DRI-322 for week of 4-6-14: How the Dead Hand of Regulation Is Holding Back the Future

An Access Advertising EconBrief:

How the Dead Hand of Regulation Is Holding Back the Future

Self-Driving Cars: What’s the Hurry? 30,000 Annual Deaths are Nothing to Get Excited About

Self-driving cars are automobiles that drive themselves. This is possible because they possess a system of sensors and computer programs that perform the basic driving functions of starting, shifting, steering, navigation, “seeing” obstacles and avoiding them, “observing” (coded) traffic and geographic signage and stopping. Most people are aware that Google has built a fleet of self-driving cars. Many people know that self-driving cars have been extensively tested, not only on private courses but also on public roads in states such as California. Some people know that self-driving cars have had no accidents during these tests.

It would seem that these facts have enormous significance. Currently, deaths due to motor-vehicle accidents constitute the leading cause of accidental death in the United States. In 2012, the most recent year for which complete data are available, over 34,000 people died on U.S. roads from motor-vehicle accidents. (This was an increase from the 2011 total of 32,000+, for which the figure of 1.10 deaths per million vehicle miles travelled was an all-time low since this safety statistic was first measured in 1921.) This does not count an additional 2,000+ pedestrians and motorcyclists who also died due to accidents in which motor vehicles were implicated.

Combine the information in the first paragraph of this section with the information in the second paragraph. This amalgamation is tantamount to saying that a disease epidemic currently kills over 30,000 people yearly, and we have a nearly foolproof cure for the disease. And we are doing virtually nothing to implement that cure.

In this case, the “cure” entails making the necessary changes in infrastructure and law to allow self-driving vehicles (SDVs) to operate in the U.S. Whether SDVs are or are not ready for mass adoption tomorrow or the next day is irrelevant – at the moment, we couldn’t adopt them even if they were ready for prime time. What we should be doing is paving their way (no pun intended) so that when all their bugs have been exterminated, we can put SDVs into use post haste.

The federal government has assumed the role of safety czar for the nation. Superficially, one would expect federal agencies to be making rules, suggesting law changes and beating the drums for the dawning new era in American transportation in the same manner as (say) they have been propagandizing for Obamacare.

Instead, this is how the federal the federal government has reacted to the prospect of self-driving cars:

“The National Highway Traffic Safety Administration (NHTSA) does not recommend that states authorize the operation of self-driving vehicles for purposes other than testing at this time.” The NHTSA, as its name implies, is the agency within the U.S. Department of Transportation whose specific mandate is traffic safety. Yet, incredible as it seems, NHTSA not only is not proceeding full speed ahead with plans for the future of self-driving cars – it recommends that states do not authorize their general use in spite of the fact that states are doing just that.

Uh…what does NHTSA recommend that states do about self-driving cars, then? “NHTSA recommends that states require issue separate driver licenses, or at least special driver-license endorsements, for those who wish to operate autonomous vehicles.” A licensure requirement is a classic example of what economists call a “barrier to entry” into an activity. In other words, the NHTSA is trying to make it harder for people to drive SDVs.

The Secretary of the Department of Transportation, Ray LaHood, had this to say about his department’s policy on SDVs: “…Our top priority is to ensure these vehicles and their occupants are safe.” Picture this hypothetical scenario: We are suffering an epidemic in which tens of thousands of people die every year. Some people step forward and volunteer to test a vaccine that will almost certainly cure the disease that causes the epidemic. Suddenly a Federal Cabinet head steps forward with hand upraised to place controls on the testing process. “Our top priority is to make sure this vaccine and these test volunteers are safe.” No, dummy! Your top priority is to keep the nation safe! Thousands of people are dying every year! If a few people have to endure a slight risk to eliminate those deaths, your job is to get out of the way and let that happen as quickly as possible!

That hypothetical scenario is an excellent analogy to the status of SDVs today.

At this point, the reader must be shaking his head in utter disbelief. Are these people crazy? Are they completely unaware of the progress of SDVs? Oh, no. NHTSA goes on to blandly admit that “self-driving cars are seen as having the potential to save many thousands of lives annually by avoiding deadly crashes caused by human error, the reason for the vast majority of auto accidents.” This means that NHTSA is placing roadblocks in the path of SDVs while knowing full well their lifesaving potential. In other words, the NHTSA will save those thousands of lives when it is good and ready or, as the late Orson Welles might put it, the NHTSA will save no lives before its time.

NHTSA to Americans: Drop dead.

Just in case the full picture isn’t clear by now, the NHTSA currently has power to affect the lives of virtually American and control the activities of all drivers. SDVs have the potential to leave the NHTSA with nobody to regulate, since there would be virtually no safety issues left other than purely mechanical ones that would gradually fall almost to zero. (But you can be sure that the agency will fight tooth and claw to retain safety regulation of SDVs anyway, to justify its existence in downsized form.)

NHTSA wants to set up its own tests for SDVs. In fact, these “tests” will be used to delay the progress of SDVs as long as possible. As precedent for this prediction, we can cite the long-drawn out deregulation and subsequent technological revolution in telecommunications, much delayed in America compared to many other countries.

 

“Someday All Planes Will Be Drones”

Ask the average American what he or she knows about “drones” and chances are the reply will focus on pilotless aircraft controlled by a military operator on the ground and used in Middle Eastern countries to assassinate terrorists. In a way, this is fitting, since drones began as military weapons over half a century ago.

The word “drone” connotes a mindless worker performing rote tasks, in the manner of worker bees. When mechanical, drones are under the control of a human operator. The earliest drones were developed for military-intelligence purposes in the late 1950s. When Francis “Gary” Powers was shot down while piloting a U-2 high-altitude spy plane in 1961, the U.S. military began substituting pilotless craft for U-2s to avoid incurring propaganda setbacks from the capture of live prisoners.

Drone technology was perfected in successive wars from Vietnam to Kuwait to Afghanistan to Iraq. Today drones are anything but an embryonic innovation, full of kinks and bugs. It is long past time for their debut in commerce. Amazon’s Jeff Bezos recently attracted attention with a plan to deliver packages via drones. Speculation about the fate of Malaysian Airlines Flight 370 has raised the possibility of pilotless commercial airliners. After all, the most common cause of airline crash, as with automobiles, is pilot error. The general public is barely aware of the fact that most basic functions of commercial airline flight have already been automated.

Whenever scientific innovation threatens to make the world a better place, government regulators can be relied upon to build barriers to progress. This sounds highly pejorative to most people, yet it is really a perfectly logical state of affairs. Entrepreneurs and business owners use scientific innovations to make our lives better, not necessarily because they long to help us but because the only way they can profit is if we approve of their business decisions. Government regulators cannot earn profits and they do not benefit personally from making our lives better by (say) improving workplace safety or blocking a dangerous drug or process from coming to market. Consequently, they strive to improve their own welfare by maximizing government budgets and payrolls and minimizing risk of public-relations disaster. They do that by strangling innovation and risk-taking by the private sector.

Aren’t government regulators members of the society they regulate? If their decisions rebound to our disadvantage, don’t they lose by that, just as we do? Yes, but for any one regulatory decision there is only a small chance that the regulator’s consumption will be reduced markedly by restrictive regulation. But a too-favorable regulation that turns out wrong – a drug allowed on the market that later causes illness or death, for example – will kill the regulator’s career. And in the case of innovative technologies like self-driving cars, laissez-faire regulation will kill the entire regulatory agency or vastly reduce its scope. The political left has made its bones by insisting that corporations cheerfully kill their customers in pursuit of profits. In reality, it is obvious that government regulators are the ones who will send tens of thousands of Americans to their deaths annually rather than face the prospect of losing their regulated captives when self-driving cars replace human-driven ones.

Any doubts about the cogency of this analysis should be erased by consideration of federal regulatory policy regarding commercial drone use. While American businesses are lining up to use drones for various applications, this is the policy of the Federal Aviation Administration (FAA) on the commercial use of Unmanned Aircraft Systems (UAS):

“The first annual UAS Roadmap addresses future policies, regulations, technologies and procedures that will be required as UAS operations increase in the nation’s airspace.” “Policies, regulations, technologies and procedures” that will be “required?” This sounds as though the FAA plans to micromanage UAS by creating a thicket of bureaucratic rules that will slow the industry to a crawl. And sure enough: “The Joint Planning and Development Office (JPDO) have developed a comprehensive plan to safely accelerate the integration of civil UAS into the national airspace system.” To a professional economist, the words “comprehensive plan” specifically mean complete control by a central authority in the manner of the former Soviet Union’s GOSPLAN. The phrase “safely accelerate” has an Orwellian ring; it means that the government is going to slow down UAS development while pretending to move it forward with all deliberate speed.

We are now observing an excellent example of the FAA’s “safe acceleration” in action. The agency announced earlier this year that it would hold a public meeting on May 28, 2014 to “discuss the agency’s plans to establish a new unmanned aircraft system (UAS) center of excellence (COE).” The FAA considered 24 U.S. cities as candidates for sites to test the safety of UAS. It “considered geography, climate, location of ground infrastructure, research needs, airspace use, safety, aviation experience and risk” in selecting 6 test sites.

Wait a minute – if the military has been using drones for over a half-century, why do we need a civilian agency (presumably lacking the military’s expertise) to test the safety of the technology? Drones have already been interacting within civilian airspace in the course of performing their military duties, both inside the U.S. (in transit) and outside it (accomplishing their mission). The testing sites and center of excellence are a classic regulatory stall. (A bureaucratic rule thumb is that the more seriously a bureaucracy takes itself by employing elevated, obfuscatory rhetoric and lengthy acronyms, the less valid is its mission.)

Superficially, the stakes may seem lower than with SDVs. There are no 30,000 lives to be saved immediately by the commercialization of drone technology. But that is deceptive. If it is possible to deliver Amazon’s goods, it is also possible to deliver vital foods, fuels and medicines, too. Public attention has focused on the possible abuse of privacy by drones, but why not focus on the potential to enhance privacy and security by using drones? History supplies plenty of cases in which the ultimate uses of technology differed dramatically from their initial ones.

In an incisive Wall Street Journal column, Holman Jenkins pointed out that most routine functions of commercial aircraft have been automated already. “Someday all planes will be drones,” Jenkins said. Predictably, his words elicited indignant denials by airline pilots whose jobs were threatened by the prospect of drones. But Jenkins is right. It remains true that airliner accidents are (still) due predominantly to human error – the very thing that drones will eliminate.

The War on HIgh-Frequency and High-Speed Stock Trades

Technology is also in the forefront of the latest regulatory jihad waged against the financial community. This particular war is waged against traders of financial assets, particularly stocks. The erring traders are not buying or selling the wrong stocks; they are trading in the wrong way. At this point, things become confusing. At times, the traders are trading too often; that is, they are engaging in high-frequency trading. Other times, though, the traders are trading too fast, engaging in high-speed trading.

Do the two sound like the same thing? Well, if you think so, you’re in bad company, because regulators apparently think so, too. A little thought will show that this need not be so. Even in the old days of trades penciled on slips of paper and consummated via open outcry, it was possible to trade many times per day, although it was rather uncommon. Of course, high-speed trades were ushered in with computer technology and became dominant during the digital Internet era. But regulators have recently issued overwrought bulletins suggesting that they view these practices as equivalent shady practices.

“The FBI has developed fact patterns of potentially illegal trading,” announced one of these bulletins. This sounds ominous, to say the least. But “because high-speed trades are executed by computer programs, it is often more difficult to detect nefarious activity and to prove that it was executed intentionally.” This astounding qualifier is enough to send a knowledgeable analyst’s eyebrows flying off his forehead. Potentially illegal trading? What on earth could merit this denomination? Why does cybernetic origin cloud the issue of intention? After all, somebody had to program the computer. And why on earth does computer trading make it hard to detect wrongdoing? Was wrongdoing unheard of back in the primitive, pre-computer days? This sounds as if regulators want to demonize high-speed trading but lack evidence of any real wrongdoing – so they have to content themselves with hinting darkly that something funny must be going on.

This impression was reinforced by subsequent comments by an FBI spokesman, who cited “the practice of placing a group of trades… to create the false appearance of market activity.” But this kind of “churning” and allegations of it have been going on for a few centuries, since the days when trades were conducted outdoors under shade trees. The FBI purports to investigate “whether high-speed trading firms are engaging in insider trading by taking advantage of fast-moving market information unavailable to other investors.” Surely the FBI must be kidding. Since time immemorial, the slogan on Wall Street has been “buy on the rumor, sell on the news.” The idea has been precisely to move fast to take advantage of market information before it becomes generally known. If that constitutes insider trading ipso facto, then Wall Street might as well close up shop and go home.

But the FBI is really serious. “There are many people in government who are very focused on this and who are very concerned about it and who think it breaks the law.” The only thing missing seems to be a Ten Most Wanted Financial Traders List.

Grizzled veterans of financial markets feel an overwhelming sense of déjà vu at all this. They remember Richard Ney, for example. Ney was the young actor who starred alongside Greer Garson as her son in the 1941 Oscar-winning film Mrs. Miniver. The next year, Garson and Ney startled the film world by marrying. Ney’s film career fizzled out despite solid work in a few more films. After working in television, Ney became a Wall Street stockbroker and wrote bestselling exposes explaining why the stock market was rigged against the small, non-professional investor and in favor of proprietary trading firms.

Ney’s complaints were focused on the activities of specialists, people hired by the exchanges to insure that a market always existed for any listed stock. The specialist was required to take the other side of any trade for which either buyers or sellers were not soon forthcoming. As compensation for the potential financial inconvenience of playing this role, the specialist was accorded the benefit of a bid-ask spread; e.g., a kind of brokerage fee embodied in the differential between buying price and selling price. This size of this spread serves as a direct index of risk in the trade of the asset.

It is ironic that the advent of computer trading has consigned the specialist, if not quite to the fate of the dodo, at least to relative insignificance. How? Well, the whole purpose of specialists was to guarantee a liquid market, but computer trading has made practically everybody a potential trader. Not only that, but the presence of John Q. Public, Joe Doakes and Joe Sixpack in the stock market has meant that more trades are being done with a lower average size of each trade. And that happens to be the hallmark of high-frequency trading, as pointed out in a recent Wall Street Journal op-ed (“HIgh-Frequency Hyperbole,” WSJ, 4/2/2014) by two veteran money managers who are not themselves high-frequency or high-speed traders (Clifford Asness and Michael Mendelson).

So Ney’s bogeyman, the foe of the small investor, has now been put in his place by high-frequency computer stock trading. This doesn’t exactly sound like high-frequency trading is a threat to the public weal. Asness and Mendelson’s opinion of high-frequency trading is that “we think it helps us. It seems to have reduced our costs [by reducing bid-ask spreads] and …enable[s] us to manage more investment dollars.” In effect, say the pair, high-frequency traders have assumed the liquidity-provision function once provided by specialists and then inherited by the “market-makers” who succeeded them. But they do it cheaper and better and “competition forces them to pass most of the savings on to us investors.”

Of course, whenever interlopers come along to chip away at profits once earned by bigger, less competitive firms or individuals, the latter invariably cry bloody murder. That is what has happened here, and the screamers form the cheering public audience for the immorality play being cast by regulators.

But a receptive audience isn’t motivation enough. Why have the national police force (the FBI) been called out by security regulators to cope with this menace that is benefitting small investors and reducing trading costs for the market at large? Precisely because the success of the market threatens to leave regulators without anybody to regulate. If the market works so smoothly that specialists are unnecessary and bid-ask spreads become tiny, people will begin to wonder why the majestic edifice of securities regulation is required. Brokers are fast going the way of insurance salesmen; prospectuses can be found on the Internet and index funds are becoming a way of life. The SEC is going to have to create a threat to justify suppressing the technology that is making it as obsolete as other artifacts of the old days.

