Bastiat's Bastions

This past Tuesday, President Obama delivered the annual “State of the Union” message .  His theme was “Winning the Future.”  He correctly noted that a major component of winning the future is investment in research and development, the production of new technologies, new ways of doing things.

President Obama noted:

 “The first step in winning the future is encouraging American innovation.  None of us can predict with certainty what the next big industry will be or where the new jobs will come from.  Thirty years ago, we couldn’t know that something called the Internet would lead to an economic revolution.  What we can do — what America does better than anyone else — is spark the creativity and imagination of our people….

“Our free enterprise system is what drives innovation.  But because it’s not always profitable for companies to invest in basic research, throughout our history, our government has provided cutting-edge scientists and inventors with the support that they need.”

President Obama correctly suggests that innovation, the development of new technology, is crucial for our society, for our economy, and that the profit motive is behind such innovation.  He is also right in understanding that the profit incentive does not work well in providing the incentive for investment in basic research.

Economists have long made a distinction between goods that can be profitably produced and marketed to individual buyers and goods with benefits that are shared amongst the general public and cannot be sold through voluntary markets because once provided, others will free ride on those who provided the good in the first place.  The first type of good, a private good , is like a sandwich—if one person buys that sandwich, he can consume it and that means less for others.  Sellers of private goods can decline to provide their goods to those who are unwilling to pay for them.  Private goods can be profitably sold in voluntary markets. 

On the other hand, some goods have a shared consumption characteristic.  For example, in a city, air quality is mostly shared.  Protection from foreign invasion of military forces is a shared good as is protection from terrorists.  If I am protected from terrorist attacks, so are those who are near me.  This type of good, called a public good http://en.wikipedia.org/wiki/Public_goods, has benefits that cannot be denied to non-payers, not from some law, but because it is just too costly to do so. 

Similarly, research is divided into several types, one of which is referred to as basic research (http://en.wikipedia.org/wiki/Basic_research) and another as applied research (http://en.wikipedia.org/wiki/Applied_research).  Basic research delves into theories and generally cannot be kept from being used by others, but does not have immediate commercial use.  Some applied research has immediate commercial use, while some applied research has a commercial use.  Applied research is often patentable, while basic research is not.  Basic research is a type of public good, while applied research is a private good.

These distinctions help us understand why universities, especially large research universities, have more of an emphasis on basic research, while companies do most of the applied research, developing patentable products.  Private firms have what economists call a “comparative advantage” in producing private goods, because there is a profit to be made.  Comparative advantage (http://en.wikipedia.org/wiki/Comparative_advantage) is about producing at a lower opportunity cost (http://en.wikipedia.org/wiki/Opportunity_cost) than others, and in this case, lower costs than other types of entities, such as governments and non-profit organizations. 

A good example of the problem when tasks are inefficiently done, in other words, not done by those who can do them at least cost, not done according to what economists call “comparative advantage” would be to have a gifted athlete, such as New Orleans Saints star quarterback, Drew Brees, selling hot dogs in the stands at the games, rather than making spectacular plays on the field.  He might be better at selling hot dogs than anyone else, but he is so much better at the quarterback position and so valued at that position, the Saints and their fans would be worse off if he sold hot dogs in the stands instead.  (Be sure to read the Wikipedia definitions and explanations of these ideas that are given above in the provided links.) 

Private for-profit firms, because of the profit incentive, enabled by the use of enabled by constitutionally mandated patents, are much better at applied research that involves product development than governments.  The profit incentive induces profit-seekers to find ways of accomplishing things that are less costly.  This includes finding lower cost ways of providing incentives to supplier operators, such as the scientists whom they employ.    

Governmental entities, having no incentive to earn profits, and so, no incentive to cut costs, are ill-suited to developing products at a low cost.  Just as President Obama noted in his “State of the Union” message, we cannot predict where the “next new thing” will be, and so, it is better left to entrepreneurs to develop new products.  Public bodies, however, are better suited to financing basic research than for-profit firms, as firms will spend little time, effort and money on developing something that suffers from the free-rider problem.

