Bastiat’s Bastions

The current credit crisis and the massive failure of financial institutions brought the usual Washington response: do something, do anything, even if it is wrong. What was done was a bailout of several institutions, especially the government inspired, government created, and government sponsored enterprises, Fannie Mae and Freddy Mac. I am not going to get into whether the bailout was the right or wrong thing to do—at least not here and now. There is another point I intend to address, the issue of pork, or fat to grease the political wheels of Congress.

I should mention that this is something that I have written about elsewhere (with Robert Tollison in this conference paper, that was later published with Gohkan Karahan in the journal, Public Choice. Our opening line in that paper is “Like other exogenous shocks, the 9/11 attack on U.S. targets opened up the possibilities for wealth transfers as public policy toward terrorism emerged in the aftermath of the horror.” In professional econ-speak, “wealth transfers” is robbing Peter to pay Paul.  The point is this: when our politicians encounter a situation that they can convince voters is a “crisis,” politicians see this as an opportunity to sell voters and their colleagues in Congress on extra spending beyond the scope of the initial problem.

Congressmen trade their votes on one project that they care very little about in order to get their way on projects that they do care about. Congressmen in New York did not mind that some money would go to Wyoming, where the threat of terror was very small, as long as they got their protection. Similarly, many congressmen did not seem to mind that some funds were going to makers of wooden arrows or research on wool as long as the bailout was passed. Of course, other congressmen may have voted for the bailout to get their wooden arrow or wool subsidies for their districts. Even worse, some congressmen may holdout for a bigger piece of the pie, withholding their support for a bill they really do want to see passed so that they can bargain for more spending in their district’s direction, basically using a tragic situation to enrich their friends and supporters.

Political trading, known as log-rolling, is much like trade in the marketplace, but the ones doing the trading or not the ones paying the bills. Often, special spending that is buried in larger spending bills usually flies under the radar, so the ones noticing the pork spending are the recipients of that pork, while others hardly notice.

There was a telling scene in a 2007 Tom Hanks movie, Charlie Wilson’s War. In the movie, Hanks as Congressman Charlie Wilson explains that he can that he can sneak through Congress the financing of a war against the Russians in Afghanistan Congress because he represented the only district in America where the voters don’t ask for much more than for them and their guns to be left alone. He was able to collect a lot of IOUs from other congressmen.

What happens is that by combining two bills or by combining them implicitly through trading support for one bill by promising support on another, two bills can get passed that would not have passed on their own, two minorities sometimes equal a majority.

This is just another face of stealth politics.

-MC

What is seen and what is unseen: Government programs and stealth taxes

In listening to the Obama-Biden team on their tax policy, I have repeatedly heard the phrase, “no one who makes over $250,000 will see their taxes increase by one penny under our plan.” That may be so, but be careful: sometimes it is what you don’t see that gets you, like the car in your blind spot when you switch lanes. In graduate school one of my professors, Nobel laureate James Buchanan, constantly pointed out how many taxes remain unseen by those who pay them. Many times taxes are levied on sellers and then passed forward to buyers in price increases, seen as price increases, not as tax increases. In particular, Buchanan constantly fought against deficit financing and hidden taxation as what he referred to as “fiscal illusion,” where the ones who face the burden of the taxes do not notice they are actually footing the bill.

This is especially seen with taxes on corporations. The truth is corporations pay no taxes in the end. Taxes always and everywhere are paid by people. Corporate taxes are paid by customers in the form of higher prices, by workers in the form of lower pay, by vendors in the form of lower prices, and by shareholders in the form of lower share values and lower dividends. None of the burden falls on the corporation, itself, but rather on real people. Such taxes are stealth taxes as most people seldom see them coming.

Talk of taxing only the rich is similarly misleading. Here is what happens. If taxes are raised on the “rich,” fewer people go into fields where people get rich. That is likely to mean fewer doctors. With fewer doctors than we would have had at lower tax rates on the rich, the supply of doctors is decreased and doctors’ fees increase. If one can get another job which pays only slightly less after taxes without requiring going to school for so many years, and without enduring difficult study and years of poverty while in medical school, why make such a heavy investment in education when the return is so small. With fewer going into medical school, the before-tax pay of doctors goes up, leaving the after-tax pay of doctors practically unchanged. Similarly, more people go into fields that are paid less and have a fun side to them, such as bartending and rock-band roadie, so the supply goes up in roadies and bartenders and their before-tax pay goes down. Admittedly, such changes in the pay of doctors near the top of the pay scale, and bartenders and roadies at the bottom of the pay scale will take place over a decade or so. It is also something people will not notice that much, as pay for doctors goes up at a faster rate than pay increases for bartenders.