Once again, the pattern is familiar. Technology is steadily improving the lives of Americans across the country and government regulators are frantically trying to hold it back to keep from losing their jobs. And they are being aided by incumbents whose jobs and profits are threatened by the competitive innovations.

The Big Daddy of Regulation

The biggest, longest-lived and most pernicious regulator of them all is the Food and Drug Administration (FDA). The story of this behemoth merits an EconBrief all its own.

DRI-311 for week of 3-30-14: The Dead Hand of Regulation

An Access Advertising EconBrief:

The Dead Hand of Regulation

One of the venerable legal principles, dating from common law and drummed into every lawyer, is the rule against perpetuities. Its purpose is to stay the “dead hand” of the past from controlling life into the indefinite future.

Economists have adopted the study of economic regulation as a specialized field. They have gradually come to realize that regulation acts as a “dead hand” that retards the advance of progress wherever it prevails.

This characterization departs radically from the conventional view of regulation as an all-purpose cure-all for whatever ails an economic system. The knee-jerk responses of mainstream news media and academia to a problem are variously to blame an absence of regulation, excoriate lax regulation, perceive insufficient regulation or lament poorly funded regulation. Indeed, these constitute virtually the full menu of choice.

The obvious inference to draw from this is that regulation is the cine qua non of problem solution. Sure, sometimes the shortsighted legislators neglect to regulate some stray industry or human activity; sometimes the regulators get lazy and just sit on their hands or posteriors; sometimes those silly laws tie the hands of regulators; and sometimes we stingy so-and-sos don’t give the heroic regulators the money they need to do their jobs. But set up a good old government bureau, populate it with noble, altruistic, tough-minded, tender-hearted civil servants and unlock the public treasury – then just watch those regulators go. The industry will hum like a Welsh chorus – so we are supposed to assume.

Unfortunately, economists have been hard put to find even one exemplary example of regulation. It isn’t just that regulatory agencies share the deficiencies common to all government agencies. No, they invent new ones. And this is just about the only kind of innovation they do promote. In all other respects, regulation is analogous to the “dead hand” that the institution of law has been trying to thwart for over a millennium.

Some of the most famous case studies of regulation provide persuasive testimony for the economic case against it.

Taxicab Regulation

Almost every major city in the U.S. regulates taxicabs. Taxi regulation began not long after the automobile’s popularity began to zoom upward; it accompanied the regulation of trucking in the 1920s and 1930s. It is a variety of occupational regulation, requiring licensure and registration with the police department. Taxi fares are regulated by city bureaus rather than marketplace competition, and this regulation serves as a cartel that prevents competitive price declines by taxi firms (or individual drivers). Licenses have been severely restricted – for example, New York City has issued virtually no new taxi licenses after World War II. The licenses, or “medallions,” could be sold. The restriction on their number and cartelization of fares combine to create monopoly profits that are capitalized into the market price of the medallions; that is why medallion prices have sometimes reached six figures.

Economics textbooks teach that consumption is the end-in-view behind all economic activity. We are all consumers. They demonstrate that competitive markets produce larger output and lower prices than do the same market dominated by a single monopoly producer, thus validating the economist’s customary preference for pure competition over pure monopoly as a form of market organization. Since the local taxi cartels created by taxicab regulation essentially duplicate the outcome of pure monopoly – but with producer benefits spread over multiple firms rather than a single one – it is not surprising that economic textbooks have long featured taxicab regulation as a real-world application of regulation-gone-wrong.

Anybody who has ridden a taxicab regularly over the last half-century didn’t need to pick up an economics textbook to know that something was wrong with taxi service. It was proverbially difficult to get a taxi during morning and evening rush hours, and also during the “bar rush” late at night. When the city was visited by bad weather or a big convention, taxis were even scarcer. Wait times could stretch into hours even during the off-peak times for predominantly black residential areas plagued by high rates of crime. The level of professionalism among drivers varied from sky high to dirt poor.

We can gauge the degree of influence exerted on political reality by academic economists and taxi consumers by the fact that only a tiny handful of communities have deregulated taxi service in response to the complaints of either group. Washington, D.C. long featured the nation’s least regulated taxi market – and lowest taxi fares – among major cities. In the mid-1980s, Kansas City, MO deregulated both taxi fares and entry into the market, ushering in a few years of fierce taxi competition and dramatic benefits to local consumers and tourists. But the forces of regulation eventually regained the upper hand in the 1990s and the market was once more cartelized. A few other cities experience their competitive moment. Until recently, the Dark Side ruled mostly unopposed.

In 2010, somebody came up with a new kind of challenge to taxicab regulation. Bucking the regulatory establishment with lawsuits and publicity campaigns was too costly and difficult. Rather than confront taxicab regulation head on, it was better to make an end run around it.

The Uber Innovation: Outflanking Taxi Regulation

Technology made it inevitable. The intersection of the Internet, online credit-card payment methods, smart phones and GPS mapping suddenly made traditional taxicab service virtually obsolete. Now customers could book a taxi the same way they make a dinner reservation, by calling up a provider, reserving a car and paying in advance. Then they could track their vehicle’s progress to their location. No more “mission impossible” trips during peak hours! No more dealing with unresponsive monopoly providers! No more surly, badly dressed drivers or uncomfortable vehicles! No more monopoly taxi fares!

But wait – what about the dearth of drivers? What happened to the regulatory bottleneck that prevented entry of firms? This is where the end run came in. The new taxicab entrant, a firm called Uber, got around taxi regulation by not being a taxicab company. First, it entered the market for transportation services by providing town cars for its trips. These Lincolns, Cadillacs, BMWs and Mercedes were functioning as livery vehicles because they were available by appointment only; thus, they were technically outside the realm of taxi regulation. (As we’ll see, that hasn’t stopped taxi regulators from trying to regulate the company or its imitators.) Then it doubled as a middleman that recruited ordinary drivers and matched them up with people who needed trips where the drivers were going – or were willing to go. Thus, Uber reduced overhead costs to the bone by utilizing pre-existing capital goods that had competing alternative uses. Either way, though, the central idea is to provide the services of a taxicab company without being shackled by taxicab regulation.

The company took about a fifth of the cost of a trip, leaving the rest as gross revenue to the driver. The trip cost itself is calculated much as a taxi fare would be – distance based unless the car is moving less than 11 miles-per-hour, then time-based. Uber’s driver compensation incorporates a tip and the passenger advisory declares tipping unnecessary. This muddies direct comparison with taxi fares, particularly for Uber’s high-end livery-like town-car trips. Most of the customary problems faced by both driver and passenger are eliminated or greatly reduced. For example, there is very little incentive to rob an Uber driver since they do not collect the revenue (even tips) for their trips. Not surprisingly, Uber has attracted imitative competitors like the ride-sharing services Lyft and Sidecar.

It would seem, then, that this innovative new form of competition to traditional taxicab service is a boon to consumers. Since the whole purpose of economic activity is to benefit consumers, that change is a good thing. Since the purpose – the ostensible purpose – of regulation is to make things better, regulators should welcome this change with open arms. How do the noble, heroic, altruistic, tough-minded municipal civil servants feel about Uber and its ilk?

Why, they hate it, of course.

The Empire Strikes Back Against Uber, et al

“I’m hoping that people will…pay attention to what this actually is, which is an attempt to deregulate the taxi industry.” That is the view of Matthew Daus, former chairman of New York City’s Taxi and Limousine Commission, as quoted in a profile of Uber in Bloomberg Businessweek (2/24-3/02, “Invasion of the Taxi Snatchers,” by Brad Stone). His opinions were apparently shared by officials in Miami and Austin, TX, where Uber was prevented from operating by regulators. Perhaps because New York City has long been profiled in so many unfavorable examinations of taxicab regulation, the Bloomberg piece focused particularly on Uber‘s operations in San Francisco.

Despite an increasing population (up by 300,000 in the last decade), San Francisco “has long capped the number of taxi medallions.” Members of the taxi cartel “didn’t seem to care about prompt customer service since they make money primarily by leasing their cars to drivers” and extracting the monopoly rents embedded in the medallions through the fees charged for lease, dispatch and phone-order services provided to drivers. (The only way drivers could afford weekly lease fees of $400 or more was by reaping the benefits of monopoly taxi fares.) The article quotes the acerbic view of David Autor, MIT economics professor, that the industry is “characterized by high prices, low service, and no accountability. It was ripe for entry because everybody hates it.”

Well, that certainly doesn’t sound like an idyllic regulated industry, does it? It sounds more like taxi operations in New York City; indeed, like the typical regulated industry anywhere. Why, then, are regulators so averse to change? Why are they dead set against interlopers like Uber?

Innovation implies change. Change means doing things differently. That means that either the people doing them now must change – or new people must do them using the new methods. And that makes the incumbent doers unhappy, since they lose their jobs or suffer a loss of income or both. In this case, the disaffected include taxi-company owners and employees and taxicab drivers.

The Bloomberg piece is replete with complaints. Some complainants are cab drivers, who “complain that they can no longer pick up riders in the city’s tonier neighborhoods.” They stare down and block Uber and block ride-sharing drivers in traffic and confront them at airport terminals. “I’ve made it my personal mission to make it as difficult as possible for these guys to operate,” vows a director of the San Francisco Cab Drivers Association.

Taxi companies play a harder game of ball. “In Boston and Chicago, taxi operators have sued their cities for allowing unregulated companies to devalue million-dollar operating permits.” Uber has faced lawsuits and regulatory objections in San Francisco, New York City and virtually everywhere else it has been. Taxi companies “accuse Uber of risking passengers’ lives by putting untested drivers on the road, offering questionable insurance, and lowering prices as part of a long-term conspiracy to kill the competition, among other transgressions.”

Of course Uber is lowering prices – that is what competition is all about, reducing monopoly prices and benefitting consumers. Uber lacks the ability to “kill competition,” as the entrance of various competing ride-sharing services proves. As for killing its own customers – well, Uber‘s interest hardly lies in attracting big-dollar liability lawsuits. Nothing could be more slipshod than traditional taxi regulation. Its taxi-inspections and employee background-checks were laughably lax; for example, it is a truism that convicted felons usually can only get a job driving a cab. Monopoly taxi firms have much less incentive to keep passenger interests in mind than Uber does today.

Regulators themselves feed off the complaints of incumbents because they need a constituency to protect. By protecting the interests of incumbents, they are really protecting their own interests. If the regulated go out of business, then regulators will have nobody to regulate and no justification for retaining their jobs and incomes. Notice the tacit premise in the quoted passage objecting to Uber‘s hidden agenda of deregulation; namely, that deregulation is unthinkable.

But what about consumer complaints? They were legion under regulation. Have they vanished with the advent of competition?

How Innovation Solves Problems that Regulation Doesn’t

The principal complaint is lodged against Uber‘s “surge pricing,” which “jacks up” (Bloomberg’s wording) prices in peak times like rush hours. While prices are announced to customers in advance, that doesn’t forestall grumbling or accusations of “exploiting customers.”

For decades, academic economists pushed this very type of “peak-load pricing” for regulated electric utilities, which experience the same peak loading problems that taxi firms do. The idea was to persuade customers to use less electricity during peak times and spread their use more evenly throughout the day.

The same logic applies to taxi demand; ironically, consumer complaints show that demand is indeed sensitive to price on-peak. But Uber‘s real innovation is that surge pricing has solved one of the age-old supply problems of taxicab operation: how to “produce” more drivers in bad weather, evening rush-hour and late night peaks. Bloomberg interviewed a dozen drivers and found agreement that the higher prices attracted drivers magnetically to the street just at the time they were most needed. The peaking problem is that the quantity of taxi services demanded greatly exceeds the quantity supplied. Surge pricing significantly reduces the former and greatly increases the latter. Voila! Problem solved in less than four years. This is something taxicab regulation never succeeded in doing – hardly even attempting – over a century of existence.

This is just the start of competition’s problem-solving career in taxi-type services. Uber CEO Travis Kalanick envisions “a dense network of Uber cars in every city,” which could be used “to deliver such things as packages from online stores and takeout food. (The company delivered flowers on Valentine’s Day.) Uber could one day even allow other companies – say, a laundry pickup startup – to use its fleet.” Eventually, the widespread coordination of private cars for multiple purposes could vastly cut down on the number of autos and fuel use and improve the efficient use of existing transportation capacity. Again, this can only be accomplished via a competitive pricing mechanism; it is something that government regulation has never come close to achieving or even contemplating.

The (Non-) Case for Taxicab Regulation

Regulators take it for granted that taxicabs must be regulated by government. For decades, New York City has been warning its residents against using the vast supply of illegal, unregulated “gypsy” cabs that prowl the streets. Customers are risking their money and their very lives, warn the regulators darkly. But the history of taxi regulation does not support the necessity of regulation.

Government regulation of business began at the state level in the second half of the 19th century with regulation of grain elevators. In 1887, the Interstate Commerce Commission was created to regulate railroads. Letters exchanged by the wealthy railroad owners at the time indicate that they intended to use the ICC to cartelize the industry, and that is indeed what happened. In the early 20th century, trucks were regulated because their competition threatened the freight-carriage business of railroads. Taxicabs were regulated because they threatened the business of streetcars, which lingered into the mid-20th century despite their technological obsolescence.

The pattern is clear. Regulation occurs not to cure the evils of competition but to protect incumbents from the effects of competition. In the vernacular of economics, regulation and competition are substitutes, not complements. This gives the lie to the pretense that regulation is supposed to polish and buff away the excesses, evils, flaws, mistakes and unsightly features of competitive capitalism. The purpose of regulation is to replace free-market capitalism with government control of markets.

To illustrate the flimsiness of the regulatory case, consider the “argument” advanced for taxicab regulation in the Bloomberg piece by – of all people – a professor of economics at Northwestern. “Traditionally, we had to have price regulation in cabs because when you are hailing a cab or standing in a taxi stand, you had to take the first car and you didn’t know the price in advance. You could be exploited.” Of course, all that price regulation does is to require all cabs to charge the same price – it doesn’t, in and of itself, inform the customer what that price is. That is accomplished by painting the fare on the outside of the cab. But that could be done under competitive pricing, too – and was in deregulated markets like Kansas City in the 1980s! In essence, the Northwestern economist was saying that a high monopoly price wasn’t “exploitation,” but the chance that a consumer might not know all possible prices charged by all companies was – even though most consumers undoubtedly don’t possess perfect knowledge of all prices. For this we need tenured professors of economics?

The Past and the Future

The history of taxicab regulation suggests that regulation produces bad current outcomes. But the inherent logic of regulation suggests that its effect on the future is just as bad through its discouraging impact on innovation. According to Bloomberg, “there’s a battle for the future of transportation being waged outside our offices and homes” involving “Uber and a collection of startups.” If regulators succeed in killing Uber and its imitators, their vast potential for economic growth will die in infancy.

The next EconBrief will review various new products and industries whose innovative benefits are similarly threatened by government regulation.

DRI-306 for week of 3-23-14: Property Rights

An Access Advertising EconBrief:

Property Rights

This space endlessly bemoans the depredations of the economics profession, often laments the teaching of economics and occasionally points out shortcomings of economics textbooks. The biggest error of omission made by economists in and out of the classroom concerns property rights. Nothing is more important to the successful function of society. Judging by the attacks launched against them by enemies of free markets, we might expect lively discussions of property rights inside every economics text. Yet they are virtually ignored by mainstream economics.