So, what we see is that the development of new products is better carried out by private firms who have both the incentive to carry out this work at least cost and are better suited to risk-taking involved in deciding which research path to try, with many leading to dead ends, and only a few being profitable.  On the other hand, basic research which results in general findings which usually have no immediate applications in profitable enterprises, but sometimes lead to a host of applications, is best financed by government because private firms are not able to keep others from using their basic research, as it is not patentable.

Imagine, then, the surprise of many when it was recently announced in this Gadiner Harris New York Times article  that officials with the National Institutes of Health “have decided to start a billion-dollar government drug development center to help create medicines.”

The reason that the government should do invest in developing new patentable products, they claim, is because of the sharp slowdown in patent applications by pharmaceutical firms.  They also claim that a billion dollars is a small initiative when it often takes a pharmaceutical firm a billion dollar investment in research to create just one new product.   

If government experts cannot tell what the most promising area for research is, and if governments are ill-suited to developing new products, it seems that taking these funds out of other places, whether basic research or from private industry, such as the oil industry, as the President suggested as the place to get funds for his new research initiatives, and using them for government directed research into new products, is like taking Drew Brees off of the field and into the stands to hawk hot dogs.

What the Obama administration should ask before beginning this new quest into the drug development enterprise is “why have patent applications fallen so drastically from 2008 to now?”  Two possible reasons should be obvious and should be examined.  First, could it be that just as investment in other areas have dropped off because of the recession and the lack of confidence people have in the future, the same reluctance to invest may have hit the pharmaceutical industry.  A second possibility that the administration may not want to believe, but, nonetheless should be examined, is that the push for health-care reform by the administration, with its likely impact on lower profitability of pharmaceuticals, may have reduced the incentive to invest in new drug development so much that patent applications fell.  But whatever the reason, it should be clear that the government’s role in research is one of supporting basic research, while private industry is better suited to developing new products, such as new drugs.  We will be in a better position to “Win the Future” if we have the players in the process in the roles for which they are best suited, where they have a comparative advantage.

-MC

Here is a “Special Report” from Reuters, titled “Special Report: Is America the sick man of the globe?”  Reuters, a respected news organization, right?  You would expect a little bit of fact checking, wouldn’t you?  The author states, in passing, ”As U.S. manufacturing declined, starting in the 1980s Congress and successive administrations focused instead on the financial sector and relied on debt — its own and that of the U.S. consumer — to foster economic growth.”

Everyone knows that U.S. Manufacturing has been declining since the 1980s.  The problem is, it just is not so.  The facts are easy enough to check out.  You can go to the Federal Reserve’s web page on Industrial Output.  Here is the combined data, from 1972 t0 2010, using the seasonally adjusted values for January of each year in a time-series graph.

While there are noticeable dips in 2001 and again starting in 2008, the long-term trend since the 1980s has clearly been an increase in manufacturing output. 

What has made manufacturing jobs so attractive, their high wages, is the high growth in output possible in manufacturing by the use of equipment to subsitute for people.  Growth in production means for the same amount of labor we can produce more, so manufacturers can cut costs per unit and pay more to their workers as well.   What has declined in the U.S. since the 1980s is the number of jobs in manufacturing, not the amount of manufacturing. 

Perhaps the author, while in Michigan, should have talked to one of the University of Michigan’s economic professors, Mark Perry, who notes here that the decline in manufacturing jobs is the result of the productivity of American workers, not the reduction of manufacturing in America. 

Daniel Ikenson wrote this article  in the Pittsburgh Business Times in November of 2007, reprinted here at the Cato Institute website. 

