The Ferguson Reality

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The Ferguson situation is unfortunate for many reasons. Those burning down the city lack a comprehensive understanding of the case, yet they clamor for the indictment of an officer they don’t know to be guilty. They supposedly act in the name of justice while reflecting a total disregard for private property and the rule of law. They behave like anarchists while simultaneously demanding government intervention. This is a serious problem on many fronts, but I’d like to comment on the business perspective.

Consider a simple question: If you run any type of chain or franchise establishment–or even a small business–would you consider opening in or moving to Ferguson? With the ongoing riots and seemingly no way to protect property there, the answer is obvious. High profile firms like McDonald’s will probably stay, lest they be accused of social irresponsibility. Many others will likely exit, taking jobs and access to daily services with them. Why rebuild a business in Ferguson?

But Ferguson is really a random community in this cycle of violence. What happened there could just as easily have occurred elsewhere. Savvy business executives with their own money on the line will attempt to identify and avoid the next Ferguson. You can’t blame them.

Ironically, while private investment in Ferguson will suffer, some are starting to call for the federal government to step in and “rebuild the community.” Doing so would be a travesty of justice, reinforcing the notion that crime really does pay.

At the end of the day, economic development depends on individual liberty and respect for the rule of law. When these fundamentals are lacking, entrepreneurs demand higher returns to compensate for the extra risk or avoid investments altogether. This is the reality for Ferguson, and perhaps for other urban areas as well.

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The President & Net Neutrality

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On Monday (November 10), President Obama definitely declared broadband Internet service as “essential to the economy.” In doing so, he asked the FCC to declare broadband as a public utility, expand its regulatory control, and invoke so-called net neutrality, the idea that all Internet traffic should be treated equally. Should the FCC oblige, there would be a fight—likely in court—with major broadband providers like Comcast, AT&T and Verizon that seek different cost structures for different types of customers.

Proponents of net neutrality claim that such an approach would ban Internet providers from discriminating against content providers. But neutrality really means egalitarian in this instance. Not all Internet applications require the same speed and bandwidth, so Internet providers should be allowed to set prices accordingly. Net neutrality would end this practice, allowing regulators to set prices, ostensibly in the public interest.

There are legitimate technical matters to consider here, but the core issue is about philosophy. The crux of the President’s argument is quite simple: Anything “essential” to the country can’t be left to the market. Whether it’s the post office, education, health care or the Internet, he’s suggesting that vital goods and services should be centrally controlled.

This argument has emotional appeal and is sold through fear: “We can’t leave the education of our kids to the profiteers.” “Everyone has a right to get the same mail service no matter where they live.” “Medical care is too important to be left to the insurance companies.” “The Internet should be available to everyone, not just large corporations.” But it also has a logical flaw. If central control of “essential industries” is in the best interest of consumers, then why not centrally control other industries as well? While most Americans would reject this idea when applied to grocery stores, restaurants, and gym memberships, many fall for the notion that important goods and services should be exceptions. In doing so, they miss the point.

In general, the more important an industry is to an economy, the less regulated it should be. Mail service, education, health care and the Internet are too important to be left to bureaucrats who lack the information necessary to make efficient decisions about products, services, and pricing. The market does all of this much better and much faster. Health care costs are not high because of greedy doctors and insurance companies who conspire to shortchange the poor. They are high because government regulations of the various related industries make it more complex and thereby more expensive.

Don’t be fooled. The President might be calling for an “open Internet,” but it’s already open without the level of federal oversight he wants. The market has already done quite well making Internet service available to the public.

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Managing the ebola crisis

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Confidence in the Obama administration’s ability to manage the ebola crisis has been low overall, but it has been driven by hourly news events. Approval ratings for the President and the CDC will almost definitely decline if there are additional cases in the US, and they will rise if there are not. This reflects human nature, but also the public’s inability to focus on the issues at hand and the government’s proper role in managing the crisis.