The great exponent of property rights was the late Armen Alchian, who may have been the greatest economist ever spurned by the Nobel Prize selection committee. Alchian wrote comparatively little, but his few papers are still among the most cited of any economist. They have been fixtures on the reading lists of graduate students for decades – except for his great work on the economics of property rights, which has been pointedly ignored by academia.

Property Rights and Human Rights

As Alchian observed, social critics have long maintained that the system of property rights maintained in capitalist societies conflicts with “human rights.” Ostensibly, this conflict hurts the poor by allowing those with property to exploit those without it. Only a society without private ownership of property can stop this exploitation.

Alchian insisted that property rights – indeed, all rights – must be human rights. The call for abolition of private property is really a call for government ownership or control of property. This has certain unavoidable implications for people of all income levels.

Alchian stated that the very concept of property is best understood as a system of rights governing the care and use of property. That system operates under the logic of economics.

The Three Elements of Property Rights

Alchian’s key writings on property rights are summarized in entries in the Fortune Encyclopedia of Economics and its successor, the Concise Library of Economics. Here Alchian identified the three key elements of a system of property rights.

First among these is control. A right to property entails control over its care and use. This applies particularly, but not exclusively, to physical or tangible property. We are accustomed to this proposition in its positive form; i.e., in the right of people to enjoy and preserve things they own. Its negative form is less familiar. Children enjoy fewer rights than adults because they lack the capability to properly exercise them. Property rights are a good example of this; since tangible property usually demands care and maintenance, children are less able to exercise a right to its ownership.

Second is the right of exclusion. A property right gives the owner the right to exclude others from the possession and enjoyment of the property. Perhaps the most common example of this is the price charged by sellers, which excludes non-payers from the enjoyment of goods for sale. One of the key requisites for a public good – one that must be produced by government because private producers cannot produce it – is “non-exclusivity,” the inability to exclude non-payers. National defense is a public good because once it is provided for one, it is available to all.

Finally comes the right of salability. A true property right gives the owner the right to sell, rent, assign or delegate all or part of the ownership interest in the property at discretion. This is a key distinction between so-called government ownership and private ownership. Although government ownership is frequently referred to as “public ownership,” this is a misnomer. The government, not “the public,” controls the use of the property. In principle, according to the Rule of Law, the government should not exclude the public, but it often does. The public lacks the right to sell, rent or bequeath all or part of its property interest. Thus, no individual owns the property when “the government” owns it.

Both history and theory are replete with examples that sharpen each of these distinctions. We offer a few of these below.

Case Study in Property Rights: The American Indian and European Settlement

North America was settled by Europeans – Spanish, French, English, Germans and Dutch – beginning in the 16th century. Prior to European settlement, the continent was inhabited by aboriginal peoples who came to be called by the mistaken appellation of “Indians.” Over a period of roughly 300 years, the Indians were displaced – that is, removed from their original habitations and resettled.

The continent was populated by a mixture of Europeans, dominated by the English but also including large numbers of French to the north and Spanish to the south. Beginning in the 17th century, the English established numerous colonies in the central section that later gained their independence and became the United States of America. The English and French coexisted more or less peacefully in the English colony of Canada, which later became part of the British Commonwealth. The Spanish colony of Mexico to the south eventually rebelled and gained its independence from Spain.

In Canada and the United States, the displacement of Indians was accomplished through treaty, land purchase and resettlement. This was historically significant, since conquered peoples were generally treated much more harshly. Indeed, for thousands of years, the principal method for mass acquisition of wealth was conquest and plunder – that is, redistribution rather than economic growth. In the U.S., the process was still violent, though, as treaties and resettlement were accompanied by Indian wars lasting from the early 17th centuries until the end of the 19th century.

Much academic and popular history has condemned the acquisition of land from Indians by Europeans and, later, Americans. “We stole the land from the Indians” is a common phrase used to describe the process. This seems an odd way to characterize a process of negotiation and purchase, the historical successor to conquest, eradication or subjugation. More important is the implication that the proper course events would have been for Indians to have retained title to “their property.” This premise deserves careful study.

The social organization of American Indians was tribal. For most, though not all, their lifestyle was nomadic. In what later became the eastern U.S., the land was heavily forested in both the north and south. Most tribes subsisted by hunting deer. Historian Stanley Lebergott quoted one tribal chief: “[W]e must have a great deal of ground to live upon. A deer will serve us but a couple days, and a single deer must have a great deal of ground to put him in good condition. If we kill two or three hundred a year, ’tis the same as to eat all the wood and grass of the land they live on, and this is a great deal.”

This explains why Indians claimed such large quantities of land as “theirs.” They hunted deer. Deer were voracious consumers of forest grassland. (Today, deer thrive in urban American settings; a recent Wall Street Journal letter writer complained that deer are “urban locusts.”) Indians, in turn, consumed large numbers of deer. Deer would ravage a section of land, then migrate in search of fresh forage. Rather than build fixed settlements, Indians would follow the deer.

Prior to the Industrial Revolution, America – like the world – was overwhelmingly rural and agrarian. The overwhelming preoccupation was producing enough food to sustain life. Lebergott estimated that, by the early 1800s, the eastern Indian lifestyle demanded roughly two thousand acres, or three square miles, to produce enough calories to feed one Indian. This is consistent with contemporary accounts like the quoted passage above. In contrast, the American settlers who cleared land and build farms needed only two acres per person. In other words, the descendants of the European invaders had become one thousand times more economically productive than the Indians. The incentive for settlers to displace Indians on the land was enormous.

Even more to the point, the Indians’ claim to property rights was very weak. They could not control the use of the land they claimed as theirs, nor could they exclude non-users. Their only resort was sporadic violence against encroachments, which was by no means synonymous with enforcement of property rights since was violent, punished the innocent along with the guilty and affected only a small minority of the “violators.” Given their inability to command the first two elements of property rights, they could hardly execute the third. Thus, the basis for denying most Indian tribes a property-right claim to most of the North American continent rested on the same logic as that by which we deny most property rights to children. In both cases, the claimant lacks the competence and capability of exercising the claim.

Rather than grant Indians a dubious de jure property right they were sure to lose de facto anyway to white settlers, American governments in the early 1800s – particularly the administration of President Andrew Jackson – paid Indian tribes off and resettled them on federally owned land outside the boundaries of the United States. (Jackson maintained that it was unconstitutional to execute treaties with Indian tribes as if they were foreign nations, then force state governments to accept resettlement within their borders. He insisted that sovereign states were not bound by the terms of a treaty between the federal government and a foreign nation.)

There was much to regret about the execution of this approach, but the property-rights logic that underlay it was sound. It is quite clear now that salvation for Indians lay in assimilation with modern civilization rather than adherence to tribalism and outmoded economic organization. By treating Indians as wards of the state and preserving the reservation system and a separatist way of life for Indians, the federal government was guilty of the same false paternalism that has condemned much of the American underclass to inferiority today.

What about the western Indians, who occupied the plains and deserts of the Midwest and west? Once again, the predominant lifestyle was nomadic. In this case, subsistence derived from the buffalo or (more properly) bison, who roamed the plains in profusion during the 17th and 18th centuries. Once again, Indians followed the bison, which followed a seasonal pattern of migration throughout the plains. They hunted buffalo with bow and arrow – Plains Indians were amazingly proficient at driving arrows through the hides and deep into the muscular bodies of bison – and by stampeding the animals over cliffs. Although legend says that Indians were thrifty in their use of each part of the bison carcass, the truth is that carcasses were often left to rot.

As with the eastern Indians, the Plains Indians were highly unproductive compared with American settlers. Cattle fed upon grass proved to be vastly more profitable than bison – they dressed out better, their meat was in better demand, cattle could be domesticated whereas bison could not.  Despite the fact that the subjugation of warring Indians predated the near-extermination of the bison by about a decade, no serious attempt was made to establish the bison as a domestic meat animal on the western prairie.

The property-rights claims of Plains Indians were just as weak as those of eastern Indians, for similar reasons. The Plains Indians could not control use of the vast prairies, nor could they exclude interlopers. For many decades, a staple plot of Hollywood movies was the eviction of Plains Indians by greedy, unscrupulous whites hoping to profit thereby. Usually the motivation is gold, newly discovered by treaty violators in some place such as the Dakota Black Hills. In reality, gold discoveries were few and far between. The real motive behind the displacement of Plains Indians was cattle, not gold. White ranchers were vastly more productive on the plains than were Indians.

To be sure, the forest Indians of the east and the Plains Indians of the west do not encompass all Indians. Some Indians, like the Pueblo and Navaho in the west, did establish viable settlements and agricultural lifestyles. They did have valid property claims. Thus, their property rights should have been respected for the same reasons that the questionable claims of most Indians were rejected.

Pure Theory of Excludability: Alchian and Allen Offer a Proof By Negation

The most legendary of all economics textbooks may be University Economics (later reissued as Exchange and Production), by Armen Alchian and William Allen (AA). Blissfully sparse in its use of mathematics but lively and witty, it offers perhaps the most complete exposition of economic logic in any general textbook. Among its many famous applications is the authors’ imaginative defense of property rights, which takes the form of a “proof by negation.”

AA ask us to envision the following world: Automobiles exist, but are not privately owned. Instead, they exist as a common resource. Each is equipped with an auto-start that vitiates the need for an ignition key. Individuals are invited to make use of any car they find on the street, use it as long as required – purchasing their own gasoline – then leave it for someone else to use.

What would such a world be like?

A little thought suggests that the most salient automotive characteristic of that world would be that we would be driving a fleet of clunkers and junkers. Why? Because nobody would have an incentive to invest in either maintenance or repairs, at least beyond the point it took to get them to their immediate destination. From any one individual’s viewpoint, what would be the point of investing any substantial amount of money in an automobile that you would probably never see again once you reached your destination and left the car to go inside a building? Remember that everybody is not only entitled but expected to appropriate any unoccupied car for his own use. If you bought a new radiator for a car you picked up on the street, you might as well kiss that investment goodbye after leaving the repair shop and reaching your house.

With nobody wanting to repair cars to any significant degree or invest in preventive maintenance, their condition would deteriorate rapidly. People would carry their own motor oil, since they would likely have to add it to any vehicle to prevent the engine from blowing a gasket. Long trips would be a risky venture.

Another feature of this brave new world of socialized car ownership would be that everybody would drive off the bottom of their gas tank. Who would bother topping off the tank – unless undertaking a long trip – only to have somebody else drive off to enjoy most of the gas they purchased? For those who have not been subjected to this form of restraint, it can be a nerve-wracking experience calling for continual mental discipline.

AA suggest their example as an intellectual corrective for people who continue to regard property rights as a form of exploitation. Once absorbed, it can be applied to other forms of property to derive some idea what life without private property would be like. Alternatively, we can refer to the closest approximations provided by history. Visitors to socialist countries like Soviet Russia and Communist China often remarked upon the poor condition of the infrastructure and capital stock, usually without realizing that the lack of stock ownership and capital markets had killed off most of the incentive to maintain those capital goods.

Case Study in Salability: Property Rights and Species Preservation

The loss of species to extinction has been a chief selling point for the environmental movement ever since Rachel Carson published Silent Spring in 1962. Schoolchildren are taught the harrowing lesson of the passenger pigeon and the buffalo and told that only placing species on government’s “endangered species list” can save them. Typically, the grant of endangered status entails special protections and stern injunctions against harm.

A country whose wildlife has faced chronic preservation problems is Africa. Its exotic wildlife has always occupied a special place, if only because of its magnetic attraction for tourists. The elephant has been especially threatened because the unique properties of the ivory in its tusks have made it tremendously valuable. Poachers have reduced the elephant to the point of extinction in parts of its natural habitat.

The reflexive response throughout Africa has been twofold: ban elephant hunting and ban trade in elephant by-products like ivory. In Kenya, the government banned the hunting of elephants, but poachers decimated the elephant population from 140,000 to 16,000. In Tanzania, the government likewise banned hunting in 1970, but the elephant population was reduced from 250,000 to 61,000 in little more than a decade. In neighboring Uganda, the situation was even worse; its elephant population dropped from 20,000 to only 1,600.

To an economist well-versed in property rights, the reason for these failures was that the ban on hunting or harvesting elephants for commercial use was born of good intentions but was bound to produce bad results. In fact, it had the effect of killing thousands of elephants!

How could this possibly be true? How could people so sensitive to the welfare of these noble creatures do something so brutal, so insensitive, so utterly contrary to their intention? Alas, reason and emotion are completely different expressions of human thought. A surplus of the latter does nothing to promote the former; if anything, emotion tends to hinder the exercise of reason.

The laws against killing elephants had no effect on poachers because poachers are criminals by definition. They would have deterred ordinary people from killing elephants, but they actually encouraged poachers by killing off the legal market for elephants and elephant by-products, thereby making all things elephantine much more valuable in the black market. Being criminals, poachers were delighted to violate the law and sell their kill in the black market. In effect, the government was operating a price-support mechanism for the benefit of poachers.

One way to protect elephants as a species is by preventing the killing of existing elephants. The elephant-protection laws failed utterly in this respect. An even better means of species protection is by encouraging the breeding of more elephants. And the elephant-protection laws failed even more dreadfully here by destroying the legal incentive to breed elephants by destroying the legal market for them.

What a travesty of logic! Is it any wonder the results were so counterproductive? Well, it is one thing to sneer at failure, but another to actually succeed where good intentions alone have failed. Does ivory-tower economics have anything to show in the way of actual results?

In 1979, the African countries of Zimbabwe and Botswana created private property rights in elephants and allowed harvesting of elephants for commercial purposes. In a little less than 15 years, Zimbabwe’s elephant population rose from 30,000 to about 70,000. Botswana’s rose from 20,000 to 68,000.

The really amazing thing about this case study is that people are amazed by it. After all, we butcher many millions of cattle, chickens, hogs and sheep every year, but these species are not endangered because the legal market for them provides a continual incentive for their preservation and maintenance in good health and sufficient numbers to ensure viability. It seems as though people switch off their reasoning faculties when environmental subjects like species preservation arise.

Property Rights and Economic Development

In South America, economic development has been frustratingly elusive. A country such as Brazil possesses vast supplies of people and natural resources and seems on the verge of breaking through to developed-nation status. A country like Argentina was once among the world leaders in industrial production and economic growth, but now lags far behind. Venezuela has gone from being a continent leader in economic growth to Third-World status and near-chaos.

The insecurity of property rights throughout the continent has been identified as a leading culprit in this lack of enduring progress. It is difficult for investment to flourish in a climate where bribery is commonplace and cronyism runs rampant, where expropriation is a continual threat and financial-market transparency cannot be assumed.

Alchian’s Ghost

Today regulation looms larger in the lives of business and consumers than ever before. The ghost of Armen Alchian hovers over our shoulders. He does not haunt us. He is friendly, but admonitory and stern.

DRI-318 for week of 3-16-14: More of What Went Wrong with ‘America: What Went Wrong?’

An Access Advertising EconBrief:

More of What Went Wrong with ‘America: What Went Wrong?’

Last week we meticulously documented the shocking malfeasance of the nation’s best-known investigative-reporting team, Barlett and Steele (BS), in their bestselling 1992 book, America: What Went Wrong? We suggested that the decline of newspapers could be traced to the overthrow of orthodox reporting by advocacy journalism. We focused narrowly on Chapter 6, “The High Cost of Deregulation,” where BS shredded the canons of journalism while managing to avoid the truth about trucking deregulation.

