatest regulatory failures of the past century, Congress and the administration are in the process of producing the greatest regulatory expansion since the 1970s, and now the catastrophic situation in the Gulf of Mexico.

The standard take on regulation is simple: government regulates to address the various forms of market failure (e.g., informational asymmetries, the failure of firms to act as price-takers, negative externalities, transaction costs, public goods, etc.).  However, as Charles Wolf and others remind us, the market and the state are imperfect alternatives. Every attempt to address market failure introduces the potential for government failure. Each has its costs and benefits, and a prudent person should carefully weigh them rather than assuming ex ante that government solutions are superior to imperfect markets.

I am a bit skeptical of the positive theory of market failure for reasons that are beyond this posting (in essence, I find the market-state dichotomy on which it is premised to be highly suspect given the role of law and public institutions in constituting the economy). Nonetheless, informational asymmetries, negative externalities, etc., do provide compelling justifications for regulation (the real challenge is finding the most appropriate regulatory instruments).

That being said, I would like to highlight an additional role for regulation:  it can induce economic actors to exercise some “enlightened self-interest” and engage in higher levels of self-regulation.

Some regulatory analysts note that corporations work under a regulatory warrant (i.e., what is permitted by laws and regulations) and a social warrant (i.e., what is permitted by a broader set of stakeholders). If corporations violate the social warrant, they may find themselves subject to a stricter regulatory warrant.  Highly salient crises can lead to an expansion of mandatory regulations. Many corporate managers understand this and, as a result, often go “beyond regulation,” seeking to nurture their reputations and protect their social warrants.

Consider the following example. Following the tragic Union Carbine chemical release in Bhopal India, the chemical industry began a concerted effort at self-regulation in the hope of forestalling more significant mandatory regulations. The result (Responsible Care) began relatively weak, but evolved rapidly into a global set of management standards. A similar story can be told in other industries (e.g., nuclear energy, wood and paper production).

For effective self-regulation to occur, it seems necessary that there be some association committed to managing the industry’s reputation as a collective good and willing to eject members for failure to comply. At the same time, regulation (or the threat of regulation) seems imperative to force industry to make the investment in self-regulation.

In the past decade or two, some scholars have concluded that market forces are sufficient to force higher levels of corporate responsibility. To the extent that pollution is a form of waste, for example, the elimination of waste streams can provide cost-based advantages. To the extent that consumers value environmentally friendly production, firms can claim differentiation-based advantages.  This may be true for some firms, but I am skeptical that market forces are sufficient when taken by themselves.

Although many libertarians discount the need for regulations (after all, “didn’t Coase show…”), they may play a positive role in creating inducements for greater self-regulation, thereby forestalling a more direct form of regulation that could prove pernicious on a number of grounds.

One can only hope that, as the recent debacle in the Gulf of Mexico focuses attention on an expansion of regulations, the petroleum industry will respond by dramatically enhancing its self-regulatory capacity. I remain somewhat mystified that the American Petroleum Institute and the International Petroleum Institute have not developed a more coherent set of responses to every potential contingency and developed rapid response teams with easily deployable equipment to ensure that when accidents occur (as they inevitably will), they will not do undue damage to industry reputation.  Hopefully, this recent disaster will help the industry better understand the concept of enlightened self-interest.

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This sounds like a story out of Nigeria or somewhere. A Michigan state senator is introducing a bill to license journalists! (Really, certification – you wouldn’t need the license to report, but it would be a state-sponsored credential.)

HT: Hit & Run

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In a 2008 piece in the Financial Times, Congressman Barney Frank, Chairman of the House Financial Services Committee, opined that the financial collapse was clearly an indictment of “America’s 30-year experiment with radical economic deregulation.” Leaving aside Congressman Frank’s diagnosis, it is worth considering briefly the question of deregulation. There is no better guide than the Regulators’ Budget Report produced by the Weidenbaum Center (Washington University, St. Louis) and the Regulatory Studies Center (George Washington University).

Some points worth reviewing:

  • Despite the above quote, during the period 1980 -2010,  regulatory budgets (expressed in 2005 dollars to adjust for inflation) increased from $15.3 billion to $50.4 billion. In short, they more than tripled, greatly outpacing the growth in GDP.
  • What of the presidency of George W. Bush? Between the year Bush entered office (2000) and the year he  left office (2009), inflation adjusted spending increased from $28.7 billion to $46.3 billion.
  • Ah yes, but didn’t Bush starve the financial regulators, hence the crisis? Once again, we have an ugly fact that slays a beautiful theory. Under Bush’s watch, financial and banking regulatory budgets increased (once again, in inflation adjusted terms) from $2.2 billion to $2.6 billion.

It is too early to make a judgment of how the Obama administration will perform relative to its predecessors, but the 2011 requests ($52.5 billion) are well above the levels he “inherited ($46.3 billion).

Adjusted for inflation, the proposed regulatory budget for 2011 would be 343 percent greater than when Reagan was elected. So much for a “30 year experiment in radical deregulation.”

Read the Regulators’ Budget. Like Pileus, it’s free,  informative, data driven and remarkably free of invective.

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