This is a classic case of crisis management. Every organization should be prepared for a crisis—an unlikely but potentially catastrophic event—but some organizations exist solely for that purpose. Police departments, fire departments and rescue squads are prime examples. The CDC is another. According to the organization’s website:

CDC works 24/7 to protect America from health, safety and security threats, both foreign and in the U.S. Whether diseases start at home or abroad, are chronic or acute, curable or preventable, human error or deliberate attack, CDC fights disease and supports communities and citizens to do the same. CDC increases the health security of our nation. As the nation’s health protection agency, CDC saves lives and protects people from health threats. To accomplish our mission, CDC conducts critical science and provides health information that protects our nation against expensive and dangerous health threats, and responds when these arise.

In simple terms, the CDC receives more than $6 billion each year to prevent medical crises when possible, and minimize their effect when they cannot be prevented. The CDC is responsible for understanding ebola and developing protocols for addressing the potential spread of the disease long before it becomes a daily news story. The fact that its director, Dr. Tom Frieden, has changed his response recommendations on several occasions is evidence that this was not done effectively. The fact that President Obama deemed it necessary to name a “czar” to manage the crisis is further evidence.

It doesn’t matter how many more cases of ebola are diagnosed. Our government was not prepared and has failed us. But many Americans won’t see it this way. They will judge the CDC on the number of additional ebola cases in the US and how many die as a result. If there are not many, the “everything is now under control” narrative will prevail and the details will be forgotten until the next crisis emerges.

I don’t expect perfection from the CDC, but I expect preparation and effective management. New leadership is needed. Too much is at stake.

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Ebola and the CDC

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There has been a lot of talk about the Center for Disease Control’s (CDC) role in the ebola scare. Some of it is accurate, but some is completely misdirected.

First things first…CDC director Dr. Tom Frieden should be fired. The CDC is, by definition, a crisis management organization. His job is to ensure that clear, consistent responses are in place when there is a direct threat to the health of Americans. He has been slow to react, evasive, and inconsistent. But the problem goes much deeper than Frieden.

A recent story in the National Review (www.nationalreview.com/article/390254/cdcs-laughable-pet-projects-brendan-bordelon) shed light on budget realities in the National Institutes of Health (NIH) and the CDC. The NIH’s inflation-adjusted budget more than doubled between 1996 and 2005, but many of its expenditures were less than essential. For example, the NIH spent $1.7 million on a Hollywood liaison to ensure the accuracy of medical portrayals on TV shows, over $5 million for a gay-porn website to provide HIV information, and $1 million on a study of sexual proclivities of fruit flies. The CDC recently spent $110 million on its new headquarters, including $10 million in furniture alone.

Republicans have rushed to criticize the President for proposing cuts in the CDC budget. This is true, but not relevant. The problem is not necessarily the size of the budget, but how it is being allocated. Precisely how much money does the CDC need to fulfill its mission? If a higher CDC budget could prevent the spread of ebola, then more spending on anti-poverty, education, and fill-in-the-blank could have the same positive effects. History has shown us that more government spending is rarely the best way to solve a problem, but Democrats—and in this instance Republicans—continue to tell us otherwise.

Leftists often criticize the private sector and those who claim “government should be run like a business.” In the private sector, it is assumed that failed organizations were not run properly in the first place. They are either directed to change course—new leaders, new strategies, new structures, new ideas—or they go under. They only get additional resources if investors can be convinced that doing so would generate a profit. However, failed government entities like the CDC are often excused because of “tight budgets.” Bang-for-the-buck is rarely discussed. This type of thinking explains the current $18 trillion national debt.

The CDC is relevant and should not be dissolved, but it should—like all other government organizations—be run both effectively (doing the right things) and efficiently (getting the most out of limited resources). It has failed in both regards and the answer begins with new leadership.

If you don’t run government like a business, then how do you run it?

