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The Wire

  • New tunnel, premium RV section at Talladega Superspeedway on schedule despite weather

    Excerpt:

    Construction of a new oversized vehicle tunnel and premium RV infield parking section at Talladega Superspeedway is still on schedule to be completed in time for the April NASCAR race, despite large amounts of rainfall and unusual groundwater conditions underneath the track.

    Track Chairman Grant Lynch, during a news conference Wednesday at the track, said he’s amazed the general contractor, Taylor Corporation of Oxford, has been able to keep the project on schedule.

    “The amount of water they have pumped out of that and the extra engineering they did from the original design, basically to keep that tunnel from floating up out of the earth, was remarkable,” Lynch said.

  • Alabama workers built 1.6M engines in 2018 to add auto horsepower

    Excerpt:

    Alabama’s auto workers built nearly 1.6 million engines last year, as the state industry continues to carve out a place in global markets with innovative, high-performance parts, systems and finished vehicles.

    Last year also saw major new developments in engine manufacturing among the state’s key players, and more advanced infrastructure is on the way in the coming year.

    Hyundai expects to complete a key addition to its engine operations in Montgomery during the first half of 2019, while Honda continues to reap the benefits of a cutting-edge Alabama engine line installed several years ago.

  • Groundbreaking on Alabama’s newest aerospace plant made possible through key partnerships

    Excerpt:

    Political and business leaders gathered for a groundbreaking at Alabama’s newest aerospace plant gave credit to the formation of the many key partnerships that made it possible.

    Governor Kay Ivey and several other federal, state and local officials attended the event which celebrated the construction of rocket engine builder Blue Origin’s facility in Huntsville.

4 days ago

The house that survived the hurricane

(Sand Palace of Mexico Beach/Facebook)

Last October, Hurricane Michael slammed the Florida panhandle with 155 mile per hour (mph) winds. Mexico Beach was largely destroyed, except for one exceptional, and now much reported on, house called the Sand Palace. Does it offer a guide for building for the future?

Strengthening buildings to reduce damage from natural disasters is called mitigation, and is a topic I have researched. I can’t tell anyone how much they should spend to strengthen their home, but I can help you think about this question.

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Engineers can design buildings to pretty much withstand nature’s extremes. The Sand Palace was built to withstand 240 mph winds. It is built on 40-foot pilings with one foot thick concrete reinforced walls. Steel cables anchor the roof. Florida’s 2001 building code requires construction to withstand 120 mph winds, and existing homes were not required to be brought up to the code. The Sand Palace was built to survive a hurricane like Michael, while surrounding structures were not.

How much extra did the hurricane-proof design cost? Owners Lebron Lackey and Russell King of Tennessee think that it added 15 to 20 percent to the cost. Let’s round up and say 20 percent. The 20 percent is added “only” to the cost of the structure, not total property value. The home for a $700,000 listing might only cost $400,000, so the added cost would be $80,000.

The full cost of mitigation, though, exceeds $80,000. Hurricane-proofing altered the Sand Palace’s design, reducing the number of windows, scrapping a planned balcony, and only a small roof overhang. The design diminished the enjoyment provided by the residence and is part of the cost.

Still, spending $80,000 to prevent destruction of a $400,000 home (and protect the contents and residents) sounds like a good deal. Especially if we knew the home would be struck by 155 mph winds within a year of construction. Yet hurricanes as powerful as Michael, rated at the very top of Category 4 of the Saffir-Simpson hurricane wind intensity scale, are rare. Only three highest-rated Category 5 hurricanes have hit the continental United States since 1900, with only Camille striking the Gulf Coast.

The Sand Palace’s engineering primarily prevents destruction from a really powerful hurricane. Yet since World War II, only two parts of the Atlantic and Gulf coast have experienced winds stronger than Michael’s. Spending $80,000 to prevent a disaster likely to never happen is less attractive.

Timing also matters. While the return on the Sand Palace’s construction occurred within a year; the owners might have waited fifty years for a Michael-type storm to hit. Time is money. The money invested in mitigation, if invested in stocks or real estate, could easily have yielded enough money to replace the home after a monster hurricane fifty years in the future.

Valuing mitigation involves even more details. The design will likely reduce losses from weaker hurricanes, storm surge, and tornadoes. We would also need the exact cost of hurricane-proofing for homes of different sizes and designs plus hurricane landfall probabilities by Saffir-Simpson category.

The calculations can only tell if the investment is worthwhile given all the assumptions made. The value of mitigation depends on how we value protecting ourselves, our loved ones, and our possessions. Two people can reasonably disagree about whether a hurricane-proof design is worth the cost. Neither is wrong, because the values are personal.

This is why building codes, I think, provide a poor way to encourage natural hazards mitigation. Building codes don’t encourage; they force everyone to build to the specified level of wind resistance. Mr. Lackey and Mr. King decided that the Sand Palace’s resilience was worth the cost, and many others will likely follow their example. Yet Florida’s 120 mph building code likely already makes many homeowners spend more on mitigation than they desire.

Just because we can build homes to resist the strongest hurricanes does not mean that we should. No single level of protection is right for everyone when the values at stake are personal.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

1 week ago

Gold, inflation and theft

(YHN, Pixabay)

President Trump is reportedly considering former Godfather’s Pizza CEO and one-time presidential candidate Herman Cain for the Federal Reserve Board of Governors. Mr. Cain’s potential selection caused a stir for at least three reasons: accusations of sexual harassment which surfaced during his presidential run, a lack of training as an economist, and his advocating a return to a gold standard in a Wall Street Journal op-ed. Gold standard proponents perplex monetary economists because, I think, they raise primarily moral rather than economic arguments.

Today most nations have government currencies managed by a central bank, like our Federal Reserve. Government monies are paper currencies, in contrast with the commodity or metallic monies of history. The dollar is money because the Federal government declares it to be. As each dollar states, “This note is legal tender for all debts, public and private.”

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Governments, though, did not invent money. Indeed, no one invented money; it emerged through the economic actions of people, particularly specialization in production and trade. A cobbler must trade the shoes she makes for food, clothing and other things. Without money, the cobbler must use barter, and find a farmer, blacksmith and clothier willing to take shoes for payment.

Trading is easier to carry out when everyone accepts the same item in exchange for shoes, clothes, food, and everything else. This is money’s role. A commodity becomes money when people who do not want it for their personal use accept it in trade. No one person hit upon this idea and ordered everyone to use gold or silver as money. People saw how money made life easier. Money is an institution created by human action but not the product of human design.

Money must maintain value to be useful in trading. If the money the cobbler accepts for her shoes disappeared or became worthless before she could buy food and clothes, she would get shortchanged.

Counterfeiting threatens money. Today counterfeiters try passing off fake dollars for real dollars. Counterfeit currency allows people to acquire valuable goods and services without giving up anything of value. A law-abiding person’s money, if not a gift, represents something of value not yet traded away, unspent earnings, or a person’s time and effort. Counterfeiters effectively steal from people who acquire money honestly.

Taking over supplying money allowed kings, and today governments, to create money not backed by production. No one could create commodity or metallic money out of nothing; alchemists tried in vain to turn lead into gold. Discoveries of gold or silver create riches, but still provide economic value – more gold to use as money.

Under the gold standard, dollars were convertible into gold at a fixed rate. When the dollar was convertible at $35 per ounce, the supply of dollars was limited to $70,000 for every ton of gold reserve. The U.S. eliminated the domestic convertibility of dollars in 1933 and abandoned the last vestiges of a gold standard in 1971.

Deliberate expansion of the money supply typically produces inflation and taxes everyone holding dollars. Modern monetary economists argue that the “tax” from inflation, or seigniorage, is typically very small, while control over the money supply can help stabilize the economy. Today the effective money supply exceeds the amount of currency in circulation, creating the potential for banking crises to destabilize the economy.

Economists recognize the potential for governments to create too much money. Inflation, for example was a significant problem in the 1970s. Central bank independence, however, can curb politicians’ control over the money supply: enlightened monetary economists running the Federal Reserve will manipulate the money supply to our nation’s benefit.

Monetary economists presume that whether governments should provide money was settled long ago and focus instead on managing our economy. Gold standard proponents want to relitigate this question, in large part to end the government’s ability to take wealth from citizens through inflation.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

4 weeks ago

Should we tax greenhouse gases?

(401kcalculator.org)

A group of distinguished economists, including Nobel prize winners and past Council of Economic Advisors members, recently supported a carbon tax. While the economic case for such a tax is strong, I nonetheless think the policy is ill-advised. Today let’s consider the economics of a carbon tax.

A carbon tax would limit emissions of greenhouse gases, most notably carbon dioxide, due to their impact on global warming. The tax differs only subtly in effect from the “cap and trade” policy considered by Congress in 2010; I will not consider the differences here. A tax is probably the best way to limit greenhouse gases if we choose.

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The economists propose replacing regulations and other policies to limit fossil fuels or encourage alternative energy – from the Clean Power Plan to tax credits for electric cars – with the carbon tax. This makes perfect sense. The pollution problem arises because actions like burning gasoline in a car effectively use clean air without the driver or oil company having to pay for it. The price is too low, resulting in too much pollution.

Economist A. C. Pigou hit upon a solution almost a century ago. Tax the good, or better yet the pollution, the amount of damage to the environment. The tax gets reflected in the price, and we can then let prices coordinate economic activity and protect the environment.

Prices never prohibit any activity for which someone is willing and able to pay. This is a huge advantage relative to regulation. A carbon tax ensures that we can use fossil fuels for highly valued activities like powering jet planes or running generators for hospitals during blackouts. Regulations often prohibit highly valued uses, causing significant costs.

Quantifying environmental damage is always challenging, and the impacts of global warming will not occur for decades. Any tax we impose now must rely on climate models to estimate future impacts. Integrated Assessment Models pioneered by 2018 Nobel Prize-winning economist William Nordhaus show how to value the estimated climate impacts.

Economic analysis shows that the carbon tax should increase over time. Fossil fuels become more expensive in a predictable manner. These rising prices provide the incentive to invest in electric cars or solar or wind energy without direct subsidies.

