Bastiat’s Bastions

One of my students raised an interesting point when we discussed international trade and comparative advantage.  It seemed that all he had heard was that the U.S. no longer made much  anymore.  Now his point was more that we consume beyond what we produce, borrowing too much to pay for the trade deficit.  Still, many have the view that since manufacturing employment in the U.S. continues to decline (it peaked in 1979), that the U.S. is no longer making much stuff to sell.  Of course, part of what has been going on is that the U.S. has been increasing its services production.  Below is a link to a CBS news video along with links to a few articles on what has been going on with our production and trade in both manufacturing and in services.

First, is the rather misleading video of the CBS report by John Blackstone that aired 2/16/2010 on manufacturing in the U.S.  Note that the declines mentioned are measured in jobs rather than in output.

Now here is an article by Dan Ikenson of the Cato Institute that appeared in National Review Online in August, 2009 where he busts the myth that “We don’t [make things] any more — at least, not like we used to.” 

Along the same lines is a little longer is another article by Ikenson, “Thriving in a Global Economy: The Truth about U.S. Manufacturing and Trade,”  from 2007.

In an email (via a list I am on) from Ikenson I got Feb. 17^th, Ikenson writes:

The manufacturing jobs number (which, by the way, peaked in 1979 and has been on the same downward-sloping trajectory since then) masquerades as a barometer for the health of manufacturing, which has been setting all kinds of records with respect to output, value-added, revenues, profits, return-on-investment year after year (with the exception of the recent recession, which affected all sectors of the economy similarly). 

American manufacturing remains the world’s most prolific manufacturing sector accounting for 20-24 percent of global value-added; China accounts for about half that.  People ask: How can that be when most shelves in retail stores are loaded with products made in China, and ”Made in USA” labels are nowhere to be found?  Part of the explanation is that products labeled made in China are only 35-50%, on average, Chinese value-added.  (Apple iPods, which each register in our trade stats as a $150 import from China, contains about $4 of Chinese value-added–that’s only 3%!)  “Made in China” often means “snapped together in China” from components made in Japan, Taiwan, Singapore, Korea, and the United States.  Another part of the explanation for the dearth of “Made in USA” products on retail shelves is that U.S. manufacturing doesn’t make a lot of products sold on retail shelves.  Pharmaceuticals, chemicals, sophisticated componentry, airplane parts, and technical textiles aren’t sold through retailers, and those are some of the high-value products made in America.

Michael McKee writes this article at Bloomberg.com (Bloomberg News) from November, 2009, also busting the myth of U.S. manufacturing declines.

Finally, take a look at this February 17, 2010 op-ed article from the New York Times by W. Michael Cox , director of the Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business.  Cox writes here on the huge and growing size of U.S. production and exports of services.  I should point out that Dr. Cox is the former chief economist of the Dallas Federal Reserve, and even though I never had a class with Dr. Cox (he arrived my second year of graduate school), I still learned a good bit from him in our twice-a-week seminars at Virginia Tech.

 -MC

(A note to my students looking to get comment points–you will need to show that you looked at the video and have read the articles linked and cited above, or have done other reading on the subject–and link to your sources.)

What got my attention this week was something I heard this past Sunday on Fareed Zakaria’s Global Public Square (GPS) program on CNN.  Zakaria states point blank, that the Bush tax cuts are the single largest part of the deficit.

Notice that Mr. Zakaria thinks he has Greenspan and Paulson in a “gotcha moment,” claiming that they fail to live up to the ”courage of their convictions”  by not supporting immediate repeal of the Bush Tax Cuts.  The problem is that Zakaria is a poor listener.  We face two problems, the recession, which is short term and acute, and the deficit which is long term and chronic.  Notice that Paulson says that the deficit is a long-term problem.  Zakaria is missing a vital point in this discussion.  Reducing deficits, either by raising taxes or cutting spending, during downturns are widely thought to exacerbate recessions.  Paulson and Greenspan both suggest that now, because of our current recession, is not the time to be raising taxes, but they never rule out raising them at some time in the future.

Zakaria later points listeners to a Feb. 4, 2010 article in Time by Jeffrey Sachs, a leading economist at Columbia University, whose work on something called the “natural resource curse” has captured my recent research attention.

The current budget deficit runs about 10% of our national GDP (US  tax receipts are currently at 15% of GDP while spending is at 25%).  Sachs writes in his article that closing up the Bush tax cuts on the rich would only amount to .4% of GDP, which means that the Bush tax cuts account for only 4% of the deficit.  Sachs states: “even with rollbacks of tax cuts for the rich, the fiscal gap will remain enormous.  The Bush cuts in rates hardly account for the biggest part of the current deficit, as Zakaria claims.  Zakaria is not only a poor listener, he is also a poor reader.

Take a look at this picture of Federal Spending and Receipts in millions of dollars:

Here are those same figures but as percentages of GDP:

I should point out that there were actually two Bush Tax Cuts, one enacted in  2001 after 9/11 and the other in 2003.

Note that tax revenues rose faster after the 2nd Bush tax cuts than they did in the Clinton era, with the tax revenue growth coming to an end in 2007 at the beginning of the recession.