BS devoted a quarter of the chapter to airline deregulation, which proceeded nearly in tandem with its surface-transportation counterpart beginning in 1978. Their arguments echoed those for trucking. “Since …1978, a dozen airline companies have merged or gone out of business. More than 50,000 employees have lost their jobs.” Sorrowful anecdotes of employees forced to take jobs “at reduced pay” are recounted. The false premise that deregulation would “stimulate competition, reduce fares, open up air travel to more Americans” is contrasted with the “reality” of “less competition,” higher fares on particular routes such as Philadelphia-Pittsburgh and Washington, D.C.-New York City and loss of air service to small communities. And just as BS claimed that deregulation “wrecked” the trucking industry, their picture of the “airline industry’s increasingly grave financial condition” and its aging, decrepit aircraft implies that monopoly, government subsidy or foreign takeover must soon occur.

It is now 36 years after the onset of airline deregulation. We know that no such fate occurred or is in prospect. We also know BS were as wrong about airline deregulation’s effects as they were about trucking deregulation. Rather than stand accused of exercising hindsight, we can cite the authority of Alfred Kahn, economist-godfather of airline deregulation and its leading scholar. Kahn wrote in 1993, just one year after BS, and the evidence he cites was available to them as well. “Most disinterested observers agree that airline deregulation has been a success. The overwhelming majority of travelers have enjoyed the benefits that its proponents expected… The best estimates…are that deregulated fares have been 10 to 18 percent lower, on average, than they would have been under their previous regulatory formulas. The savings to travelers have been in the range of $5 billion to $10 billion per year… In 1990…91 percent of all passenger miles traveled were on discount tickets, at an average discount of 65 percent from the posted coach fare.” [Typically, business travelers made up the bulk of the remaining 9%.]

As with trucking, airline deregulation vastly increased industry productivity by allowing airlines to operate much more efficiently. The greatest productivity increase was the improvement in the “load factor.” “Carriers have put more seats on their planes – the average went up from 136.9  in 1977 to 153.1 in 1988 – and succeeded in filling a greater percentage of those seats – from an average of 52.6 percent in the ten years before 1978 to 61.0 percent in the twelve years after.” Kahn also cited better equipment utilization via use of small-prop and jet-prop planes for short hops and the wider variety of destinations made possible by the hub-and-spoke mode of routing flights. These are clear examples of the superiority of deregulation over the previous regulated regime.

What about airline safety? Contrary to the insinuations of BS, Kahn notes that “accident rates during the twelve-year period from 1979 to 1990 were 20 to 45 percent (depending on the specific measures used) below their average levels in the six or twelve years before deregulation. Moreover, by taking intercity travelers out of cars, the low airfares made possible by deregulation have saved many more lives than the total number lost annually in air crashes. [Emphasis added]“

To be sure, Kahn noted a number of problems experienced during the first decade of deregulation – “congestion and a limited reemergence of monopoly power” – but he called it “a mistake …to regard these developments merely as failures of deregulation: in important measure they are manifestations of its success.”

In the subsequent 20 years, Kahn’s verdict has been reinforced by events. The principal failure of airline deregulation was its incompletion. Major airports remained government-owned and operated; landing and loading have remained significant bottlenecks due to inadequate space and lack of a pricing mechanism to allocate it.

BS failed to inform their readers on airline deregulation as they did on truck deregulation, and for the same reasons. Now, we divide the remainder of the book into analytical categories to suit our purposes.

Fear of the Foreign

BS’s emotive style plays to common fears, one of which is the fear of the foreign. Foreign nationals, foreign businesses, foreign mores and culture are presumptively suspect, hence an excellent scapegoat for authors purporting to reveal “what went wrong” with an entire nation. Two chapters, 2 and 5, play to this fear.

BS press the emotional buttons of their readers using familiar institutions as their explanatory fall-guys. Government – specifically, non-regulatory elected officials in Congress and the Executive branch – arbitrarily decided to bias its rules against ordinary, middle-class Americans (that is, readers of BS). Corporations took advantage of loopholes in the “government rule book” and acted in “their” interest and against the interests of the middle class.

Chapter 2, “Losing Out to Mexico,” follows this format. The introductory page warns that “American corporations are closing plants or slashing work forces in the U.S. and shifting the jobs to Mexico,” to the tune of “1,800 plants employing more than 500,000 workers,” mostly relocated by U.S. corporations. The entire chapter – at nine pages the book’s shortest – consists of anecdotal cases involving companies and people.

BS presume that this southward shift is a bad thing. It is bad because “the new plants are replacing facilities that once provided jobs for U.S. workers.” BS ascribe this specifically to low tariffs (taxes) on goods assembled in Mexico and shipped back to the U.S. To add insult to injury, foreign companies (BS specifically name the Japanese) have the effrontery to “dump” their manufactured goods on our markets at prices that are too low. (As authority for this evaluation, they cite the U.S. Tariff Commission’s claim that Japanese television receivers were sold in the U.S. at “less than fair value.”)

BS also pinpoint low wages earned by Mexican workers as a lure leading American firms to Mexico. Not only are Mexican wages unconscionably low compared to U.S. wages (BS conduct a monetary comparison, presumably with the aid of an unnamed exchange rate), but they are too low to enable the Mexican workers to buy U.S. products – thereby eliminating the only possible rationale BS could think of for allowing this sort of free international commerce.

In Chapter 5, “The Foreign Connection,” BS ramp up their assault on the foreign. Once again, government starts the rot by greatly increasing the number of years during which corporations can take a deduction for “net operating loss (NOL).” Not surprisingly, corporations respond by actually taking the deductions they are offered. This affects not just American corporations but foreign ones, too, since the U.S. NOL deductibility period now greatly exceeds those available abroad. Foreign corporations take up residence in the U.S. This tends to bias the corporate migratory inflow towards money-losing companies with deductions to take, which allows BS to pejoratively compare foreign corporate deductions taken and taxes paid to the figures for U.S. firms (which are higher and lower, respectively).

This is the springboard from which BS paint the 1980s as a period during which the government deliberately set out to benefit foreign companies at the expense of the American middle class. In addition to the NOL-deductibility expansion, BS also cite several other alleged examples of global finance as a game rigged against ordinary Americans. Net foreign investment, particularly the purchase of American assets by foreign investors, is portrayed as inherently prejudicial to our interests. As always, BS make their points by anecdote. They cite case after case in which American industry has merged with or been subsumed within foreign industry – then conclude with “once, all were American-owned.” They do not mention that Americans have been investing abroad throughout the 20th century in exactly this same manner.

Why is all this bad? BS expect their readers to find it suspicious on its face. “So it is that corporations constantly shift their costs to countries with high tax rates, in order to maximize their deductions, while they shift their profits to low-tax havens in order to keep their tax payments down.” BS contrast corporate behavior with the tax reporting of individuals, who lack the capacity to repatriate profits so as to duplicate the tax optimization practiced by corporations.

Then, of course, there is also the corporate practice of “exporting jobs” – illustrated copiously by BS with lavishly appointed anecdotes of individuals whose lives were ruined, blighted or otherwise made unpleasant by business decisions of which BS do not approve. Once again, BS top all this off by using crime as their piece de resistance. Here, their villain is an international businessman named Marc Rich, who operates international businesses with apparent impunity despite various outstanding felony warrants bearing his name issued by U.S. courts.

The Truth About Foreigners and Corporations

As usual, BS cite no economists or economic sources – the word “economic” is used advisedly to distinguish between a valid system of logic and mere numerical data or aggregated information. Reference to basic economic theory would have cast their findings in an entirely different light.

It is no surprise that corporations – more particularly, corporate owners and managers – act to protect their interests in light of circumstances. They are obliged to do so even were it not in their interest. Thus, BS cannot in good conscience call their information investigative reporting. But BS owe their readers coherent presentation. That is utterly lacking unless they recognize the economic significance of the corporation.

A corporation is an idea or concept, given form on a piece of paper filed with government. This piece of paper does not eat, sleep, make love, raise children, pay taxes or enjoy subsidies. Only people can do those things. More formally, tax incidence requires a forfeiture of utility or satisfaction from a reduction in consumption and/or saving. Only people consume and save.

BS imply – implicitly assume – that what is good for corporations is bad for their readers. Why? BS must first explain what people gain or lose from the effects felt by corporations. Since nobody knows, say, the actual incidence of the corporate income tax – that is, nobody knows who actually pays it – nobody can say for sure whether it is good or bad for particular people. The people who might pay it are corporate shareholders, corporate employees and corporate consumers. They constitute the rich, the middle class and even a big slice of the poor.

BS imply that government is willfully benefiting the rich at our expense. It is true that corporations constantly change their operations to benefit their shareholders. But in a competitive market, any changes in profits will be short-run changes, because movement of firms will tend to equalize rates of profit in industries and across geographic areas. It is consumers and input suppliers, not owners, who tend to be long-run beneficiaries of change. That means that the multifarious changes pointed to with such alarm by BS are mostly just waste – roundabout ways of transferring money from one pocket to another with only short-term net gains or losses. The waste derives from the overhead costs of effecting and administering all the moving around – changing rules and compliance costs and monitoring. The long-run beneficiaries of the waste are not corporate fat cats but rather BS’s hero class of government; namely, regulators and civil servants whose jobs exist because of all this wasted motion.

Of course, actual organic incentives exist to move companies and jobs to Mexico. If iron ore (let’s say) were cheaper to mine in Mexico, it would make perfect sense to move steel companies to Mexico or to import the ore to America. The same holds true for wages; if labor is cheaper in Mexico, it is economically proper to bring the companies to the labor or bring the labor to the companies. After all, that is what we do within the U.S. – we don’t let the artificial boundary lines separating states or cities stop us from producing goods efficiently. The economic logic of efficient production is unaffected by international boundary lines.

BS don’t introduce any economic expert testimony here because economists have traditionally favored free international trade; that is, they would reject the BS case completely.

The bogey of “job exportation” is a product of the “lump of labor” fallacy – the presumption that only so many jobs exist to be distributed among existing workers. Ironically, this attitude is encouraged by the myriad of disincentives to job creation and hiring established by U.S. labor laws supposedly designed to protect the worker. By making it more difficult and costly to hire, these laws defeat their own object.

From BS, we learn none of this.

The Paper Pushers

In addition to corporations, BS also introduce other villains who were empowered by government in the 1980s. One of these is a composite group best described as paper-pushers. BS treat them as inherently unproductive individuals who collect large amounts of money for doing things that have little or no value.

In Chapter 4, “The Lucrative Business of Bankruptcy,” BS lament the 1978 change to Chapter 11 of the U.S. Bankruptcy Code that made it easier to companies to declare bankruptcy but continue to operate in an effort to resolve their business problems and get out from under debt. This change produced the largest surge in annual bankruptcy filings since the Great Depression.

According to BS, this is ad because it “has been a bonanza for …the lawyers, accountants and other specialists who charge up to $500 an hour for their time.” They spend half of this chapter, some 10 pages, recounting in gruesome detail the activities of a corporate turnaround artist named Stanford Sigoloff, who specialized in managing bankrupt firms. Sigoloff charged $500 for his time. BS devote pages to listing the fees charged by him and his colleagues in managing the L.J. Hooker Company, the bankrupt subsidiary of a large Australian corporation.

In addition to high fees, bankruptcy liberalization is also responsible for the runup of corporate debt that occurred in the 1980s. The ability to reorganize in bankruptcy gave companies an incentive to borrow in an effort to stay afloat. When corporate turnaround specialists acquired the assets of failing companies by borrowing, they then often applied this debt to the company’s balance sheet. Debt came to be viewed as a disciplinary force, tightening up company spending by imposing constraints. The deductibility of corporate interest on debt encouraged this attitude.

In Chapter 7, “Playing Russian Roulette With Health Insurance,” BS explore additional consequences of corporate bankruptcy in the 1980s. They enumerate the shrinking fraction of employees in large companies who are fully covered by employer-provided health-insurance benefits. Employee plan contributions rose during the 1980s. Part-time employment also rose, undoubtedly because part-time employees are normally not eligible for health benefits. And in bankruptcy, employer-provided health insurance may be one of the first casualties of reorganization, subject to bankruptcy-court approval. (Of course, in the case of Chapter 7 bankruptcy liquidation, health benefits are lost along with the employee’s job, subject to the qualification that Cobra plans can provide a temporary life-support plan for those benefits.)

In this chapter, BS’s paper-pushing villain is the financier. In contrast to the production manager, the financier in inherently unproductive because he produces nothing real. In Chapter 7, the CEO of Heck’s chain of department stores, Russell Isaacs, rose from financial officer to CEO. “…Aside from a grasp of the numbers… he had little understanding of the business he was running or what made it work.” BS spend the chapter juxtaposing the actions of Isaacs with the travails of four employees who lost their jobs in the chain’s bankruptcy.

Paper-pushers Under Competition

BS never explain how or why the paper-pushers wield their influence. The outsize fees charged by bankruptcy managers are approved by the bankruptcy court because they comport with fees charged by lawyers in general practice. Because the firms in question are in bankruptcy, the managers do not have to meet the productivity standard to which employees of competitive firms are held; namely, that the discounted value of the output they produce is greater than or equal to their wage. Thus, the only applicable standard for judging the outcome is the bankruptcy process itself.

Bankruptcy is a process for reallocating resources to get more out of them. The fact that more firms declared Chapter 11 bankruptcy following the Code change is unremarkable, since its purpose was to encourage firms to remain active and work out their problems. The question is, can we improve the allocation of resources by altering the balance between liquidation and reorganization?

BS do not even attempt to answer this question. Indeed, they do not even pose it. Nor do they explain why corporate boards would continue to select chief financial officers as CEOs if a background in production were a necessary prerequisite for the job.

The Fear of Takeover

Another fear exploited by BS is the fear of loss of control. BS personalize this fear in the form of the corporate takeover. Having established corporations in imagination as bad guys, they next link the pejorative adjective “corporate” with the fear-object “takeover.” A takeover is a loss of control, something to be feared. That makes a corporate takeover bad by definition; readers are conditioned to fear it. In two chapters, BS proceed to link it with a reign of terror and destruction worthy of a Mongol conqueror.

In Chapter 8, “Simplicity Pattern – Irresistible to Raiders,” BS paint this picture in lurid colors. Simplicity Pattern Co. was a peaceful, successful company in 1981, “as much a part of the American home as the radio and the sewing machine.” It “was sitting on tens of millions of dollars in cash and investments.” But, according to BS, “it was too good to pass up.” So “over a decade six different moneymen made runs at the dowager company. When they were done, the money was gone. And Simplicity was drowning in debt.”

BS devote the entire chapter to this one company, taking it through its dealings with the various corporate raiders, including Carl Icahn and Victor Posner. (One subhead is entitled “The Raiders Attack.”) This is the BS implicit theory of journalism taken to its logical extreme: investigating reporting via anecdote and extended appeal to emotion.

The Truth About Corporate Takeovers

In the 1930s, two academic students of business, Adolf Berle and Gardener Means, made names for themselves by theorizing that American corporations suffered from the “separation of ownership from control.” Because shareholders were cut off from actual operation of the companies they owned, they were forced to rely upon corporate managers to secure shareholder interests by maximizing company profits. Instead, those managers were running the companies to benefit themselves, the managers. They were maximizing company size and managerial salaries to increase their own prestige and income, but allowing profits, investment and innovation to lag. It was problem of “agency;” shareholders had no agent upon whom they could rely to safeguard their interests. Indirectly, consumers also suffered from this lackluster corporate performance.