A carbon tax would also hit “alternatives” to fossil fuels generating significant carbon dioxide emissions. Ethanol blends corn with gasoline and is subsidized as a clean fuel. Yet growing corn uses fossil fuels to power tractors, harvesters, and irrigation equipment. We can avoid wasting money on politically favored non-solutions.

Using pollution taxes to fund government offers another benefit. When we tax anything, we get less of it. Taxing income, investment, or employment leaves us with less of things which drive prosperity. Each dollar in taxes raised costs the economy more than a dollar. When we tax pollution, we get less of a bad thing.

The economists propose rebating carbon tax revenue to Americans as a climate dividend. This also makes sense. A carbon tax will increase energy prices and poor Americans spend more of their income on energy than others. A carbon tax would be regressive, falling more heavily on lower income families.

Each household’s climate dividend would be an equal share of the tax revenue. Poorer households spend a larger share of their income on energy, but high-income households consume more energy. Low-income households should receive a dividend larger than carbon tax paid.

Rebating the revenue might seem to just reverse the tax. Yet this is not true provided that the revenue is not refunded exactly as collected. If paying an extra $50 tax increases our climate dividend by exactly $50, then the refund cancels the tax. If I pay an extra $50 tax, it will be divided among more than 100 million households, so effectively I get none of it back.

A carbon tax makes economic sense, particularly if we eliminate other climate change regulations and alternative fuels subsidies. But the political process does not always employ policies as economists suggest. There’s more to this story than just economics, although the rest of the story will have to wait until next time.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

1 month ago

Is anything an accident?

(CNN/YouTube)

California Attorney General Xavier Becerra has suggested charging Pacific Gas & Electric (PG&E) with murder in connection with last November’s Camp Fire. The deadliest wildfire in California history, Camp killed 86 people and destroyed the town of Paradise. A cause has not been officially determined, but evidence suggests that PG&E electric transmission wires may have started the blaze. The case illustrates a conundrum implied by the economics of accidents.

I do not wish to accuse PG&E of starting the Camp Fire; that is to be determined. But Mr. Becerra’s comments, numerous lawsuits already filed, and news reports of PG&E’s potential bankruptcy, I think, justify this discussion. I am not a lawyer and wish to focus on the economics, not the legal requirements of sustaining murder charges or winning a civil lawsuit.

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The fire was not deliberately started and so in this sense was an accident. But could it have been avoided? Quite likely. Better maintenance on transmission lines and towers could have prevented aging, sagging power lines from sparking. Trimming trees would make high winds less likely to bring down power lines.

PG&E could also have shut down parts of the electric grid on high fire risk days. The company formalized planned blackouts to prevent wildfires earlier in 2018 and shut off power to over 60,000 customers on a high risk day in October. Southern California utilities have also used blackouts to prevent wildfires.

Power lines, of course, are not the only cause of wildfires; lightning and other human actions and carelessness are also causes. All power line related fires, however, could be prevented through enough maintenance, tree-trimming, and blackouts. If the Camp Fire could have been prevented, was it truly an accident?

Diligence and safety can prevent most types of accidents. Workplace accidents claimed over 5,000 lives in 2017. The Occupational Safety and Health Administration has helped reduce workplace accidents significantly over the past fifty years. Still, more can always be done. Railings prevent falls; taller, sturdier railings make falls even less likely. Safety nets can help as well.

Auto accidents kill 35,000, injure millions, and cause billions in property damage each year. Most traffic accidents are due to driver error, mechanical failures, and unsafe roads and bridges and are preventable. Highway redesign could further reduce accidents. And driving very slowly – imagine a 25 mph national speed limit – would dramatically reduce accident severity.

Should we prevent all fires, workplace accidents, and highway crashes? Economics recommends balancing the benefits of preventing accidents against the costs. Such balancing will almost certainly involve accepting some accidents. Even if we think that human lives are infinitely valuable and should be saved whenever possible, accidents often involve fatal consequences either way. For instance, blacking out hospitals and nursing homes can cost lives. We will almost certainly choose a level of safety resulting in some accidents.

If we deliberately choose less than perfect safety, are the fires, workplace mishaps, and traffic crashes truly accidents? This is debatable. We know that drunk drivers do not intend to maim people, but we consider this act so reckless as to be criminal. Some commentators think that deaths from workplace accidents and product defects are best viewed as corporate murder.

Personally, I think that an important difference exists between mishaps occurring while pursuing a valuable and ethical goal and intentionally harming others. Still, many Americans find evaluating accident tradeoffs too explicitly discomforting.

This is costly. As Vanderbilt economist Kip Viscusi notes, corporate America lags behind in applying risk analysis. Jurors find it offensive when a business determines how much it would cost to prevent deaths due to product design flaws or workplace risks and still chooses not to eliminate the risk. Because risk analysis seems to trigger mega-verdicts, businesses forego the analysis. Yet a lack of analysis merely leads to bad decisions, not safety.

Economics suggests that perhaps nothing is an accident. But as humans, we can intuitively distinguish intentional harms and unfortunate events. However we resolve the conundrum, ignorance of risk analysis is definitely not bliss.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

1 month ago

Controlling the price of drugs

(AF Medical Service)

Can the government lower the price of prescription drugs? The effects of price ceilings provide a cautionary warning, even though price controls appear to work in other countries. Unfettered competition generally provides a more effective way to keep prices in line with costs.

Several government efforts seek to lower drug prices. The Trump Administration has proposed basing Medicare Part B prices on international prices. The Department of Health and Human Services found that the U.S. had the highest average price for 27 drugs, almost double the international average. Forty six states are suing 15 generic drug makers for price fixing. Senator Elizabeth Warren wants the Federal government to manufacture generic drugs to eliminate profit-seeking.

Price ceilings demonstrate government’s rather limited ability to reduce prices and ensure adequate supplies. A price ceiling is a legal maximum price for a good. For instance, a law might set a maximum price for gasoline at say $2 a gallon and prosecute anyone selling for more. Would this ensure drivers reasonably priced gas?

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Not really. Market transactions require a willing buyer and seller. Businesses aren’t charities and will not operate at a loss. While occasionally businesses sell at a loss, they must normally expect to cover costs.

A price ceiling does not require any firm to sell. If the wholesale price of gasoline were $2.50, a station facing a $2 price ceiling will shut down. Price ceilings set below the market price produce shortages, meaning that some consumers will go without.

Price ceilings have long been popular with emperors and legislatures, as Forty Centuries of Wage and Price Controls details. Price controls were included in ancient Babylon’s Code of Hammurabi and contributed to the suffering of George Washington’s army at Valley Forge. A lower legal price appears to benefit consumers but does not make the good available.

Pharmaceutical companies charge more than $10,000 a month for some cancer drugs. To the extent that such prices reflect costs of research, development and manufacture, setting a $5,000 legal maximum price will reduce the quantity of drugs available. A shortage of life-saving drugs costs lives.

The development and approval process accounts for much of the cost of drugs. According to Tufts University’s Center for the Study of Drug Development, the development costs for drugs that reach the market are $2.6 billion. The cost of manufacturing many drugs is often low. Price controls may not prevent sales of already developed drugs, but rather reduce development of new drugs.

If price controls are generally ineffective, why do other countries pay less for prescription drugs than we do? Restrictions on importation allow the same drug to sell at different prices in different countries. If a company sells at a price covering most of the development cost on the U.S. market, it could accept a lower price in Europe. This makes price ceilings appear effective. Yet someone must pay for development costs. If we match other nations’ low prices, we may not have future wonder drugs.

Instead of resorting to price controls or litigation, I think we should try more competition. Let’s let pharmaceutical companies undercut each other’s prices in the pursuit of profit.

Two sets of policies currently limit competition. One is patents for medicines. Patents grant inventors a temporary monopoly to allow them to earn back the costs of research and development. The second is the Food and Drug Administration’s (FDA) approval, which requires demonstration of a new drug’s safety and effectiveness. Limiting competition facilitates price fixing as well.

Limited competition in generic drugs, whose patents have expired, illustrates the vulnerability of government rules to manipulation for profit. Generic drugs copy successful drugs and are clearly safe and effective, yet the FDA’s approval process limits the number of producers. Smart and greedy companies profit by manipulating the rules, like finding generics without approved alternative producers and raising the price.

More government regulation will not end the profitable manipulation of government rules, it will only create more rules to manipulate. Streamlining the patent and drug approval processes offers a better path to a steady supply of reasonably priced pharmaceuticals.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

2 months ago

Are our highways less safe?

(YHN/Pixabay)

Highway fatalities have increased from under 33,000 in 2014 to 37,461 in 2016, before declining slightly in 2017. Many have speculated whether drivers distracted by smartphones have caused this increase. Before further restricting driving, we should examine the problem.

The recent increase in fatalities is unsettling because driving has become safer over time. Fifty years ago, over 50,000 Americans died annually on the highways; the worst year was 1972 with 54,589 deaths, according to the National Highway Traffic Safety Administration (NHTSA). Vehicle miles driven have increased dramatically as the death toll has fallen. Indeed, fatalities per mile driven have fallen by 80 percent since 1966. If we still had 1966’s fatality rate with today’s 3.2 trillion miles driven, we would have had 176,000 highway deaths in 2017.

Has driving truly become more deadly since 2014? The increase in fatalities might seem to answer this in the affirmative, but real world data never lies exactly on a smooth curve. Could the recent increases in fatalities just be random variation?

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The two largest year-to-year percentage increases in highway fatalities were in 2015 and 2016, a total 14 percent increase. And yet multi-year fatality increases have occurred since 1966, including four consecutive years in the late 1970s and five consecutive years in the 1990s. The 1970’s fatalities increase was 15 percent. The recent increase in fatalities is not entirely unprecedented.

Thankfully, a very small percentage of accidents produce fatalities. If roads are more dangerous, we should also see increases in injuries and accidents. NHTSA injury totals go back only to 1988 and are much less accurate than fatalities data. Still, reported injuries increased 34 percent, or 800,000, between 2014 and 2016, including a 28 percent increase in 2016. The largest previous one-year increase in injuries was only 6.5 percent. Reliable nationwide totals on accidents are not available.