More importantly, notice that starting in 2001, public spending as a percent of GDP started to grow again after shrinking, as it had over the Clinton era.  While we should avoid post hoc thinking, we should also note that while the  tax cuts may have led to revenue declines, there were also large increases in government spending that started at the beginning of the Bush era.  The Bush spending programs included a generous pharmaceuticals program for the elderly, an increase in Homeland Security spending, an expensive war in Iraq in 2003 and allowing Republicans in Congress to spend heavily in their districts to increase their reelection chances.

It is the growth of entitlement spending that is at the heart of our future deficit problem, and in the very near future, growth in entitlement spending, from Social Security to Medicaid to Medicare, will be the drivers in our deficits.  Driving these spending figures are an aging population and rising health care prices.  One of the biggest reasons for the rising health care prices is that we have an aging population, boosting the demand for health care goods and services.  Increasing entitlements, through the health care bills that have gotten approval in the House and the Senate are destined to push projected deficits even higher.

A more realistic, as well as more pessimistic, view of the growing defict is reported in this ABC article.  The article reports the findings of the Peterson-Pew Commission on Budget Reform.  One of the commission’s publications is the testimony of Alice Rivlin.  Rivlin, an economist who was appointed by Johnson, Carter and Clinton to various government posts, recently testified before the Senate Budget Committee.  In her testimony, she states “In the next decade and beyond, federal spending, driven by the impact of an aging population and rising health care costs on Medicare, Medicaid, and Social Security, will rise substantially faster than the whole economy can grow–faster than the GDP.  Revenues, at any likely set of tax rates, will grow only slightly faster than the GDP.  The gap between spending and revenues will keep widening.” Obviously, repealing the Bush Tax Cuts, as Zakaria suggests, will do little if “revenues, at any likely set of tax rates,” will grow more slowly than the promised spending from Medicare, Medicaid, and Social Security.

Recently, my daughter and her roommate drove from Natchitoches, LA to Monroe, LA and followed her roommate’s global positioning device.   The car’s GPS routed them through Shreveport, doubling the usual time through Winnfield and Ruston.

As bad as the advice my daughter and her roommate got from the auto GPS, it did get her to her destination.  Zakaria’s suggestion that repealing the Bush tax cuts, or allowing them to expire, would put us much closer to erasing the deficit is just seriously misleading.   Zakaria’s GPS does not even set us on the right path.  Perhaps if Zakaria would listen more carefully and read the articles he suggests to his listeners, he might be worth listening to.

And this just in, President Obama has created a bi-partisan commission to come up with ways to deal with the deficit crisis.  From what I understand, the commission’s proposals would come before Congress to be voted on, yes or no, without amendments.  Unlike Zakaria’s suggestion of dealing with the Bush Tax Cuts (which should be on the commission’s table), President Obama has put us on course to effectively dealing with the long-term deficit problem, looking at both the spending and the revenue side of the deficit problem.

-MC

Once again, the idea of introducing a Value-Added Tax (VAT, better termed the “Stealth Tax”) to curb our mushrooming deficits is being discussed. This time, in a Feb. 4, 2010 article in Time magazine, Columbia University economist Jeffrey Sachs suggests the use of a new tax in America, the VAT, stating “Both sides could agree, for example, on a value-added tax (VAT) – a sort of national sales tax – combined with closing loopholes and reducing some marginal tax rates, including the corporate tax rate….”

Suggesting that we use a VAT instead of a straight-up sales tax to finance anything in this country, even a reduction in the corporate income tax, signifies either a lack of understanding of basic public finance or a willingness for the federal government to increase taxes on American buyers in ways unperceived by most voters.  While a VAT would be more visible than running deficits, which is another form of unperceived taxation, a regular sales tax would be far more visible by tax payers and works better in other respects, as well.

Sachs is right that a national VAT is sort of a national sales tax. With the VAT, instead of charging a flat rate on every dollar of retail sales, that same rate is collected from producers on the difference between the cost of the goods that they sell and their sales revenues, that is, on the value that they add to goods at each stage of production, from raw materials producer to manufacturer to wholesaler to retailer. Take the case of a loaf of bread that sells for a dollar. In the process of making the bread, a wheat farmer sells wheat to a mill which sells flour to a bakery which sells bread to a store which sells it to the final customer. The wheat that went into the flour that went into a loaf of bread sold for a quarter, while that much flour sold for a half dollar while the baker sold the bread to the retailer for 75 cents. Each producer adds a quarter at each of the four stages of production. If each producer is charged a 10 percent VAT, each of the four pays a tax of 2 1/2 cents, which adds 10 cents to the cost of the bread. The price of the bread ends up going up by 10 cents, the same amount as it would if there were just a national sales tax of 10 percent. Who ends up paying for this tax? It is the same person who ends up paying the sales tax, mostly the consumer.

This does not mean that there is no difference between these sales taxes and the VAT. Since most areas of the country already have some sort of sales tax, a national sales tax would cost little extra to collect. With a VAT, we would have to add a huge bureaucracy of accountants to check the cost of goods sold and the sales at each stage of production. This is a very costly tax to collect. With a sales tax, however, we could, in most states, piggyback collection and enforcement efforts on state and local government efforts.

Another difference is that the burden of a sales tax on the poor can be eased by putting exemptions on certain classes of goods, such as groceries, utilities or medicine, because the poor spend a larger portion of their income on these items than wealthier citizens. With a VAT, producer groups can be excluded, not consumer groups. Instead of easing the burden on certain consumers by exempting certain items such as groceries and medications from the sales tax, the VAT can only exempt certain producers.  This not only makes it difficult for the tax to be eased on the poor, but also makes it more likely that many producer groups will be lobbying in Washington to get their group excluded from the tax. Special interests do not lobby as much for exemptions from sales taxes because it is harder for consumer groups to organize than it is for producer groups. For Sachs, who rightly complains of the influence of special interests in Washington, to give special interests a greater incentive to lobby in Washington means that he does not understand the political incentives posed by certain forms of taxation.