Not only are taxes that we call taxes always and everywhere a burden on real people, but alternatives to taxes also burden someone somewhere. The real alternative to taxation in funding programs is to run a deficit. And deficits are financed in two basic ways, by inflating the money supply (creating money through the Federal Reserve System) and by issuing government securities, which means borrowing. Inflation, by reducing the value of the dollar, taxes every dollar in everyone’s pocket, in everyone’s bank account. Borrowing, by using credit that could have gone to businesses that could have purchased equipment that would have increased worker productivity and worker pay, as well as profits for business owners, or to consumers for homes and automobiles by raising interest rates.

Professor Buchanan was particularly critical of an idea referred to as “the Ricardian equivilance theorem.” The Ricardian equivalence theorem is based on the work of an early 19^th century economist, David Ricardo, who is better known for his comparative advantage theory of trade. Ricardo suggested that borrowing to pay for government spending or taxing people to pay for that spending are equivalent because people will have to pay for the borrowing through higher taxes (or lower government spending, that should benefit someone) in the future. The taxpayers could borrow the money themselves to pay for their taxes which would amount to the same level of borrowing as would occur if the government went ahead and borrowed it by running a deficit. Ricardo, contrary to the theorem that bears his name, goes on to discuss why people fail to realize that the future tax burdens from deficit spending are their own.

So here, with the fiscal illusion problem, the cost of any government-financed program is often not fully grasped by the voter-taxpayer. Thinking that someone else is really paying for the program, the voter-taxpayers choose to take on more public spending, more programs, than they would have if they fully realized the cost they bear. Hidden taxes, whether taxes that someone else is paying or deficit financing or inflation, lower apparent government costs and entice us to buy more government.

Fiscal illusion, what I call “stealth taxation,” deludes us to agreeing to government programs we would not have chosen if we knew their real costs to us. Whether it is government monopoly provided healthcare as Obama wants paid for by taxes on the rich, which are really taxes on us all, or deficit financing of a war that McCain may want, stealth taxation in any of its forms distorts reality the way too much beer distorts our own vision leading us to make various unwise decisions of the moment. Politicians always make sure we see how wonderful their spending plans are. But just as we have laws against drunk driving and that require corrected vision for those of use whose eyesight needs help, perhaps there should be fiscal choice rules, constitutional-level rules, requiring that fiscal choices be made only when we can fully see our costs.

-MC

I like to think I have a gained a modicum of wisdom since my childhood, though my wife may disagree. For starters, I’ve learned that virtually no good can come from rushing into anything. I’ve also figured out that, for any of its faults, capitalism does what it’s supposed to – it allows people to make money.

So, now that the pundits are trying to sell us on “the greatest crisis since the great depression,” and politicians are telling us how important it is that they pass a bill yesterday, maybe I do have something to offer.

Perhaps the crisis is not as substantive as is being made out, and perhaps the government should be doing less, not more. Admittedly, I’m still researching (and reading through the text of the just failed-bill), but here are some thoughts. Take it as….food for thought.