Believers in free markets saw flaws in this theory. Astute entrepreneurs could borrow money and bid up the company’s share price to acquire its stock – thereby benefitting the stranded shareholders. They could depose the delinquent managers, cut the bloat and high costs, innovate and increase firm earnings, thereby earning the profits to pay off the debt they incurred to buy the company. Then they could sell the company, whose share price now reflected its lean status and elevated earning power. Now they have paid themselves back for their shrewd evaluation of the firm’s condition. So much for the “separation of ownership from control!”

And according to academic researchers like Michael Jensen, that is exactly what corporate raiders like Carl Icahn and Ivan Boesky did beginning in the late 1970s and continuing to the present day. Of course, they didn’t succeed with every venture. Sometimes the laggard managers saw their pink slips written on the wall and paid the corporate raider to stop buying the company’s stock – “greenmail,” it was called. Sometimes, the debt burden taken on by the raider proved too great and the company later succumbed to bankruptcy. Of course, if the company couldn’t earn enough to pay off a loan, there may have been problems with its operations. That takes us back to the BS case study.

BS told their readers that Simplicity Patterns was the picture of health. But companies do not “sit on millions of dollars in cash” without a reason. “As with many mature businesses, the earnings from Simplicity’s major business, the sale of [sewing] patterns, had begun to trail off in the late 1970s, a problem the company’s management had yet to deal with.” No kidding. Simplicity was in a dying business. Once, sewing patterns were ubiquitous. Today the proliferation of ready-made clothes and foreign competition has relegated them to hobby status. This, not the rapacity corporate raiders, was the company’s ultimate undoing. Simplicity’s shareholders were repaid when raider number one, John Fuqua of Triton Industries, bought it for $64 million in 1984. He resold the company in 1987 for $117 million, proof that the logic of the raid had been sound enough as far as it went. The fact the Simplicity “couldn’t sell patterns fast enough to pay the interest on its bonds and loans” was due to the fact that both sewing machines and sewing machine patterns were on the same road previously trod by the horse-drawn carriage.

In fairness to BS, they couldn’t be expected to foresee all this in 1992. But the economic theory outlined above had been developed well before their articles and book were written.

The Disappearing Pensions

In Chapter 9, “The Disappearing Pensions,” BS follow their modus operandi of using one case study as a proxy for an entire industry, country or era. Corporate raider Victor Posner “raided” the pension assets of companies he controlled. This was facilitated by changes in the “government rule book,” which permitted companies to withdraw pension assets provided sufficient assets remained to fund the plan.

In this chapter, however, BS undercut their own method by admitting that the real problem confronting America is “pension chaos” – the steady dissolution of an unsustainable system. They point with alarm to the decreasing number of workers receiving pensions and the falling average size of those pensions. The disparity between the number and size of corporate pensions relative to those provided by state and local governments is particularly distressing to BS. Last but not least, BS find the relative pension security of members of Congress outrageous.

As usual, BS cite no authoritative sources for their contentions. Their professional and analytical shortcomings are never more painfully evident. For example, BS proclaim that “women who retire from jobs in business receive smaller pensions than men.” They ascribe this to male discrimination, aided and abetted by lacunae in the “government rule book.” But any financial professional could have told them that most pensions are distributed in the form of a life annuity, which – by definition – pays out a smaller annual amount of a given total distribution the longer is the life expectancy of the recipient. Women live longer than men on average; thus, smaller annual pension payouts are an actuarial given, not an artifact of discrimination. Incredibly, BS note longer average female longevity, but nevertheless ascribe lower female pensions to “Congress,” whose “tax-writing committees have heavily skewed the tax law against most women.”

This chapter highlights our purpose in reviewing BS in retrospect. From today’s perspective, it is easy to see where BS went wrong – and why they were right to be concerned about pensions. The corporate pension steadily lost favor as a vehicle for retirement security because corporations could not fund pensions reliably. By definition, the income used to fund corporate pensions is a business residual. It is subject to the highest form of risk. It cannot form the basis for secure funding because it is not sufficiently diverse. That is the reason why defined contribution retirement systems have left defined benefit (i.e., pension) systems in the dust. Defined contribution systems allow recipients to tailor the mix of investments to suit their own risk preferences and to greatly modify that mix as they age in order to reduce the risk of loss.

Insurance companies are the exception to this principle. They can and do sell annuities because their core income is so stable and reliable and their investment portfolio is so diverse. In this respect, they are diametrically opposed to the single-purpose company, all of whose eggs are nested in its own basket.

BS never pause to question the security of government-worker pensions – they use them as the standard by which corporate pensions are found wanting. We now know that government pensions are the shakiest, least sustainable of all. Politicians have faced no constraints on their willingness to give in to union demands. The entire system of government retirement benefits is unfunded, “pay as you go;” this puts pensions in permanent jeopardy even if they are nominally funded. Political promises are the most worthless currency of all. The current financial and political instability in Europe is merely the overture to the coming collapse. BS’s fixation on the peccadilloes of an individual corporate raider seems quaint today in light of subsequent developments.

Markets are vehicles for accomplishing the possible. They also reveal what is impossible. Markets have revealed that corporate pensions are untenable and government-employee pensions are impossible. Insurance companies are the proper vehicle for providing pensions and they are doing it. BS are disconnected from reality. Not only do they approve of government-worker pensions – they want government to reinsure corporate pensions! As it stands, corporate pensions are now “guaranteed” by a quasi-government agency, the Pension Benefit Guaranty Corporation. Like all such government promises to pay, it is only worth the political will that stands behind it.

The Rest

There are three chapters of America – What Went Wrong? that we have not discussed. Chapters 1 and 3 deal with taxes and tax policy. Chapter 1 also makes sweeping assertions about the distribution of income in America and the disappearance of the middle class. These issues are either too complicated (taxes) or complex (income distribution) to warrant discussion here. Once again, BS follow their standard procedure of eschewing expert assistance; in effect, they are acting as their own experts. Considering the difficulty of these issues, this willingness is baffling and disheartening.

Chapter 10 lines up the special-interest villains that BS blame for ruining America during little more than a decade. In a concluding Epilogue, they unveil their solutions: Pass more laws, tighten up regulation and make big government much, much bigger by re-writing the government rule book.

Reviewing BS in retrospect is a cautionary exercise. BS were the crème de la crème of journalism, yet these results show that they could not be trusted to report or analyze. They were unaware of their own limitations. They had an agenda that took precedence over fact and logic. This agenda was clearly left-wing and “progressive” in orientation. Their solutions were to regulate, restrict and pass laws in profusion to thwart “special interests.” They may have escaped censure because they were careful to criticize Democrat lawmakers and elected officials as well as Republicans.

Today, America is in the throes of a political divide. It is easy to see how the work of BS sharpened this divide. Left-wing readers were emotionally charged by its omnibus indictment of the “Reagan era” – one might suppose that those were years of deep Depression rather than the biggest postwar expansion. Right-wing readers were shocked and startled, but finally brought to realization that the mainstream print media were ideological opponents rather than neutral purveyors of journalism.

The right-wing half of the audience began to look for the exits. That was the beginning of the end of newspapers; the Internet merely ratified the decision made earlier by customers.

DRI-313 for week of 3-9-14: Economic Rewind: What Went Wrong With America: What Went Wrong?

An Access Advertising EconBrief:

Economic Rewind: What Went Wrong With America: What Went Wrong?

Steadily increasing technological innovation carries with it a growing focus on the future. Looking backward nowadays tends to be more and more an occasion for nostalgia. This denies us a valuable tool. Reviewing yesterday in light of subsequent events and discoveries can improve our navigation through the future.

In 1991, the Philadelphia Inquirer published a nine-part series of articles by its star investigative reporting team, Donald L. Barlett and James B. Steele. The series was entitled “America: What Went Wrong?” The articles purported to show what had recently gone wrong with the country, roughly over the preceding decade. The popularity of the series encouraged the publication of the collected articles in book form under the same title. The book became a runaway New York Times bestseller. The authors, who had both previously won two Pulitzer Prizes for investigative reporting, gained national fame and climbed the career ladder to high-level writing positions at Time Magazine and Vanity Fair.

One motive for reinvestigating this subject matter is immediately apparent. In retrospect, the suggestion that America went to hell in a hand basket during the 1980s seems decidedly eccentric, to say the least. Although the nation began the decade in a mood often characterized as “malaise,” dramatic changes in economic policies fostered by President Reagan, Federal Reserve Chairman Paul Volcker and a small number of maverick economists ushered in an economic boom that eventually became the longest peacetime economic expansion in American history up to that point. True, there was a mild recession in 1991, the year of the Philadelphia Inquirer series, but this was followed by an even longer period of expansion.

It is possible to formulate a theory that bad things happened in the 1980s and subsequently. Former Reagan administration official David Stockman developed this thesis in his recent lengthy memoir. But Stockman didn’t portray those years as years of deprivation and despair; rather, he maintained that the underlying foundations of the boom were built on excessive government spending. The good times were good enough while they lasted, in other words, but were destined to end badly.

This was most definitely not the picture painted by Barlett and Steele. It behooves us to closely examine their bestselling book today. The perspective of time enables us to appreciate how bizarre and wrongheaded their thesis was. Our economic focus will show how completely wrong their conclusions were. And, most startling of all, we will realize that the two most celebrated investigative reporters of their day apparently failed in their duty to their readers and their profession.

Readers who remember the powerful impact Barlett and Steele’s book had over twenty years ago and who are awed by their current eminence will find the foregoing contentions incredible. They should swallow their incredulity and read on.

BS on “The High Cost of Deregulation”

Barlett and Steele (hereinafter shortened to BS) organized their book into ten chapters (one more than the original number of articles). We will focus on the most economics-intensive chapters, as determined by the subject matter. Chapter 6, entitled “The High Cost of Deregulation,” is probably the narrowest in its concentration on pure economic subject matter.

We can infer that the chapter deals intensively with economics from the fact that an economist is quoted in it. You would never know that, though, from this chapter. BS quote “Darius W. Gaskins, Jr., former Chairman of the ICC.” But they do not bother to tell their readers that he is economist Darius Gaskins, leading specialist in the field of Industrial Organization, who was appointed Chairman of the ICC by President Carter specifically because of his expertise in trucking regulation.

Most of the chapter deals with the deregulation of the trucking industry that began in 1978 and resulted in the passage of the Motor Carrier Act of 1980, which deregulated the substance although not the technical form of pricing and entry into interstate trucking. This is odd. The introductory page (“What Went Wrong”) previews the topic: “Thousands of firms gone. 200,000 jobs lost. Deregulation has been costly to workers and consumers alike.” It continues by citing the costs of the savings and loan cleanup and claiming that “now the push is on to deregulate the banking industry.” Yet the chapter itself deals almost completely with the two big deregulatory efforts of the 1980s – trucking and commercial airlines.

The headline of the section on trucking deregulation is “Wrecking Industries and Lives.” The inference is clear: the trucking industry was “wrecked” by deregulation and lives were destroyed as a direct result. How was the industry wrecked?

Here is the BS explanation: “Since deregulation of the trucking industry in 1980, more than 100 once-thriving trucking companies have gone out of business. More than 150,000 workers at those companies lost their jobs.” They provide a full-page table headed “The Collapse of the U.S. Trucking Industry.” It lists “the top 30 trucking firms of 1979,” most of which are “gone.” More precisely, 17 had folded, 3 merged and 10 still operated.

How did this destruction occur? The BS view is that deregulation was based on false premises: “Removing government restrictions on the private sector would let free and open competition rule the marketplace. Getting rid of regulations would spur the growth of new companies. Existing companies would become more efficient or perish. Competition would create jobs, drive down prices and benefit consumers and businesses alike…That’s the theory. The gritty reality, as imposed on the daily lives of the men and women most directly affected, is a little different.”

BS illustrate the difference between the promise of deregulation and its actual performance with anecdotes. A trucking-company employee was stricken with a “rare bone cancer.” His company went bankrupt. He lost his medical insurance and could not pay for his medical treatment. (Oddly, BS say that the company’s checks paying for the treatment “began bouncing.”) The treatments apparently continued until the man’s death, but his wife suffered harassment by the collections department of the hospital.

A woman worked for nineteen years as an accountant for a trucking firm. It went out of business. She took part-time jobs at a lower salary. Another woman suffered the loss of her husband, who was killed in a highway accident. Rather than paying her out of the state worker’s compensation fund, regulators allowed the trucking company to pay her directly. But “deregulation was helping drive it…out of business.” After bankruptcy, the woman’s checks stopped and she became an unsecured creditor.

These three anecdotes are attenuated and decorated with detail to stress the suffering of the principals. Likewise, the good old days of regulated trucking are fondly recalled. “My uncle was a truck driver twenty years ago and, wow, he made a lot of money…drove a nice car…had a nice house.” “Trucking was a good job in those days…the pay was good, it was steady work.” The contrast with deregulation is stark. “Deregulation has been a nightmare…

now, drivers are struggling to survive.” “For truckers, the 1980s were a dismal time.”

The BS Theory of Deregulatory Disintegration

It is one thing to claim that things are bad under deregulation but another to actually state a logical chain of reasoning to underpin the disintegration. Why did things go bad? Why must it be inevitable that deregulation is doomed to failure while regulation should succeed? The closest that BS come is to insist that government statistics do not tell the true story, that deregulation causes wages to spiral downward and “good, middle-class jobs” to disappear and that deregulation produces financial disaster for the industry.

BS actually cite a Brooking Institute study claiming a $20 billion net benefit from trucking deregulation. (They say nothing about who did the study, how it was done or the nature of the benefit.) They are willing to concede that “companies that hire truckers have profited from lower rates” but maintain that “there are no economic data showing that the cost savings have been passed along to consumers.”

BS admit that “according to the Bureau of Labor Statistics…between 1980 and 1990, the number of employees increased 248,000 [and] average yearly earnings went from $18,400 to $23,400″ in the trucking industry. But the good jobs, those with seniority, high wages, benefits and health insurance, went down the tubes along with the 100 big trucking firms that failed. In their place came a raft of “one-owner, shoestring trucking operations.” Deregulation “eliminated two jobs that paid, say, $30,000 and created three jobs that paid $20,000 or less.” The $23,400 earnings figure is misleading because “the government excludes one major category of drivers from its figures – self-employed drivers. And their earnings are generally lower than those for drivers employed by major companies.”

BS spend the best part of seven pages decrying the particular efforts that failing companies employed to stay afloat. These included mergers, leveraged buyouts and particularly the use of employee stock ownership plans (ESOPs) as a means of raising capital by selling ownership in the company to its employees. “Since 1980, more than two dozen ESOPs financed by worker wage cuts have been adopted by large trucking companies. With few exceptions, the companies failed anyway.” BS wax especially indignant at the activities of one (1) financier who owned an S&L as well as a trucking company and was eventually convicted of fraud and sentenced to twenty-four years in jail.

Such is the BS theory of deregulatory disintegration. On regulation, BS are even vaguer. They see it as a kind of mediative or ameliorative process, apparently intended to smooth out (or saw off) the rough edges of the competitive process. BS drop stray hints that regulation was not perfect. (“Undoubtedly, the ICC, like its counterpart in the aviation industry the Civil Aeronautics Board (CAB), had had stifled competition and discouraged innovation…If the ICC had been guilty of overregulation in the past…”) But deregulation was not the answer; instead, policymakers should have repaired regulation. (“Rather than correct the defects in the regulatory system, Congress chose instead to throw it out…It was somewhat akin to eliminating the referees in a football game because of flawed calls, instead of merely replacing them.”) Do BS mean that regulators should have been replaced? Of course, civil-service regulations make it difficult, if not impossible, to replace anybody below cabinet level for political or policy reasons. Higher-ups usually get replaced anyway as administrations change.