A national VAT differs from a national sales tax in another important way. With a sales tax we see what we pay in these taxes at the cash register. The consumer never sees the bill for a Value-Added Tax, though the consumer ends up paying for the tax since it is mostly passed forward to the buyer. The lack of visibility of the VAT has prompted some critics of this tax, including me, to call it the Stealth Tax, because it hits the taxpayer/voter before she ever sees it coming. If there is a tax increase to pay for some new spending program, the tax increase is passed on as a price increase, and the buyer tends to blame the seller instead of the government.  But when the taxpayer/voter sees the bill for big government, she starts to question whether the spending is necessary. But when we don’t perceive the costs, we seldom question the value of the spending program.

The problem of the lack of visibility of a tax was first pointed out in 1903 by the Italian economist, Amilcare Puviani (as we see in this Richard Wagner paper), and then popularized among English-speaking economists by one of my professors, Jim Buchanan, a problem that has been called “fiscal illusion.” As voters, we are more likely to ask for new spending programs if we never notice how much it costs.   Importantly, Buchanan and others have noted that tax cuts and deficits fail to “starve the spending beast” of government, as many conservatives have proposed to deal with government spending, and instead reduce the visibility of the cost of spending to voters. Voters, then, become more supportive of almost every new spending program that comes along.  If the problem we are tackling with the VAT is the deficit, a very visible national sales tax makes a better weapon against the deficit than the stealthy VAT.

Sachs is quick to remind us that the VAT is widely used in Europe. This is true. And the Europeans have tackled the regressivity of the VAT buy introducing many spending programs to help the poor.  If we are facing a deficit problem, it would seem that additional programs to help alleviate tax regressivity unnecessarily add to the deficit by increasing spending on uncontrollable entitlements.

We should also note that the Europeans arrived at their VAT by their own peculiar history. Their VAT evolved from their former business tax, a tax on gross receipts at each stage of production. In our bread example, a 10 percent tax would collect 2 1/2 cents from the farmer, a little more than a nickel from the miller, about 8 cents from the baker and about eleven cents from the retailer, adding up to more than 21 cents. The Europeans quickly found that businesses could avoid the tax by combining the various stages of production into one business which would lower their taxes considerably, giving vertically integrated firms an advantage over those there are not.  It should also be pointed out that the Europeans already had a system in place to tax at each stage of business sales rather than a retail sales tax bureaurocracy.

So, if we are to go down the road of a new national tax on spending, we should note that a true national sales tax is superior to a VAT at every step, from being more visible and more of a deterrent to federal spending sprees, to being better suited to being shaped to help protect the poor from tax regressivity, to being less prone to being shaped to the liking of special interests, to being cheaper to administer.

-MC

(Note: I have written more than once about the Value-added tax, or VAT, and have repeated some of my own words from past articles, especially see “Vat for financing health care proposals still a bad idea.”)

If you have not heard it yet, Pat Robertson said something that was almost surprising about Haiti’s horrible disaster, that Haiti’s founding fathers made a pact with the devil to help them throw off the bonds of slavery with the French, and so God cursed the Haitian people. I say “almost surprising” because Robertson has said some pretty crazy things in the past, such as calling for the assassination of Venezuela’s President Hugo Chavez.  Here is a more reasoned discussion of the myth by the Haitian theologian, Jean Gelin.

While thinking about Robertson’s remarks on a drive to north Louisiana, I came to the conclusion that on Haiti, Pat Robertson is correct, figuratively, though not literally. On a disaster that has claimed the lives of thousands upon thousands of mostly good and innocent people of Haiti, that sounds about as outrageous as Robertson’s remarks.

While a Haitian pact with Satan himself is absurd, people often support or at least abide and enable corruption among their public officials. Haiti has long had very corrupt leadership, and corruption in Haiti is widespread. The Haitians may, from time to time, get rid of corrupt leaders, but they have always seemed to replace corrupt leaders with other corrupt leaders. (There is an excellent discussion of this phenomenon in a memorable chapter in Hayek’s The Road to Serfdom, “Why the worst get on top.”) While many Haitians are sure to be good, moral people, their feelings of helplessness and fatalism have left them very apathetic, allowing corruption to be pervasive in their society.

In surveys of perceptions of corruption, Haiti ranks near the bottom of all countries as shown by the rankings from Transparency International “Corruption Perceptions Index”, where Haiti ranks 168th out of 180 countries ranked by TI, tying with 5 others. It is also the lowest of the Americas, ranking ahead of only Uzbekistan, Chad, Sudan, Iraq, Afghanistan, Myanmar and Somalia, meaning that Haiti is perceived to be more corrupt than the notoriously corrupt Nigeria.

