Pro-Investment, Rent-Seeking Crony Capitalism

A recent New York Times Magazine article by Adam Davidson, co-founder of NPR's "Planet Money," discusses the issue of income disparity, job growth and investment incentives with Edward Conrad, a Bain Capital executive and friend and colleague of Mitt Romney. Conrad's pro-investment view of the economy provides little sympathy for the recent financial collapse and offers no support whatsoever of any government attempt to promote income equality. In Conrad's view, the 99% ought to be thankful for the increasing wealth of the 1% on the theory that if payoff (incentives) for risk-taking investment is large enough, then people will take more risks, industry will become more efficient, and every dollar earned by a risk-seeking investor will produce $20 in value for the rest of the general, and presumably risk-averse, public.

When asked about the influences of power and politics on economic growth, a.k.a., crony capitalism, and the rent-seeking behavior of firms that often defies free market mechanisms, Conrad dismisses the notion as phenomena common to third-world countries, not the United States. Of course many economists point out that gains from risk-seeking behavior can often be large and concentrated in the hands of the few even if the the costs, which are also large, are spread out among many. This especially true when powerful incentives, such as monopoly profits, encourage wealthy and powerful firms to lobby government for such things as tax rebates, deregulation (or regulation against competitors), and special franchise rights to control a market.

Too often, the result of rent-seeking behavior is that the benefits of risky investment fail to outweigh the investment's costs, including the costs of negative externalities and dead-weight losses to society. Rewarding wealth to those in power, and those who  have greater resources to influence policy, comes at a greater cost to society when those who can offer more innovative ideas, products and services, are prevented from entering the market. When large gains (monopoly profits) can be attained through exclusive agreements, patent protection, protectionist policies, legislative action, deregulation, and so on, powerful and wealthy firms will spend large sums of money in order to enhance their odds of being chosen as the beneficiaries of those gains. Because the advantage to any particular beneficiary is an increasing function of the amount of money it spends lobbying for those gains, an unfortunate consequence of rent-seeking behavior is that entitlement and privilege is often granted to firms even when the benefits do not exceed the costs (economic and social) of the entitled firm's investment opportunity.

Consider how lobbying behavior in the U.S. auto industry has historically led to inefficient markets, stifled innovation and wasteful spending when the Big Three firms were able to "purchase" the privilege and entitlements to engage in monopolistic behavior. Because these firms faced intense competition from overseas competitors and rising gas prices in the 70's and 80's, the firms sought to influence government to impose import restrictions and other trade barriers on the foreign competitors, thus enabling U.S. automakers to earn substantially more expected profits than they would without such barriers, particularly in an environment where gas prices and demand for more fuel efficient automobiles would have forced the U.S. firms to invest in substantial technology. The lure of expected savings via government regulation encourages firms to engage in lobbying behavior and spend an amount of money that is no greater than the expected profits that can be attained from the firm's project or investment; and in Conrad's pro-investment view of the world, incentives to invest are only attractive if the rewards are large enough.

Yet, a firm's investment does not always lead to innovation and long-term sustainability, even if it does lead to short-term price reductions. The U.S. auto industry is a prime example of how concentrated wealth in an oligopoly--achieved through aggressive lobbying and government regulation--can actually stifle innovation and result in long term damage to the economy and the environment. In Conrad's view, it is perfectly rational for U.S. firms to incur exorbitant expenses in its lobbying efforts, so long as those costs do not exceed the firm's expected economic profits.

What Conrad fails to consider however is the social cost of such firm behavior. An efficient economy is one where firms consider the triple bottom line and one where government takes every feasible step to discourage rent-seeking by entitling private industry participants on the basis of social and environmental well-being rather than on the amount of money spent on lobbying.

Generation Y Bother

In a recent New York Times Op-Ed, co-authored by Todd Buchholz, an economist, Harvard instructor, former White House director of economic policy, best-selling author of Rush: Why You Need and Love the Rat Race, and one of Successful Meetings magazine's "Top 21 Speakers of the 21st Century," the authors misrepresent the motives, aspirations and work ethic of the present generation of young adults facing the new economy, and in doing so, egregiously misinterpret some of the most important and persistent themes and characters in classic American literature.

