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There were several letters in today’s Wall Street Journal commenting on my recent op-ed with my son Joe on second best arguments for various forms of crony capitalism.

Overall, these articles are critical of our position, but I do not disagree with them. Our original article was at best a weak defense, with terms like “may be” and “a second-best world is messy” and “there may be better ways.”  The letters are basically amplifying these caveats, and I do not disagree that the second best alternatives Joe and I proposed were flawed.  Clearly, as the letter writers indicate, a first best world with no inefficient regulation would be better.  Would that we could get there. 

But it does seem odd to pick on the Export-Import Bank as the major effort to reduce crony capitalism. The Bank makes money in an accounting sense, but loses in terms of the risk-adjusted cost of capital.  The cost is estimated as $2 billion.  The ethanol program or the import-restriction policies of the Commerce Department and the International Trade Commission are much more costly, and would make better targets for deregulation.  

There is another political point.  Those of us in favor of free markets are fond of pointing out that being pro-market is not the same as being pro-business, and may point to opposition to the Ex-Im Bank as an example.  But while being pro-market is not the same as being  pro-business, it is also true that business is one of the major forces generally advocating freer markets and decreased regulation.  There is a cost to antagonizing a major ally in the fight against inefficient rules.

 

The Times seems to specialize in stories that use lots of economics but still miss the important points. Two examples from today: Stories about Uber, and about the dispute between Amazon and Hachette.

UBER:  The article describes Uber’s using price changes to measure elasticity of demand, and more or less gets it right.  But it goes on to discuss the competition between Uber and Lyft with taxi companies.  However, what is not mentioned is that taxis are greatly handicapped in this fight because of their own sins.  They have lobbied for price fixing and supply limitation, thus creating the very market that Uber is entering.  It is quite plausible that if the taxi market were a free entry free price market there would be no demand for firms such as Uber.  Interesting to see how Uber does in cities such as Washington D.C. with relatively free entry into the taxi market, compared with New York city with highly restrictive rules.

The article also misses another point.  It discusses an agreement recently signed by Uber that limits “surge” pricing in times of disasters.  But what is not mentioned is the effect of this restriction in reducing supply and increasing demand during the very times when transportation services are most needed.  While we economists have won some public relations battles, we have not weaned the public away from its hatred of “price gouging.”

 

AMAZON: The story about the Amazon-Hachette dispute is interesting.  But again, some of the key economics is missing. 

Traditional publishers serve two purposes: They organize the physical publishing of books, and they certify quality.  Neither of these functions is needed any more an a world of ebooks.  For ebooks, there is no need of physical publishing, and reader comments are a good substitute for quality certification, at least for fiction.  Amazon provides other services to help inform consumers about books that might be of interest.

Moreover, authors should have a natural affinity with ebook publishers.  For physical books, there is a conflict between authors and publishers.  Authors are paid a royalty based on dollar volume, so they want a price that maximizes revenue.  All of the author’s costs are fixed costs.  Publishers have the marginal cost of actually printing and distributing the book, so their goal is to maximize profit, revenue minus cost.  When costs are positive, the profit maximizing price (MR=MC) is greater than the revenue maximizing price (MR=0), so authors traditionally think that publishers have overpriced their books.  This conflict does not exist for ebooks (marginal cost is zero) so Amazon and authors both want the revenue maximizing price.  As a result, I predict that in the long term Amazon will win because it will have a comparative advantage in dealing with authors. 

As another Israeli-Muslim armed conflict begins, it instructive to consider the lethality of previous conflicts.  The best estimate is that about 35,000 Muslims have been killed in all of the Israel-Muslim conflicts since 1948. During that same period, about 10,000,000 Muslims have been killed by other Muslims.  The Arab-Israeli conflict overall is the 49th deadliest conflict since 1950.  Of the total 85,000,000 deaths in that period, the Israeli-Arab conflict is responsible for .06 percent of all fatalities.  Hard to understand why this conflict generates so much attention and news. Also hard to understand why so many blame Israel for killing Muslims when many many more Muslims have killed each other. (All data from Daniel Pipes website.)

My son Joe and I have an op-ed in today’s WSJ that should stir up some controversy.