In a paper that came out in July of 2007 in the interdisciplinary social science journal, Public Choice, Monica Escaleras, Nejat Anbarci and Charles Register examine the interaction of natural phenomenon, earthquakes, with the social phenomenon of public sector corruption and show how when these two occur together, the death tolls are higher. They develop a theoretical model and then examine 344 quakes between 1975 and 2003 and find more deaths from earthquakes that occur in more corrupt countries. Their result holds even after the researchers account for other factors related to deaths from earthquakes, such as the magnitude of the quake, its proximity to population centers, the country’s level of development or how poor people are in the country, and several other factors.  Their main explanation is that inspectors of buildings and other infrastructure are more likely to take bribes in such societies and look the other way with some cash in an envelope. Poorer building code enforcement (for buildings, roads, bridges, port facilities and airports) results in more deaths from a given quake.

So, due to apathy, people allow venality to survive and spread, especially among those in the public sector, Haiti’s pact with or surrender to the devil. The corruption leads to more deaths from earthquakes, just as if there had been some sort of curse. I am not suggesting that Pat Robertson is literally correct, just that venality is to allowed to survive, people curse themselves, their loved ones and their fellow citizens.

Hmmm. I seem to recall voter acceptance and support for corrupt public officials leading to more deaths from a natural disaster somewhere. Could that have been here in Louisiana?

-MC

Opinions expressed here are the author’s alone and do not necessarily represent the views of Nicholls State University.

The L.A. Times reports some of the problems with the new homeowner $8000 tax credit in this story.  Besides fresh ground for tax cheats to exploit, this tax credit may not be worth getting.

In my introductory economics class, we just finished looking at how taxes get passed forward to buyers in higher prices or back to the sellers in reduced prices received.  What we saw in class was that if the buyers faced few alternatives, while the sellers had many, most of the tax gets paid for by the buyer in the form of a higher price.  If the sellers have few alternatives, but the buyers have many, the sellers pay most of the tax in terms of a lower received price, while the buyers pay only a little more than the original price. 

Of course, if the government subsidizes buyers in a market instead of taxing them, the same thing happens, but in reverse.  Subsidies are only negative taxes, so a subsidy to buyers in a market just raises the amount the buyers are willing to pay to the sellers.  Consider the $8000 tax credit to home buyers.  This tax credit merely raises the amount buyers will pay to sellers.  And since the buyers have many alternatives while the sellers, often facing foreclosures, have few alternatives but to sell, have few alternatives but to sell, the price the buyers pay ends up rising almost by the amount of the tax credit.  Few new homes are being built in response to the tax credits.  So mostly, the tax credit for buyers boosts the prices received by those facing losing their homes in a foreclosure, where only the bank receives the money. 

So those considering buying a home before the December 1st deadline because of the tax credit should probably think twice.  Most of the tax credit will go to the sellers. 

But even if some of it goes to the buyers, shouldn’t it be worth the buyer’s effort?  The answer is maybe, but  maybe not.  One provision of the tax credit is that the buyer has to live in the home at least three years, or the buyer must repay half of the tax credit, or $4000.  If the buyer faces the possibility of losing her home, facing repayment of $4000, while having to pay $7000 more for a house and getting an $8000 tax credit may not be that good of a deal.   

-MC

Some months ago I was asked to find someone who could determine the feasibility of a device reinvented by a local fisherman.   The machine was an alternator driven by a bicycle that charged a car battery bicycle.  An electric motor hooked up to the battery turned the wheel of the bicycle.

The claim was that the device produced electricity.  Of course, it produced a charge, but used more energy than it produced—a perpetual motion machine.  Such machines have been invented and reinvented for hundreds of years.  And well-meaning garage inventors reinvent perpetual motion devices with every up-tick in energy prices.   But physics triumphs and we know that the law of conservation of energy and matter still rules.  Only part of the energy from the battery gets converted to work, with the rest being converted into friction and heat.  Energy is not created out of nothing.

In trying to reinvent the health care delivery system, Senator Baucus seems to have invented a perpetual financing device , but one that will only push up prices and inhibit real innovation.  What Senator Baucus wants to do is to tax the very providers of health devices, such as heart stents, artificial hips, and diagnostic machines in order to help pay for the new health care system that the federal government is reinventing.

There is a slight problem with all of this.  Taxes collected from businesses are only partly paid by the producers, with the rest of the tax paid by the buyers in the form of higher prices.  The easier sellers can move to something not taxed to sell, the more the tax gets passed along to buyers.  The more these taxed items are covered by insurance, by other people paying the bill, the more the tax gets passed along to the buyers.  If buyers have many non-taxed alternatives and find it easier to switch to them than the sellers can switch to non-taxed goods to sell, then less of the tax gets passed to buyers and the sellers will have to pay more of the tax.  Of course, if sellers find switching easier than buyers, the taxed gets passed on to the buyers.  In other words, the side of the market that can avoid the tax the easiest by switching what they have been doing will be the side that contributes less to paying the tax.

With medical devices, it is very likely that the sellers find it easier to go from making wheel chairs to making non-taxed items than wheel chair users can switch to some non-taxed item.  Still, to the extent that the tax is borne by sellers, it reduces profits in these industries and reduces innovation as well.

What looks like will happen with this financing plan is that the tax will be passed along to buyers including Medicaire and insurance, who will raise taxes and raise premiums to pay for the higher priced devices which will lead to higher prices for the medical devices, higher premiums and higher taxes.  Of course, after a while, the increasing out-of-pocket expenses reduce purchases along the way.

This financing scheme looks as if it were designed by the same guy who hooked up a car battery to an electric motor, a bicycle and an alternator.  The problem is that both of these end up coming to halt and are unsustainable schemes.  Genius at work?  Not!

