Bastiat's Bastions

No electricity becomes no gasoline?  In this news story from NBC Connecticut’s Leanne Gendreau and Brynn Gingras, we see that the snowstorm in the Northeast this weekend has left many gas station pumps without power to pump, and so, has left those residents a way to get gasoline in their towns.  Now, these stores could power their pumps and their cash registers with generators, but that is not happening.  Instead, residents are driving to nearby towns, lining up at the pumps, with some lines reaching a half mile long.  The extra demand at these nearby towns has drained the gas from these stations, and so, these folks without power are having to drive even further in search for gas (remember “search costs?”).

Aren’t prices supposed to increase when shortages appear, causing the shortage to disappear?  Well, if you read the whole article, you will see why that did not happen in Connecticut, and will not happen until November 7th.  The authors state in the story,  “Attorney General George Jepsen put pricing controls in effect Monday to keep people from being gouged at the pump, according to Malloy.  The price controls will remain in effect until Nov. 7.”

John Stossel, in this video, asks “what is price gouging?” in this video.

What is price gouging, really?  It is keeping people from starving, dying, freezing after a snowstorm or running out of everything after a hurricane.

-MC

A recent study   released by the Tax Foundation and reported by the Pelican Institute (here) states that extended unemployment benefits, which has been part of the stimulus programs passed by Congress, have increased the unemployment rate and slowed our recovery.

Under ordinary conditions, an unemployed individual is eligible for up to 26 weeks of unemployment benefits.  Through several federal extensions, supposedly for stimulus purposes, eligibility for unemployment benefits has been extended to 99 weeks.  President Obama’s “American Jobs Act of 2011” would extend the date for starting their 99 weeks of eligibility.  Notice that these extensions have lengthened eligibility for collecting assistance from half a year to slightly less than two years.  Under three recently passed free trade agreements with South Korea, Panama and Columbia, Democrats added extra weeks of eligibility for unemployment benefits under the guise of “trade adjustment assistance” for those losing jobs because imports from these countries.

What is pointed out in the Tax Foundation’s study, is that the supposed countercyclical nature of unemployment benefits, that benefits rise in bad times and fall during good times, is destroyed by the way that states have financed their portion of the funds to pay these benefits, raising unemployment insurance taxes when their unemployment funds get depleted during sharp recessions and lowering them in better times.

The Pelican Institute’s story includes discussion of what economists have long known, when you increase payment for certain behavior or reduce the costs to individuals for living in certain conditions, that behavior or condition increases.  Dr. Walter Block at Loyola University New Orleans is quoted in the Pelican Institute piece saying “The more you subsidize something, the more of it you get. If the government wanted the unemployment rate to fall, it would find a way to tax unemployment.”

Even Obama’s former economic advisor, Larry Summers, states in the Concise Encyclopedia of Economics:

Empirical evidence shows that two causes are welfare payments and unemployment insurance. These government assistance programs contribute to long-term unemployment in two ways.

First, government assistance increases the measure of unemployment by prompting people who are not working to claim that they are looking for work even when they are not…

The second way government assistance programs contribute to long-term unemployment is by providing an incentive, and the means, not to work. Each unemployed person has a “reservation wage”—the minimum wage he or she insists on getting before accepting a job. Unemployment  insurance and other social assistance programs increase that reservation wage, causing an unemployed person to remain unemployed longer.

Many people while unemployed get job offers or could get, but often at wage rates far less than what they have been accustomed to.  Their “reservation wage,” while falling over time, is sometimes not low enough to accept a low-paying job.

Another way to understand the point is to see these benefits as the opportunity costs of taking a job while still eligible for benefits.  Once one runs out of eligibility, the opportunity costs of taking a job fall considerably and job offers are more likely to be accepted.

