Friday, June 16, 2017

Does Public Choice Describe Political Reality?

by Levi Russell

Ben Southwood, Head of Research at the Adam Smith Institute, recently wrote a piece for Jacobite Magazine in which he argues against the applicability of public choice theory to politics in Western democracies. Below I quote Southwood at length and explain in detail where I think his analysis goes wrong. The overarching theme is this: Southwood seems to think (erroneously) that public choice is about ill intent or corruption on the part of politcians. In fact, it is merely about the application of rational, individual choice frameworks of economics to the study of politics. Politicians may have the best of intentions, but the limitations of collective action and opportunities to maximize their own benefit (as we all try to do, even if that sometimes entails benefiting others we care about or with whose interests ours align) in the political sphere lead them to act in ways that are inconsistent with an idealized view of politics.

In his description of public choice, Southwood starts off well, but understates the predictive power of public choice theory.
Public choice is true on the margin—that is: people’s actions in politics and government tend to be affected by self-interest—but if you predicted what people did using only or mainly public choice you’d get it wrong nearly every time, at least in the modern West.
In fact, public choice theory can predict the actions taken by politicians, bureaucrats, and voters well, if not perfectly. Politicians may have altruistic motives, but they cannot effectuate their agendas without acting in ways described by public choice theory. Southwood's first example is voting:
Start with voting. Voting is an extremely widespread behavior in Western societies. A third or two fifths of adults will turn out even for the most trivial local elections. Eighty per cent might turn out for a major contest. But public choice cannot explain this.

Your vote has a tiny influence on the outcome of most elections. The chance of an individual voter deciding an American presidential election is about one in sixty million (ranging from one in ten million in some swing states to about one in a billion in Texas or California). If you only care about the election’s impact on your own personal prospects, then the election would need to be worth about a billion dollars to you personally. Elections often make trillions of dollars worth of difference overall, but rarely more than thousands or hundreds to individuals or their families.
This is a complete misunderstanding of public choice theory on voting. The cost-benefit analysis of voting for an individual is straightforward if we account for the social dimesion. People turn out to vote because they and their peer group believe it is part of their civic duty. The cost of voting is small relative to the benefit of signaling to one's peer group that we care about our civic duty. The fact that an individual vote is highly unlikely to affect an election simply doesn't matter.

Southwood goes on:
In public choice theory politicians stand for elected office not in order to enact a program, based on their views and convictions, but in order to maximize their personal power. To do so, they maximize votes at elections. This claim is also a familiar conventional wisdom to the point of cliche: politicians are unprincipled schemers who will do anything for votes.
There's a lot to unpack here. The first sentence gives the impression that politicians' desire to enact a program "based on their views and convictions" precludes their intent to maximize personal power. On the contrary, the former is dependent on the latter! Immediately after their elections, presidents and prime ministers are often said to have a "strong mandate" if they win more votes than expected. This "mandate" is said to give them political leverage to implement their agendas. All of this is orthogonal to their status as "unprincipled schemers who will do anything for votes." They may be unprincipled schemers, or they may be very well-meaning people. The fact is, if they want to implement the policies they think best, they have to work the system. The idea that politicians are evil might be a popular shorthand for public choice theory, but it doesn't represent the theory itself.

Southwood continues:
Public choice also predicts that officials are easily lobbied: they can be bought by rent-seeking special interests. But the literature is almost unequivocal: the source of campaign funds makes little difference to campaigns or policies. The fact that the decisions politicians make affect how trillions of dollars are spent, and yet firms spend figures in the low billions on elections caused a famous economics paper to ask “Why is there so little money in US politics“?
Again, Southwood starts off fine. Campaign donations, lobbying, and the revolving door more generally are all ways certain interest groups can influence politicians. The literature, specifically the paper he cites, does find that campaign donations only influence legislators' votes in some cases. However, this doesn't include lobbying and other rent seeking behavior. There is a revealed preference component here; even if interest groups are not "buying votes" with campaign funds or lobbying firm fees, they apparently see some value in spending several billion dollars per year (at the federal level) on it. We can't observe a counterfactual world in which there is no "money in politics," so it's difficult to know precisely how much impact campaign funds and lobbying have on legislator's behavior. Finally, there is a point to be made here about marginalism. It's true the US federal budget is in the trillions. However, the votes held in any single legislature will only affect this budget at the margins, not halving or doubling the budget year to year.