-MC

Many on the conservative side have had many negative things to say about the “Cap and Trade” system.  It should be pointed out that “cap and trade” itself, is not  the source of their ire.  Rather, many conservatives do not like limitations being placed on CO₂ emissions in the US. 

What is this “Cap and Trade” system that is being implemented in the new climate change bill?  Cap and Trade is merely an approach to regulating emissions, and it is one that efficiently reduces those emissions.  It contrasts with two other approaches: one that is called the “command and control” approach to regulation and the other is an approach that taxes emissions, such as the proposed “carbon tax” to regulate greenhouse gases a decade ago.  Before looking look at these regulatory systems, let’s look at the ideal environmental regulatory outcome.

At first glance, it would seem that no pollution would be the best regulatory outcome.  Think of what this would mean when we consider CO₂ as a pollutant.  We inhale oxygen, but if CO₂ is a pollutant and we want no pollution, then, we better hold that breath.  But we cannot.  Stopping all pollution is just too costly. Anything we do to reduce our pollution will cost us something. But, of course, pollution itself is costly, either health costs, or aesthetic costs, or costs in losses of biodiversity. The ideal, then, is really to keep the total costs of pollution and the costs of reducing that pollution to a minimum. 

Generally, each extra ton of emissions of CO₂ causes the added costs of pollution to increase.  Also, if we look to reducing CO₂ emissions, we can find some inexpensive ways to cut emissions, and after we cut emissions in those ways, to cut emissions further, we would have to employ costlier and costlier means.  To keep these total costs to a minimum, the added costs from cutting a ton of CO₂ emissions have to equal the added costs of the damage done by another ton of CO₂ emissions.  If the added costs are higher from the damage done from another ton of CO₂ than from cutting emissions, we could lower total costs by cutting emissions.  On the other hand, if the added costs of cutting emissions by a ton are higher than from the damage done from another ton, total costs could be lowered if we go ahead and pollute that ton.  The “right amount” of pollution, then, is the amount where another ton would cause costs of cutting pollution by the same amount as the costs of the damage done by another ton of pollution.

Of the three methods of pollution control to understand, the easiest to understand is the “command and control” system.  Here, the regulatory commission sets requirements for each source of pollution, monitors them for compliance, and then sets fines and punishments for those who fail to comply with the regulatory requirements.  Here, possible polluters just do what they are told or face extremely high fines or other punishments.  The “command and control” name for this regulatory type comes from the management form used in the military.  Historically, most of regulation of the EPA has been of this “command and control” type.  The best way of thinking about this approach is to recall the lines from Tennyson’s “Charge of the Light Brigade:”

Theirs not to make reply

 Theirs not the reason why

    Theirs but to do or die.

 This command and control system of regulation does not do a very good job of keeping costs of regulation down, nor does it do a good job of balancing the costs of damage with the costs of reducing emissions.  The regulatory authority just does not have information on all of the costs.  This information is mostly diffused throughout the society—various electric power generating companies have a good idea of what their costs of cutting emissions are like, so a lot of people have bits and pieces of this information, and no one knows it all. 

One of the earliest regulatory suggestions for reducing the costs of pollution control was made by A.C. Pigou in 1920 in his book, The Economics of Welfare (with the word “welfare” meaning “wellbeing”).  Pigou suggested that a tax could be levied on certain activities, such as pollution, that would give people an incentive to reduce those activities.  Economists in the 1960s and 1970s saw that such a tax would get polluters to reduce pollution in a least-cost way.  Any producer who could reduce emissions at a cost below the tax would do so, while those who could only cut their emissions at a higher cost would not.  Suppose the tax on emissions is $100 per ton.  All pollution reduction that costs more than $100 per ton will not take place, but pollution reduction that costs less than $100 per ton will take place.  Lower cost cleanup activities replace higher cost cleanup and costs cannot get any lower.

A little later on, economists came up with a slightly different approach.  The environmental regulatory authority would first decide how much emissions would be allowed, create “pollution rights” which would be tradable.  Polluters who could reduce pollution very cheaply could then reduce their emissions and sell their rights to those who could only cut their emissions at a very high cost.  If the price of a pollution permit were higher than the cost of cutting emissions, the producer could then reduce their emissions and sell off their permit.  If the emission permit sold for a price below the cost of cutting pollution, the emitter would buy up permits.  If you think that such a scheme is unworkable, think again.  We have been using tradable permits of this sort to control SO₂ emissions that cause acid rain since the 1990s, and these permits trade on the Chicago Board of Exchange, along with various commodities.

The Pigou tax on pollution, which we saw a decade ago called a carbon tax, gives polluters a constant price to respond to, and the total amount of emissions could be higher or lower and can change over time.  If the costs of cleaning up go up, we end up with higher levels of emissions.  On the other hand, the tradable permits system produces a constant level of emissions but with a price of pollution that varies.  Both of these methods minimizes the costs of cutting pollution because both produces a price for cleaning up so that those with costs of cutting a ton of emissions above that price do not cut their pollution and those with costs of cutting a ton of emissions below that price do cut emissions.  Only the low-cost emission cutters reduce their pollution while high-cost emission cutters do not, and face either taxes or having to pay for pollution permits. 