In their article, the Buchholzs claim that young Americans today are "risk-averse and sedentary" and have somehow inherited a "stuck-at-home mentality," as evidenced by a 40% decline in interstate mobility among 20-somethings since 1980. The Buchholzs support this view by referencing a recent study by the Pew Research Center which shows the proportion of young adults living at home nearly doubling between 1980 and 2008; and in order to emphasize their point, the Buchholzs juxtapose what they consider to be the typical young adult’s situation today with that of Tom Joad, the iconic, Depression Era protagonist in Steinbeck's great novel, The Grapes of Wrath. They propose that the young adults of today's generation, whom they dub, "Generation Why Bother," should learn to recognize the courage of Tom Joad, yank out their power cords, and do whatever it takes to get back out on the road. Unfortunately, the Buchholzs’ portrayal of Tom Joad "load(ing) up his jalopy with pork snacks and relatives" –as if to a Beverly Hillbillies soundtrack--and "flee(ing) the Oklahoma dust bowl for sun-kissed California," is a rather foolhardy depiction that utterly contradicts and discredits Steinbeck’s message. Did the Buchholzs even read the book?

Steinbeck's main character is by no means a determined capitalist or a savvy entrepreneur, or ambitious career-seeker. He is an egocentric, ex-con, turned humanist. Having just been released from prison amid the great Oklahoma dust storms of the thirties, Tom Joad is introduced to readers as a pathetic man of self-interest who developed a carpe-diem attitude in prison as a means of coping with the disillusionment and bleak prospects faced by those struggling to make a living during the Great Depression. The Joad's journey West, via Route 66, is by no means a risk-seeking capitalist adventure for restless movers-and-shakers who prefer transient, entrepreneurial lifestyles; and the Buchholzs’ suggestion that "sun-kissed California" held any real promise of fortune for migrating farm workers is a sorely misunderstood reference to the novel that falsely presents Steinbeck's California as some archetypal or mythological Land of Opportunity.

A closer look at the Pew Research study, from which the Buchholzs base their critique, reveals that employment status, among other variables, plays a significant role in the formation of multi-generational households. According to the study’s findings, nearly half of today’s unemployed adults, aged 18 to 34, are living with their parents because of economic conditions. While the study does not identify any clear socio-economic pattern or ethnic bias, it does find other contributing factors such as delayed marriage, immigration, and the economics of multi-generational living arrangements, the sorts of variables which the Buchholzs conveniently exclude from their analysis entirely.

The study surveyed young adults aged 25 to 34, a large segment of the demographic commonly referred to as Generation Y, or Gen Y, for short. Today, Gen Y comprises the largest segment of the population, representing those Americans born between 1979 and 1996 (ages 16 to 33, in 2012), and making up approximately 80 million people. That's about 5 million more people than those in the Baby Boomer generation, America's second largest population segment. The year was 1962 when the Baby Boomers ranged in age from 16 to 33, and it's clear from the Pew Research study's chart (left), that this group's declining trend in multi-generational household arrangements in the fifties and sixties stands in stark contrast to the trend set by succeeding generations since 1980. The shift is indeed striking, but hardly provides evidence that Gen Y, or the Breakfast Club generation preceding it, is somehow less adventurous and less industrious than their Baby Boomer counterparts were more than thirty years ago. Are we really to believe, as the Buchholzs suggest, that Gen Y is "literally going nowhere"?

What the Buchholzs also fail to acknowledge in their stinging critique of Gen Y are the multitude of historical, cultural and societal changes that have shaped our current socio-economic environment and have greatly influenced American multi-generational household arrangements. One important contributing factor is the rate of poverty in our country. In post World War II America, the U.S. poverty rate was in a constant decline every year before bottoming out in 1973, at just under 9%, then steadying (on average) between 1974 and 1980--a period marked by an oil crisis, an energy crisis, and the beginnings of a global economic recession. Shortly after 1980, however, the U.S. began to experience high rates of inflation, and the Fed's contractionary monetary policy eventually brought about a severe economic recession in the U.S. The recession peaked just before the start of 1983, when nationwide unemployment rates were 10.8%, the highest levels since our country's (and Tom Joad's) Great Depression.

What's even more striking is the strong correlation between the percentage of those living in multi-generational households and the U.S. poverty rate between 1961 and 2009. In somewhat crude fashion, I superimposed a rough approximation of the poverty rate (taken from U.S. Census data) onto the Pew Research Center's chart to illustrate the relationship. The two lines follow a strikingly similar pattern, with the movements in multi-generational households lagging slightly behind poverty rates.