Not all states have seen fatality increases. In Alabama fatalities rose 26 percent between 2014 and 2016. Rhode Island had a 63 percent increase in fatalities, and eight other states saw increases of 30 percent or more. Yet fatalities declined in three states and increased less than 5 percent in four more. Are cell phones more distracting in some states than others?

Substantial differences in fatality rates exist across states. Between 2014 and 2017, South Carolina’s rate was more than two and a half times higher than Massachusetts’. Factors like rural vs. urban driving, highway type, and speed limits explain much of this variation, but making driving in all states as safe as in the safest states could save thousands of lives annually.

The NHTSA also reports fatalities by vehicle type, which have increased by 12 and 13 percent for cars and light trucks. Motorcyclists and bicyclists (15 percent each) and pedestrians (22 percent) saw larger increases, even though drivers of cars and trucks seem more likely to be distracted by cell phones. The fatality increases for cyclists and pedestrians suggest another cause, or may combine drivers’ distractions and these individuals’ vulnerability.

Cell phone use and texting have been around longer than we perhaps remember; Washington state banned texting and driving in 2007. According to NHTSA statistics, drivers’ cell phone use has fallen over the past decade, and fatalities fell 20 percent nationally between 2007 and 2014. New phones provide more ways to distract drivers, but why did cell phones start increasing fatalities only in 2015?

Many scholars from different disciplines study highway safety, including yours truly. To date, published research has not really addressed the recent jump in fatalities. World events drive academic research, so research should soon start offering concrete insights.

Highway fatalities continue to impose a heavy toll on the U.S. Even though the fatality rate has fallen 80 percent since 1966, the modest increase in fatalities since 2014 should concern citizens and experts. Fortunately, fatalities fell three percent during the first half of 2018. Perhaps the increase from 2014 to 2016 was only a pause in the long-term improvement in highway safety.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

2 months ago

The battle against inflation

(YHN/Pixabay)

Inflation fears rose briefly during 2018, as the increase in the Consumer Price Index (CPI) approached three percent. In 1980, three percent annual inflation would have set off celebrations. Our success in reducing inflation provides a lesson about policy-making by elected officials.

To avoid confusion we should be clear about the meaning of inflation. Americans often mean the cost of living when they say inflation. Economists, by contrast, specifically mean an increase in the overall price level.

A pure five percent inflation would be exactly a five percent increase in every price. Salaries and wages are prices and would be included. Inflation should not reduce the ability of households to buy goods and services, as income and expenses both increase equally. Economists call an increase in the price of gasoline or housing a change in relative prices, not inflation, even though either raises living costs.

Housing costs more in New York or San Francisco than in Alabama. That the cost of living in Manhattan is more than double that in Montgomery matters for weighing job offers. Differences in living costs, however, are also not inflation.

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The CPI does not include wages and rises even for relative price increases, yet still measures inflation pretty well. The annual change in the CPI exceeded 10 percent in 1974 and 1979-1981, hitting 13.5 percent in 1980. By 1983, inflation was below 5 percent and has only topped this level once since.

The U.S. has not been the only nation to bring inflation under control. U.S. inflation fell from 8.5 to 1.7 percent over 1974-83 and 2008-17. Yet over these decades, inflation fell from 11.3 to 1.1 percent in France and from 16.7 to 1.1 percent in Italy and Spain. Even Latin America has experienced progress; inflation fell from 33 to four percent in Mexico and from 112 to 6 percent in Brazil.

International success argues against a uniquely American explanation for our decline in inflation. For instance, I might wish to credit Ronald Reagan for defeating inflation. While President Reagan undoubtedly deserves some credit, a “great person” story would require great leaders in many nations, which seems less likely.

During the 1970s, many blamed inflation on rising world oil prices. A decline in oil supply would raise oil prices and hike the CPI, but would be a relative price change, not inflation as defined by economists. And significant oil price increase last decade did not produce double-digit inflation.

One economist who never wavered about the cause of inflation during the 1970s was Milton Friedman, who insisted that “inflation is everywhere and always a monetary phenomenon.” Governments and their central banks, like our Federal Reserve, inflate the money supply, driving up prices. Behind the focus on oil, the Federal Reserve did indeed fuel the 1970s inflation with money supply growth. With Paul Volcker as Federal Reserve chair and Ronald Reagan in the White House, the brakes were put on the money creation and inflation fell accordingly. The economics profession now largely accepts that Professor Friedman was right on inflation.

Why then did so many nations cause themselves the pain of inflation? And what has changed? Monetary economists have identified central bank independence as a key. A central bank is like a bank for the nation’s banking system, and generally controls the money supply. Politicians find easy money and credit irresistible, particularly when running for reelection. If politicians have too much control, they will inevitably inflate the money supply.

The Federal Reserve has always had some political independence. When the Fed chair and governors want monetary stability, as Mr. Volcker and his successor Alan Greenspan did, they can often prevail over the president and Congress. Other nations increased their central banks’ independence, based on economists’ advice. The European Central Bank was modeled on Germany’s independent Bundesbank.

People are imperfect and face problems of self-control. Our elected officials are human, and the potential to shift blame in politics exacerbates self-control problems. The world’s success battling inflation shows that elections alone do not always ensure wise economic policy.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

2 months ago

Heading for a fiscal cliff?

(YHN, Pixabay)

Is the Federal government spending us into financial ruin? The current numbers and budget projections suggest so. Yet I think that the scary numbers reflect an unresolved conflict over the role of government more than a threat of bankruptcy.

The national debt of the United States, the accumulated borrowing since the Republic’s founding, stands at $21.85 trillion. The deficit, or amount borrowed to cover spending in excess of tax revenues, for fiscal year 2018 was $780 billion.

A sense of magnitude is difficult to maintain once we get into the “illions” – meaning millions, billions, and trillions. A good way to size up Federal red ink is as a percentage of U.S. GDP, the value of all the goods and services produced in a year, which is currently $20.1 trillion. So 2018’s deficit and the national debt are 3.9 and 109 percent of GDP respectively.

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A second debt figure, the debt held by the public, confuses the matter. What is the difference? Some Federal government agencies hold debt, including Social Security and the military and civilian pension plans. As this debt is sometimes described as “owed to ourselves,” some experts focus on debt held by the public, which is currently $16 trillion (78 percent of GDP).

Which measure matters more? Debt held by the public is the amount the U.S. Treasury borrows in global credit markets. Interest rates are prices adjusting to bring demands for borrowing – by businesses and households in addition to government – into line with the supply of funds from savers and investors. Publicly-held debt potentially crowds out productive investment.

The intra-government debt is also real. The $800 billion the Treasury has borrowed from the Department of Defense’s pension program is supposed to pay retirement benefits, but was used for other Federal spending. If not repaid, military pensions would need to be paid out of current taxes.

Does the national debt spell inevitable bankruptcy? Warren Buffett has observed that the debt is not necessarily a problem because it was higher relative to GDP at the end of World War II. Mr. Buffett’s observation highlights the importance of budget projections. We borrowed to fight World War II, and investors expected spending to decline precipitously after the war. It did, and debt fell below 40 percent of GDP during the 1950s.

By contrast, spending is expected to increase significantly in the future. The most recent Congressional Budget Office (CBO) 30-year forecast projects Federal spending to increase from 20.6 to 27.9 percent of GDP. An aging population using more medical care will increase spending on Social Security, Medicare, and Medicaid. The CBO expects debt held by the public to reach 152 percent of GDP by 2048. This will be uncharted territory for the U.S. and could trigger a debt cycle through rising interest rates.

Will debt at 150 percent of GDP mean bankruptcy? Perhaps. Greece has teetered on the verge of bankruptcy with debt at 180 percent of GDP. But Japan remains sound despite debt at 220 percent of GDP.

Debate over insolvency obscures a common assumption that tax revenues will not rise significantly. The CBO, for instance, projects Federal revenues of 19.5 percent of GDP in the 2040s, only three percentage points higher than today. A Cato Institute analysis of fiscal imbalance kept tax revenue at current levels.

Potential Federal insolvency demonstrates that we cannot afford a European-style welfare state without European-style taxes. This tension, I think, goes back to Ronald Reagan, who pursued tax cuts even though his desired spending cuts proved politically unachievable. Reagan set Federal spending on a collision course with our distaste for taxes, likely hoping that his tax cuts would eventually force spending cuts. Maintaining Social Security and Medicare as they are given demographic changes will require paying more taxes.

I am not advocating for higher taxes and would prefer downsizing government. We cannot, however, afford a Cadillac on the payments for a Chevy and will soon have to decide whether we are truly willing to pay for big government.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

2 months ago

Men, women, marriage and earnings

(Flaticon/YHN)

The #metoo movement has brought renewed focus on gender equity questions. Economics examines the pay gap between men and women, and a recent analysis from the Federal Reserve Bank of St. Louis links this gap to marriage, creating a puzzle for economics.

The gender pay gap is large: among workers with at least a high school diploma between ages 45 to 54, men earn almost 50 percent more than women, roughly $75,000 versus $50,000 annually. Is this evidence of discrimination against women we could address through comparable worth pay legislation? Perhaps, but first let’s dig deeper into the issue.

Labor economics explains wages and salaries based on productivity, or the extra output that a worker helps a business produce. Firms can afford to pay workers the value of this product and still make an adequate profit. Competition among firms to attract and retain good workers should drive salaries up to this level. If Alabama underpaid Nick Saban, other universities would happily compensate him fairly.

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Salary differences should then depend on differences in productivity. Economists would want to make more nuanced salary comparisons by gender in narrower job categories before concluding that women are paid less. Education and skills requirements differ way too much across jobs requiring a high school diploma to be conclusively informative.

The St. Louis Fed analysis provides a different perspective: the gender pay gap is really a gap between married men and everyone else. Single men, single women, and married women all make around $50,000 in the prime earning years of 45 to 54; married men make almost $90,000. Interestingly, no pay gap seems to exist between single men and single women.

Can we make sense of this? First off, marriage may not necessarily make men more productive. Men who are more productive – that is, have more education, training, and drive to succeed – may be more likely to be married. We need not believe that reciting the marriage vows increases men’s (but not women’s) productivity.