Public choice is fundamentally not about corruption or other criminal behavior; it's simply economics applied to political problems. Oftentimes, it's about incentive and information problems specific to the political world that result from the constraints we face in human interaction. Regulation can indirectly benefit special interests incentivizing rent seeking behavior, some laws can give politicians the power to benefit themselves personally, and arbitrary enforcement can create confusion and uncertainty. Even popular and well-meaning politicians understand the poor incentives they sometimes face.

Wednesday, May 31, 2017

Environmental Law Tradeoffs for Ag

by Levi Russell

Tiffany Dowell at Texas A&M has a great, concise blog post about a recent circuit court decision that will undoubtedly increase costs associated with environmental regulation of farms. As usual, I encourage you to read the entire post, but here's an excerpt:
Environmental groups, led by Waterkeeper Alliance, argued that CERCLA and EPCRA do not allow the EPA to exempt anyone from reporting requirements if there are releases over the statutory reportable quantity.  Further, the environmental groups claim that the rule is arbitrary in treating waste on farms differently than similar waste in other places, such as at a zoo or a slaughterhouse, which would not be exempted from reporting.  On the other side, the National Pork Producers Council also filed suit, albeit for a very different reason.  The Council claimed that the CAFO exception is not allowed because it was based upon the public’s desire for information, rather than based upon the purpose for which the statute was enacted–facilitating emergency response.
...
Now that the rule containing the farm exemption is no longer in place, under federal law, farms that may emit hazardous substances from animal waste above the threshold amount are legally required to report such emissions.   One major problem, which was noted by the court, is that there has been no determination of how these emissions should be measured.  It is unclear how farmers are expected to know whether their emissions are above reportable quantity, or how they are to measure them for reporting.  It may be that some operations can simply file an annual notice of continuous release if the releases are “continuous and stable in amount and rate.”  Hopefully, the EPA will offer some additional guidance documents in light of this ruling.  Operations for which this may be an issue should consult with their attorney to determine what steps to take.
A few things to note here:

1. The exemption was not for large animal feeding operations, it was for regular farms. With that exemption gone, farmers will be subject to significant regulatory uncertainty and cost.

2. That uncertainty and cost will fall disproportionately on small farmers. While this type of regulation will apply to larger farms, it will be difficult, at least in the short run, to know exactly where the threshold is. How many cows/hogs/chickens/etc does it take to create 100 pounds per day of ammonia or hydrogen sulfide? It will also complicate investment decisions for small farmers.

3. There's clearly an industry concentration vs environmental quality tradeoff here. A public concerned with the continued existence of the "family farm" would be smart to consider this tradeoff.

4. Tiffany notes that public comment played a role in the circuit court's decision, implying that interested parties can have some say in the regulatory process, at least when regulations are challenged in the courts. I suspect this will be a losing battle for ag in the future if the public continues to grow more concerned about these issues.

Friday, May 26, 2017

Boetkke on Buchanan

by Levi Russell

I've enjoyed reading every bit of George Mason University economist Peter Boettke's work that I've had the time to read in the past several years. His work is very interesting in part because he addresses issues most of us don't spend a lot of time on. In this post, I reproduce some of my favorite quotes from a recent speech Boettke gave. The speech focuses on Jim Buchanan's perspective on economics generally and political economy specifically. As usual, I suggest you read the whole speech, as it is very good and very short.