Although their Op-Ed piece is brief, the Buchholzs never mention the evolving cultural and economic climates, or the shifts in consumer behavior, or the evolution of a greater environmental and social consciousness among young generations during the past half century. Gen Y is a generation of information processors, social net-workers, and telecommuters who, in my opinion, are highly innovative and highly productive in their own right; and who are not inclined to follow beaten paths, take on traditional careers, or place much emphasis on material possessions as those in the generations that preceded them. The Happy Days of the fifties-sixties, the sexual/cultural revolution of the seventies, and the mass consumerism that defined the eighties-nineties, has given way to a new generation that prefers to be more socially conscious, more environmentally conscious, and more health conscious; a generation that prefers to be connected (wirelessly or otherwise), not just to friends and family, but to the local communities where they live and the global communities in which they dream of living; a generation that prefers to wage voice rather than war, and prefers social change over expensive, gas-guzzling cars, and would prefer to create a cool Internet business rather than toil away at the production line of some auto factory.

Tom Joad doesn’t leave for California because he longs to be on the road; nor is he driven by any entrepreneurial hunger or capitalist spirit. His journey begins as a means of survival against the hardship and hostility and economic injustices facing his family and countless others who lost their farms to wealthy bankers and are coerced by wealthy California landowners to migrate West, risking life and limb, for jobs that do not exist. As Steinbeck’s story progresses, Tom Joad transforms from a man of pure self-interest to one who eventually sets out on a course of public action against the world’s injustices. Tom Joad is by no means the Jed Clampett character whom the Buchholzs romanticize about. Steinbeck’s Tom Joad represents the migrant's suffering, not the migrant's entrepreneurial success. Steinbeck's California, far from being "sun-kissed," is a state that represents a broken promise to the migrants. It symbolizes the exploitation of land for the means of mass production and support of an industrial system where workers like Tom Joad are treated like animals, denied livable wages and forced to kill to survive.

According to the Buchholzs, young Americans today are less inclined to buy a car or get out on the road, and are more inclined to spending too much time on the Internet checking Facebook. Yet the migrant lifestyle led by Tom Joad and his family is hardly the life we'd wish our children to consider. It is a harsh and cruel way of life that lacks family unity and home identity. What the Joads rely on most for strength and support is not the individual courage the Buchholzs are trumpeting, but rather a social connectivity to, and unity with, other families and individuals who share in the same plight and who are committed to one another's survival. Imagine what the Joads would have accomplished through the Internet.

For Steinbeck, the evils that plagued the Joad family and California's migrant workers were self-interest and an unsustainable capitalist system designed to reward a few at the expense of sinking thousands into poverty.  This was the Occupy movement Steinbeck was most concerned about, and it is not the one the Buchholzs describe in their article. Steinbeck wrote about his novel’s purpose: "I want to put a tag of shame on the greedy bastards who are responsible for this (Great Depression and its effects)."

Why are the Buchholzs so nostalgic for an era where a kid "longed for his driver's license and a chance to hit the road and find freedom" when we now have an era where a kid longs for his computer, an Internet connection and a chance to advance freedom by connecting and communicating with the world? I'm not suggesting that our young adults ought to spend more time on computers and less time getting out and exploring the natural world. I happen to have a son who belongs to Generation Y; and he's every bit the mover-and-shaker the Buchholz claim that young adults were prior to 1980. In any case, I'd rather my son stay out of his car, and have dinner more often with his family, and if he ever has a chance to, connect with someone from across the globe to do the very thing Tom Joad does: become a tireless advocate for the oppressed.

Do Food Stamp Restrictions Really Work?

A recent article in the L.A. Times describes how Ronda Storms, a Republican state senator in Florida was so galled at the sight of grocery shopper using federal food stamp money to purchase junk food that she sponsored a bill in the state of Florida that would prohibit people from using funds provided by the Supplemental Nutrition Assistance Program (SNAP) to purchase “non-staple, unhealthy food.” Proposed legislation seeking to restrict SNAP purchases may be driven by politician’s concerns (genuine or not) about public health, but such legislation can be subject to the resistance of a rather odd coalition of anti-hunger advocates and powerful business lobbyists. If you think the Coca-Cola and its upstream raw material producers don’t profit from SNAP revenues, think again.

Aside from avoiding further stigmatization of the poor, there may be good economic reasons for rejecting such proposals. Can earmarked funds really prevent a SNAP recipient from purchasing junk food? If a person with a monthly income of say $400 receives $100 in food stamps, and the person’s monthly food budget under the SNAP program is $200 ($100 purchased with her own cash, and $100 purchased with food stamps), and the person typically spends say a quarter of her budget ($50 of the $200) on “junk food,” then obviously the person will still be able to purchase $50 worth of junk food—at no additional cost—even if the earmarked food stamps are restricted to healthy food items. Under the restriction she simply uses $50 of her own cash to buy the junk food, whereas before she could have used the SNAP money to buy the junk food. In either case, the total food purchased is $200, with $50 of that amount spent on junk food.