For global pollutants, such as greenhouse gases, there could be international trade in CO₂ permits.  This is the general idea behind “cap and trade.”  For this to work well, however, there would have to be a global monitoring agency that could monitor each source of CO₂  emissions and would be ready to punish those polluters who do so without a permit.  This is the part of “cap and trade” that faces the biggest difficulties.  Remember that real regulation is not done by Soloman-like regulators who are infinitely fair, but by actual people, like international soccer referees, so that various human biases rather than fairness would show through in international environmental regulation.  The problem of political bias and lack of information in regulation is seen in this warning from Pigou himself (Some Aspects of the Welfare State,” Diogenes 7:1-11 (1954), p. 10.):

It must be confessed, however, that we seldom know enough to decide in what fields and to what extent the State, on account of them could usefully interfere with individual freedom of choice. Moreover, even though economist were able to provide a perfect blueprint for beneficial State action, politicians are not philosopher kings and a blueprint might quickly yield place on their desks to the propaganda of competing pressure groups. “Fancy” finance, like a fancy franchise, whatever its theoretical attractions, has, at all events in a democracy, dim practical prospects.

“Cap and Trade,” itself is a good idea.  It is a market-based approach to efficiently reduce the amount of emission of CO₂.  The real difficulties are first, setting the right amount of emissions to allow and second, monitoring and regulating by a global authority, giving up sovereignty to regulators who are likely to want to tilt the playing field away from favoring Americans.  Before going down the road of regulating CO₂ through any approach, we should be very sure of what human reductions in CO₂ will actually accomplish and whether there are alternatives that might work better, such as re-forestation of large areas of the planet.

-MC

There are many words used to describe people who have some strong difficulty that might put them at a disadvantage to others. Yet, I am constantly reminded by a major finding in my discipline, economics, in one of its core concepts called “comparative advantage.” The idea is that any person who can interact with others has a place in the society where they can be productive and can engage in trade that is both beneficial to them and to other members of the society. Even someone who is especially good at everything is in need of trading with others: being able to do all things does not mean that a person can do all things, since we all face only 24 hours in a day and cannot possibly do all things.

Now, I should point out that having a place to produce goods or services that others will demand does not mean that all of us are especially good at any one thing, nor does it mean that all of us can provide others with goods or services of sufficient value that we can support ourselves without help of others. It does mean we all have a place and something we can do to help provide something to others of value. I often mention in classes that there are two paths to comparative advantage: one is to be relatively good at that one thing, and the other is to be relatively bad at everything else.

Still, there are some people who face certain substantial difficulties in life that it is amazing that they excel and even lead their fields in what they have chosen to do. Here are some personal recollections of three people I have come across at one time or another who were so astounding to me that the difficulty in their life was, for a time, invisible to me. Perhaps, I am just not that observant.

Walter Oi

Walter Oi is one of those economists whose articles were required readings in economic theory classes in graduate school. The most important of his theoretical works was an article titled “A Disneyland dilemma: Two-part pricing for a Mickey Mouse Monopoly.” The subject of that paper is something that I teach to my MBA students in managerial economics.
More socially importantly though, his paper in the American Economic Review in 1967, “The Economic Cost of the Draft,”  and his related book, The Costs and Implications of an All-Volunteer Force, were instrumental in bringing an end to the military draft in the nation, showing that the draft was a more costly way to raise a military force than was an all-volunteer force of the same size.

In graduate school at Virginia Tech (better known as VPI back then), on Wednesday evenings and Friday afternoons, we had seminars that all graduate students were expected to attend. These seminars almost always had guest lecturers. One Wednesday night I arrived right after Professor Oi had been introduced. I do not recall the subject of that evening’s lecture. Professor Oi, though of Japanese descent, spoke perfectly clear English, as he had grown up in California (and was one of those Japanese Americans sent to a concentration camp during WWII). While his English was perfectly clear, when he furiously wrote equation after equation on the blackboard I had trouble reading his handwriting on the board, even though my own handwriting is difficult to make out (one reason I am a fan of Powerpoint). I could make out a few lower-case deltas and alphas in the equations and could read some of it, but with great difficulty.

While after about 30 years I do not recall exactly what Professor Oi’s lecture was about, I do recall that it was brilliant, as his work usually was. At the end of his lecture, the moderator thanked him for coming and giving his talk, and Dr. Oi received the usual round of appreciative applause. As he was leaving, I discovered the reason for Dr. Oi’s illegible blackboard handwriting when a German Shepard came around from the other room to Dr. Oi’s side. It was his seeing-eye dog. As it turns out, Oi, who received his Ph.D. from the University of Chicago in 1961could not read ordinary text at all when he began college.

Incidentally, Oi also once served as the Vice-Chair of the President’s Commission on Employment of People with Disabilities. For more on Oi, this Wikipedia entry is rather accurate.

Vernon Smith

Several years after I finished my degree at Virginia Tech, I was at a meeting of the Public Choice Society (devoted to using economic methods and theories to study political, sociological and other non-market activities), which met jointly with the Economic Science Association (devoted to experimental methods) in Tucson. At that time, Vernon Smith, who is credited for beginning the study of experimental economics was at the University of Arizona in Tucson, as was Gordon Tullock, one of my Virginia Tech professors, who was one of the most influential originators of public choice economics. About 10 or so years later, Smith, along with the psychologist, Daniel Kahneman won the Nobel in economics in 1999. While there in Tucson, Vernon Smith, invited me and several other young professors out with him and his graduate students, to a Western bar, which had a country and western band.