Marriage could also make men focus seriously on work and a career. We might recognize that at some point we became much more serious about work; for me, this occurred in grad school. Marriage may have this impact on many men. Seriousness and focus could explain higher earnings, and since economists can’t easily measure a person’s seriousness directly, in the data this will look like a marriage effect.

There’s another possible explanation. In many workplaces, bosses have discretion over giving out raises, and an employee might have to ask for a raise. Suppose married and single male employees both ask for raises. The boss might believe that the married man “needs” the raise more – to pay for his kids’ braces, or to help take care of his in-laws. While plausible, salaries based on need violate the labor economics theory.

And it undermines a potential argument against comparable worth pay legislation to narrow the gender pay gap. The argument maintains that businesses must be given the freedom to pay employees based on productivity. But if compensation based on perceived need does not ruin our economy, then raises for women surely won’t cause an economic train wreck.

All the above factors likely contribute to married men’s higher earnings. Businesses can deviate at least some from productivity in setting wages and salaries without going bankrupt. The greater consequence of comparable worth legislation is shifting salary determination ultimately from businesses to bureaucrats. In the long run as politics determines more salaries across the economy, economic performance may decline significantly.

Labor economics seeks to explain salaries across different jobs, but productivity theory is also gender (and color) blind. Although women may indeed not be paid according to their productivity by every employer, competition should prevent pay from getting too far out of line with productivity. Hopefully bosses will reward underpaid women employees, because #metoo has sadly shown that politicians are not always gender blind.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

3 months ago

Treading water on economic freedom

(YHN)

Economic freedom means the ability of individuals and businesses to contract freely with each other. The Fraser Institute recently released its 2018 Economic Freedom of North America, which rates freedom in the states. Alabama’s economic freedom score remained virtually unchanged from 2017, ranking us 25th among the states.

The state freedom rankings have three equally weighted components, government spending, taxes, and labor market freedom, and complement Fraser’s ratings of the freedom of nations. The scores range from 0 to 10 (the most freedom), and states are graded on a curve for each of the various elements of policy.

Alabama’s score now stands at 6.22, vs. 6.25 in 2017. Florida has the top score in 2018 at 7.87, followed by New Hampshire and Texas; New York brought up the rear (at 3.90), with Kentucky and West Virginia next.

Alabama does best on taxes, thanks to our low income and property taxes, while we trail the national averages for spending and labor market regulation. This year, our score for labor market freedom improved, our spending score declined and taxes remained unchanged.

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Economic freedom indices were developed in response to a challenge by economist Milton Friedman about better measuring all the ways government impacts the economy. They have allowed economists to more thoroughly investigate whether markets deliver the benefits promised by some economists. Dozens of studies now document that economic freedom yields higher standards of living, faster economic growth, higher incomes for the poor, and better environmental quality. The strongest results are found internationally, as freedom varies more between nations than across the U.S. states. Still, the states with the most economic freedom have more entrepreneurs and attract more new residents.

And yet in recent years cities and states have enacted or considered laws curtailing economic freedom. For example, three states and Washington, DC, now have $15 per hour minimum wages. Seattle nearly passed a $275 annual tax per employee on large employers, dubbed the Amazon tax. A November ballot proposal in California nearly lifted a 1995 state prohibition on municipal rent control laws. If economic freedom spurs prosperity so significantly, why are so many states embracing freedom-restricting policies?

A first factor, I think, is our now nearly decade-long recovery. People are more willing to share when they feel prosperous. We see this in charitable contributions, and I think it carries over to politics and, specifically, policies intended to help less fortunate Americans. Forcing Amazon and Starbucks to subsidize housing for low-income Seattle families seems like less of an imposition when the companies are earning profits.

Second, the costs of policies restricting economic freedom are often hard to see. Consider the minimum wage. Businesses employ fewer workers in low skilled jobs when the minimum wage rises. But the job losses rarely come in the form of pink slips immediately following an increase. Instead, businesses change their staffing as they typically do, through attrition. Workers never being hired can often go unnoticed.

Finally, the tendency of free-market economists like myself to exaggerate the costs of rent control or the minimum wage contributes. We often claim that ill-advised policies will wreck the economy. Economists have warned that President Trump’s tariffs on imports from China will likely trigger a “crippling” trade war.

Why economists resort to extremes makes sense. News organizations which use alarming headlines to get people to watch or click are more likely to report dire predictions. And perhaps sound bites can only communicate extreme warnings. But dire predictions combined with largely hidden costs make the economy appear impervious to price controls, taxes, and subsidies.

So perhaps it is good news that economic freedom remained basically unchanged in Alabama in 2018. We are largely resisting the temptation to indulge in well-meaning but costly government assistance during a strong economy. When the next recession inevitably occurs, times will be tougher for states not exercising restraint now.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

3 months ago

The cost of employees

(YHN/Flaticon)

Most Americans have to work for a living. We must trade for the goods and services we want to consume, and for most of us, we trade our labor. Conflict over two legal work classifications, employees and independent contractors, illustrate how government’s rules can imperil economic prosperity.

People must work for a living, but people who want a job done, must secure assistance voluntarily through compensation. Difficult, physically demanding, boring, and dangerous tasks will require extra compensation.

Regulation heavily burdens business. According to a U.S. Small Business Administration study, federal regulations cost small businesses over $10,000 per employee. The National Small Business Association found that small businesses face $83,000 in regulatory costs during their first year of operation when owners struggle just to survive. Around 30 percent of a business’ labor cost is for benefits and paperwork.

How much do government rules affect hiring? Rules affecting employees include the minimum wage, overtime pay, workplace safety rules, collective bargaining and the National Labor Relations Act, the Americans with Disabilities Act, the Civil Rights Act, immigration eligibility, worker’s compensation and unemployment compensation. Many regulatory rules do not apply to independent contractors. Furthermore, requirements imposed on larger businesses are generally based on employees, not contractors.

Consumers must eventually pay for a business’ costs of complying with state and federal laws and rules. And costs tied specifically to employment reduce hiring to do tasks which create value in our economy. Half of small businesses report having held off hiring due to regulation.

Why do politicians impose so many rules on employment? In part, because mandates cost the government little; politicians do not spend tax dollars to boost wages or pay insurance premiums. The complexity of employment relations also matters, helping sustain an illusion of significant benefits to workers.

Businesses care about the full cost of an employee, meaning the wage or salary plus the cost of benefits, training, required paperwork, and so forth. When government mandates better terms for employees on one item, businesses can trim back others to contain the cost. For instance, less on-the-job training or flexibility in scheduling can offset the cost of a higher minimum wage.

The adjustments can cancel out mandated benefits. A college student might consider an $8 per hour job with the flexibility to adjust work hours around exams equal to a $10/hour with no flexibility. Raising the minimum wage to $10/hour may lead employers to eliminate flexibility, leaving the college student no better off.

Such offsets of government policies often go unnoticed. Supporters celebrate a hike in the minimum wage, or mandatory overtime pay, or required health insurance. Adjustments like a loss of scheduling flexibility may never get linked back to the policy. The mandate appears like a better deal than in reality.

As rules increased the cost of employment, businesses have not surprisingly tried reclassifying employees as independent contractors. The IRS and state governments enforce rules regarding these classifications, but some employers clearly try to bend the law. Efforts by state and federal regulators to protect traditional employment, however, also frustrate Americans seeking new self-employment options.

Work flexibility will be crucial to realize the full potential of the sharing economy. Exploiting opportunities for sharing will require many people to perform small tasks. Scooter rental companies like Spin and Lime, for instance, need people to charge their electric vehicles left on city sidewalks. Power and gardening tools sit in garages most of the time and could be widely shared. Getting tools to paying users and back to their owners will require on-demand delivery service. Each rental is unlikely to generate enough surplus value to cover employees’ costly regulations.

A market economy enables voluntary action in pursuit of our goals. The labor market forces people to pay for tasks they want performed. Burdensome government rules should not prevent willing parties from agreeing to deals to get work done.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

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4 months ago

Fake news and the market for ideas

(YHN/Pixabay)

Traditional social media have been criticized recently for purveying fake news. California may form a commission to investigate stemming fake news, while Congressional hearings have implored Facebook and Twitter to act. Is the news market failing?

Classical liberals back to John Milton and John Stuart Mill have stressed freedom of speech and expression as crucial in allowing citizens to control government. Free expression is vital for two reasons. The first is the value of free inquiry in discovering the truth. The second is the potential for government power to regulate expression to stifle criticism.

The metaphor of a marketplace of ideas illustrates the truth-seeking argument. Just as competition supplies us with cars, clothes or soft drinks, competition will work for ideas. Let truth and falsehood compete, and truth will win out. This reasoning believes that most citizens can distinguish good from bad arguments.

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Yet, I find the marketplace of ideas metaphor slightly off. In my research on media bias, I emphasize how our evaluations of public policies draw on our personal values and information about the world. Is the $15 per hour minimum wage recently enacted by some cities wise policy? The answer depends in part on values – whether one believes that government should try to raise poorer households’ income. And also on information – the number of $9 an hour jobs eliminated by a $15 minimum wage.

News deals with the information element of policy assessment. Peoples’ values differ, but to paraphrase former Sen. Daniel Patrick Moynihan, we all face the same facts. The news media hopefully provides truthful information for readers or viewers.

Information differs from ideas. Assessing the truth of information requires significant resources and not just common sense; specifically, a news organization’s reporters and editors. Ideas combine information and values. Citizens have no capacity to verify a report claiming that the $15 minimum wage eliminated 10,000 jobs.

Media bias involves deliberate manipulation of information to advance political values, not inevitable reporting errors. A story might deliberately exaggerate the job losses from the $15 minimum wage to influence people’s policy evaluation.

We can only identify some relevant factors about when biased reporting will advance specific values. For example, the persons we trust most can most easily mislead us. Blatant propaganda is often recognized and consequently ineffective. Information advancing an organization’s values may be discounted. And bad news is frequently denied; President Trump dismisses any report suggesting that his policies are not working perfectly as fake news.