Output per worker has dramatically increased over the years.  Machines, while replacing some workers, have so increased the productivity of the remaining workers, that those highly productive workers are able to fetch higher pay.  The high pay has also contributed to the incentive for manufacturing innovation, as businesses seek to find ways to do without so many expensive workers.  Technology and the education and training that make that technology usable have increased the output per worker, raising manufacturing wages.

The lesson is that some things become part of general knowledge that may not be so–check out media claims–go to the data.   So much information is publicly available and easy to check out.  Be on the lookout for undocumented, “supposed” facts. 

-MC

In posts as early as July of 2007, I have bemoaned the misallocation of resources as a result of poorly conceived policies by politicians to help special interests line their pockets.  For humorous effect, I have pointed out that the ethanol subsidy increases the use of corn as fuel instead of as food, and that land used for other crops, such as barley, gets transferred into land to produce corn. For instance, read these two posts: “John Barleycorn must die” and “A misallocation of agricultural resources.”

Al Gore, who has had an enormous effect of U.S. energy policy, admits in this article from Reuters http://af.reuters.com/article/energyOilNews/idAFLDE6AL0YT20101122?sp=true

that he was wrong in promoting ethanol subsidies, and that those subsidies have proven disastrous in raising food prices.  He also states that the subsidy created rent-seeking and rent-protecting lobbies that will make it difficult to eliminate the subsidy.

Gore’s excuse for promoting a poorly thought-out policy was his political ambitions for the presidency and seeking the support of Tennessee (his home state) and Iowa farmers.   While the effect  political ambition on poorly conceived policy remains long after it is shown to be bad policy, the short-sighted rush for “change,” AKA, the quick fix, turns into wonder at why we have problems elsewhere in the society.  In the case of ethanol, the wonder is why we have such high food prices.  Inflation from our ineffective quick fixes for our recession are surely playing a huge part in food prices–but only part of the problem.  Let’s hope we give some more thought and more debate to fixing our high food prices.

-MC

Read this article from Reuters report that the intrusive patdowns and full naked-body scanners are causing some people to reconsider flying.  If people drive to some of the places they would have flown to, more highway deaths are sure to follow.  The question remains, however, “which saves more lives, flying instead of driving or body scans and getting “felt up” by a stranger at the airport stopping a would-be terrorist?”

-MC

Among the many insightful essays that Frédéric Bastiat, this blog’s namesake, penned, “What is seen and what is not seen” was particularly perceptive.  There, Bastiat wrote,

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen those effects that must be foreseen.

Public policy makers, whether legislators or bureaucrats, similarly, must look for both the direct and intended impacts of the rules they wish to impose and those that are less direct and unintended.

For instance, in the wake of a 2009 commuter plane crash that killed 50 people, an accident attributed to pilot error and lack of training, this past summer the Congress passed a law requiring airline co-pilots to have 1500 hours of flight time, the same experience as pilots, up from 250 hours.   While this might make air travel marginally safer, an unforeseen consequence of this new policy could actually put U.S. travelers at increased risk.

Shane Sanders, my colleague at Nicholls and my partner at Bastiat’s
Bastions, along with Dennis Weisman and Di Long, both of Kansas State, published a paper in the Journal of Economic Education in 2008 that discussed the decision making at the Federal Aviation Administration (FAA) that led the reject calls for requiring child safety seats for children under 2.  After a carefully planned statistical study, the FAA found that for every 1 percent increase in a family’s air travel costs, travel by car would increase .36 percent.  Based on travel by a family of 4, with 1 under the age of 2, they figured that air travel costs would increase by 21 percent, leading to an increase in motor vehicle travel by these families of about 7.5 percent, or by 300,000 families annually.

With a mortality rate for auto travel more than 48 times that for commercial air travel, the FAA concluded that the extra expense of air travel for families with children under 2 would lead enough families switching to driving themselves, leading to more deaths than expected to be saved from the child safety seat requirement.  Those proposing a requirement of child safety seats never took into account the unforeseen consequence of the requirement, that people would switch from a very safe mode of transportation to one that is far less safe, resulting in a more deaths expected from the requirement than without it.  The FAA seemed to have some good economists doing their evaluation.