Opinion Wall Street Journal

The Case for Crony Capitalism

Many government regulations choke off entirely legal avenues of potential bank profits.

By

Paul H. Rubin And

Joseph S. Rubin

July 7, 2014 7:34 p.m. ET

Economics has a formal “theory of the second best” that in simplified terms may be expressed this way: If a government intervention leads to inefficiencies in markets but can’t be eliminated, an additional intervention may be the next-best alternative to eliminate the inefficiencies caused by the first.

It’s not the optimal solution to government-induced inefficiency, but it may be the best we can do. And it applies in many cases to what today is variously called “corporate welfare,” “loopholes,” or even “crony capitalism.”

The U.S. economy is rife with inefficient interventions—laws, regulations, taxes and subsidies that lead to inefficient markets. What some disparage as crony capitalism is in many cases an attempt to reduce the costs of these interventions.

Consider the Export-Import Bank, a federal agency that assists U.S. firms in financing international transactions. A first-best efficient policy would be to eliminate the agency, on grounds that if private banks will not finance a transaction, then the transaction is not worthwhile. The government shouldn’t become the financier of otherwise unprofitable transactions.

Yet that’s not the whole story. The Foreign Corrupt Practices Act, for example, makes it illegal for U.S. businesses to pay bribes to foreign officials. But it is not always so easy to determine what is illegal, and companies may be penalized for normal business practices. It is certainly not cheap to comply. The Ex-Im Bank website says that “to avoid such consequences [of the FCPA], many firms have implemented detailed compliance programs intended to prevent and to detect any improper payments by employees and by third-party agents.”

This adds to the costs of U.S. firms doing business abroad, lowering the amount of legitimate trade. Maybe the Ex-Im Bank is a reasonable, second-best response. One government subsidy may be necessary to help overcome other inefficiencies imposed by the government to begin with.

The banking bailout is another purported example of cronyism and corporate welfare. The poor lending practices of banks were undoubtedly part of the cause of the Great Recession. But banks, as well as government-sponsored enterprises such as Fannie Mae FNMA +0.50% and Freddie Mac, FMCC +0.51% were under tremendous pressure to make loans to unqualified borrowers.

Many other government regulations choke off entirely legal avenues of potential profit for banks by limiting with whom and under what circumstances they may do business. Examples include the financing of online and payday lenders, and firms that process payments for these lenders. If regulations cause banks to take excessive risks and limit profits, it may be efficient to provide some protection from these risks when things go bad, particularly if the damage is in large part caused by government policies.

Some claim that Medicare Part D, which pays for drugs, was a giveaway to the pharmaceutical industry. But 40 years of research has clearly shown that the Food and Drug Administration’s regulatory process makes drug development and approval unnecessarily and inefficiently expensive. Perhaps, in this environment, supplementing the costs of drugs may move us toward a more efficient drug policy, and bring more life-saving drugs to market.

Corporate taxes are too high, retarding investment. But when cutting rates is impossible, maybe tax breaks that encourage investment of various sorts is the second-best response. Environmental Protection Agency regulations are costly and inefficient. In some cases waivers or exceptions are less a payoff to cronies than a way to counter inefficient restrictions.

A second-best world is messy, and there may be better ways to overcome government-induced inefficiency. Yet sometimes what appear to be special favors may actually be moves in the direction of efficiency.

Of course, some examples of crony capitalism are worthy of the term, and the scorn that goes with it. For example, the various farm price-support programs, including sugar quotas and the ethanol program, which raise food prices world-wide and increase poverty, would be very difficult to justify under any second-best theory.

Nonetheless, as long as there is a push for more regulation, and particularly inefficient regulation, with little opportunity to rein in the already severe drag that these regulations impose on the economy, second-best solutions may be useful to temper some of their costs.

Paul H. Rubin is an economics professor at Emory University. His son, Joseph S. Rubin, is an attorney at Arnall Golden Gregory LLP in Washington, D.C.