In any case, as we shall see below, virtually everything BS say in this chapter is wrong, misleading or irrelevant.

The Truth About Trucking Deregulation

That this account of trucking deregulation could appear in a major metropolitan newspaper under the guise of investigative reporting, then subsequently form the basis for a non-fiction bestseller, is astonishing. America: What Went Wrong was subsequently named one of the 100 leading pieces of investigative journalism in the 20th century by New YorkUniversity’s Department of Journalism. This gives it a status approximating that of Piltdown Man in the scientific world. We can begin to appreciate this by methodically recounting the truth about trucking deregulation, as revealed by the logical and empirical tools of economics.

As with all forms of industrial regulation, the roots of trucking regulation have been meticulously traced. It did not arise owing to a spontaneous, grass-roots demand by the public. Railroads resented the competition for freight carriage presented by trucks during the 1920s and 1930s. They strenuously lobbied state regulators and the ICC. In 1935, the ICC subjected the interstate trucking industry to tight regulatory control governing entry into the market and prices charged by trucking firms to shippers, as well as safety standards of operation. Meanwhile, each state established analogous control over intrastate trucking.

The essence of entry control was the certificate of convenience and necessity, which required would-be new entrants to prove to regulatory authorities that their new service was both necessary and appropriate. (Incumbent firms were mostly grandfathered into the business without having to meet the requirements.) The regulatory authorities included current active truckers, so would-be entrants were begging their competitors for permission to compete with them. Not surprisingly, their entreaties were seldom heeded. Applications for new service by certificated firms were given precedence over those by new entrants.

Prices were submitted to regulatory authorities at least 30 days in advance of effective date. Anybody interested party could view them and object to them. Once again, this was a virtual bar to any effective form of competition, since objections would give rise to a bureaucratic investigation and competitive gains would be eroded or eliminated altogether by the investigative costs.

The rules governing service authority under regulation were staggeringly inefficient. Because the chances of passing muster for a certificate of convenience and necessity were virtually nil, the only way companies could enter the business in practice was to buy the authority to provide trucking service to a particular route. This cost hundreds of thousands of dollars (in today’s money, the equivalent of millions of dollars). The lack of price competition and difficulty of competitive entry meant that trucking companies earned monopoly profits. The only way an existing trucking firm would sell its authority to operate was if it were compensated for the loss of those monopoly profits in the sale price; that is, the price reflected the discounted present value of anticipated future monopoly profits. This is directly analogous to the sky-high prices received for the sale of taxicab medallions in places like New York City, where entry and price competition were similarly restricted. Unlike the taxi case, though, trucking-company owners had to split the monopoly profits with unionized company employees, who made up about 60% of large-company workers. (Deregulation was vehemently opposed by both the Teamster’s Union and the American Trucking Associations, which included the large trucking firms.)

If a trucking firm was lucky enough to raise the price of entry, it still faced barriers to efficient operation. Consider the case of a firm serving the route from Cleveland to Buffalo under regulation. Let’s say it purchased the right to a route from Buffalo to Pittsburgh. Could it carry freight traveling from Cleveland to Pittsburgh? No, it couldn’t travel straight between those two cities because it had no authority to serve that route; it must travel many miles out of its way by going through Buffalo in order to serve Pittsburgh from Cleveland. And what about the return trip? As every commercial drive knows, “deadheading” or returning empty is mindboggingly inefficient. But that’s what trucks had to do under regulation.

How inefficient was regulation? Certain commodities were exempt from regulated carriage, and their rates averaged 20-40% lower than regulated rates. Dressed poultry was exempt; its rates were 50% below that of regulated cooked poultry. Trucking rates in West Germany and the U.S., which had similar forms of trucking regulation, were 75% above those in unregulated Great Britain.

Does something seem not exactly copasetic about this arrangement? So it must have seemed to Congress, which passed the Reed-Bullwinkle Act in 1948 exempting motor carriers from the anti-trust laws. Thus, the ICC effectively functioned as a cartel allowing trucking-industry firms to act collectively as a monopoly and the firms were immunized against the legal consequences of doing that by act of Congress.

How much of this did BS tell their readers? Absolutely nothing.

Deregulation was proposed by John F. Kennedy in 1962. It was proposed again by Gerald Ford in 1975. It was backed by economists who studied the industry virtually from the outset of regulation in 1935 until 1978, when Senator Edward Kennedy sponsored the enabling legislation signed by President Jimmy Carter in 1980.

BS’s piece on deregulation appeared in October, 1991; their book appeared in Spring, 1992. By then, careful economic studies on the effects of trucking deregulation had already appeared. Since then, of course, even more empirical work has been done confirming and strengthening the initial results.

Economist Thomas Gale Moore published an early study in 1987 and later contributed two summaries, one to the Fortune Encyclopedia of Economics and one to its successor, the Concise Encyclopedia of Economics. He found that average rates for (full) truckload shipments declined by 25% between 1977 and 1987 and LTL (less-than-truckload) rates fell by 10-20% between 1979 and 1986. Overall, revenue per truckload ton fell by about 22%. The cause of the decline in prices and revenue was the increase in price competition caused by the tremendous influx of new entrants into the market, which broke up the monopolies exerted by the big trucking firms and destroyed their monopoly profits. It also produced an increase in trucking output. By 1990, there were about 40,000 truckers in the U.S., more than twice the number operating under regulation. (BS themselves recognized both an increase in truckers and an 11% increase in trucking output, which they derided as “too many trucks…suddenly chasing too little freight.)

In surveys, 77% of shippers approved of deregulation. Official complaints by shippers against trucking firms fell to less than 10% of their former levels under regulation. The Department of Transportation conservatively estimated the gains from trucking deregulation at $38-56$ billion per year.

One of the major unanticipated gains was the role played by deregulation in adoption of the “just-in-time” (JIT) system of inventory control. JIT is now recognized as a key prophylactic against the fate suffered by the U.S. economy in 1920, when the large inventories accumulated by firms produced a short but extremely sharp recession. The tremendous improvement in trucking efficiency produced by deregulation allowed business firms to cut their level of inventories from 14% of GNP in 1981 to 10.8% in 1987.

BS noted with disapproval the role played by Senator Kennedy in deregulation. Other than that – and the derogatory reference to the increase in trucking output – they told their readers absolutely nothing of the true genesis and effects of trucking deregulation.

What Did BS Owe Their Readers? What Did They Deliver?

Readers may be a bit dizzy at this point. Can it really be true that the two leading investigating reporters of all time – ranking above even Woodward and Bernstein in the esteem of many commentators – could have produced an article so completely lacking in merit? After all, BS are not themselves economists; they were only reporters and never pretended otherwise. Is this EconBrief holding them to an impossibly high standard?

The following compares what the readers of BS had every right to expect with what BS delivered.

Journalistic Integrity. A reporter is not an editorialist. He is not supposed to state unsupported opinion. He is supposed to seek out expert, authoritative opinion whenever possible – not set himself up as an expert. He should cite his sources of information or state that their anonymity is being preserved. An investigative reporter is supposed to learn the facts and present them, not create a story to fit his preconceptions. The reporter’s opinions are irrelevant to the story.

Economists are the authoritative experts on the organization of industry, consumer benefit and government regulation. They offer university courses on these subjects, provide expert testimony in regulatory and judicial proceedings and advise government in official and unofficial capacities. They offer the only formal theory of human behavior dealing directly with these issues.

BS made no visible effort to consult expert, authoritative opinion. They cited no economist. They quoted one economist, but hid his economic credentials from their readers. They did not understand the economic theory and logic underpinning their subject. They did not understand the implications of the scanty data they did cite on the subject. They operated on the basis on an apparent, implicit “theory” concerning the trucking market and its deregulation. That implicit theory bore no relationship to reality or to economic logic.

BS violated most of the canons of sound reporting. They adopted an advocate’s role with no factual or logical basis underlying it. The case they presented to their readers was incoherent, resting on illogic and non sequitur. Thus, they relied entirely upon eliciting an emotional reaction from their readers. Whatever else this is, it is not good journalism.

Analytical Coherence. BS paint a picture. In order to be worthwhile, that picture must be coherent. Otherwise, it has value only as a kind of surrealist exercise. “The High Cost of Deregulation” fails that test completely. The very title is a misnomer. The word “cost” – like all terms used by economists – is a term of art. It denotes opportunity cost, the highest-valued alternative foregone. BS assumed the burden of proving that (say) the failed businesses were in fact in their highest-valued use, or that employees had greater productivity in the job they lost than in their subsequent employment. They didn’t do this and made no attempt at it.

BS want us to presume that an industry is “wrecked” when large businesses fail and people lose their jobs. But business failure happens daily throughout the economy. A majority of small businesses fail within five years of inception, but their industries survive. Large numbers of restaurants fail and their employees must seek out new jobs, while others prosper and create wealth for their owners and employees. That is how the competitive process learns exactly what buyers want and weeds out inefficient suppliers. Considering that “wants” and “efficiency” change frequently, successful competition is something we should cherish, not deplore.

BS invert the stereotypical casting of the left-wing business morality play. Here, it is the big, bloated corporations that are heroic because they provide their doughty workers with “good, middle-class” wages and safe jobs. They are undone by the hordes of evil, one-owner small businesses that invade the industry when unleashed by deregulation. But economics is not a morality play. Trucking deregulation was beneficial because it replaced a monopolistic cartel with competition. The beneficiaries of monopoly were made unhappy by deregulation. But their satisfaction did not take precedence over that of workers, business owners and consumers who benefitted from it.

The trucking industry was not “wrecked.” Numbers of trucking firms increased dramatically. Today, trucking carries roughly two-thirds of all freight moved in the U.S. The only problem with deregulation was that it was not complete; it did not extend to intrastate trucking and it only affected pricing and entry, not the remaining aspects of the business. BS complain that deregulation was based on a false premise, yet everything that BS say did not happen under deregulation – free and open competition, entry of new firms, removal of burdensome regulations, lower prices, more output, job creation, benefits to consumers and businesses alike – did happen.

Incredibly, BS insist that there is no “data” verifying that the “lower rates” produced by deregulation were “passed along to consumers.” Apparently, BS were expecting to find an actual government data category reading “price decrease to consumers caused by deregulation,” or some such. If the “rates” refer to freight rates, that is what happens by definition; that is what is measured by the benefit studies done by Brookings, Moore, et al. If “rates” refers to wages rates, it is again true by definition. After all, deregulation abolished the monopoly cartel run by the ICC, it did not introduce monopoly. There is no mechanism by which sellers can benefit from lower wages created by competition and than arbitrarily keep all the gains for themselves. If they believe otherwise, BS should go start a trucking firm and utilize that mysterious arbitrary power to earn profits that will prove their case.

BS also insist that government data showing a $5,000 yearly increase in average yearly earnings for truckers is “misleading” because deregulation “eliminated two jobs paying $30,000 and created three jobs paying $20,000 or less.” But their own arithmetic doesn’t even support their argument; it produces stable or falling earnings. And their claim that government data excludes self-employed truckers does not support their case, either – deregulation destroyed the cozy monopoly combination between big trucking firms and unions, thereby freeing up the market and enabling small-business truckers to increase their incomes.

BS rest their anti-deregulation case on anecdotal misfortunes suffered by workers. But in every case, deregulation was a non sequitur, not the cause of the misfortune. Loss of health insurance in bankruptcy is caused by the linking of insurance coverage to employment, which is the major cause of the crisis in health care generally. Deregulation is merely one of a myriad of factors that bring this problem to the surface. By her own admission, the fifty-nine year-old accountant who lost her job chose to limit herself to part-time employment thereafter. Substitution away from worker’s compensation was done by regulators; there was no “deregulator” who made the decision that the widow’s compensation would be paid by the failing firm rather than the state fund. ESOPs originated in 1974, well before deregulation. The same is true of the other tactics used by struggling firms. Indeed, the fraud and safety derelictions complained of by BS were failures of regulation, not deregulation; these areas were not deregulated. BS are blaming the invisible hand of deregulation because the visible hand of regulation failed in its explicit duties.

There is nothing left of the BS case. Every single point made against deregulation by BS was analytically wrong, misleading or irrelevant.

 

The Implications of BS

Since 1992, the world of journalism has undergone earthshaking change. The print newspaper business has become an endangered species. The conventional thinking ascribes this fall to the rise of the Internet. But the decline in newspaper circulation began before the rise of the World Wide Web.

Up to this point, our focus has been purely analytical. Now is becomes speculative. An educated conjecture is that newspapers throughout the land emulated the techniques of BS. Those were the techniques of “advocacy journalism,” which is a euphemism for disregarding the objective basis of reporting in favor of political partisanship. They can be summarized below.

“First, write the basic outline of your story – then research it. Your every action as reporter will serve your agenda. Objective fact will enter only as an incidental by-product in your story. Do not approach any sources whose views will dispute or even mitigate that story. Tell your story mainly in personal anecdotes. Use emotive language that paints a vivid picture for your audience. Limit yourself to short factoids that will intensify the picture you are painting. Make your story a morality play, a Manichean struggle between good and evil. Poor helpless victims grip the emotions of the audience and are ideal centerpieces for your story. Rich, powerful villains trigger anger in your audience and sway them in your favor.”

Roughly half the country gradually came to the realization that this agenda, not the precepts of journalism, now guided the reporting as well as the editorial policy of most major metropolitan newspapers. They gradually lost respect for, and enjoyment of, those papers, patronizing them only when absolutely necessary. The rise of the Internet made their decision much easier and speeded their transition away from print media, but it was not actually the decisive factor in that move.

Has this speculative addendumgiven BS less than their due? No, it has done them a favor. Otherwise we would regard their work simply as hopelessly incompetent. The next EconBrief will continue to analyze this watershed work in the decline of American journalism.

DRI-304 for week of 3-2-14: Subjugating Florists: Power, Freedom and the Rule of Law

An Access Advertising EconBrief:

Subjugating Florists: Power, Freedom and the Rule of Law

A momentous struggle for human freedom is playing out in a mundane setting. Two people in Washington state are planning to wed. They want their florist, Arlene’s Flowers and Gifts, to supply flowers for the wedding. The owner, Barronelle Stutzman, refuses the job. The couple wants her to be compelled by law to provide service to them.

Even without knowing that particular facts distinguish this situation, we might suspect it. In this case, the couple consists of two homosexual men, Robert Ingersoll and Curt Freed. Ms. Stutzman’s refusal stems from an unwillingness to participate in – and thus implicitly sanction – a ceremony of which she disapproves on religious grounds.

The points at issue are two: First, does existing law forbid Ms. Stutzman’s refusal on the grounds that it is an illegal “discrimination” against the couple? Second, is that interpretation the proper one, regardless of its legality?

The first point is a matter for lawyers. (Washington’s Attorney General has filed suit against Ms. Stutzman.) The second point is a matter for all of us. On it may hinge the survival of freedom in the United States of America.

The Facts of the Case

The prospective married couple, Messrs. Ingersoll and Freed, has granted numerous interviews to publicize their side of the case. To the Christian Broadcasting Network (CBN), they described themselves as “loyal customers for a decade” of Arlene’s.

“It [Stutzman's refusal] really hurt because it was somebody I knew,” Ingersoll confided. “We stayed awake all night Saturday. It was eating at our souls.”