President Trump has seemingly used evidence of liberal bias to convince his supporters to dismiss all news from prestigious news organizations as fake. Convincing analyses find that liberal bias is typically nuanced and subtle, involving misleading headlines, a lack of perspective, or perhaps omissions, not outright falsification. Biased news still contains truth.

Charges of liberal bias are decades old, so what has changed? The more explicit branding of outlets as liberal or conservative, I think, encourages wholesale dismissal. Hosts like Sean Hannity or Rachel Maddow with conservative or liberal views organize most cable news content (This is not necessarily bad; contrasting takes on current events may be a good way to assess the truth). Editorials set a newspaper’s brand, even though the rules of objectivity still apply to the news content. And conservative outlets like Fox News and the Washington Times makes liberal branding of CNN and the Washington Post more plausible.

The most surprising aspect in our more partisan news market has been the lack of an outlet building an information-only brand trusted across the political spectrum. The New York Times and Washington Post may think they occupy this space, but conservatives’ dismissal demonstrates otherwise.

The marketplace of ideas is a powerful metaphor, but information is not ideas. Common sense cannot substitute for a network of trained, experienced reporters. Is the market for news hopelessly broken? Fortunately, a missing product creates a profit opportunity for a clever entrepreneur. Perhaps trusted news sources are evolving right now, obscured by the noise of current events.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

4 months ago

A lesson from the school pickup line

(Pxhere)

Our school district does not provide school bus service, so parents must take their children to and from school each day. Waiting in line to pick up our children provides a first-hand lesson about an important category of economic contests.

Troy Elementary School dismisses students at 3pm. I always want to be one of the first parents in line when I pick up my son. Chuck then gets perhaps an extra ten minutes at home. And I show him that he is important enough to me that I will make time to be first in line.

Only try as I might, I have not yet this year gotten close to the front of the line. Even arriving 30 minutes early is not enough. The people of Troy love their children very much, which makes Troy a great place to live. We also seem to have very flexible schedules.

As a group, we parents face a reality: only one person will be first in the pickup line. The line is an example of what economist Robert Frank labeled positional goods – where we care about our position relative to others. The pursuit of positional goods can be wasteful.

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Life features many positional goods. Black Friday, the day after Thanksgiving, is traditionally the biggest shopping day of the year. Some people line up well in advance of the store openings to show that they are the most serious shoppers. At the college I went to, students had a tradition of camping out in advance of hockey season tickets going on sale. The first students in line were the most serious supporters of the team.

Positional goods can involve other forms of competition. Neighbors sometimes engage in positional contests to put up the most amazing Christmas light and decoration displays. The costs include the decorations and higher electricity bills. Having the newest, latest, and shiniest computer, big screen TV, or car is a positional contest as well.

Competition in positional contests uses scarce resources just trying to move ahead of others when in the aggregate this isn’t possible. Even if parents waited all day in line after dropping off our children, only one would be at the front of the pickup line. Everyone engaged in a positional contest might agree that we would be better off spending less time and money.

And yet our incentives work against us here. If all other Troy Elementary School parents arrived at 2:55pm, I would show up at 2:50pm. Economist Thomas Schelling explained how sometimes people might choose to have someone limit our freedom to compete. Government can perform this role, or associations which can enforce rules on their members.

Two factors complicate limiting competition. First, competition may also improve contest quality. Consider high school football. Winning has a positional element – only one team can win the state title in each class each year. Extra practices, voluntary off-season workouts, and attending college camps may be seen as providing only a relative advantage. Yet this might also increase the quality of play, benefitting fans, coaches, and the players. A pure positional contest has no element of quality.

Beyond this, working hard in pursuit of our goals is an important part of life. The players may enjoy working hard together during the offseason and may be building life-long friendships. The freedom to outwork others is integral to America’s opportunity society.

To see this, imagine if students were not allowed to prepare for the SAT exam. An SAT score affects college admissions and scholarships; it matters for life. Aptitude tests do have a positional element. All students spending $1,000 on prep classes may not change their percentile rankings. Yet being denied the freedom to study hard and improve one’s performance seems profoundly unfair.

We need to be aware of positional contests, of the times in life where we simply are trying to get ahead of others. We may want to accept limits on such contests to curb wasteful competition. But we also need to remember that the freedom to work and create opportunities for ourselves is a crucial part of life.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

4 months ago

Rental scooters and innovation

(KPIX CBS SF Bay Area/YouTube)

Rental bikes and scooters came to Troy University this fall, courtesy of the rental company Spin. Similar efforts by Spin, Bird, and Lime across the country, however, have been met with controversy. The so-called “Scooter Wars” reflect how government permission affects innovation and growth.

Technology makes such rentals, long available in resort locales, economical. The companies use GPS tracking and electronic billing, and rentals can be unlocked by scanning a driver’s license. People leave the bike or scooter at their destination and an app directs customers looking for a ride to the nearest rental.

The companies use public spaces like sidewalks to “store” their rental units. This makes the rentals convenient for customers, as walking several blocks to and from rental locations would offset most of the time savings on short trips. Yet bikes and scooters clogging sidewalks have contributed to hostile reactions.

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Numerous cities have banned the scooter companies, including Miami (which banned Bird and Lime within weeks), Seattle, Boston, Nashville and St. Paul. The bans have occurred in part because the companies entered some cities by just dropping off bikes and scooters on the streets for use. And Miami’s ban may not be permanent; Denver, Portland and Salt Lake City all eventually permitted scooter rentals after initial bans.

The government permission of relevance is more than simple business licenses, which are generally issued upon completion of required paperwork and payment of relevant fees. Instead, the permission requested here can be denied altogether. And this alters the prospects for innovation in our economy.

Should scooter companies need permission slips from cities? This is where the “Scooter Wars” highlight an important tension. Are people free to do whatever the law does not prohibit? Or do we need permission from government to start new businesses, offer new products and services, or use our property as we wish?

Rentals undoubtedly raise some valid concerns. Increased bike and scooter use can affect traffic safety. The rentals take up space on sidewalks, interfering with pedestrians. They could obstruct building entrances. Wouldn’t it be wise for city officials to evaluate the tradeoffs involved and impose rules to reduce potential problems?

Yes, but unfortunately requiring government permission does not produce only wise and benign oversight. Government permission empowers a NIMBY, or Not in My Backyard, society. NIMBY becomes the default response when people can object to a new venture for any reason, good, bad, or imagined. Do you find scooters unsightly, annoying, or threatening? Then pressure city officials to ban them.

Requiring government permission also allows economic interests to block competition. Economist Joseph Schumpeter described capitalism as a process of creative destruction: automobiles, cell phones, and email rendered horse-drawn buggies, landlines, and traditional mail largely obsolete. Existing businesses, often long-standing pillars of local economies and politics, have an interest in preventing innovation. If local governments must give permission, people’s natural NIMBY reaction and existing business’ interests create biases against innovation.

The scooter companies resorted to surprise deployments as a means, I think, of counteracting government’s status quo bias. Miamians took 30,000 trips on Lime scooters while they were available, and these users also spoke to city officials. Ridesharing company Uber similarly sought to develop loyal local customers to fend off local political efforts to ban ridesharing.

Progress requires innovation, even though the new and different can be frightening. Unfortunately, the need to get government permission becomes a formula for stasis, as Tyler Cowen examines in The Complacent Class. And dynamic innovation doesn’t mix well with permission. Computers and technology have been leading sources of innovation in recent decades in part because innovation here often still doesn’t require permission.

Personally, I’m too uncoordinated to try to use an electric scooter. So don’t expect to see me on a Spin scooter soon. But regardless of your age or coordination level, the Scooter Wars’ clash between NIMBY and innovation matters for us all.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

5 months ago

Is Facebook really like Ma Bell?

(Pixabay)

Some commentators and politicians have proposed regulating Facebook, Twitter and Google as public utilities.

To make sense of this proposal, let’s consider the economic role of public utilities.

Today’s social media giants might meet the popular definition of monopoly, namely having a very large market share. Economists, however, use a much stricter definition, and public utility regulation is applied only to the specific type known as a “natural” monopoly. Natural monopoly refers to industries where the cost per unit produced or customer served falls due to a very high first unit cost and a very low cost of serving extra customers.

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Consider the electric grid. Establishing the grid requires generation plants, transmission lines, substations, and finally the power wires in our communities. Once built, the cost of connecting one more home or business to the grid is very low. The same dynamic applies to water and sewer systems, landline telephones and roads and streets.

One large firm will likely dominate such industries. Why? Competition drives price down to the cost of production. Here, the largest firm has a cost advantage and can profitably charge lower prices than its rivals. Smaller firms can either match the leader’s price and lose money or maintain a profitable price and likely lose customers. After the smaller guys go bankrupt, the large firm can raise its price and earn big profits.

We frequently use anti-trust laws to prevent the establishment of or to break up existing monopolies. But breaking up a natural monopoly is unlikely to produce competition for long. The largest firm’s cost advantage doesn’t go away.

What are the alternatives? One is government ownership of the utility, which we rely on for water, sewers, roads, and electricity in communities like Troy. Cooperative ownership by customers – electric and natural gas co-ops – prevents managers from trying to profit at customers’ expense.

Public utilities regulation gives a private, for-profit company an exclusive service territory, albeit with restrictions. Government regulators, in Alabama the Public Service Commission, set prices and other terms of service. And the utility is a common carrier who must provide service to all customers willing to pay the regulated price. Economists and lawyers developed the public utilities doctrine around 1900.

Another way to think about a public utility is that competition between profit-seeking businesses normally best serves customers. But the enormous cost of power grids renders multiple systems and competition unattractive. Perhaps having one grid and economists deliver the benefits of competition through rules makes more sense.

Whether the public utilities doctrine served America well during the 20th Century is a question for another day. How about applying this model to social media today?

Facebook and Google meet the popular definition of monopoly – they dominate their markets. Twitter dominates its unique product, but alternatives exist to push out messages. None of the three has a massive, critical physical infrastructure creating declining cost per customer.

The social media giants do possess an advantage resembling natural monopoly. They have coordination value: the value of being on Facebook increases with the number of other users. Economists call this a network effect. Although many economists fear that network effects might lock us into inferior technology, in practice entrepreneurs can get consumers to switch: we do not still watch VHS movies and listen to cassettes.