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Venezuela’s oil disaster

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Venezuela’s nationalization of the oil industry has been a disaster. After running off the evil capitalists, the government hasn’t been able to extract and process oil at a competitive rate. The nationalization scheme has also failed to compensate oil companies fairly for their assets. Companies are entitled to fair market compensation if their assets are confiscated, but they rarely get it. Governments typically underpay because they get to set the price. Consider the case of Exxon in Venezuela.

In 2007, Venezuela expropriated Exxon’s Cerro Negro oil venture. Exxon attempted to negotiate a fair settlement with the government, but got nowhere and appealed to arbitration. Two years ago the International Chamber of Commerce ordered Venezuela to pay Exxon an additional $900 million. The World Bank’s International Center for Settlement of Investment Disputes (ICSID) just raised that payment to $1 billion.

This might sound like justice for Exxon, but the $1 billion figure is much less that the company should have received. Exxon was actually seeking $10 billion in additional compensation. While the actual value of the venture can be legitimately debated, most analysts agree that $1 billion is far too low.

This type of government intervention is not only inefficient—Exxon would have done a better job managing the venture—but it violates basic property rights. It is not disputed that Exxon has a right to fair compensation for its assets. However, Exxon should not have been required to sell the venture in the first place.

But socialist governments like Venezuela don’t respect private property. They take what they want and pay what they determine is fair. It’s an immoral system. If I tried this with my neighbor’s big screen TV I’d be in jail.

Venezuela’s bully government has run off oil producers, retailers, airlines, and a host of other foreign companies. The private sector is vanishing, leaving production to the bureaucrats. It’s no wonder that the Venezuelan economy is in shambles.

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Republican economics

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Larry asked a great question in response to my last post…so are the republicans supply side economists or Austrian economists?

If you are referring to Republican (or Democrat) politicians, most are attorneys, not economists, and there are different views within each party. The following is my oversimplified interpretation of national politics.

Let’s start with the Democrats. In general, most are part Keynesian and part central planner. Keynesians recognize some value in free markets but think they will ultimately self-destruct if not constantly reigned in by government. Central planners could be socialists, fascists, or some combination of the two; they believe that markets just don’t work or are overtly unfair. I don’t think most Democrats want to completely destroy markets; they just want to “control” them for the better. Obamacare is a great example because it touted “managed competition” in healthcare markets. Of course, competition is–by definition–free and cannot be managed.

It’s not easy to get a good read on Republicans as a group. Most campaign like Austrians in the primaries, promising to cut regulations and scrap the current tax code in favor of a flat or fair tax. They campaign like supply-siders in the general elections, promising a softer version of tax cuts and general regulation relief while promoting certain types of central planning, such as healthcare and education. They usually end up governing like soft Keynesians, favoring a combination of pro-market policies and populist, anti-market intervention.

When you mix the Democrats and Republicans in Washington, you get a blend of hard and soft Keynesian economics, a far cry from either the supply side or the Austrian views. This general mistrust of free enterprise explains why Washington’s best effort at reform typically regresses to talk about cutting the growth of spending or running existing programs more efficiently, and even watered down proposals like these usually don’t go anywhere.

Now back to the specific question…There are some exceptions to the rule, but most Republicans are neither supply sider nor Austrians. They’re middle-of-the-roaders who really favor a mixed economy. They want the growth of free enterprise and the security of big government, and don’t understand why the two cannot peacefully coexist. But trying to do both simply breeds cronyism. Supply-side policies are a move in the right direction, but a more potent Austrian approach attacks cronyism at the core.

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Supply-side economics revisited

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In my recent post on Obama’s “bottom-up economics” I referred to supply-side economics and largely positive but with shortcomings. My reference to shortcomings generated multiple comments and questions on- and off-line. Let me explain—at the risk of oversimplifying some complicated issues.

Economics is about supply and demand, but most “mainstream economists” tend to emphasize the latter. When consumers demand more goods and services the economy grows. This is true to a point, but Keynesians and other demand-side economists are shortsighted. Their solution to a stagnant economy is always about increasing demand and they prefer government spending to tax cuts because they can directly control how the money is spent. This ultimately leads to more centralized control, large deficits, and the like.