For her part, Ms. Stutzman declared that “you have to make a stand somewhere in your life on what you believe….” The unspoken implication was that she had faced repeated challenges to her convictions, culminating in this decision to stand fast. “In America, the government is supposed to protect freedom, not… intimidate citizens into acting contrary to their faith convictions.”

The attitude displayed by major media outlets reflects the Zeitgeist, which decrees: Ms. Stutzman is guilty of illegal discrimination on grounds of sexual orientation. It is significant that this verdict crosses political boundaries. On the Sunday morning discussion program Face the Nation, longtime conservative columnist and commentator George Will claimed that “public-accommodations law” had long ago “settled” the relevant legal point regarding the requirement of a business owner to provide service to all comers once doors have been opened to the public at large. But Mr. Will nonetheless expressed dissatisfaction with the apparent victory of the homosexual couple over the florist. “They [homosexuals in general] have been winning…this makes them look like bad winners.” Mr. Will seemed to suggest that the couple should forego their legal right and let Ms. Stutzman off the hook as a matter of good manners.

Legal, Yes; Proper, No

The fact that the subjugation of the florist is legal does not make it right. For decades, the Zeitgeist has been growing ever more totalitarian. Today, the United States of America approaches a form of authoritarian polity called an absolute democracy. In an absolute monarchy, one person rules. In an absolute democracy, the government is democratically elected but it holds absolute power over the citizens.

The inherent definition of freedom is the absence of external constraint. In this case, that would imply that Messrs. Ingersoll and Freed would be free to engage or refuse the services of Ms. Stutzman and Ms. Stutzman would be free to provide or refuse service to Messrs. Ingersoll and Freed – on any basis whatsoever. That is what freedom means. A concise way of describing the operation of the Rule of Law would be that all (adult) citizens enjoy freedom of contract.

But in our current unfree country, Messrs. Ingersoll and Freed are free to patronize Arlene’s or not but Ms. Stutzman is not free. She is required to serve Messrs. Ingersoll and Freed, like it or not. The couple’s sexual orientation has earned them the status of a privileged class. They have the privilege of compelling service. This is a privilege enjoyed by a comparative few.

George Will and company may pontificate about settled law, but the truth is that refusals of service happen daily in American business. Businesses often refuse other businesses as a courtesy, typically as an acknowledgement of their own shortcomings or lack of specialized knowledge or expertise. Sometimes a business will frankly admit that a would-be customer falls outside their target customer class. This sort of refusal rarely, if ever, leads to recriminations. After all, who really wants to pay for a product or service unwillingly supplied? The only exception comes when the customer falls within one of the government-protected categories covered by the anti-discrimination laws. Then the fear of litigation, financial and criminal penalties and adverse publicity kicks in.

This may be the clearest sign that the Rule of Law no longer prevails in America. The Rule of Law does not mean scrupulous adherence to statutory law. It means the absence of privilege. In America today, privilege is alive and growing like a cancer. In the past, we associated the term with wealth and social position. That is no longer true. Now it connotes special treatment by government.

The Role of Competition Under the Rule of Law

Under the Rule of Law, Messrs. Ingersoll and Freed would not be able to compel Ms. Stutzman to provide flowers to their wedding. But this would not leave them without resource. The Rule of Law supports the existence of free competitive markets. The couple could simply call up another florist. True, they would be denied the service of their longtime acquaintance and supplier. But nobody is entitled to a lifetime guarantee of the best of everything. What if Ms. Stutzman was ill on their wedding day, or called out of town, or struck down by a beer truck? What if she went bankrupt or retired? The Rule of Law simply protects a free, competitive market from which Messrs. Ingersoll and Freed can pick and choose a florist.

That is not the only benefit the couple get from the Rule of Law and competition. In a competitive market, any seller who refuses service to a willing buyer must pay a penalty or cost in the form of foregone revenue. In strict, formal theory, a competitive market produces an equilibrium result in which the amount of output produced at the equilibrium price is exactly equal to the ex ante amount desired by consumers. A seller who turns away a buyer is throwing money down the drain. This is not something sellers will do lightly. Anybody who doubts this has never run a business and met a payroll. Thus, free competitive markets offer strong disincentives to discrimination.

Of course, that does not mean that businesses will never refuse a customer; the instant case proves that. But refusals of conscience like the one made by Ms. Stutzman will be comparatively rare, because it will be unusual for the owner to value the moral issue more than the revenue foregone.

The existence of competition under the Rule of Law is the safeguard that makes freedom and democracy possible. Without it, we would have to fear the tyranny of the majority over minorities. With it, we can safely rely on markets to protect the rights and welfare of minorities.

The Rule of Law and Limited Government

Free choice by both buyers and sellers is not the enemy of minority rights. The real danger to minorities is government itself – the very government that is today advertised as the champion of minorities.

After the Civil War, newly freed and enfranchised blacks entered the free economy in the South. They began to compete with unskilled and skilled white labor. This competition was successful, both because blacks were willing to work for lower wages and because some blacks had mastered valuable skills while slaves. For example, professional baseball originated in the 1860s and increased steadily in popularity; blacks participated in this embryonic period.

White laborers resented this labor-market competition. In order to artificially increase the wages of their members, labor unions had to restrict the supply of labor. Denying union membership to blacks was a common means of catering to member desires while furthering wage objectives. But the competition provided by blacks was difficult to suppress because employers had a clear incentive to hire low-wage labor that was also productive and skillful. Businesses had a strong monetary incentive not to refuse service to blacks because the money offered by blacks was just as green as anybody else’s money.

The solution found by the anti-black forces was the so-called “Jim Crow” laws. These forbade the hiring of blacks on equal terms and denied blacks equal rights to public accommodations and service. In effect, the Jim Crow laws cartelized labor and product markets in a way that would not otherwise have occurred. Governments also handed out special privileges to labor unions that enabled them to compel membership and deny it at will. Historically, labor unions excluded blacks from membership for the bulk of the 20th century. Blacks were banned from organized baseball and most other professional sports until the 1940s, when sports became the first wedge driven into the Jim Crow laws.

The apartheid law passed in southern Africa in the early 20th century also arose in order to thwart successful competition offered by white labor by black labor. Left alone, competitive labor markets were enabling black South Africans to enjoy rising wages and employment. South African labor unions agitated for government protection against black workers. The result was the “pass laws” or “color bar” or apartheid system, not unlike the Jim Crow laws prevailing in America. Once again, the purpose was to cartelize labor markets in order to erect barriers to competition offered to white labor by black workers.

The rationale behind public utilities was ostensibly to limit the pricing power and profits enjoyed by firms that would otherwise have been “natural monopolies.” In actual practice, by guaranteeing public utilities a “normal profit,” government removed the specter of a loss of revenue and profit associated with discrimination against black customers and employees. Sure enough, public utilities were among the chief practitioners of discrimination against blacks – along with government itself, which also did not fear a loss of profit resulting from its actions.

A recurring effect of government regulation of business in all its forms has been the erosion of competition. Sometimes that has been caused by costly compliance with regulation, driving businesses bankrupt and reducing market competition through attrition. Sometimes this has come from direct government cartelization of competitive markets, resulting from measures like marketing orders and quotas in milk and citrus fruit. Sometimes that has come from price supports, target prices and acreage allotments that have reduced agricultural output and raised prices or, alternatively, raised prices while creating costly surpluses for which taxpayers must pay. Sometimes the reduction in competition results from anti-trust laws like the Robinson Patman Act, deliberately designed to raise prices and restrict competition in retail business.

There is no formal, coherent theory of regulation. Instead, regulatory legislation is accompanied by vague protestations of good will and good intentions that have no unambiguous translation into policy. The typical result is that regulators either take over the role of controlling business decisions from market participants or they become the patrons and protectors of businesses within the industries they regulate. The latter attitude has evolved within the financial sector, where regulators have gradually taken the view that the biggest competitors are “too big to fail.” That is, the effects of failure would spill over onto too many other firms, causing widespread adverse effects. This, in turn, precludes discipline imposed by competitive markets, which force businesses to serve consumers well or go out of business.

The enemy of minorities is government, not free competitive markets. Government harms minorities directly by passing discriminatory laws against them or indirectly by foreclosing or lessening competition.

The Two-Edged Sword of Government Power

Many people find it difficult to perceive government as the threat because government vocally broadcasts its beneficence and cloaks its intentions in the vocabulary of good intentions. It bestows noble and high-sounding names on its legislative enactments. It endows them with historic significance. Like Edmund Rostand’s protagonist Chanticleer, government pretends that its will causes the sun to rise and set and only its benevolence stands between us and disaster.

But the blessings of government are a two-edged sword. “A government powerful enough to give us everything we want is powerful enough to take from us everything we have.” One by one, the beneficiaries of arbitrary government power have been also been stung by the exercise of that same power.

In 1954, government insisted that “separate was inherently unequal” and that the segregated education received by blacks must be inferior to that enjoyed by whites. Instead of introducing competition to schools, government intruded into education more than ever before. Now, six decades later, blacks still struggle for educational parity. And today, it is government that stands in the schoolhouse door to thwart blacks – not through segregation, but by resolutely opposing the educational competition introduced by charter schools in New York City. The overwhelming majority of charter patrons are black, who embrace the charter concept wholeheartedly. But Mayor Bill de Blasio has vowed to fight charter schools tooth and claw. The state and federal governments can be relied upon to sit on their hands, since teacher unions – diehard enemies of charter schools – are a leading constituency of the Democrat Party.

For over a century, blacks have lived and died by government and the Democrat Party. Now they are cut by the other edge of the government sword.

The print and broadcast news media have been cheerleaders for big government and the Democrat Party throughout the 20th century and beyond. First-Amendment absolutism has been a staple of left-wing thought. Recently, FCC regulators in the Obama administration hatched a plan to study journalists and their employers with a view towards tighter regulation. The pretext for the FCC’s Multi-Market Study of Critical Information Needs was that FCC broadcast licenses come with an obligation to serve the public – and how can government determine whether licensees are serving the public without thoroughly studying them? All hell has suddenly broken loose at the prospect that journalists themselves might be subjected to the same stifling regulation as other industries.

Of course, in a competitive market it is quite unnecessary to regulators to “study” the market to gauge whether it is working. Consumers make that judgment themselves. If businesses don’t serve consumers, consumers desert them and the businesses fold. Other businesses take their place and provide better service – or they join their predecessors on the scrap heap. But the presumption of government is that regulation must be necessary to promote competition – otherwise “market failure” will strand consumers up the creek without locomotion.

For decades, the knee-jerk reflex of journalists to any perceived problem has been that “no government regulation exists” to solve it. Now journalists tremble as they test the opposite edge of the government sword.

Now homosexuals are the latest group to successively experience both blades of the government sword. After years of life spent in the shadow of criminal prosecution, homosexuals have witnessed the gradual dismantling of state anti-sodomy laws. State-level bans on marriage by couples of the same gender have been invalidated by the U.S. Supreme Court. Not satisfied with their newly won freedom, homosexuals strive to wield power over their fellow citizens through coercion.

This is the only sense in which George Will was correct. His characterization of homosexuals as “bad winners” was infantile; it portrayed a serious issue of human freedom as a schoolboy exercise in bad manners. But he correctly sensed that homosexuals were winning something – even if he wasn’t quite sure what – and that this latest shift toward subjugating florists was a disastrous change in direction.

What Do Homosexuals Want? What Are They Owed Under the Rule of Law?

The holistic fallacy treats homosexuals as an organic unity with homogeneous wants and goals. In reality, they are individuals with diverse personalities and political orientations. But the homosexual movement follows a clearly discernible left-wing agenda, just as Hispanic activist organizations like La Raza hew to a left-wing line not representative of most Hispanics.

The homosexual political agenda strives to normalize and legitimize homosexual behavior by winning the imprimatur of government and the backing of government force. This movement feeds off the angst of people like Ingersoll and Freed – “It really hurt…it was eating at our souls” – who ache from the sting of rejection. The movement is selling government approval as a psychological substitute for parental and societal approval and economic rents as revenge for rejection. Homosexuals have observed the success of blacks, women and other protected classes in pursuing gains via this route.

There was a time, not so long ago when measured by the relative standard of history, when male homosexuals were not merely criminals but were subjected to a kind of informal “Jim Crow” persecution. They were routinely beaten and rolled not only by ordinary citizens but even by police. It is worth noting that these attitudes began to change decades ago, even before the advent of so-called “affirmative action” programs ostensibly designed to redress the grievances of other victim classes.

The Rule of Law demands that homosexuals receive the same rights and due-process protections as other people. It applies the same standards of consent to all sexual relationships between consenting adults. It grants the same freedom of contract – marital and otherwise – to all.

By the same token, the Rule of Law abhors privilege. It rejects the chimerical notion that the past harms suffered by individual members of groups can be compensated somehow by committing present harms that grant privilege and real income to different members of those same victimized groups.

The Rule of Law and Social Harmony

Sociologists and political scientists used to marvel as the comparative social harmony of American society – achieved despite the astonishing ethnic, racial, religious and political diversity of the citizenry. The consensus assigned credit to the American “melting pot.” The problem with this explanation is that a culture must first exist before new entrants can assimilate within it – and what mechanism achieved the original reconciliation of diverse elements?

Adherence to the Rule of Law within competitive markets made social harmony possible. It allowed the daily exchange of goods and services among individuals in relative anonymity, without disclosure of the multitudinous conflicts that might have otherwise produced stalemate and rejection. Milton Friedman observed astutely that free markets permit us to transact with the butcher, baker and candlestick maker without inquiring into their political or religious convictions. We need agree only on price and quantity. The need for broader consensus would bring ordinary life as we know it to a grinding halt; government would have to step in with coercive power in order to break the stalemate.

When everybody wears their politics, religion and sexual orientation on their sleeves, it makes life unpleasant, worrisome and exhausting. Shouldering chips weighs us down and invites conflict. This is the real source of the “polarization” complained of far and wide, not the relatively trivial differences between Republicans and Democrats. (The two parties are in firm agreement on the desirability of big government; they disagree vehemently only on who will run the show.)

Intellectuals wrongly assumed that the anonymity fostered by the Rule of Law reflected irreconcilable contradictions within society that would eventually cause violence like the Stonewall riots in 1969. The truth was that the Rule of Law reconciled contradictory views of individuals and allowed peaceful social change to occur gradually. Homosexuals were able to live, work and achieve outside of the glare of the public spotlight. It slowly dawned on the American public, at first subliminally and then consciously, that homosexuals were successfully contributing to every segment of American life. The achievements pointed to with pride today by homosexual activists were possible only because the Rule of Law facilitated this gradual, peaceful process. They were not caused by self-righteous activists and an all-powerful government bitch-slapping an ignorant, recalcitrant public into submission.

Subjugating Florists: A Pyrrhic Victory

Free competitive markets cash the checks written by the Rule of Law. Homosexuals have lived and prospered within those free-market boundaries, mirroring the tradition of Jews, blacks and other stigmatized minority groups. For centuries, homosexuals have faced ostracism and even death in various societies around the world. That remains true in certain countries even now. While it is true that homosexuals were formerly treated cruelly in America, it is also true that their cultural, economic and political gains here have been remarkably rapid by historical standards. Historical memory, rather than etiquette, should counsel against trashing the free-market institutions that have midwived that progress.

Violating the Rule of Law in exchange for the power to compel service by businesses would be far worse than a display of bad manners. It would be the worst kind of tradeoff for homosexuals, gaining a temporary political and public-relations triumph at the expense of long-run economic stability.