• The Federal Reserve Chairman and the Treasury secretary are telling us we’re in a crisis, but who told them? What if the answer is: investment bankers who don’t want to lose money? Paulson is, after all, a former investment banker (and the former CEO of Goldman).
• The Fed set a dangerous precedent by allowing investment banks to borrow from the central bank (in early 2008). Now, in the Fall of 2008, investment banks should have every expectation of being bailed out by the government. I’m not sure if the Fed blinked or winked, but the end result is the same: if you’re an investment banker holding risky investments that may be losing value, go see the Fed; by all means, don’t cut your losses.
• If we can agree that the root cause of the crisis is the worthlessness of the underlying mortgage assets (sub-prime related derivative securities), why should anyone, least of all taxpayers, be forced into lending money to shore up the hole these investments are putting in balance sheets? The assets are worthless.
• We’re told part of the problem is the danger of this thing blowing up into a liquidity crisis. This begs the question: for whom?
  • My brother, who does not have great credit, bought a new car last Thursday. He drove off the lot before his paperwork was complete.
  • Last week, JP Morgan and Goldman Sachs raised $20 billion (yes, that’s a “b”) in new capital.
  • This week, Citigroup announced it would buy Wachovia’s banking unit for $2.1 billion.
    • I go back to my second point: if you’re an investment bank and you know you’re in trouble, go to the Fed. If you’re a well-run company, no problem, you can raise capital. Raising capital will probably get more costly soon, but most prices fluctuate in markets….which means they do move in both directions.
• One aspect of the current crisis is that certain derivative securities cannot be easily valued. For any market transaction to take place, we need a buyer and a seller. We’re being told there are no buyers….but what if the reality is that there aren’t any sellers? Again, I go back to my second point: If you are an investment bank and think the paper you’re holding is worth $0.25 cents on the dollar, why try to sell it on the market? Hold out for more from the feds. It appears, after all, they are quite willing to help you out. If this is the case, the markets are frozen because of government intervention or the expectation for government intervention.  Three years ago nearby in New Orleans, we saw people who reasonably expected the government to shelter them from the storm who were quite disappointed when the government did that job so poorly.  The expectation of sheltering came about because of previous government sheltering just as the expectation of sheltering Wall Street from this mortgage storm planted by previous bailouts, such as with the auto industry.
• For years now, the Fed has pumped billions and billions of “credit” into the system. If this hasn’t worked yet, why are we to believe another round will produce different results?
• If the root-cause of the crisis is that housing prices stopped rising so much and started falling, thus making the derivative securities worth less (or worthless), why were they rising so fast in the first place? If government action had anything to do with the housing bubble, why do we want more government action now?
• If there are all of these bad loans and investments out there, let’s get the revaluation going instead of putting it off with “loans” on top of bad loans.
• In early September, the U.S. Treasury nationalized Fannie Mae and Freddie Mac, getting rid of the “implicit” part of the implied government guarantee that was always attached to their debt. Treasury obtained Congressional authority for this action on the pretense that further intervention would not be necessary. Is anyone buying this?

-NM

If you haven’t heard, the Cubbies have a pretty good team this year. They’ve clinched a birth to the playoffs, and are predicted to do some damage in the playoffs.

(Or wait - is that the fans that are predicted to do some damage? I’m getting ahead of myself.)

Read this article from the Chicago Sun-Times.

It seems some local political types are worried that, gasp, should the cubs win their first world series in 100 years (seriously, it would have been 100 years), that the numerous bars around Wrigley Field should stop serving beer after the 7th inning of any game in which they could clinch the series. They are worried about some unruly behavior.

The thought process is, that because the cubbies fan will stop drinking for an hour (beer will be served after the game ends), there will be less unruly behavior.

I find it a bit of a stretch…

We’ve talked about what happens to current demand when there is an increase in the expected future price of a product. Current demand increases when the price is expected to rise.

If the bar can’t sell you beers after the 7th inning, then you can think of the price becoming very very high after the 7th inning ends. As such, we’d expect a big spike in alcohol purchases just before the 7th inning.

But two more questions to consider. If people just buy an extra hour’s worth of beer before the 7th inning and drink at the normal pace, there is no effect of the regulation. A useless government intervention.

But could it be worse? Could people guzzle the last one, or guzzle the next one, or buy some Jaeger-bombs (they still taste ok warm), and become more unruly than they would have if there hadn’t been the ban? Could the rule induce substitution from beer to liquor?

Granted, there might be some people who just stop drinking for an hour.

However, the article says that policy is voluntary. How many bars do you think are going to volunteer to follow this policy?

Would you be in favor of this rule if you owned a bar near Wrigley? If you owned a bar just outisde of the covered area?

In the end, what does the rule accomplish?

Or does it really not matter at all because the cubs have no hope of clinching anything? Sadly, I worry about this option the most.

A hat tip to the folks over at sportseconomist.com for pointing out the article and writing a post similar in spirit.