The social media companies serve their customers very well. For instance, YouTube’s advertising allows performers to earn money, with some stars earning millions per year. Facebook has offered users innovative features and an easy interface. Market domination due to better service benefits consumers.

Alternatives to Facebook currently exist, like LinkedIn and even MySpace. More significantly, a new rival would not have to duplicate a massively costly physical infrastructure. The economic case for regulating the fast-changing digital world with a model designed for the physical world is weak. Today’s social media giants will likely have a much shorter time on our economic stage than phone and electric utilities unless we cement their positions via regulation.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

5 months ago

Should we exercise the freedom to bet on sports?

(W.Miller from C. Karl/Flickr)

Four states have already legalized sports betting in the wake of last May’s Supreme Court decision. While many Alabamians have moral objections to gambling, economics also provides a reason not to bet on sports, namely that betting will prove unprofitable. And this illustrates an important aspect of financial markets in general.

To understand the likely unprofitability of betting, let’s consider the most common football bet, one against the point spread. One team is favored by a given number of points and must win by this number to win a bet; the underdog wins by winning or losing by less than the spread. Bets against the spread should be fair, meaning that the favorite and underdog should be equally likely to win. Bets are not quite fair because sportsbooks deduct a fee so they can make money.

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Despite the fees, sports bettors who pick all winners will make handsome profits. And if you think you know football, you might think you can pick winners for at least some games. But sports’ entertaining unpredictability also makes picking just winners impossible. And because of the betting lines, you cannot profit by just betting on the Alabama Crimson Tide, who win almost every game.

If point spreads are accurate, bettors will not be able to pick enough winners to profit. Accuracy does not mean that the spread exactly predicts each game, but is better at forecasting outcomes than any other method.

Is this really true? Dozens of published papers have found that sports betting lines accurately predict outcomes. Alternatively, economists try to find profitable betting strategies given the sportsbooks’ fees; the published research yields few winning formulas.

Accurate point spreads yield a surprising implication: experts should not do any better than amateurs or luck in picking winners. Flipping a coin to decide who to bet should be as reliable as a super handicapper’s “lock of the year.”

This theory of efficient financial markets was first developed for the stock market. The price of a company’s stock should be our best forecast of its future performance. Some stocks clearly deliver tremendous returns: a $1,000 investment in Amazon or Netflix in 2007 would have been worth $12,000 and $51,000 respectively a decade later. But who knew to invest in Amazon in 1997, Apple in 1978 or General Motors in 1920? Warren Buffet passed on investing early in Amazon.

How do financial markets accomplish this? Once markets exist for stocks, bonds, sports bets, gold, Bitcoin, or anything else, millions of investors can invest where they see value. If you think that Amazon’s stock is still underpriced, then buy now. Of course, someone will only sell to you because they do not think Amazon is undervalued at today’s price. Stocks, gold, and football point spreads must all be priced to balance the number of buyers and sellers most of the time.

One guiding principle for financial research has been that it cannot be easy to get rich. If it were easy to get rich and remained so over time, then everyone would be rich. A satisfactory theory of financial markets must reflect this reality. Prices generally quickly incorporate news affecting a company’s or team’s prospects.

Why then bet on sports? Some people enjoy having action on games and sweating their bets. Betting on your favorite team can also signal your loyalty. Finally, some people, I think, like the challenge of trying to beat the market by finding some heretofore unrecognized pattern. Market efficiency does not mean that nothing remains to be learned about teams’ performance.

The potential to make money in stock, bond, futures and foreign currency markets motivates similar efforts by analysts on Wall Street and across the world. This research further improves financial markets.

Even should Alabama legalize sports betting, I won’t be placing many bets. I would be denying the power of markets if I did. Studying economics pays off, sometimes just by avoiding unprofitable decisions.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

5 months ago

Should Alabama bet on sports betting?

(YHN/Flaticon)

The U.S. Supreme Court ruled last May that states could legalize sports betting. New Jersey, Delaware, West Virginia and Mississippi have joined Nevada in offering legal sports betting, and about twenty other states have taken steps toward legalization.

Should Alabama join this crowd?

The size of the sports betting market is one argument in the affirmative. We lack accurate statistics on the current largely illegal U.S. sports betting market. A 1999 Congressional study estimated that Americans bet between $80 and $380 billion annually, while pro and college football betting has recently been estimated at $100 billion. A study by Oxford Economics for the American Gaming Association estimated that nationwide legalization and mobile betting could result in a $300 billion a year market.

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Most of the bets are paid out to the winning gamblers, but bookmakers keep some for expenses and profits. Legalization brings this gaming revenue out of the black market or back from offshore casinos to support jobs in states legalizing betting. Oxford Economics projects that nationwide legalization could create 90,000 jobs and annual tax revenue of $8 billion, through taxes on gambling and taxes paid by now legal employees.

Without legalization, Alabama will not share in these jobs and tax revenues. Alabama sports bettors’ money will support businesses and government services in other states.

While jobs and tax revenue are nice, prosperity ultimately involves providing goods, services, and activities people want. Jobs from value-creating businesses – those providing the most desired goods and services – create economically thriving communities. Alabama will miss out on a value-creating industry by not legalizing sports betting.

But does sports betting truly generate value? A skeptic could point out that gambling is a zero-sum game (the losses cancel out wins) and creates no products. Yet millions of people value having action on games and get satisfaction from their winning bets. People willingly place bets they know they might lose. Economists call such satisfaction utility. All economic activity beyond sustenance and survival is about generating utility by providing people with things they want.

Why do people enjoy betting? Economists leave such questions to psychologists. The exclusively voluntary nature of market activities excludes predatory activities from value creation. Everyone must either want to participate (place bets) or be compensated to participate – say cleaning up the sportsbook at night. Sports betting passes the voluntary participation test.

Sports betting’s biggest negative is the problem gamblers who lose more than they can afford, resulting in bankruptcy and often devastating their families. This is most unfortunate, but are problem gamblers better off with prohibition? People have long been able to bet illegally, with online betting only making access easier. Prohibition, however, makes problem gambler’s difficulties worse. Legal sportsbooks will not break legs to collect debts; indeed, it will not be profitable to let gamblers make bets they cannot pay off. Regulations on legal betting can help protect problem gamblers from themselves and ensure help is available when wanted.

The increased betting volume from legalization increases the risk of gamblers paying players to fix games. This is a real threat: the “Black Sox” scandal nearly ruined Major League Baseball, and college players who will never play professionally might find gamblers’ dollars very tempting. NBA Commissioner Adam Silver proposed that an integrity fee on all bets, with leagues using the proceeds to guard against illicit deals.

Sportsbooks, though, already have a strong incentive to protect the integrity of games. A $300 billion a year betting market will generate significant profits for years to come provided the public does not view the contests as rigged. Sportsbooks also will not want to pay off rigged bets. Suspicious betting patterns and statistical analysis can help identify rigged contests. Scandals will undoubtedly occur, but cooperation between sportsbooks, the leagues and law enforcement should keep the contests legitimate.

Jobs, taxes and losing both to neighboring states are all worthwhile considerations. But I think that the most compelling argument is the freedom to engage legally in an activity many Alabamians value. Despite the benefits, I wouldn’t bet on Alabama legalizing sports betting anytime soon.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

5 months ago

Paying for checked bags

(Pixabay)

United and Jet Blue recently increased their checked bag fee to $30. Nobody likes paying for things we didn’t pay for in the past, like checked luggage. A bill in the U.S. Senate would limit airlines’ checked bag and other fees, which topped $7 billion in 2016. But economics suggests that bag fees can make air travel more efficient, not merely extract money from travelers.

American was the major airline to charge for checked bags in 2008. The fee rose from $15 initially to $25, and almost all airlines except Southwest use this fee, while some regional airlines even charge for carry-on bags. Airline credit cards and frequent flier programs often allow free bags.

It is tempting but inaccurate to say that until 2008 passengers did not pay for checked bags. Carrying luggage is costly: airlines need larger planes with cargo space and must hire baggage handlers, while extra weight requires extra jet fuel. U.S. airlines are businesses and cannot lose money for too long. Revenue must at least cover costs, with or without bag fees.

Prior to 2008, the price of tickets covered the cost of carrying bags, averaged across all fliers. If passengers checked on average one bag each, perhaps $25 of the ticket price would have covered baggage costs. Fliers with many bags would prefer paying a ticket price covering the average number of checked bags, while passengers without bags effectively paid for others’ luggage.

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Travelers now must pay for checked luggage. This should make air travel more efficient overall. Previously passengers might have checked a bag with contents providing only $10 or $20 of value to them. If the $25 bag fee approximately equals the airlines’ cost of transporting bags, a bag valued at $10 will no longer fly, which is good because it was not worth the cost.

My points about bags apply to other airline services like meals and beverages. If airlines do not charge for alcoholic beverages or meals, ticket prices must cover these costs. First class passengers still receive such “freebies” but their expensive tickets certainly cover the costs.

Should airlines then charge for everything, including the reading light or the lavatory? Two factors limit charging for everything. One is the cost of restricting access and collecting money from willing users. Electronic payments make collecting fees easier, but lavatories would need to be accessible only after paying. Negative reactions from passengers also matter. People do not like being nickel-and-dimed for every little thing; losing a frequent flyer due to a $3 fee is bad business. Social media now amplifies customer complaints.

Until 1978, the Civil Aeronautics Board (CAB) regulated U.S. airlines, including the routes airlines could fly and fares. Forty years of deregulation have reduced fares by 50 percent in exchange for few extra services. Today, most Americans can fly at least occasionally; under government regulation, flying was primarily for business travelers and the well-to-do.

Senators Markey of Massachusetts and Blumenthal of Connecticut have introduced the Forbid Airlines from Imposing Ridiculous Fees, or FAIR, Act to limit fees of any sort, including for changes or cancellation. Rebooking fees run from $75 to $300 plus the difference in price of the flights. Cancellations can result in seats going unused on high demand flights and thus cost airlines. While these fees seem high to me, airlines know much more about their operations and costs than I do.