The economics Nobel laureate and liberal columnist, Paul Krugman, in his college economics textbook co-authored with his wife, Robin Wells, states

[P]ublic policy designed to help workers who lose their jobs can lead to structural unemployment as an unintended side effect. Most economically advanced countries provide benefits to laid-off workers as a way to tide them over until they find a new job. In the United States, these benefits typically replace only a small fraction of a worker’s income and expire after 26 weeks. In other countries, particularly in Europe, benefits are more generous and last longer. The drawback to this generosity is that it reduces a worker’s incentive to quickly find a new job. Generous unemployment benefits in some European countries are widely believed to be one of the main causes of “Eurosclerosis,” the persistent high unemployment that affects a number of European countries.

Michael Elsby, Bart Hobijn and Aysegul Sahin report in the spring 2010 Brookings Papers on Economic Activity that the extensions in unemployment benefits we have seen from various stimulus programs that have increased the length of eligibility “correspond to between 0.7 and 1.8 percentage points of the 5.5 percentage point increase in the unemployment rate witnessed in the current recession.”  In other words, almost a fourth of the increase in the unemployment rate we have witnessed from the recession and lagging recovery is due to the extensions of unemployment benefits.

We need to be careful in how we structure these benefits and what we do to extend them.  While these benefits to ease the pain of unemployment, such pain killers lead to dependency and make it harder to get “afford” to take a job.

-MC

Here is an ABC News report on GDP growth for this year’s 3rd quarter, the months of July, August and September.  In a month, the 3rd quarter figures will be revised and more data comes in for September.  The report from the government agency that gathers this information, the Bureau of Economic Analysis, is here. This updates a blog post I had earlier this summer.

-MC

While you can never determine the cause of a factor, call it Y, merely by its correlation with another factor, X, you can sometimes rule out causes.  Even then, one must take a great deal of care in the analysis.  Remember that Y and X might be correlated because X causes Y, but Y could cause X.  Also Z might cause both X and Y.  To help in your thinking about all of this, consider an association that we find between charter schools and teacher burnout that I noticed on John Stossel’s Blog “John Stossel’s Take.”

While true enough, this is quite misleading.  Stossel points in his blog to a study, “Parallel Patterns: Teacher Attrition in Charter vs. District Schools,”  by the National Charter School Research Project (note that this could be a biased study).   While the study did find 52% higher attrition rates for teachers in charter schools, once one statistically controls for the sometimes conveniently neglected fact that charter schools are more likely to be in disadvantaged areas and that charter schools disproportionately hire teachers right out of college, teachers who are more likely to quit, the study finds:

“Teachers working in urban charter schools are 24% less likely to exit the system than similar teachers working in urban traditional schools.”

The use of appropriate control variables, our Ceteris Paribus  or “holding other things constant,” are vital to any serious study.

-MC

Today, I note the passing of Bill Niskanen, who, at the age of 78, died of a stroke this last week (see David Segal’s obituary of Niskanen  in the 10-28-11 New York Times).  Niskanen was not only an important and influential economist, but at 6’4”, he stood tall figuratively as well as literally.  Niskanen earned his undergraduate degree at Harvard and his Ph.D. in Economics from the University of Chicago, studying with Milton Friedman.  He later taught at UCLA and UC Berkeley and had various positions in the Office of Management and Budget and the Defense Department.

Niskanen served as chief economist for Ford until he was fired for being critical of Ford for seeking trade protection from Japanese automakers, noting that the problem of the American auto industry was their reluctance to producing the more fuel-efficient type of cars that Americans wanted to drive and that is was wrong for corporations to ask Washington for special treatment, writing in a Ford memo “A common commitment to refrain from special favors serves the same economic function as a common commitment to refrain from stealing.”

His criticism of Ford cost him his job there.  Niskanen rebounded, though, serving on Reagan’s Council of Economic Advisors, and then becoming the Chairman of the Cato Institute, a free-market think tank in Washington, where he served until 2008.  Though an admirer of Reagan, he was critical of the Reagan administration’s inability to cut government spending, stating that there was really no Reagan revolution.