–CT

Before anyone gets too excited about the prospect of universal healthcare insurance, we should stop to think about what this will really accomplish. First, we should acknowledge that the very poor and the old are mostly covered, and that the largest part of the uninsured really are people who expect to have little use for medical care, and so, take the risk upon themselves. This is the group of 18-35 year old males.

We should note that universal health insurance, by itself, will do nothing to reduce healthcare prices, and in fact will tend to increase prices of health care and the premiums for health insurance because it will serve to increase the demand for healthcare while doing nothing to also increase the supply. Any increase in demand for healthcare because doctor’s visits may suddenly appear to be less costly (paid for through premiums or payments from the government) will merely push up the basic price of healthcare. Healthcare premiums will be pushed up as a result to cover the extra demand.

What is happening now, though, with partial coverage is a problem as well. Here is what happens. Some are covered, and some are not. Those covered are able to access health care at subsidized prices (that they pay for in fixed monthly payments), while those who are not covered pay full price. I think of it like making beer insurance available to college students, insurance that pays their beer tabs. This boosts the beer consumed relative to the full price, or in economics lingo, it boosts the demand for beer. If beer were like medical care, the problem would suddenly become very serious, because the supply of medical care is tightly limited, by medical schools, professional associations, licensure, and even government limits on supply.

But medical care is not quite like beer, because getting poked, prodded, probed, stuck, bled and disrobed, is not as appealing to most as a few cold ones. Many go to the doctor only reluctantly, just as many leave the pub only reluctantly.

The problem is that when some get their health care at some subsidized price, the demand ends up increasing and the full price to the uninsured increases. Some get healthcare a little cheaper perhaps, while others find it difficult to afford.

But what happens when we all are covered with healthcare insurance? It is much like the problem when we all stand to get a better view of a play in a football game–none of us end up getting a better view. When we all get healthcare insurance, we end up paying very high premiums and doctor visit fees much like we would have faced without coverage for doctor visits.

When we have privately paid for health care, or privately paid insurance and managed care plans, the managers of such plans cover certain treatments and do not cover others, bringing to mind the 1997 movie, “As Good as It Gets,” with Jack Nicholson, Helen Hunt and Greg Kinnear, where a boy’s asthma treatment was not covered by his mom’s HMO. At least there is some competition between plans, and employers do most of the “picking” amongst plans, but do so as an alternate means of paying their employees. As a result, though, legislators then have an incentive to mandate coverage of treatments that have political support.

The decision as to what is covered and what is not comes about as a political decision, with the benefits going to small concentrated groups and the costs spread over the premium payers. Politicians can point to greater coverage as an accomplishment of theirs, and since payments are not coming from tax payers but rather from premium payers, politicians can also point out that the government spending and the tax burden was not increased, laying the blame of ever higher premiums on the shoulders of the health insurers and HMOs. The politicians are ordering greater coverage, but someone else is paying for it off budget.

What differs with government health single-payer plans or nationalized plans is that it becomes clear that the politicians are responsible for the costs—they no longer have private firms on which to lay the blame for mounting costs. Then, they act much like the HMO Helen Hunt faced in “As Good as It Gets,” but now without competition. Then we start to see both tough choices and questionable choices being made. For instance, this summer stories (see these at Fox and KATU, Portland, OR) began to pour out of Oregon of cancer patients being denied chemotherapy, but offered physician assisted suicide instead, because easing the pain and bringing about earlier death of patients too costly to treat is the right thing to do.

So it goes.

Then there is this recent story from Britain about Baroness Warnock, a medical ethicist and an advisor to the British government, who has even suggested that dementia patients may have a “duty” to die.

“She insisted there was “nothing wrong” with people being helped to die for the sake of their loved ones or society. The 84-year-old added that she hoped people will soon be ‘licensed to put others down’ if they are unable to look after themselves.” And so it goes. And Welcome to the Monkey House.

-MC

One of most viewed economics blogs is Steve Levitt’s Freakonomics New York Times blog.  Levitt is the primary author of the “bestselling” non-fiction book, Freakonomics.  Take a look at what Levitt’s colleagues, Doug Diamond and Anil Kashyap (all at the University of Chicago) have to say about what has gone on these last few weeks with bailouts and failures of financial institutions.