 

 

Today’s (July 5, 2014) New York Times has an interesting story about rationing of water in California.  There are apparently rules in place urging people to cut back on water use, but they are apparently not well enforced.  Unsurprisingly, these appeals and unenforced rules are having relatively small effects.  So many municipalities are urging neighbors to report each other for misuses of water.  Economists know that a price increase would be the most efficient method of  limiting use.  But we may not have known that other forms of rationing would lead to increasing conflict among neighbors and increasing ill will.  This is an example of the sort of hostility generated by non-market institutions, as opposed to the cooperation generated by markets, and further evidence of the fundamental morality of markets.   Of course, the Times being what it is, there is no mention of the possibility of price increases to reduce water consumption, although the article does mention “water flowing very cheaply” but there is no suggestion that this should be changed.

In today’s (Sunday, June 22, 2014) New York Times Steven Rattner Has a column  that at first appears to get the economics right, but blows it at the end.  Most of the column is an explanation of why increased automation will not cause unemployment.  He describes past fears of automation leading to unemployment, going back to 1589, and shows that these fears have always been incorrect.  (He did not mention President Obama’s fear of ATM machines.)  But at the very end of the column, he presents what he believes to be the cause of unemployment.  “That honor belongs to globalization, and particularly the ability of companies to substitute far less expensive and increasingly skilled labor in developing countries.”  Of course, this claim is just as absurd as the claim that automation is causing unemployment.  Mr. Rattner is a smart man, although not an economist, and it is not clear whether his misguided diagnosis is due to ignorance or to politics — an unwillingness to blame increased regulation and particularly Obamacare for the slow growth in employment.

Today’s New York Times has an interesting article on restaurant reservations (Julia Moskin, “Getting a Good Table by Flicking an App, Not Greasing a Palm,” Saturday, June 14, p. A1, As the title suggests, there are now various apps and online services that obtain hot restaurant reservations and then sell them to willing buyers. This process of course creates welfare gains for patrons who prefer paying to waiting in line (either physically or on endless telephone calls and redials). It can also create welfare gains for the restaurants themselves, both by reducing costly no-shows and sometimes by sharing in the revenue from the sale of the reservation. It is another example of the gains that can be realized by reducing transactions costs by using the internet and its progeny.
Let’s be clear about the gains. Reservations at a restaurant are worth more at some times of the week (Saturday night) than at other times (Wednesday noon.) Restaurants capitalize on some of these differences – cheaper lunch menus are standard. But in general restaurants have not charged more for Friday or Saturday nights than for other days, probably because of high transactions costs of such differential pricing. These new services allow differential pricing by day of the week and other factors leading to different demand. This differential pricing is in the form of a fixed charge for reservations. If part of the premium goes to the restaurant itself, then the restaurant can increase revenue without changing menu prices. Ultimately this will lead either to increased supply of high end restaurants or to reduced menu prices, or likely some combination. Diners will benefit from reduced prices or increased availability, and restaurants will gain as well. There is an efficiency gain from saving the time wasted by diners in waiting for seats or reservations. Part of the gains will go to those developing the apps, as a reward for their efforts.
What is also interesting about the article is the discussion of the “controversial” nature of these transactions. To an economist, anything that reduces transactions costs and allocates resources more efficiently to those willing to pay the most is efficient and so desirable. The developers of the apps seem to understand this. But to others, including many restaurateurs themselves, the system is immoral. One says “It’s online bribery.” Another, on learning that reservations are being sold online, says “Of course it bothers me.” Another “has crusaded against third-party reservation services.”
Much of my recent writing has been about the dislike of markets, including an article (Folk Economics), my Presidential Address to the Southern Economic Association, and a Wall Street Journal op-ed. In the case of reservation apps, the dislike probably comes from a variant of the zero-sum fallacy – the view that new institutions redistribute money and the ignoring of real benefits created for all parties. But it is particularly sad that even successful entrepreneurs – the founders and owners of successful restaurants –do not understand the benefits from efficient institutional arrangements.

 

David Brat

Paul H. Rubin —  11 June 2014

I do not know David Brat and had never heard of him before he won the primary.  I have looked at his Vita.  However, I am bothered by seeing him called a free market economist and a Randian.  Apparently one of the major issues distinguishing him from Mr. Cantor is Mr. Brat’s opposition to immigrants and immigration reform.  I cannot understand how someone can be a free market economist and opposed to immigration reform. Our immigration laws are a major limitation on free exchange, and anyone who really favors free markets must be in favor of major reforms, including allowing those who are here illegally to legalize their status.