So what happens to the consumer who has the same $200 budget, but who typically spends $150 on junk food? Will she be forced to buy $50 worth of healthy foods that she would not have otherwise purchased? Or will she let some of the SNAP benefits go unused? Many would argue that either outcome would be more beneficial. However, such a condition may be the exception rather than the rule; and before we introduce a policy that restricts all recipients' food consumption, we ought to do a little research. Besides, if politicians like Ronda Storms want to implement policy that substantially improves public health for all citizens, it might be more efficient (a better use of taxpayers’ dollars) and more effective to target the producers of unhealthy foods rather than the consumers. Check out my post on Denmark's fat tax.

There is also strong evidence to support that idea that a cash grant program is superior to a restrictive food stamp program. The idea here is that if recipients would have spent at least as much of their own money on food purchases as they received in stamps then not being able to use stamps to buy other goods is a somewhat meaningless restriction; and if recipients spend less on food than they receive in food stamps, then of course the food stamp program has the effect of forcing the consumer to devote more to food than she would have chosen to spend on her own.

The USDA Food and Nutrition Service issued a report in 2007 that suggests there is no known research-based evidence to support restricting food stamps and therefore no basis for singling out low-income recipients. The USDA’s own estimates indicate that approximately 70 percent of all food stamp recipients—those who receive less than the maximum benefits allowed—are expected to purchase some portion of their food with their own money.

Fat Tax Burden

The truth is the Danes are some of the leanest folks on the planet, with less than a 10% rate of obesity, about a third of the United States’ obesity rate. The other truth is the new “fat tax” in Denmark has been quite successful in achieving the goal of limiting Danish citizens’ intake of unhealthy foods. That government would dare regulate food intake is what Fox News commentators will decry as social engineering. Denmark prefers the term, social responsibility.

Among the chief complaints registered by anti-taxivists is that a tax on food products, such as Denmark’s fat tax, creates dead-weight welfare losses and shifts the tax burden unduly onto the consumer.  Welfare (in economic terms) aside for the moment, we have to examine more closely the demand and supply elasticities of unhealthy food products to check if anti-tax rhetoric is fully supported by fundamental economics. To clarify, the Danish fat tax is an ad-valorem (“according to value”) tax, a percentage tax. Instead of shifting the supply curve directly upward, as a per unit excise tax does, the ad-valorem sales tax effectively rotates the producer’s supply curve counterclockwise from its axis point, such that the spread between the pre-tax and after-tax supply curves is proportional to the percentage tax rate at every output level. It turns out that demand elasticity for a sweet, fatty danish—we're talking food here—is rather elastic, meaning that demand for danishes and other fatty treats, unlike the demand for say gasoline, tends to be very responsive to changes in price.

Notice from the two graphs drawn in the figure below, that when demand for a product is more responsive to a change in price, the share of the tax burden on the buyer is reduced. This makes intuitive sense; another way of describing it is that the tax burden falls most heavily on the side of the market that can least escape it. If the buyers have greater alternative substitutes, and suppliers do not, then most of the burden will fall on suppliers. Hence, the share of a buyer’s tax burden is inversely related to the buyer’s demand elasticity. In other words, the greater the responsiveness of a buyer to the price of a product, the lesser will be the buyer's share of the tax burden—all else equal, of course.

The lower graph in the figure below reflects a greater share of tax burden to consumers who are less responsive to price changes. However, we expect there to be plenty of available substitutes to sweet, fatty danishes; thus the lower graph may well represent a tax on a more inelastic product, like gasoline (for American consumers). Notice also the higher new price (P1) associated with the less elastic demand curve in the lower graph. Danes, by the way, prefer bicycles over automobiles.

Greater demand elasticity, all else equal, also has the effect of reducing the quantity supplied. This also makes intuitive sense, and this can be seen in both graphs. If the demand curve is steeper (less elastic), as shown in the lower graph, the new quantity (Q1) supplied will be greater than if the demand curve is less steep (more elastic).

As far as economic welfare losses are concerned, I think it's safe to say that while the consequences of a fat tax result in higher prices to consumers, and lower quantities sold by producers, the switch to other food substitutes will likely result in lower prices and higher quantities sold of healthier alternatives, for a positive net gain to the health of society in general.

There’s an interesting opinion in the NY Times that describes the Danish rationale for taxing unhealthy products. When something is bad for its citizens, but not quite bad enough that it can be outlawed, it is TAXED! I can think of plenty of American products that would fall into this category. In Denmark the fat tax generates revenue to cover the some of the rising costs of universal healthcare. In the United States it seems excise taxes rarely garner much support unless the revenue generated is used to offset a reduction in another, more loathed, form of tax like the income tax. It’s a matter of social priorities, I suppose.