Smith was friendly and courteous, but a barroom was obviously not home for him. Some years later, Smith began to talk about his Asberger’s Syndrome, which is a type of Autism. As a result, Smith, unlike many of us, seems to function just fine for long periods of time isolated from others. Actually, Smith’s autism may have worked well for him, allowing him to become a very prolific writer, even for someone who is such an original thinker. (For more on Smith, see
http://en.wikipedia.org/wiki/Vernon_Smith.)

Evelyn Glennies

Some years later, sometimes in the 1990s, I attended the meetings of the Atlantic Economic Society to present one of my papers. One of the more enjoyable aspects of the Atlantic meetings is that they often arrange for attendees to go to some very nice cultural event and at reduced rates. I went to hear the Philadelphia Symphony at one meeting, but I especially recall hearing the National Symphony at the Kennedy Center in Washington at another.

While I still recall the grandeur of the Kennedy Center, mostly I recall the performance. The audience was told that the performance was being recorded for later broadcast on National Public Radio or for Public Television. There were just two pieces on the program, with the second being a rare percussion concerto. The percussion concerto called for the soloist, Dame Evelyn Glennies, to play almost 30 different percussion instruments that were arranged around the stage. Dame Glennies must have been in her mid thirties at the time, and this very beautiful and talented woman came to the stage in a flowing, gauzy white dress that made her appear as a forest faery as she flitted from instrument to instrument about the stage the way a humming bird flies from blossom to blossom. What was out of place, though, in this most formal of musical performances for a soloist with the National Symphony at the Kennedy Center, was that she was barefooted. I thought perhaps this was to make as little noise as possible as she went from drum to marimba to water tympani across the stage. She finished the evening with a brilliant encore with just her and a snare drum on the stage.

The next morning, I had a 7:30 flight out of Reagan National Airport. This flight was one of the few I have been on where they showed an in-flight interview program. Imagine my surprise to see an interview with the very performer featured at the performance the evening before, Evelyn Glennies. I was even more surprised when the interviewer asked Dame Glennies how long she had been completely deaf. Yes, this Scottish musician, and the only solo symphonic percussionist in the world at the time (she still may be for all I know), was completely deaf. Anyone who has ever performed with a musical ensemble, a band, a choir, an orchestra, a trio or quartet, knows that being able to hear the others you are performing with is essential for proper balancing, blending and timing. Then I understood the reason for her bare feet at this performance. Bare feet enabled her to “listen” to the rest of the orchestra through her feet from the stage floor.

You can hear Dame Glennies talk about listening as a deaf person and, more importantly, as a deaf musician at the TED conference. Listening to her over and over (and “listening with my whole body”), I still cannot detect any signs of deafness.

Extraordinary people and the rest of us

Some people are just extraordinary and would be extraordinary almost no matter what difficulty faced them, making their adversities seemingly disappear before their brilliance. Most of us are not so gifted. Each of us does, however, have something to offer, something to make the world better for others, some comparative advantage, even if it is just that one thing we can do. We should all understand and appreciate others for what they do for us, from the musician that thrills us, to the shortstop who amazes us, to the doctor who saves the life of a child, and on to the person who takes away our garbage or cleans restrooms. Everyone has something of value to contribute, and they should be valued and appreciated for making our lives better.

The question posed at the beginning was “what was the right word for those with disabilities?” Under various circumstances, any of those words may be appropriate, but remember that most of us have some area where we fall short, for some of us it is noticeable and for others, our disabilities are as invisible as Professor Oi’s and Dame Glennies’ disabilities were to me. I am constantly reminded of the words of the great American humorist, Will Rogers, who noted “everybody’s ignorant, only on different subjects.” We all fall short somewhere, even the brilliant and the beautiful. The word I tend to prefer is “human.”

-MC

As we should all know by now, there is an outbreak of swine flu spreading around the world. While this strain of flu has proved rather deadly in Mexico, it has not yet been so fatal in its U.S. cases. While most of the response in the U.S. and the rest of the world has been cautious, some voices have been on the panic end of the scale. Vice President Joe Biden, always ready to open his mouth wide enough to fit his foot, told the press that he advises his family to avoid air travel, and any other mass transportation mode, such as trains and buses (see the USA Today’s “Today in the Sky” air travel blog by Ben Mutzabaugh).

The problem is that many people will take Biden’s advice. But shouldn’t that reduce the spread of swine flu? Maybe. But there is something else that people need to keep in mind that may not occur to them. By thinking that air travel is now more costly, in terms of one’s health and the risk of getting the flu, this increase in the non-monetary cost flying will reduce the amount of miles traveled by plane and will surely increase the miles traveled by automobile if there is a significant positive cross-elasticity of demand between air and auto travel. Shane Sanders, Assistant Professor of Economics at Nicholls, had a paper published recently in the Journal of Economic Education that should help us think about value of Biden’s advice.

In his paper with Dennis Weisman and Dong Li, Sanders discusses the substantial cross-price elasticity of airline and automobile travel, which suggests that higher prices for airline travel induces people to substitute auto for air transportation. Of course, health fears, as they raise the perceived cost of air travel, should also induce substitution into auto travel.

The problem is that auto transportation is not as safe as air travel, and it is not even close. According to the Department of Transportation’s statistics (shown and cited in the Sanders, Weisman and Li paper), for every 100 million air passenger miles traveled, there are .3 fatalities, while for every 100 million auto passenger miles traveled, there are .97 fatalities, so passenger mile for passenger mile traveled , auto transportation is over 32 times as deadly.