From July 30 WSJ

Paul H. Rubin —  8 August 2012

Wall Street Journal

‘A Climate That Helps Us Grow’

By PAUL H. RUBIN

President Obama’s riff on small business—”If you’ve got a business, you didn’t build that, somebody else made that happen”—has become a major controversy. The Romney campaign has made this quote the subject of several speeches and ads, and there have been rallies all over the country of business people with signs saying that “I did build this business.”

Mr. Obama is now claiming that his words, delivered at a campaign stop in Roanoke, Va., on July 13, were taken out of context. “Of course Americans build their own businesses,” he said in a campaign ad last week. What he meant was simply that government sets the stage for business creation. In his speech, and again in his campaign ad, the example Mr. Obama pointed to was “roads and bridges.”

The context of the speech indicates the president really did mean that “you didn’t build that.” But let’s give him the benefit of the doubt; let’s assume he merely meant that business is impossible without government institutions that create the infrastructure for the economy to operate. As Mr. Obama’s deputy campaign chief Stephanie Cutter said, in clarifying his original remarks on July 24, “We build our businesses through hard work and initiative, with the public and private sectors working together to create a climate that helps us grow. President Obama knows that.”

But business is certainly not getting “a climate that helps us grow” from the current administration. That administration has instead created a hostile climate through its regulatory policies.

The news media report almost daily about new regulatory burdens. More generally, according to an analysis in March by the Heritage Foundation, “Red Tape Rising,” the Obama administration in its first three years adopted 106 major regulations (those with costs over $100 million), compared with 28 such regulations in the George W. Bush administration. Heritage notes that there are 144 more such major regulations in the pipeline.

Consider a major example of government investment—roads and bridges. A transportation system needs roads, but it also needs gasoline. This administration’s policies—its refusal to allow a private company to build the Keystone XL pipeline, its reduction in permits for offshore drilling and increased EPA regulation of pollutants—retard the production of gasoline. If transportation is an important input from government to creating a favorable climate for business, shouldn’t we be encouraging, not discouraging, gasoline production?

Other inputs needed by business are capital and labor. The Dodd–Frank Wall Street Reform and Consumer Protection Act, signed by Mr. Obama and enforced by his appointees, makes raising capital and investing more difficult. Since many regulations needed to implement this law have not even been written, business cannot know how to adapt to them. This increases uncertainty and so reduces incentives for investment.

The increased minimum wage, passed and signed in the early days of the administration, discourages hiring of entry-level workers. ObamaCare has increased uncertainty regarding future labor costs and so hindered business in hiring and expanding. The pro-union decisions by Obama appointees at the National Labor Relations Board do not create a climate to help the economy grow.

There are many other burdens placed on business. Example: The Americans With Disabilities Act is being interpreted by the Justice Department to require all hotel-based swimming pools to provide increased access to disabled persons. This will come at a high cost per pool. Many hotels and motels are small, family-run enterprises. This requirement will either lead to an increase in prices or to a decision not to have pools at all.

Either policy will induce patrons to shift to larger chain motels. Interestingly, the application of this rule has been delayed for existing pools until Jan. 31, 2013, after the election. Families vacationing this summer will not notice the new requirement.

If we accept the plain meaning of Mr. Obama’s speech, it indicates that he does not believe in the importance of entrepreneurs in creating businesses. But if we accept the reinterpretation of his speech in light of his administration’s deeds, it indicates a belief that a hostile regulatory climate poses no danger to economic growth. Either interpretation means that this administration is not good for business.

Mr. Rubin is professor of economics at Emory University and president-elect of the Southern Economic Association.

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Our greatly lamented colleague Lary Ribstein was a movie buff. Some time ago he wrote an encyclopedic article on business in the movies, “Wall Street and Vine: Hollywood’s View of
Business.”  At the time of his death, he and I were in discussions about publishing this article in the journal I edit, Managerial and Decison Economics.  After his tragic death, I contacted his widow, Ann, and received permission to publish the article.  It is now published in the June issue of MDE.  (If your library does not subscribe to MDE, the article is still available on SSRN.)  Anyone with any interest in the movies and their perception of business must read this article. Given the volume of Larry’s scholarship, it is amazing that he had time to see as many movies as he discusses in this article.