-MC

Continuing on my oil and gasoline prices theme, I thought I would mention something that is already obvious to many of you, and that is how much gasoline prices have skyrocketed, in spite of the drop of crude oil prices below the $100 mark.  As I write this, on the Sunday evening after Ike hit the Texas coast, gasoline prices in Thibodaux, Louisiana range from $3.79 per gallon at my neighborhood convenience store to $4.68 near downtown Thibodaux.  (For a basic lesson on gasoline pricing, take a look at this primer from the Energy Information Administration of the U.S. Department of Energy.) 

Before your knee starts to jerk, and you want to scream “price gougers,” stop for one moment to consider where Ike hit and the industry in that area.  Ike struck Galveston and Houston, but caused flooding all the way to the Mississippi coast.  Lake Charles, Louisiana, which was badly damaged by Rita in 2005, was flooded worse by Ike.  The Gulf Coast from Lake Charles, Louisiana to Corpus Christi, Texas, have more than 39 percent of the U.S. capacity for producing gasoline (I found refining capacity information also at the Energy Information Administration site).    

With workers to nearly 40 percent of our domestic capacity to refine gasoline unable to get to work, many still in the dark and the sweltering Southern September, with no electricity in their homes and their workplaces likely damaged by the winds and floods, it is perfectly reasonable for the refineries to raise their prices to send the gasoline consumers a clear message: “Conserve! We don’t that have much to go around, and it will have to last until we get these refineries back on their feet.”

Clearly a worse situation would be one where we forced the refineries to keep their prices low, keep them from price gouging, and instead, run out of gas in a week and a half. 

Many of us in the aftermath of Gustav, with memories of Katrina still all too fresh, know the feeling of not being able to get gasoline, electricity, fresh water and sometimes even food.  We know that running out of some things, such as gasoline, can sometimes have dire consequences.  I have run out of gas before and probably will sometime in the future.  But if we all run out of gas, our society grinds to a halt.  The food on the grocery store shelves runs out very soon.  Food does not make it from producer to consumer.  We starve.

The large price variation of almost a dollar a gallon from low to high prices should tell us that something else is going on, that is failing to keep prices in their usual close range.  I cannot be sure that this is the reason, but it may have something to do with what we observe:  Many states, and Louisiana is one, have laws that force gasoline retailers to charge a price in accordance to the wholesale price they paid for gasoline.  In Louisiana, before Katrina, gasoline retailers were forced, by law, to charge a 6% markup over wholesale price.  After Katrina, the Louisiana legislature allowed prices to fall to the wholesale price, but no lower.  As explained, wholesale prices went up as Ike wound his way to the beaches and refineries of the Texas oil coast.  Some gasoline retailers still had cheaper gas (as far as the already paid “wholesale price” was concerned), while others had empty tanks and were forced, by law, to charge the new, higher price. 

High prices during low production periods send us the same message as a ship captain putting his crew on half rations upon learning that half of his galley supplies became contaminated.  To fail to put a crew on half rations in such a situation would be reckless and irresponsible.  High prices let consumers decide which uses are important enough to pay the high prices and which are not important enough.

You can listen to a brainless, jerking knee and call $4.68 a gallon for regular gasoline “price gouging,” but I call it something else: “social responsibility.”

—-An update:  It seems the fears of the refiners were not borne out and Ike did little damage to our refining capacity as reported by Bloomberg.—-

-MC

In response to the Republican tune (click here to hear the real tune, by Aaron Tippin) of “Drill Here, Drill Now,” Senator and Democratic Presidential Candidate, Burack Obama dismissed the idea of more drilling leading to lower gasoline prices, insisting that we cannot drill ourselves out of high gas prices.  Instead, Obama suggests that we can lower gasoline prices by conserving more, by taking mass transit and by inflating our tires more and by making sure that our vehicles are properly tuned. This call to individual conservation measures will do little that people are not already doing, as people everywhere are driving less, taking mass transit more, riding bikes more, riding their motor cycles more, all out of a sense of individual conservation.