While additional study would be necessary to compare the expected lives saved to expected lives lost from the new co-pilot experience requirement, it is likely that the increased costs for the airlines of this new law would lead to some increased danger from increased driving.  It is even more likely that Congress never considered the increased risks that their new law imposed.  Congressmen seemed to fail Bastiat’s test of a good economist.

Similarly, we may all feel safer because of increased screening at our airports, but consider how some people may react to the costs of radiation and modesty costs from the so-called “naked body scanners.”  And for those who want to avoid the radiation danger from the body scanners, the TSA is ready to grope you, your wife and your children .  The increased costs in radiation risk and invaded personal privacy and modesty along with the extra time spent at the airport going through security steps are likely to lead some people to substitute driving for flying, which again may outweigh the danger of terrorists getting through our security undetected.

Can we anticipate all unforeseen consequences of a law or regulation?  Of course, not!  However, this inability to make perfect decisions should not keep us from making better decisions by considering probable consequences that we have the ability to foresee.

–MC

Gary Wolfram, an economics professor at Hillsdale College, penned this excellent article on international trade for the Michigan View.

What do you think?

–MC

Lafayette’s Daily Advertiser reports here  that there is a group pushing for higher gas taxes in Louisiana for road building and repairs.  OK, fair enough, taxes on gasoline in Louisiana and in most states go to a road building fund of some sort, and so, people who pay these taxes, users of roads, pay for their use based on their use, or at least on the gas they buy.  And of course, the more people use the roads, the more gas they buy.

So, a gasoline tax is just about an ideal benefit tax.  There are two somewhat conflicting standards of fair taxation, and the benefit principle of tax fairness is one that involves a real exchange.  If a person uses our roads, they pay for gas here and so, pay for the use of the roads.  In other words, the benefit principle suggests that a person should get what they pay for, or at least pay for what they get.  That sounds fair to me.  Just like someone who drinks coffee that they got at a cafe pay for what they get. 

So, this organization, Driving Louisiana Forward, wants better repaired roads.  I understand that—me, too.  But a more careful reading of the article reveals something important.  The group is not an organization of drivers, but a coalition of road construction companies and road engineering companies.  These are folks who want the rest of us to hire them.  These are folks who want the drivers of this state to pay more into the road fund to keep them well paid. 

At least the legislators interviewed for the story gave the tax hike proposed a zero chance of passing.  This is definitely a group and an issue to keep an eye on.

–MC

What was that again, about our hypocrisy?  Recently (10/8/10), I posted an article “Drugs, Money and American Hypocrisy.”  Here are a few updates, some news articles about the currency dispute with China and what we in the US are doing about our own currency. 

First is this article from Reuters on how some Federal Reserve officials are advocating inflation to affect the dollar’s exchange rates.  

Next is this article from Bloomberg on how the expectations of the Federal Reserve expansion of the money supply to increase inflation is already affecting our exchange rates with other currencies. 

With this devaluation of the dollar relative other major currencies as reported here by the Financial Times, there is the possibility that other countries will retaliate with their own devaluations (see this article from Reuters).   With no major currencies holding their value, one would expect gold to get bid up even higher. 

The US continues its fight with China, claiming that the Chinese are manipulating their currency, but ignore that man behind the curtain who seems to be pulling levers and turning knobs, just watch the Chinese currency.  Even if the Chinese are pushing their prices down, why should we in the US really complain?  This just gives us lower prices, particularly at Wal-Mart, helping the poor and the unemployed. 

At least for now, the Obama administration is taking the higher road, and has backed off of labeling the Chinese as currency manipulators.  They seem to be waiting at least until after the midterm elections in the US and after the meeting by the leaders of the “Group of 20″ in Seoul, S. Korea on 11/11/10. 