As a graduate student in the late 1970s and early 1980s, I read many of his works on the economics  of government bureaucracies.   As a fellow member of the Public Choice Society, where Niskanen served as president in the 1990s, I would often see him at annual conferences, and having similar interests, we were often in the audience in the same sessions, if not in each other’s sessions.  In 2005 I was invited by the book review editor of Public Choice to review a book of his, Autocratic, democratic, and optimal government: Fiscal choices and economic outcomes. I saw Niskanen in May of that same year for the last time, as Niskanen presented one of the thirteen papers at the “Political Economy of Terrorism” at George Mason University’s School of Law and Economics where I was privileged to be among the remaining presenters.

Niskanen, ever critical of big government and special favors handed out by big government, especially to businesses, I am sure he saw ideas he could agree with from both the Tea Party and the Occupy movements, though I think he would have disagreed with both on several fronts, too.

Niskanen, while always a thoughtful gentleman in discourse, always stood on principle, committed to free markets, the rule of law and ethical behavior.

-MC

In case you haven’t noticed in the news these last several months, there are many life-saving and life-extending drugs in very short supply, here is a rather informative article on the issue from The Atlantic, originally from TheDoctorWillSeeYou.com, that should provide some background.

Normally, markets have a self-correcting mechanism for dealing with shortage and surplus problems:  shortages bring about a rise in prices that increase the amount producers offer and rising prices cut some buyers out of the market, as they turn to substitutes, and surpluses bring about the opposite market responses.   Why isn’t this self-correction response happening in these drug markets?  The article from Thedoctorwillseeyou.com offered a few reasons.  What is not the answer is that the market for drugs is somehow different.  In some cases, foreign drug suppliers may not be meeting our drug purity standards by lax quality control, but this could be handled through standard setting in contracts.

Any student in introductory economics sees that most shortages are caused by a lack of an incentive to produce what customers want and at prices customers are willing to pay.  Shortages usually occur because of either price controls or because of government or public production which lacks profit incentives.  Dr. Exekiel Emanuel, a medical ethicist, oncologist and former White House advisor, wrote this article in the New York Times back in August.  Dr. Emanuel cuts to the problem in the article.  He writes:

The underlying reason for this is that cancer patients do not buy chemotherapy drugs from their local pharmacies the way they buy asthma inhalers or insulin. Instead, it is their oncologists who buy the drugs, administer them and then bill Medicare and insurance companies for the costs.

Historically, this “buy and bill” system was quite lucrative; drug companies charged Medicare and insurance companies inflated, essentially made-up “average wholesale prices.” The Medicare Prescription Drug, Improvement and Modernization Act of 2003, signed by President George W. Bush, put an end to this arrangement. It required Medicare to pay the physicians who prescribed the drugs based on a drug’s actual average selling price, plus 6 percent for handling. And indirectly — because of the time it takes drug companies to compile actual sales data and the government to revise the average selling price — it restricted the price from increasing by more than 6 percent every six months.

The act had an unintended consequence. In the first two or three years after a cancer drug goes generic, its price can drop by as much as 90 percent as manufacturers compete for market share. But if a shortage develops, the drug’s price should be able to increase again to attract more manufacturers. Because the 2003 act effectively limits drug price increases, it prevents this from happening. The low profit margins mean that manufacturers face a hard choice: lose money producing a lifesaving drug or switch limited production capacity to a more lucrative drug.

The result is clear: in 2004 there were 58 new drug shortages, but by 2010 the number had steadily increased to 211. (These numbers include noncancer drugs as well. )

Just as Bastiat wrote repeatedly in such essays as “What is seen and what is unseen,” the law of unintended consequences lays waste to our plans and shows the stupidity of our poorly considered laws over and over again.    Unfortunately, we often fail to “connect the dots,” to see the consequences of our misguided actions, to see that the shortages are because of the price controls.  The 2003 legislation limited the ability of drug manufacturers to raise their prices and has kept more and more drugs from reaching patients.