Why are people conserving? Because of the high gas prices. We conserve because of the high prices and we take conserving actions for what we might think of as rather selfish motivation–because gasoline costs too “damned” much, we do it because we cannot afford the high gas prices. And we are also inflating our tires more and getting our cars tuned up more, and we are driving a little slower and a lot less, too.  So, what’s the point?

The point is this. To the extent that people cut consumption of gasoline because of the high gas prices, those conservation actions cannot reduce the price of gasoline. Such conservation actions, as a result of the higher prices, are really the sliding along the downward sloping demand curve that we all know and love. Sliding along the demand curve does not push that demand curve down. It does nothing to shift the demand curve. And unless the demand curve is shifted, the conservation efforts, done because of the high prices will do nothing to reduce those prices. Those conservation efforts, an economist and a mathematician would note, are endogenous.

Now, if tire inflating and tune ups were made mandatory, forced upon everyone, with drivers being pulled over for their engines misfiring or for underinflated tires, there will be little shifting of demand as a result of someone in Washington telling us how to take care of our autos.

So unless the folks in Washington have a plan to force us to take these conservation measures, there will be little effect of this tire inflation campaign, or about as much as Gerald Ford’s WIN buttons (WIN stood for his campaign to “Whip Inflation Now”). Even if we all get our tire gauges out and pump up the tires instead of the volume, we won’t see any kind of price reduction, unless the same amount of pumping up tires occurs at both low and at high gas prices.

By the same token, if we only allow drilling in the OCS or in ANWR because of high oil prices, but we would not do the same thing at lower prices, there will be little effect on prices of such drilling. Neither would there be an effect on oil prices from increased use of alternative fuels (substitutes) if the turn to alternative energy sources is due to the high price of petroleum.

Think of the reasoning a bit more closely. At high gas prices, people inflate their tires to save money, but they don’t do this much at low gas prices because the savings are not as much. Suppose by inflating your tires because of the high gas prices, the demand for gasoline would actually be lower (this, however, is NOT the case). If demand would actually come down, then prices of gasoline would fall, and with the lower gas prices, people would not inflate their tires as much, they would buy more gasoline and the demand for gasoline and the price of gasoline would both go up. And pushing this illogical thought process a bit further, the high price of gasoline would, in turn, pull demand down, with people inflating their tires more, pulling prices down. Around and around she goes, where she stops….

This is exactly how demand and supply analysis is not done. Consumption that changes as a result of the price cannot lead to changes in prices. Production that changes in response to price changes also cannot affect prices. It is only the conservation and production efforts that occur independently of price of the good that can affect that good’s price.

-MC

In Econ 211, we often talk about the principle of diminishing marginal value. We say, that as you increase the rate of consumption, the marginal value eventually diminishes.

When we are being lazy or sloppy, we often neglect that there is a time dimension in this concept. As you increase the *rate* of consumption… This means so many goods per day or per week.

In my class, we talked about the diminishing marginal value of consuming BLTs. Consuming the first BLT per day has a higher marginal value than the second BLT per day. It would be reasonable to assume that the marginal value of the 23,000th BLT per day would be exceedingly low.

Now read this article?

And yet that man ate 23,000 Big Macs. Is our theory all wrong?

If we forgot about the rate dimension, you might ask what is the marginal value of the 23,000th Big Mac?

But he has consumed these Big Macs over a long period. Given that he eats roughly 3 a day, we do know the marginal value of the 3rd is lower than marginal value of the 2nd. Because he voluntarily purchases the 3rd Big Mac, that tells us his marginal value of the 3rd Big Mac per day still exceeds the price.

I believe we also know something about how the marginal value of the 4th Big Mac per day compares to the price too.

Admittedly technical and a bit boring - but we don’t forget there is a time dimension in our marginal values and demand curves.

–CT

A picture of the price of the Louisiana contract. The prices are the squares (right axis) and the bars are the volume (left axis). See the previous post for some details, but the basic idea is the price of the contract reflects the probability that the hurricane would make landfall in Louisiana and be at least category 2.

If we could find an enterprising student that would gather some data on how the “cone of error” evolved, it might be fun to put them together and so some analyzing.

If you click on the picture, a new window appears where the image is a bit more clear.

–CT

Update: I’ve added the picture for an identical contract on Hurricane Ike as of Monday night at 9:00 pm.