Competition between airlines for passengers is a better way to keep fees reasonable, fares low, and service quality high. Southwest advertises that bags fly free, and airlines seeking competitive advantage will undercut any excessive fees. If the Senators want to assist the flying public, they should address access to gates at our nation’s airports, a factor which economists find limits competition.

Travelers will pay for checked luggage, either through fees for each bag or higher ticket prices. While it is nice when someone pays for us, air travel is more efficient when we each pay our own way.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

6 months ago

Economics and Aaron Rodgers’ new contract

(M. Morbeck/Flickr)

The Green Bay Packers’ Aaron Rodgers just signed a contract extension making him the NFL’s highest-paid player. Can economics make sense of athletes’ enormous salaries? And are such salaries justified?

Top athletes now make eight-figure salaries; Mr. Rodgers’ four-year contract extension will pay at least $134 million, including $67 million before the end of this year. Top earners in other sports make even more. Clayton Kershaw of the Los Angeles Dodgers tops baseball at $33 million per season, while the Los Angeles Lakers will pay LeBron James $38 million a year. And Mr. James makes more annually in endorsements than salary. Boxer Floyd Mayweather topped Forbes’ list of top-earning athletes (which includes endorsements) with $285 million in 2018.

To focus on explaining athletes’ compensation, let’s temporarily set aside any notions of fairness. Economists use demand and supply to explain prices and salaries. Teams demand athletes’ services. The NFL generates about $10 billion in annual revenue, funding a 2018 salary cap of $177 million per team. Quarterbacks get the largest slice of this pie.

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Many quarterbacks would happily work for a fraction of the $33 million per season Green Bay will pay Mr. Rodgers. And yet the Packers and their fans do not necessarily want a less expensive quarterback. Rodgers possesses an amazing combination of physical skills, the intelligence to read defenses, and the capacity to make correct split-second decisions in the face of a pass rush.

Top athletes’ skills cannot be duplicated simply because they are valued by teams. Buyers of unique items must outbid other potential buyers. Prices must get very high to determine the winning bidder for top quarterbacks, beach-front property in Malibu, or famous works of art.

The nature of sports contests boosts demand. Only one quarterback leads the final drive, only one pitcher starts the seventh game of the World Series, and only one player attempts a game-winning shot. And only one team wins the championship each year. Fans can value a season even if their favorite team doesn’t win the title but winning also matters. Having the best quarterback, pitcher, or shooter provides your team a huge advantage. Economist Sherwin Rosen found that the top performers in such “superstars” markets will earn substantially more than the next best players despite typically a small difference in skills.

This explains the why of athletes’ salaries. Fairness depends on values and not just economics. Economics shows that the revenues paying athletes’ salaries come (mostly) from voluntary transactions. Fans choose to buy tickets, TV packages, and team merchandise. Advertising spending, which enables TV networks to pay billions for broadcast rights, may appear less clear. But advertising enables modern commerce, businesses want their ads to reach viewers, and sports attract audiences. Ad revenues ultimately derive from fans’ decisions to watch the contests.

Taxpayer subsidies for stadiums provide the one arguably involuntary revenue source. Letting teams pay less for stadiums or arenas increases the revenue available to pay salaries. Whether an expenditure of taxes approved by politicians is involuntary is a topic for another day.

Still, it seems disturbing that athletes get paid tens of millions of dollars for playing games while police officers and firefighters earn far less doing perform dangerous and arguably more important jobs. And we cannot defend the salaries as necessary to get athletes to play; Aaron Rodgers would likely still suit up even if top quarterbacks made “only” $3 million per year.

The salaries of athletes, firefighters and teachers are not set based on anyone’s assessment of moral worth. The market determines salaries, which ultimately means the spending choices of millions of people like you and me. If we disapprove of some market salaries, we could let the government set earnings, either directly by capping compensation or indirectly through high-income taxes. Yet are the decisions of politicians necessarily fairer than the spending decisions of millions?

I will gladly watch the NFL this season and not be mad at Aaron Rodgers for how much he makes. I will reserve my anger for when he beats the Detroit Lions again.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

6 months ago

New challenges for Alabama’s old rules

(YHN/Pixabay)

Like many cities, Troy is trying to figure out how Airbnb rentals fit into the existing legal and regulatory environment. Technology offers new ways to organize our economy to improve our lives.

Hopefully, our laws and regulations will accommodate such new ventures.

Airbnb is an online home-sharing platform launched in 2008. People can rent out their home while on vacation or even an extra room while they are home. Airbnb does not own properties. Instead, it connects renters with hosts and provides trustworthy information about both parties.

A growing economy must create new things and new ways of doing old things. The new sometimes renders the old obsolete, and legacy businesses unable to keep up may go bankrupt. This process, labeled creative destruction by economist Joseph Schumpeter, ends up making us better off. But new things can disrupt old ways, including the categories of our laws, regulations and contracts. Airbnb rentals create issues for Troy’s business licensure and zoning laws.

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New or unforeseen circumstances challenge our existing agreements. Law and economics teach that business contracts cannot spell out exactly what the parties must do in every possible circumstance. For example, suppose that a stream serves as the boundary between two farms. If a flood alters the stream bed, does the property line change too?

Laws are similarly incomplete. People in the early 20th Century wrestled with whether flying an airplane over someone’s property without permission was trespassing. Today, we face a similar question with drones. The common law in England and America tended to evolve to handle new situations. Judges would make a ruling, but the precedent was not completely binding. A decision which proved too costly could be adjusted through trial and error. Planes were determined to not be trespassing, and modern aviation developed.

The U.S. Supreme Court arguably applied an adjustment process this year. The decision in South Dakota v. Wayfair allows collection of sales taxes from online retailers lacking a physical presence in a state. The Court overturned its decision in Quill v. North Dakota from 1992, which increasingly seemed inappropriate for an age of online commerce.

Airbnb similarly challenges Troy and other cities. A business license is not needed to rent your house or sublease your apartment. But many properties listed on Airbnb are exclusive short-term rentals and function equivalently to hotels. Perhaps cities will make Airbnb get a business license in each community where it has a host.

Zoning laws try to limit costs arising from conflicting uses of nearby properties. People do not typically like to live next door to factories, so residential, commercial and industrial zones locate factories away from homes. Similarly, homeowners do not want the house next door becoming a party pad for a procession of visitors who may not fear offending strangers.

Covenants adopted and administered by homeowners’ or neighborhood associations provide an alternative to government zoning. Many homeowners’ association agreements did not foresee the emergence of a short-term home rental market. Airbnb hosts have seen their neighborhood associations limited short-term rentals after they listed their homes on the site.

Some libertarians celebrate disruptive technologies like Airbnb and ride-sharing services Uber and Lyft as ways to repeal in practice excessively restrictive taxi and zoning laws. I sympathize with this argument; New York City’s limits on cabs left many residents without legal taxi service, while zoning has often enforced racial segregation. Zoning is one of the tools Americans use to prevent any change. The “Not in My Back Yard,” or NIMBY, syndrome dominates in much of American today with significant negative consequences, as economist Tyler Cowen details in his The Complacent Class. Nonetheless, ill-advised laws are better repealed, as we risk creating legal questions over technologies which should make our lives better.

Cities enact laws to make our lives better. We can demand that business license laws and zoning not be used to crush innovations that should improve our lives. Our regulations should adjust with the economy, just like our contracts and laws.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

6 months ago

Have Alabama schools found free lunches?

(Amanda Mills/Pixnio.com)

Several dozen Alabama school districts are offering free lunches to all students this year. Economists have long claimed that “There’s no such thing as a free lunch!” Although I don’t think that Alabama schools have proven economists wrong, this case illustrates a challenge of limiting government.

School systems offering free lunches this year, according to the Alabama Department of Education, include Birmingham and Tuscaloosa city schools, and Mobile, Montgomery, Barbour and Crenshaw county schools. More than 4,000 schools nationally take advantage of the Community Eligibility Provision (CEP) of the Healthy, Hunger-Free Kids Act of 2010, funded by the U.S. Department of Agriculture (USDA). The CEP provides free lunches and breakfasts, long available to children from low income households, to all children in qualifying low-income schools regardless of family income.

Economists’ skepticism about free lunches flows from the most fundamental economic fact of our world, scarcity. Scarcity means that our wants and desires exceed our ability to satisfy them, or that we can’t have everything we want. Resources used for lunch cannot be used for other things.

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Alabama’s school lunches are not free; they cost us as Federal taxpayers. They are better described as zero priced, as USDA funds let schools charge students a price of zero. The government cannot provide lunches or breakfasts – or college, healthcare, or any other good – for free, they can only pay the bill.

Even if not free, is the CEP good policy? Answering this involves two separate questions. The first is the wisdom of free lunches for children from low-income families. The second is whether extending this to all students in low-income schools makes sense.

Poor children have long received free school lunches. Educators (and citizens) realize that hungry children will learn less, defeating the purpose of public schooling. Charities and school PTAs began providing lunches in the early 1900s. States and the Federal government helped during the Great Depression. Congress passed the National School Lunch program in 1946.

School lunch programs also encourage healthy eating. One out of three American children today is overweight. Lunch programs let children eat at least one reasonably healthy meal each day.

But what about feeding children from well-to-do families? I can afford to feed my son, even though he attends a school which may be eligible for the CEP. Surely this is a waste of our tax dollars.

College football season is rapidly approaching, so I will borrow a “Not So Fast!” from Lee Corso. Providing free lunches for all students in low-income schools offers some advantages. Parents must sign their children up for free or reduced-price lunches. The CEP keeps children from slipping through a crack and going hungry. Schools save the money reviewing applications and verifying income eligibility.

Furthermore, children who do not pay for lunch may be stigmatized. Whether recipients of government assistance should be stigmatized is a very divisive question. We can debate whether adults should be held accountable for their choices that perhaps contributed to being on government assistance. But stigmatizing children for the (potential) sins of their parents seems cruel.

Collecting money from children who still must pay is costly and problematic for schools. Should children without lunch or lunch money go hungry? If allowed to eat, the district may never collect the money owed. Aggressive collection efforts, like pinning notes to parents on the child’s school uniform, again impacts children far more than parents. But it’s hard to blame school administrators either. Paying for lunches for children whose parents can afford to pay strains tight budgets.