The problem as Buchanan sees it is that economics as a discipline has a public purpose, but modern economists have shirked on that purpose and yet are still being rewarded as if they were earnestly working to meet their educational obligation. As he put it:“I have often argued that there is only one ‘principle’ in economics that is worth stressing, and that the economist’s didactic function is one of conveying some understanding of this principle to the public at large. Apart from this principle, there would be no general basis for general public support for economics as a legitimate academic discipline, no place for ‘economics’ as an appropriate part of a ‘liberal’ educational curriculum. I refer, of course, to the principle of the spontaneous order of the market, which was the great intellectual discovery of the eighteenth century” (1977 [2000]: 96).

Prices serve this guiding role, profits lure them, losses discipline them, and all of that is made possible due to an institutional environment of property, contract and consent. These are the basic principles from which we work in economics. Important to note, economic analysis relies neither on any notion of hyper rational actors myopically concerned with maximizing monetary rewards, nor on postulating perfectly competitive markets. It relies simply on the notion that fallible yet capable human beings are striving to better their situation, and in so doing enter into exchange relations with others. Atomistic individualism and mechanistic notions of the market is, as Buchanan has stressed, nonsensical social science.

From a Buchanan perspective, basic economics can be conveyed in 8 points.
1.Economics is a "science" but not like the physical sciences. Economics is a "philosophical" science and the strictures against scientism offered by Frank Knight and F. A. Hayek should be heeded.
2. Economics is about choice and processes of adjustment, not states of rest.Equilibrium models are only useful when we recognize their limits.
3. Economics is about exchange, not about maximizing. Exchange activity and arbitrage should be the central focus of economic analysis.
4. Economics is about individual actors, not collective entities. Only individuals choose.
5. Economics is about a game played within rules.
6. Economics cannot be studied properly outside of politics. The choices among different rules of the game cannot be ignored.
7. The most important function of economics as a discipline is its didactic role in explaining the principle of spontaneous order.
8. Economic [sic] is elementary.

Monday, May 15, 2017

Potpourri

by Levi Russell

Here's a collection of articles I've read over the last week or so.

David Henderson on Thoma on potential changes to banking regulation.

Economist Allan Meltzer recently passed away. Here and here are two commentaries on his work.

A major contribution of another recently-deceased and well-known economist William Baumol is discussed here.

Don Boudreaux has a fantastic post on the importance of Econ 101. Here's a short excerpt:
To put the point a bit differently, ECON 101 instills the good habit of looking past stage 1, which is the stage at which most non-economists stop their investigations of economic consequences.  ECON 101 prompts those who grasp it to look also to stages 2, 3, and 4.  More-advanced economics courses – all the way to ECON 999 – teach that in theory there is also the possibility of stages 5, 6, 7, …. n.  Awareness of these theoretical possibilities is, of course, useful.  But awareness of stages 5, 6, 7, … n is either meaningless or, worse, practically dangerous without also an awareness of stages 2, 3, and 4.  And nearly all economic ignorance in the real world is simple unawareness of stages 2, 3, and 4.  (It’s also mistaken to conclude – as Kwak concludes – that awareness of stages 5, 6, 7, …. n regularly nullifies policy conclusions drawn from awareness of stages 1 through 4.)
Here's a great piece at Cato on the Net Neutrality issue.

Economics blogger Jim Rose corrects Noah Smith's oft-repeated claim that the economics profession was, until recently, dominated by right-wingers and libertarians.

Saturday, May 6, 2017

A Modest Proposal for Improving Health Insurance and Care

by Levi Russell

I want to start off by saying I'm not an expert in health insurance or healthcare economics. That said, I've read my fair share of analysis on the subject and understand how the math of insurance works. In the current debates over the ACA vs the AHCA, "high-risk pools," redistribution, and (largely academic) discussions over the inability of insurers to accurately price risk due to regulations, I thought I'd sketch out what I think is a basic free-market healthcare "system." Please note that I often about the mistake of committing the Nirvana Fallacy, so none of what you read below should be interpreted as a claim that "markets are perfect" or any other silly Utopian view. I think there's a lot that can be done to simply improve on current policy. Here I discuss how I would like to see that happen.