Of course, homosexual activists are hardly the first or the only ones grasping at the levers of government power. The history of 20th-century America is dominated by such attempts, emanating at first from the political Left but now from the Right as well. It is grimly amusing to recall that early efforts along these lines were hailed by political scientists as encouraging examples of “pluralism” and “inclusiveness” – they were supposed to be signs that the downtrodden and marginalized were now participating in the political process. Today, everybody and his brother-in-law are trying to work local, state or federal government for an edge or a subsidy. Nobody can pretend now that this is anything but the unmistakable indicator of societal disintegration and decay.

Heretofore, the visible traits of democracy – representative government, elections, checks and balances – have been considered both necessary and sufficient to guarantee freedom. The falsity of that presumption is now dawning upon us with the appreciation of democratic absolutism as an impending reality. Subjugating florists may provide the homosexual movement with the thrills of political blood sport but any victories won will prove Pyrrhic.

DRI-265 for week of 2-23-14: False Confession Under Torture: The So-Called Re-Evaluation of the Minimum Wage

An Access Advertising EconBrief:

False Confession Under Torture: The So-Called Re-Evaluation of the Minimum Wage

For many years, the public pictured an economist as a vacillator. That image dated back to President Harry Truman’s quoted wish for a “one-armed economist,” unable to hedge every utterance with “on the one hand…on the other hand.”

Surveys of economists belied this perception. The profession has remained predominantly left-wing in political orientation, but its support for the fundamental logic of markets has been strong. Economists have backed free international trade overwhelmingly. They have opposed rent control – which socialist economist Assar Lindbeck deemed the second-best way to destroy a city, ranking behind only bombing. And economists have denounced the minimum wage with only slightly less force.

Now, for the first time, this united front has begun to break up. Recently a gaggle of some 600 economists, including seven Nobel Laureates, has spoken up in favor of a 40% increase in the minimum wage. The minimum wage has always retained public support. But what could possibly account for this seeming about-face by the economics profession?

The CBO Study

This week, the Congressional Budget Office (CBO) released a study that was hailed by both proponents and opponents of the minimum wage. The CBO study tried to estimate the effects of raising the current minimum of $7.25 per hour to $9 and $10.10, respectively. It provided an interval estimate of the job loss resulting from President Obama’s State of the Union suggestion of a $10.10 minimum wage. The interval stretched from roughly zero to one million. It took the midpoint of this interval – 500,000 jobs – as “the” estimate of job loss because… because…well, because 500,000 is halfway between zero and 1,000,000, that’s why. Averages seem to have a mystical attraction to statisticians as well as to the general public.

Economists looking for signs of orthodox economic logic in the CBO study could find them. “Some jobs for low-wage workers would probably be eliminated, the income of most workers who became jobless would fall substantially, and the share of low-wage workers who were employed would probably fall slightly.” The minimum wage is a poorly-targeted means of increasing the incomes of the poor because “many low-income workers are not members of low-income families.” And when an employer chooses which low-wage workers to retain and which to cut loose after a minimum-wage hike, he will likely retain the upper-class employee with good education and social skills and lay off the first-time entrant into the labor force who is poor in income, wealth and human capital. These are traditional sentiments.

On the other hand, the Obama administration’s hired gun at the Council of Economic Advisers (CEA), Chairman Jason Furman, looked inside the glass surrounding the minimum wage and found it half-full. He characterized the CBO’s job-loss conclusion as a “0.3% decrease in employment” that “could be essentially zero.” Furman cited the CBO estimate that 16.5 million workers would receive an increase in income as a result of the minimum-wage increase. Net benefits to those whose incomes currently fall below the so-called poverty line are estimated at $5 billion. The overall effect on real income – what economists would call the general equilibrium result of the change – is estimated to be a $2 billion increase in real income.

The petitioning economists, the CBO and the CEA clearly are all not viewing the minimum wage through the traditional textbook prism. What caused this new outlook?

The “New Learning” and the Old-Time Religion on the Minimum Wage

The impetus to this eye-opening change has ostensibly been new research. Bloomberg Businessweek devoted a lead article to the supposed re-evaluation of the minimum wage. Author Peter Coy declares that “the argument that a wage floor kills jobs has been weakened by careful research over the past 20 years.” Not surprisingly, Coy locates the watershed event as the Card-Krueger comparative study of fast-food restaurants in New Jersey and Pennsylvania in 1994. This study not only made names for its authors, it began the campaign to make the minimum wage respectable in academic economic circles.

“The Card-Krueger study touched off an econometric arms race as labor economists on opposite sides of the argument topped one another with increasingly sophisticated analyses,” Coy relates. “The net result has been to soften the economics profession’s traditional skepticism about minimum wages.” If true, this would be sign of softening brains, not skepticism. The arguments advanced by the re-evaluation of the minimum wage have been around for decades. Peter Coy is saying that, somehow, new studies done in the last 20 years have produced different results than those done for the previous fifty years, and those different results justify a turnabout by the economics profession.

That stance is, quite simply, hooey. Traditional economic opposition to the minimum wage was never based on empirical research. It was based on the economic logic of choice in markets, which argues unequivocally against the minimum wage. Setting a wage above the market-determined wage will create a surplus of low-skilled labor; e.g., unemployment. Thus, any gains accruing to the workers who retain their jobs will come at the expense of workers who lose their jobs. The public supports the minimum wage on the misapprehension that the gains come at the expense of employers. This is true only transitorily, during the period in which some firms go out of business, prices rise and workers are laid off. During this short-run transition period, the gains of still-employed workers come at the expense of business owners and laid-off workers. But once the adjustments occur, the business owners who survive the transition are once again earning a “normal” (competitive) rate of profit, as they were before the minimum wage went up. Now, and indefinitely going forward, the gains of still-employed workers come at the expense of laid-off workers and consumers who pay higher prices for the smaller supply of goods and services produced by low-skilled workers.

The still-employed workers are by no means all “poor,” despite the face that they earn the minimum wage. Some are teenagers in middle- or upper-class households, whose good educations and social skills preserved their jobs after the minimum-wage hike. Some are older workers whose superior discipline and work skills made them irreplaceable. The workers who rate to lose their jobs are the poorest and least able to cope – namely, first-time job holders and those with the fewest cognitive and social skills. The minimum wage transfers income from the poor to the non-poor. What a victory for social justice! That is why even the left-wing economists like Alan Blinder formerly pooh-poohed the minimum wage as a means of helping the poor. (While he was Chairman of the CEA under President Clinton, Blinder was embarrassed when the arguments against the minimum wage in his economics textbook were juxtaposed alongside the administration’s support of a minimum-wage increase.)

This does not complete the roster of the minimum wage’s defects. Government price-setting has mirror-image effects on both above-market prices and below-market prices. By creating a surplus of low-skilled labor, the minimum wage makes it costless for employers to discriminate against a class of workers they find objectionable – black, female, politically or theologically incorrect, etc. Black-market employment of illegal workers – immigrants or off-the-books employees – can now gain a foothold. Business owners are encouraged to substitute machines for workers and have done so throughout the history of the minimum wage. In cases such as elevator operators, this has caused whole categories of workers to vanish. This expanded range of drawbacks somehow never finds its way into popular discussions of the minimum wage, which are invariably confined to the effects on employment and income distribution.

“If there are negative effects on total employment, the most recent studies show, they appear to be small,” according to Bloomberg Businessweek.  The trouble is that the focus of the minimum wage is not properly on total employment. The minimum wage itself applies only to the market for low-skilled labor, comprising roughly 20 million Americans. There are certainly effects on other labor and product markets. But it is difficult enough to estimate the quantitative effect of the minimum wage on the one market directly affected, let alone to gauge the secondary impact on the other markets comprising the remaining 300 million people. The Obama administration, the vocal economists, the Bloomberg Businessweek and the political Left are ostensibly concerned with the poor. Why, then, do they insist on couching employment effects only in total terms?

It is clear that the same reasons why economists have traditionally chosen not to confuse the issue by dragging in total employment are also the reasons why economists now choose precisely to do so. They want to confuse the issue, to disguise the full magnitude of the adverse effects on low-skilled workers by hiding them inside the much smaller percentage effect on total employment. That is what allows CEA Chairman Jason Furman to brag that the “CBO’s central estimate…leads to a 0.3% decrease in employment… [that] could be essentially zero.” 500,000 is not 0.3% of 20 million (that would be 60,000) but rather 0.3% of the larger total work force of around 170 million. 0.3% sounds like such a small number. That’s almost zero, isn’t it? Surely that isn’t such a high price to pay for paying people what they’re worth – or what a bunch of economists think they’re worth, anyway.

But we digress. Just what is it that causes those “apparently small” effects on total employment, anyway? “Higher wages reduce turnover by reducing job satisfaction, so at any given moment there are fewer unfilled openings. Within reasonable ranges of a minimum wage, the churn-reducing effect seems to offset whatever staff reductions occur because of higher labor costs. Also, some businesses manage to pass along the costs to customers without harming sales.”

This is mostly warmed-over sociology, imported by economists for cosmetic purposes. American industry is pockmarked with industries plagued by high turnover, such as trucking. If higher wages were a panacea for this problem, it would have been solved long since. Today, we have a minimum wage. We also have a gigantic mismatch of unfilled jobs and discouraged workers. The shibboleth of businesses “passing along” costs to consumers with impunity was a cherished figment imagined in books by John Kenneth Galbraith in the 1950s and 60s, but neither Galbraith nor today’s economists can explain what hypnotic power businesses exert over consumers to accomplish this feat.

The magic word never mentioned by Peter Coy or the 600 economists or Jason Furman is productivity. Competitive markets enforce a strict link between market wages and productivity – specifically, between the wage and the discounted marginal value product of the marginal worker’s labor. Once that link is severed, the tether to economic logic has been cut and the discussion drifts along in never-never land. The political Left maunders on about the “dignity of human labor” and “a living wage” and “the worth of a human being” – nebulous concepts that have no objective meaning but allow the user to attach their own without fear of being proven wrong.

Bloomberg Businessweek‘s cover features a young baggage handler holding a sign identifying his job and duties, with a caption reading “How Much Is He Worth?” Inside the magazine, a page is taken up with workers posing for pictures showing their jobs and their own estimation of their “worth.” These emotive exercises may or may not sell magazines, but they prove and solve nothing. Asking a low-skilled worker to evaluate their own worth is like asking a cancer victim what caused their disease. Broadcast journalists do it all the time, but if that were really valuable, we would have cured cancer long ago. If a low-skilled worker were an expert on valuing labor, he or she would qualify as an entrepreneur – and would be set up to make some real money.

A Fine-Tuned Minimum Wage

Into the valley of brain death rode the 600 economists who supported a minimum wage of $10.10 per hour. Their ammunition consisted of fine-tuning based on econometrics. Let us hear from Paul Osterman, labor economist of MIT. “To jump from $7.25 to $15 would be a long haul. That would in my view be a shock to the system.” Mr. Osterman, exercising his finely-honed powers of insight denied to the rabble, is able to peer into the econometric mists and discern that $10.10 would be …somehow… just right - barely felt by 320 million people generating $16 trillion in goods and services, but $15 – no, that would shock the system. In other words, that first 40% increase would be hardly a tickle, but the subsequent 38% would be a bridge too far.

In any other context, it would be quite a surprise to the economics profession to discover that the study of econometrics had advanced this far. (The phrase “science of econometrics” was avoided advisedly.) For decades, graduate students in economics were taught a form of logical positivism originally outlined by John Neville Keynes (father of John Maynard Keynes) and developed by Milton Friedman. Economic theory was advanced by developing hypotheses couched in the form of conditional predictions. These were then tested in order to evaluate their worth. The tests ranged from simple observation to more complex tests of statistical inference. Hypotheses meeting the tests were retained; those failing to do so were discarded.

Simple and attractive though that may sound, this philosophy has failed utterly in practice. The tests have failed to convince anybody; it is axiomatic that no economic theory was ever accepted or rejected on the basis of econometric evidence. And the econometric tools themselves have been the subject of increasing skepticism by economists themselves as well as the outside world. One of the ablest and most respected practitioners, Edward Leamer, titled a famous 1983 article, “Let’s Take the Con Out of Econometrics.”

The time period pictured by Peter Coy as an “econometric arms race” employing “increasingly sophisticated” tools and models overlapped with a steadily growing scandal enveloping the practice of econometrics – or, more precisely, statistical practice across both the natural and social sciences. Within economics alone, it concerned the continuing failure of the leading economists and economic journals to correctly enforce the proper interpretation of the term “statistical significance.” This failure has placed the quantitative value of most of the econometric work done in the last 30 years in question.

The general public’s exposure to the term has encouraged it to regard a “statistically significant” variable or event as one that is quantitatively large or important. In fact, that might or might not be true; there is no necessary connection between statistical significance and quantitative importance. The statistician needs to take measures apart from ascertaining statistical significance in order to gauge quantitative importance, such as calculating a loss function. In practice, this has been honored more in the breach than the observance. Two leading economic historians, Deirdre McCloskey and Steven Ziliak, have conducted a two-decade crusade to reform the statistical practice of their fellow scientists. Their story is not unlike that of the legendary Dr. Simmelweis, who sacrificed his career in order to wipe out childbed fever among women by establishing doctors’ failure to wash their hands as the transmitter of the disease.

This scandal could not be more relevant to the current rehabilitation of the minimum wage. The entire basis for that rehabilitation is supposedly the new, improved econometric work done beginning in 1994 – the very time when the misuse and overemphasis of statistical significance was in full swing. The culprits included many of the leading economists in the profession – including Drs. Card and Krueger and their famous 1994 study, which was one of dozens of offending econometric studies identified by McCloskey and Ziliak. And the claim made by today’s minimum-wage proponents is that their superior command of econometrics allows them to gauge the quantitative effects of different minimum-wages so well that they can fine-tune the choice of a minimum wage, picking a minimum wage that will benefit the poor without causing much loss of jobs and real income. But judging the quantitative effect of dependent variables is exactly what econometrics has done badly from the 1980s to the present, owing to its preoccupation with statistical significance. The last thing in the world that the lay public should do is take the quantitative pretensions of these economists on faith.

This doesn’t sound like a profession possessing the tools and professional integrity necessary to fine-tune a minimum wage to maximize social justice – whatever that might mean. In fact, there is no reason to take recent pronouncements by economists on the minimum wage at face value. This is not professional judgment talking. It is political partisanship masquerading as analytical economics.

The Wall Street Journal pointed out that the $2 billion net gain in real income projected by the CBO if the minimum wage were to rise to $10.10 is a minute percentage gain compared to the size of a $16 trillion GDP. (It is slightly over 0.001%.) The notion of risking a job loss of one million for a gain of that size is quixotic. Even more to the point, the belief that economists can predict gains or losses of that tiny magnitude in a general equilibrium context using econometrics is absurd. The CEA and the CBO are allowing themselves to be used for political purposes and, in the process, allowing the discipline of economics to be prostituted.

The increasing politicization of economics is beginning to produce the same effects that subservience to political orthodoxy produced on Russian science under Stalin. The Russian scientist Lysenko became immortal not because of his scientific achievements but because of his willingness to distort science to comport with Communist doctrine. The late, great economist Ronald Coase once characterized the economics profession’s obsession with econometrics as a determination to “torture the data until it confesses.” Those confessions are now taking on the hue of Soviet-style confessions from the 1930s, exacted under torture from political dissidents who wouldn’t previously knuckle under to the regime. Today, politically partisan economists torture recalcitrant data on the minimum wage in order to extract results favorable to their cause.

The CBO and the CEA should have new stationery printed. Its logo should be an image of Lubyanka Prison in old Soviet Russia.