Fiscal conservatives sometimes suggest that government can be easily kept in check by cutting waste. The late William Niskanen, the long-time President of the Cato Institute, remarked that in all his decades in Washington, he never saw any budget line labeled “waste, fraud, and abuse.” Not paying for lunches for well-to-do kids might seem like a no-brainer. But controlling government spending almost always requires difficult choices.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

7 months ago

Is Alabama’s school sales tax holiday good policy?

(YHN/Pixabay)

Last weekend was Alabama’s annual back-to-school sales tax holiday. If you have a child in school, I hope you were able to take advantage. Tax holidays provide an example of using tax policy to shape peoples’ decisions and raise questions about the role and even size of our government.

Alabama was the first of sixteen states with school sales tax holidays in 2018. Alabamians could avoid sales tax on over $900 in school-related purchases, including clothes, books, and computers. A family could save over $80 in taxes.

Tax exemptions encourage spending which we judge worthwhile. School supplies certainly qualify as worthy. Millions of children nationwide may not have the supplies they need for school, a gap that our teachers generously help fill. A recent survey found that 94 percent of teachers spend their own money on supplies for students, averaging almost $500 over two years. Letting a lack of supplies compromise a $12,000 annual per pupil expenditure on public schools would be a tremendous waste.

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Still, targeted tax exemptions and deductions are controversial. Some critics label these exemptions “tax expenditures” to highlight an equivalence to government spending. Consider our sales tax holiday. Alabama alternatively could have collected the sales tax as normal and purchased supplies for children. Tax expenditures are not identical to spending tax dollars, as no family is required to buy school supplies. But a resemblance exists.

The individual and corporate income taxes contain America’s most significant tax expenditures. The ones most familiar are the mortgage interest and charitable contributions deductions. Deductions lower the cost of the designated activity, resulting in more people owning homes and more dollars going to charities.

The Tax Foundation estimates that Federal tax expenditures in 2015 totaled $1.2 trillion and $130 billion for individual and corporate taxes. That amounted to almost 80 cents in tax expenditures for every dollar of individual income tax revenue, and over 50 cents per dollar of corporate tax revenue.

Viewing taxes not collected as spending increases the size of the Federal government. Washington spent $4 trillion in 2017, or 21 percent of GDP. Adding tax expenditures brings this to almost 28 percent of GDP. Tax expenditures probably shouldn’t count equally to spending, because people would have bought school supplies and homes without tax breaks. But spending alone understates the impact of government.

How one views reducing Americans’ taxes via deductions likely depends on how one views the relationship between government and citizens. Believers in limited government probably view citizens as entitled to keep the money they earn. And if government answers to the people as the Declaration of Independence proclaims, government shouldn’t tell us how to spend our money. People who believe that government should address pressing societal needs might view the loss of tax revenue as limiting the good government can do.

Economists raise two points about tax expenditures. The first involves the impact on economic growth. A tax code with many deductions requires higher tax rates to collect the same amount of revenue. High tax rates reduce growth. Taxing all income at lower rates should increase economic growth without reducing government spending.

The second point involves the consequences of government dispensing tax breaks as it chooses. A healthy, growing economy requires investment in promising businesses which provide new and better products and services and earn profits, not merely avoid paying taxes. Lobbying Congress for tax exemptions can become more profitable than expanding a successful business. The House of Representatives recently passed a Health Savings Accounts reform including tax breaks for gym memberships. Passage of this tax break increased the value of Planet Fitness’ stock by four percent.

Nobody likes paying taxes, so giving people a break for good deeds seems reasonable. Yet exempting good causes, like school supplies, induces others to pursue tax breaks for themselves. When the dust clears, keeping tax rates low and making everyone pay for school supplies might look like a better plan.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

7 months ago

Fire safety or compliance waste?

(Troy Fire Department)

Troy’s fire department rating will improve this October, which should lower our insurance rates. Fire protection ratings show how markets can ensure the quality of our services. They also provide an example of value creation as opposed to compliance-driven documentation.

The Insurance Services Office’s (ISO) Fire Suppression Rating Schedule dates back to 1909. Insurance companies wanted reliable information on the quality of cities’ firefighting services. Entire city blocks of tightly bunched wooden buildings could burn without effective firefighting response. Insurers wanted to know where poor fire protection created a risk of devastating losses.

The ratings range from 10 (worst) to 1 (best). Troy’s rating will improve from 3 to 2. Only three percent of over 43,000 departments have a rating of 2; just 305 departments nationally (0.7 percent) have a score of 1. Twenty percent of departments have scores of 9 or 10, so ISO is not like a teacher who gives only A’s and B’s. The rating formula assigns points for a fire department’s equipment and training, water resources, and communications.

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The ratings cannot tell a community how good of a fire department they should have because quality is costly. For instance, opening a third fire station helped drive Troy’s improved rating. The third fire station improves response times, which could save lives or contain damage in a fire. The money for the station, however, could have been spent on the police force, street repairs or lowering taxes.

Are the benefits worth the cost? That’s for cities across the country to decide. Fire suppression ratings assist us as citizens in making such decisions. The city of Troy has been spending money upgrading our fire department for several years. The ISO score signals that our investment is paying off.

And yet can we really be sure that a better ISO rating means better protection? This is a significant question. The ratings are based on many factors. If the factors do not improve protection, a better rating does not make us safer. Public schools can provide lots of documentation of the attainment of performance criteria without noticeable improvement. Could a similar dynamic be at work in firefighting?

We can trust the ratings because insurance companies continue to offer premium discounts for them. An insurer offering discounts will write more policies in communities like Troy. Lower premiums bring in less money per insured home or business; if fire losses are not lower, the insurance company will lose money. Insurers can verify reduced fire losses using their loss data.

Trial, error and adjustment are all crucial here. Sending three fire engines on structure fire calls instead of two to earns the Troy fire department ISO rating points. This seems prudent, but may not necessarily reduce losses. If dispatching an extra engine does not reduce losses, insurers will not want to offer an additional discount and communities will not want to bear this extra cost. ISO drops factors from its formula which fail to reduce fire losses.

Research by economists finds that quality verification works better when voluntary. Making all insurance companies give discounts for ISO ratings might seem to make sense. Instead, insurers do not have to use and must pay for access to the ratings. Insurers will only pay if the ratings provide value. ISO must ensure that the criteria correlate with lower fire losses and not impose costly and ineffective requirements. If insurers had to use the ratings, ISO could sell access regardless of usefulness and would have little reason to refine the criteria over time.

Economic activity increasingly involves documenting compliance with company policies or government regulations. We now have a saying that if you haven’t documented it, you haven’t done it. Yet, fire-fighting demonstrates the weak connection between documentation and value creation: people can be rescued from a burning building without the rescue being documented. Fire suppression demonstrates the potential relevance of performance measures and allows Troy residents to sleep better knowing we are safer.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

7 months ago

Do DIY projects make economic sense?

(Pixabay)

Millions of Americans engage in do it yourself (DIY) home improvements. Each summer I choose a project, and about half of the time I actually do it. This year’s project is painting our house’s exterior windows and trim. And yet DIY produces professional angst for me as an economist, because core economic principles imply that I should hire someone for home projects.

About two thirds of American homeowners typically report planning a DIY improvement task. The more than 4,000 Lowe’s and Home Depot stores nationwide largely cater to DIYers. Cable TV channels, magazines, blogs, and YouTube videos assist aspiring DIYers.

DIY, however, ignores the principle of comparative advantage. What does this mean? Suppose that I could have hired a professional for my painting project for $1,000, plus the cost of paint. Paying someone would have taken me less time than doing it myself. This might seem trivial, since I could just watch if I paid someone, but holds even considering raising the money to pay for the job.

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Why? I can earn $1,000 working as an economist faster than I can paint. Alternatively, I could earn more than $1,000 in the time I’ll spend painting. I am skilled as an economist (although some of my students might disagree), while painters are better at painting. Comparative advantage shows that we will both be better off by focusing on what we’re good at. Teaching a summer class is a faster way for me to paint my house.

Comparative advantage applies for other projects – decks or landscaping the yard – and other professionals – doctors, plumbers, basically everyone. Much of our modern prosperity is due to specialization based on comparative advantage and buying what we need and want.

Closely related to specialization is another fundamental economic principle, the division of knowledge. A pro knows more about painting than I do; they will have and know how to use all the latest tools. A DIYer is more likely to waste wood building a deck due to mistakes a pro will avoid.

DIY could even make us poorer. If twenty families in Troy decided to build decks themselves this summer, they would likely waste a lot of wood and other materials making the similar mistakes. One specialized company could more quickly and efficiently build all twenty decks.

And yet I am probably painting as you read this. Am I crazy? Perhaps, but let’s not go there. My depiction of comparative advantage, however, does omit several things.

Many people cannot work extra hours (for pay at least) to earn the cash needed to pay for home improvement projects. Opportunities for overtime may not come when you want to do a project. DIY purchases a deck or fire pit we otherwise couldn’t afford using our spare time.

Having workers come into your house is also inconvenient. Hiring a painter or contractor is a hassle. Good contractors are often referred by friends, so you may end up with an unreliable one. (Many free-market economists have contractor horror stories, which should perhaps make us rethink how well markets work.)

Emotional considerations also factor in. DIY was part of life in the Sutter home growing up. We did things like put a new roof on the garage and build a deck, and we helped friends with such projects. I learned DIY before economics, and maybe some lessons are hard to unlearn. Many people enjoy working on their home, which factors into consideration.

Specialization leads to the creation of so much new knowledge that it limits our ability to DIY. YouTube videos level the playing field some, but only help someone who is already handy. The ability to DIY is valuable, even when we choose to pay others to do our tasks. The growing percentage of Americans not confident about changing a flat tire will be dependent on road service.

Good luck with your summer projects DIYers. You probably don’t have to worry while working about failing to apply basic principles you teach students. Perhaps painting my house makes me a bad economist; if so, I’m glad I have tenure!

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.