Update on this update–this just in–(10/25/2010), from Reuters and on the CNBC website: I just read hear that Germany is now accusing the US of currency manipulation, the same claim the US is about to make against China.   

Perhaps our own leaders would do well to follow that New Testament advice, to ”Judge not, lest ye be judged.”

–MC

Now, I am not an America basher.  But, from time to time, we can be a bit hypocritical.  For instance, at the same time that we complain to Mexico about the drug traffic through their country, Californians are considering the decriminalization of marijuana.  The Mexican government has surely noticed (see article here)

But worse, is the hypocrisy of our elected officials in the U.S. House of Representatives, along with the Secretary of Treasury, Timothy Geithner, Senator Olympia Snowe (ME-R), and others for condemning China’s currency policies, in what they claim to be manipulation of the currency value, while the U.S. seems to be devaluing the dollar in the same fashion.  Mark Perry, Professor of Economics, University of Michigan-Flint, and a visiting scholar at the American Enterprise Institute in Washington, D.C., cleverly highlights the hypocrisy of the China currency bashers in this blogpost by editing or marking up an article on China currency manipulation, replacing China and its renminbi (yuan) with the U.S. and the dollar.

Of course, even if China is manipulating the renminbi in order to make Chinese goods less expensive for Americans, low prices happen to be one of the best anti-poverty programs we could have, making each dollar a poor person has go further in the marketplace.  If the Chinese wish to send us their goods at very low prices, subsidizing the American consumer, especially the poorest consumers, should we tell them no?  It is just as if the Chinese were writing all of us a check each month, that is, if they are truly manipulating their currency.

Protectionist policies, such as those endorsed in the recent House of Representatives vote that sacrifice the wellbeing of the poor at the expense of well-healed special interests that especially harm the poor.  Moreover, such trade policy action is likely to bring about countermeasures by China which could lead to a deepening of the recession, the same way that the Smoot-Hawley Tariff of 1930 led the country into the Great Depression (see Wikipedia on this).

We should also be mindful that we depend on the Chinese to keep lending us to fund our huge deficits.  Should the Chinese retaliate against our self-harming protectionist moves by just slowing down in their purchases of our treasury bills at auction, our interest rates could jump dramatically, and our debt will climb at an even greater pace than it is climbing now.

–MC

Years ago, I read Tom Godwin’s science fiction short story, “The Cold Equations.”  Wikipedia has a pretty accurate summary of the story here.  Sometimes in life we have to make decisions not to help someone, because by doing so, others will react in ways that bring harm to themselves and others. 

A fire department in Tennessee let a house burn to the ground and did nothing to put it out, but then put out a fire that spread to the neighbor’s house (read the story here).  Whoa.  Harsh.  But perhaps, the result of those cold equations.

Notice that the fire was in a rural part of a county, outside of the town fire department’s jurisdiction.  The fire department for years had offered to provide fire protection to homeowners in areas outside of their city limits, provided the homeowner had paid a $75 annual fee–sort of a form of fire insurance.

If they accepted the $75 fee when a fire was burning, no one in those rural areas would ever pay again for fire-fighting services.  Then, the fire department would not have the resources to fight fires outside of the city limits.  No one in the rural parts of the county would have fire protection after that.  This is a problem economists call the “free-rider problem,” where people expect to be able to let others pay for their goods or services.  The suppliers are not able to collect enough to be able to provide the service at all, and so they do not, even though it is worth what the sellers are asking for the service.  The result is that no one gets the service.

And while I do not like the Obama Health Care program, forcing people to pay ahead of time making them buy health insurance is just a reaction to a free-rider problem we have in health care, especially since emergency rooms in hospitals are not allowed to do what the fire department did, they must treat the patient.

So, while the decision of the fire department seems harsh, if they were to have gone ahead and put out that fire, they would soon have been unable to provide such services to their rural neighbors at all.

–MC