Notice another result of the law.  Since it causes shortages, it raises what economists call “search costs.”  In this article from McClatchy, it is suggested that  the estimated size of these search costs for these drugs is $216 million per year.   So, under the 2003 legislation that expanded Medicare into prescription drugs, we keep prices from rising too quickly, but at the expense of patients dying and extra millions of dollars of search costs in attempts to locate drugs that are not to be found.

The consequences of treatments of price controls are well unknown, and the experimental trials have been conducted repeatedly over forty centuries, with the effects always being shortages.  Sometimes a problem can be poorly diagnosed, leading to the wrong treatment.  Sometimes, though, policy makers power fail to understand both the side effects of the treatments they prescribe and that those side effects can be worse than what they aimed to treat.  Such policy makers deserve to get their licenses revoked.

-MC

Solyndra, the company that has recently drawn so much attention to policies of the Obama administration because of its failure after receiving a half a $ BILLION in a federal loan, epitomizes why the federal government should not make such loans to businesses.   Not only has the federal government handed $528 million to Solyndra, but they were ready to give the company another $ 469 million, almost a full $ 1 billion, shortly before the company declared bankruptcy.
David Baker with the San Francisco Chronicle writes about the controversy here  and here noting that California companies got the most of these “green energy” dollars, totaling about $6 billion in loans and loan guarantees, while another 4.2 billion in federal loan dollars went to companies outside of California for green energy facilities in California.

It is misguided to think that the government can do a better job in investing in businesses than those in the private sector.  The White House has come under increased scrutiny in its loan decision regarding this company, both because it ignored advisors who pointed to the company’s likely failure because its costs were not competitive and also because one of the company’s key investors was a major financier of the President’s election campaign, who had repeatedly visited the White House while the company’s loan was being considered.

The problem with the Solyndra fiasco is not that the deal involved  corruption, with heavy political donors receiving taxpayer loans that never get repaid because of the company’s failure (here, I am reminded of Mel Brooks’ great comedic film “The Producers,” a film remade in 2005), nor even the appearance of corruption or even the potential for corruption, though we should make notes about this in our memories.  The problem is that the bureaucrats approving such loans have very little to gain if the companies they invest in succeed and nothing to lose if the companies fail.  Instead of being careful stewards of taxpayer funds, the bureaucrats tend to use taxpayer funds for projects that are supported by their ideology, whether that ideology be radical or conservative.

While GE’s CEO, Jeff Immelt defends the role of the government in providing as venture capital, even if some of them fail, there is a great argument against this activity provided in a classic discussion by Milton Friedman, one of the greatest economists of the 20^th century, about why people are more careful with their own money than the government is with taxpayer or “other people’s” money in this video on doing good with other people’s money, noting that people are seldom as careful spending other people’s money than they are in spending their own.

-MC

In 2008, Bernie Madoff became famous when he was charged with investment fraud,  operating a Ponzi Scheme, a scheme the SEC defines as

an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.

And, as the SEC page for “frequently asked questions” on Ponzi schemes points out, such schemes tend to collapse because

With little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.

Recently, Republican frontrunner and Texas governor, Rick Perry, has come under attack for calling our Social Security system a “Ponzi Scheme.”   While no fan of the governor, I am not sure he is as far off the mark in his criticism of the program as his critics claim.

On one of the New York Times’ blogs, The Caucus, there was this item:

Social Security, by contrast, is a pay-as-you-go retirement system by design. Current workers and employers pay taxes that are used to pay benefits to current retirees. For many years, the program took in more money than it paid out, and invested the surplus — the “Social Security trust fund” — in treasuries. In 2010, Social Security began paying out more in benefits than it received in taxes. As more baby boomers retire, and there is a shortage of new workers, that shortfall is expected to grow.

The Social Security Administration issued a briefing paper in 2009 noting the differences between Social Security and a Ponzi scheme. “There is a superficial analogy between pyramid or Ponzi schemes and pay-as-you-go programs in that in both money from later participants goes to pay the benefits of earlier participants,’’ it wrote. “But that is where the similarity ends.”