Health Insurance

The way I see it, the primary problem with the current health insurance system is that it isn't actually insurance. It's a third-party payer system in which people pre-pay primarily for routine care. These plans have low deductibles, co-pays, and high "premiums." Again, a large percentage of one's "premiums" aren't really premiums.

These generous "insurance" plans are a product of decades-old payroll tax policy. Employees are taxed on their earnings, but are not taxed on so-called "fringe benefits." Employers, competing for the best talent, provided more and more generous fringe benefits rather than increase taxable wages. This led to the current comprehensive health insurance plans prevalent today and created the perverse third-party-payer incentives that have driven up the cost of insurance and care.

Due to concentration in the (massively regulated) medical care industry, hospitals are able to dramatically inflate the cost of care, which pushes up premiums. Insurance companies, also a highly concentrated industry partly thanks to the ACA, have very little incentive to negotiate for lower prices resulting in a bizarre circumstance in which paying out of pocket for routine care is cheaper than using comprehensive care "insurance."

Given these problems, what can we conclude about policy changes that could improve insurance?

1. Stop favoring "fringe benefits" with payroll tax policy. This will allow for a divorce of employment from health insurance, partly solving the pre-existing condition issue.

2. Stop forcing insurers to ignore basic health factors in pricing insurance and to cover pre-existing conditions. This has led to more concentration and certainly hasn't helped drive premiums down overall. However we handle redistributive aspects of health care, we certainly need a functioning price system.

3. Remove caps on contributions to health savings accounts. Provide subsidies to low-income people in the form of tax credits so they can afford catastrophic plans and can contribute to their health savings accounts (HSAs). This will allow parents to ensure that their children have insurance for horribly tragic terminal conditions long before they are born. This would also go a long way to solving the pre-existing conditions problem.

4. Provide something like Medicaid/Medicare for the (I suspect relatively small number of) people who would fall through the cracks if the changes in 1, 2, and 3 above were made.

For more of my thoughts on HSAs, including an example, see this FH post.

UPDATE - Joshua Hendrickson at Ole Miss pointed me toward this article on health insurance by John Cochrane at U Chicago. I recommend checking it out.

Health Care Costs

It stands to reason that one primary cause of high insurance costs is that the care itself is expensive. All sorts of laws restrict the ability of consumers to find primary care at affordable rates: certificate of need laws (which put the power to increase the quantity of medical care facilities up to a state-level board consisting of hospital administrators; discussed here and here on FH), scope of practice laws (which restrict the ability of nurses and nurse practitioners to provide routine care, thus decreasing the supply of care and increasing costs), restrictions on direct primary care (a fee-based service that connects doctors and patients directly without the use of "comprehensive care insurance"), and a whole host of other things I'm probably missing.

In my mind, whatever happens at the federal level, we will continue to see states move away from their restrictive laws and increasingly allow doctors and patients to make decisions about health care on their own. As this article notes, monthly fees for all-inclusive primary care through a "direct primary care" physician can be as low as $25 per person thanks to the reduction in bureaucratic paperwork. This podcast interview has more information. Thanks to innovative medical entrepreneurs, there's even a surgery center in Oklahoma that posts all-inclusive prices for all the procedures they perform on their website. I assume I don't need to tell you that their prices are far below what a typical hospital would charge an insurance company for the same procedures. Imagine that; the price system works to provide care at low costs when it is not chained down by bureaucracy.

As Milton Friedman said, there are no panaceas. Health insurance and health care will never be free and some people will have a tough time taking care of their medical bills. This is true regardless of the institutional structure; the world isn't perfect. However, I think the points discussed above would improve outcomes across the spectrum, especially for those in the bottom two income quintiles. Reduce restrictions on health care providers, allow doctors and patients to interact directly without excessive red tape, level the playing field for HSAs and catastrophic insurance plans (i.e. actual insurance), and provide cash assistance or some other means of helping those who fall through the cracks. As a result, we'll get lower costs, more choice, and far less deadweight loss. What are your thoughts?