So, without realizing the relative safety of air and auto transportation, when people hear that Vice President Biden is suggesting to his own family that they avoid air travel, some people will switch from air travel where the chance of a fatality is very small, even after factoring in the very minute chance of getting swine flu, and passing it on to family members. In this case, the number of fatalities, including swine flu, is likely to increase.

-MC

As I discuss in my Health Economics class, hospitals are, in most places, the largest employers of nurses.  With the nursing profession still dominated by women, often as second earners in their household, nurses tend to be less mobile than many other professionals.  In addition, in many communities there are few hospitals within commuting distance, giving those hospitals in commutable distance what economists term as a “monopsonistic” position in wage determination.

A monopoly is a market type characterized by having only one seller or by a very dominant seller. A market that is monopsonistic, or simply a “monopsony,” on the other hand, is a type with just one buyer.  The “mon” (from Ancient Greek “monos”) part of the word means “single,” while the “opsony”  (from Ancient Greek “opsnia”) part means “purchase,” so “monopsony” means a single-purchaser market.

When a market has a single buyer, that buyer has an extraordinary amount of bargaining power and can strongly influence the market price.  To get more nurses, better pay and/or better benefits must be promised or the hospital will be unable to attract more people to be nurses at their hospital.  That is, the supply curve of nurses is upward sloping, so if a hospital wants more nurses, they would have to increase nurses’ pay, new and incumbent nurses alike, or incumbent nurses may just quit to be rehired later at the higher pay.  Or they may just make things difficult for the hospital administration that pays new nurses more than loyal workers.

Let’s look at a simple numerical example.  Suppose that a hospital could attract and maintain a workforce of 500 nurses by paying them each $50,000 a year, for a labor cost of $25 million a year.  Now suppose in order to increase this workforce up to 600, pay would have to go up to $60,000 a year to attract the next 100 nurses, often from greater distances.  In this case, labor costs increase from $25 million to $36 million, or 44% more in labor costs for a 20% larger force.  This is because both the additional 100 nurses had to be paid more, but so did the 500 incumbent nurses.

How can the higher pay be limited to just those new nurses without paying more to the existing nurses?  This is where nursing contractors come in.  The contractors work for someone else and usually commute great distances.    The pay is higher for the contract nurses and the hospital’s nurses do not revolt.  In this case, the labor costs are the $25 million for the hospital’s 500 nurses and another $6 million for the contract nurses, pushing costs up to only $31 million instead of $36 million, or by 24%, not much more than the increase in nurses.

This past Saturday I, along with some colleagues and a student of mine from Nicholls, attended the Louisiana Political Science Association meeting at the Grambling State campus.  The meeting was helpful and very cordial, even though many of us strongly disagreed with one another.

There was a panel of undergraduate papers with two papers from Centenary students (my student and I presented a joint paper with Dr. Sanders in another session).  There was another panel of graduate student papers.  Both of these undergraduate papers were very interesting.  Allison Saylor an undergraduate student at Centenary had a nicely done paper titled ““The Bush Administration, Private Military Contractors, and the War on Terrorism,” in which she examined the substantial growth in the use of military contractors in the war in Iraq.  She posed a very useful question, “why would the war in Iraq require so many more contractors than we saw in previous wars?” (Quote marks are used here for my interpretation of her paper rather than a quote from her.)

During the discussion period after her presentation, I think the presenters, discussant, session chair and the audience arrived at a reason for this large expansion of contractors.  The last protracted war that the U.S. was involved in was Vietnam, and soldiers could be drafted then.  Any “desired” expansion (by the Administration) was met by increases in the number drafted. To expand under a voluntary force, we need to either attract more soldiers by increasing their benefits or by outsourcing non-combat roles to civilians.

The latter solution, outsourcing to private contractors, is likely to be less costly for two reasons.  Many of the non-combat requirements of a military force are things that many private sector companies are already doing and things where they have particular expertise, such as warehousing and goods distribution, food services, accounting services and construction.  Soldiers are no better at doing these activities and are probably worse than trained civilians at these sorts of  activities.  While this was also true during earlier wars, these activities in those days could be manned with soldiers who were drafted and forced to work below their opportunity cost or their voluntary wage rate.

The other reason for outsourcing certain tasks often performed by soldiers is exactly analogous to the nursing monopsony story told above.  The market for warriors is a monopsony market with the Department of Defense just about the only buyer in the market.

How can the higher pay be limited to just those new soldiers without paying more to the existing soldiers?  The contractors fill certain non-combat roles, while the military personnel perform the combat roles.    The pay is higher for the contractors, and the combat troops do not revolt.

While it might have been the case that certain contractors got sweetheart deals, no-bid contracts or cost-plus contracts, it is likely that troop increases with a voluntary force may have to increase pay to all rather substantially to get only a few more warriors.

I should point out that the return to the draft is not a solution to this high incremental cost of troop expansion, because the real opportunity cost of a draft is that some people are forced to do military jobs, often giving up positions where they are far more valuable to the country than as soldiers.  This social cost of the draft is hidden from presidents, congressmen, taxpayers and voters and they often do not consider such costs in their decisions.

Finally,it is almost ironic that those who kill and those who heal face the same sort of labor market issues, and those who hire them face similar incentives to price or wage discriminate.

-MC