The paper noted that a program with 40 million people receiving benefits, and 40 million people paying taxes, could be sustained forever. “It does not require a doubling of participants every time a payment is made to a current beneficiary, or a geometric increase in the number of participants,’’ it found.

Well, I guess such a retirement system could theoretically be sustained, but consider this, the average social security payment received at the beginning of 2011 was $1,177, so for 40 million workers to support 40 million social security recipients, the average worker would have to pay $1,177 into the system every month of their work life. They would have to continue to do this knowing that they are paying into the system for about 40 years, but with the confidence that they will receive payments themselves for about 15-20 years, given no change in benefits or retirement ages.    But if we assume that the person will live until he or she is 90 years old, then that  monthly payment of $1177, if invested at only a rate of 2%, would amount to about $864,430 by the time they reach 65.  If the person were to retire at 65, they could receive $3663 for every month until they reach 90, which would be a much better deal than the social security promise of only getting back $1177 per month.  How politically viable would such a social security system be?   Imagine having to pay over $1000 a month just for social security taxes.

Whoops, I forgot that there is the overhead of the social security administration to pay as well.  So let’s make that $1200 a month for each worker to pay.  Realistically, though, there is projected to be a sustained 2 workers for each retiree, so we can figure that the social security tax would “only” amount to $600 per month.  Still, while social security is popular now among those receiving payments, a large part of that popularity may have to do with the fact that current recipients get far more in benefits than they could have earned on the amounts they paid in.

But what about the social security trust fund?  Won’t that help keep so much from being paid for by current workers?  The answer there is no.  That trust fund gets spent every year by congress.  Or should I say, they have wisely invested it in safe government securities.  Ask those holding Greek government debt how safe they feel with those investments.  Government securities, instruments of our government debt, require taxpayers to pay the debt.  The system is still “pay as you go” even when taking into account the amounts that have been invested in government securities.  While I feel rather confident that we will continue to pay our debt, and that we will continue to fund social security payments, we have to get realistic about what we can expect our younger generations to pay us.

Actually, the long term problem has been discussed over the years.  In 1998 I penned an article for the Bayou Business Review that expressed some hope for the future of Social Security.

Now back then, quite a bit was done to improve funding for Social Security.  It just was not enough to keep it funded.  Already, part of Social Security funding is coming from the general fund.  Social Security may be a promise, but is it one we can really keep any more than Bernie could keep his?

-MC

If you look at Bastiat’s writings, you will notice a major theme.  Freer trade improves the lives of people in the society, while protectionism promotes the interests of some at the expense of others in the society.  In this recent article in The National, the prominent Indian economist, Jagdish Bhagwati, repeats Bastiat’s theme of free trade not only increases overall prosperity, but also elevates the well being of the poor by examining the evidence from history.  If you think “oh, free trade ideas from another Republican economist,” think again.  If you go to the Wikipedia entry for Bhagwati, you will see that Bhagwati is a Democrat.

-MC

Contrasting to gas prices seen earlier this month, I saw the lowest gas prices I have seen in a while as I drove to New Orleans tonight.  I saw gas prices around $3.32 in Boutte, and then down to $3.29 by Avondale and then down to as low as $3.19 in Westwego.  I wondered why, but quickly remembered seeing stories like this one from Reuters that the Obama administration has released a part of the US strategic oil reserve and will continue to release oil from our reserves over the next month, as part of an international effort to increase the supply of oil to counter the reductions in supply because of the war in Libya.

How long can we count on these lower prices?  My bet is that these reserves will be used up and prices will be back up long before Gadaffi is forced from office.  And then, we will have high prices and a big hole in our strategic reserves, that we would be wise to replenish.  Then, we will have sold our reserve oil at low prices and will have to replace it at higher prices.  “Sell low, buy high” is the strategy of fools.

-MC