Friday, May 5, 2017

Bryan Caplan on Pricing and Market Power

by Levi Russell

Previously on the blog, I've shared Bryan Caplan's interesting perspective on monopoly and market power. He recently wrote another post that is at least as interesting as the first one I discussed. Below I reproduce the first half of his post.
In the real world, prices often seem far above marginal cost.  Yesterday, for example, I bought a pair of tweezers for $14.99.  But it's hard to see how the marginal cost - metal, electricity, transportation, miscellaneous - could even reach $1.00.  That's a markup well in excess of 1000%.  If you're steeped in the perfectly competitive model, where price always equals marginal cost, it's easy to feel "ripped off" whenever you make a purchase.

The obvious rebuttal is to point to all the fixed costs of production.  While the marginal pair of tweezers costs pennies to produce, the first pair plausibly costs millions.  Factoring in fixed costs, tweezer producers are probably roughly breaking even.  So how is that a "rip-off"?

But on reflection, this greatly understates what a fantastic deal we consumers get.  To see why, I often invoke my Consumer Gratitude Heuristic.  Here's how it works.  When I bought my tweezers, I asked myself, "How much would it have cost me to make these tweezers all by myself?"  On reflection, the answer is... more than my lifetime wealth!  I'd have to spend years learning the basics of mining and metallurgy to acquire minimal competence.  And after a lifetime of training, I still probably wouldn't have the skill to make a single tweezer as good as the one I bought at Wegmans.  $14.99 versus more time than I have on Earth: that's what I call a bargain.
Caplan goes on to note that this is not an exceptional case. Indeed it isn't; Leonard Reed's famous "I, Pencil" is really a great example of what Caplan is getting at as well. If you're interested in more technical economics on this, I suggest a (tragically forgotten) paper by Armen Alchian (short summary at the end of this FH post) on fixed cost and marginal cost.

Monday, May 1, 2017

Review of Sunstein's Latest Book

by Levi Russell

I came across a review of Cass Sunstein's latest book The Ethics of Influence: Government in the Age of Behavioral Science by Michael D. Thomas in Public Choice. It's a great review that provides a succinct summary of each chapter. Since I'm often critical of Sunstein's "nudge" theory, I thought I'd share the last few paragraphs of the review. The review itself is, unfortunately, behind a paywall.

The Ethics of Influence appeals to the reader interested in the scope of government. It challenges Buchanan’s (2004) response to Warren Samuels about the “status of the status quo”. One could respond to Sunstein’s analysis by adding Buchanan’s observation that pure rent seeking results when the status quo is simply one among many possible outcomes. Another view would be that the status quo emerges tacitly over time. Here a defense of customary and common law could include writings by Hasnas (1995) on the emergence of law.

In dealing with Sunstein’s treatment of Hayek, it is important to respond not only to the explicit claims about how emergent law works, but also to his characterization of Mill’s harm principle. This is where public choice must defend the epistemic argument in Mill. The individual is not justified because he is a rational chooser, as Sunstein puts it. Instead, Mill says, “Men are not more zealous for truth than they often are for error…” (2009, p. 31). Multiple choosing groups do not preserve the truth, but the possibility for recovering lost truths. Readers might incorporate theories of discovery here, such as those developed by Kirzner (1985). Sunstein’s choice architects, on the other hand, form law through the inclusion of popular sentiment which reduces competing truth claims to one.

Since this book was published before the most recent presidential election, one wonders if such a view is weakened by the dramatic shift in popular sentiment and large changes in policy. Public choice concerns over who wields the power of this ever increasing authority gain additional profile from these recent events. The Ethics of Influence is a must read because it lays out many issues that are important for the next round of debates in public choice.