Carterfone Rules

1968, the year that Yale University decided to admit women, a landmark regulatory decision by the FCC permitted the Carterfone (shown below) and other communication devices to be connected directly to AT&T's phone network. The decision helped spawn a consumer market for consumer-owned devices like answering machines and fax machines. The Carterfone was a simple device that enabled two-way mobile radio to connect to the AT&T telephone network--much to the monopolist's vexation--and the device became a symbol for legislation known as the "Carterfone regulations," the FCC rules which govern the attachment of such devices. More importantly, and as Columbia legal scholar, Tim Wu, points out in his book, The Master Switch, the FCC's decision made it possible for inventors and entrepreneurs like Dennis Hayes and Dale Heatherington to mass-market their invention, the Hayes modem (a device that connects personal computers through a telephone network). The modem was an important innovation that contributed to the evolution of the Internet.

So what makes this historical tid-bit relevant today? AT&T's planned $39 billion takeover of T-Mobile leads some experts to believe the move would help restore AT&T to its former throne, and together with Verizon, control approximately 80% of the mobile market. Considering that AT&T currently (Nov 2010) controls 38% of the Smartphone Network, the experts have good reason to be concerned. Why would the FCC consider such a merger? And what does the 1968 Carterfone legislation teach us about the potential for stifled innovation in the communications industries?

Consider this: Before the AT&T monopoly was dismantled in 1984 (the same year Apple's Macintosh computer was introduced) the firm was in command of more than 90% of the market. The initial break-up,  which was designed to segregate AT&T from local carriers, did little to prevent the firm from reorganizing by digitizing its entire network, moving into the international market and engaging in merger activity that resulted in the acquisition of computer makers and cellular phone companies. By 2007, the newly reconstituted Bell system (which included Pacific Telesis, Cingular, Bell South, and a half dozen Baby Bells) dubbed itself the "New AT&T" and was positioned to become the most dominant player in the wireless services industry. It's no surprise then that many have lately been calling for stiffer regulation in the wireless industry, fearing that mergers like the latest one proposed between AT&T and T-Mobile, will do little to enhance competition and will only serve to reinstate AT&T's monopolistic control.

Wu argues for greater restrictions (Carterfone regulations among them) on AT&T and the mobile wireless industry in general, citing firms' anticompetitive and parallel behavior. The issue of whether parallel behavior alone can be relied upon to evaluate a firm's anticompetitive conduct lies at the heart of a counterargument written by Marius Schwartz, Professor of Economics, Georgetown University, and Federico Mini, a senior consultant with Bates White. In their paper the authors claim the wireless industry (as of 2007) is "so distanced from monopolistic conduct and poor performance that it is presumptively not a candidate for regulation," and that parallel behavior and concentration indicators alone do not necessarily reveal the degree of an industry's anticompetitive behavior. Schwartz makes his case by demonstrating evidence of ongoing technological competition, heavy comparative advertising, and pricing diversity, among the largest carriers; and he asserts the industry is therefore not a candidate for "intrusive regulation."

Nevertheless, the potential for a merger to create monopoly power, particularly if such a merger involves the largest two firms vying for a combined share of more than half the market, becomes a serious issue in the horizontal case. Naturally such agreements are generally disfavored under anti-trust laws, but without the additional evidence (the "plus factors") to support any sort of conspiracy, parallel behavior can be seen as ambiguous and can be readily defended, with reasonable explanations, on the grounds that firms are simply acting in their economic best interests.

Should we be concerned with the proposed AT&T-T-Mobile merger? It might be helpful to resolve whether a carrier like AT&T can be considered anything more than a wireless data provider. Notwithstanding the economic wisdom provided by Schwartz, the question of whether a carrier like AT&T (exhibiting conscious parallelism or not) should have complete discretion to restrict access to its wireless network from competing wireless service providers like Skype also speaks to the bigger issue of net neutrality. Recall it was the Carterfone device that the FCC allowed to be connected to AT&T's phone network more than 40 years ago. The decision, some would argue, made possible the innovative development of consumer devices that ultimately contributed to the development of the Internet. Interestingly, the recent debate over Skype's "device" connectivity to the AT&T network bares striking resemblance to that of the Carterfone's, except that the network (which now transmits data, not just conversation) is being used to connect a present-day wireless web application rather than a 1968 mobile radio system.

So while some economists may support horizontal mergers or deregulation on the basis of competitively proper conduct, legal scholars and consumer advocates may argue that such conduct (whether competitive or not) results in anticompetitive outcomes.