Supply-side economists like famous Reagan advisor Art Laffer emphasize the other side of the equation. From this perspective, lower barriers to production and greater access to capital increase supply and grow the economy. Laffer is known for the “Laffer curve,” a simple but powerful supply-side concept about tax rates and tax revenues. According to the Laffer curve, when tax rates become too high, a cut in taxes can actually increase government tax revenues by increasing incentives for companies to produce and individuals to work. There are a lot of other factors that influence government tax revenues, but the Laffer curve helps explain why Reagan’s tax cuts spurred both economic growth and increased government revenues. Reagan fell short of tackling the deficit, but that was largely a spending problem, then as it is today.

There’s no question that supply-side economists offer a breath of fresh air to a Keynesian-dominated world. Supply-siders attack burdensome regulations and confiscatory tax rates, both of which are byproducts of a demand-side approach. Unfortunately, they don’t go far enough. Most supply-siders don’t object to Federal Reserve intervention in an economy. While they tend to be more sensitive than demand-siders to Fed abuses, they take a middle-of-the-road approach and fail to see the long-term problems with an activist Fed.

Second, supply-siders don’t directly address the problem of cronyism, the ongoing collusion between politicians/bureaucrats and private interests. While a regulation rollbacks and tax cuts tend to reduce the influence of cronyism, most supply-siders are satisfied with a tax system with certain elements of social engineering (i.e., special deals designed to favor special interests) and heavy government control in select industries like healthcare and education.

My views are more closely aligned with the Austrian school of economics. Austrians realize that most—not just some—government intervention in the economy is detrimental. They don’t just favor tax cuts, but instead a complete overhaul of the tax system in favor of a fair tax or a flat tax with low rates and few deductions. They also insist on substantial reductions in government spending, not just minor tweaks, reductions in spending increases, or spending freezes. Government spending has always been and continues to be the number one problem. Austrians understand the importance of addressing this head-on.

At the end of the day, I agree with much of what supply-side economists have to say. Reaganomics was certainly a step in the right direction, but the current situation is dire and requires stronger medicine. The Austrian approach offers a more complete solution.

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Obama’s Bottom-Up Economics

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In a Labor Day political push for a minimum wage increase, President Obama ridiculed trickle-down economics and reiterated his support for what he calls bottom-up economics. The former is the pejorative frequently associated with former President Reagan’s supply-side economics, a philosophy built on lower business/corporate tax rates and reduced regulation. While Reagan’s approach was largely positive, it’s fair to say that supply-side economics has some shortcomings. That’s a topic for another post. What’s interesting here is that Obama seems to have backed into the truth with a catchy, but poorly understood quip.

I’m sure bottom-up economics has been thoroughly tested with focus groups or the President would not be using it. While it rings of concern for the common man–the “bottom” of the supply chain–Obama is anything but willing to let individuals determine their own economic fate. His proposed minimum wage hike is a top-down, centrally planned approach to economic growth. It would cost jobs by raising the cost of labor for employers. Prices of products and services generated by minimum wage workers would also rise as employers pass along the increased labor costs to consumers. There’s nothing bottom-up about raising the minimum wage, or about health care mandates, carbon taxes, or most of his fixes for our stagnant economy. Obamanomics is top-down economics.

Many on the left think that corporations control free markets, but consumers have the last say in a free economy. At the end of the day, buyers decide what to buy and companies must compete to win their favor. While many corporations wield lots of power these days, this is due to cronyism–collusion between firms and government–not the free enterprise system. The President has is backwards.

Contrary to the President’s rhetoric, a bottom-up approach to the economy should mean letting individuals make their own choices in the marketplace. Government interference picks winners and losers, and constitutes the very cronyism that is stifling economic growth. I’m all for bottom-up economics. The President is the one who doesn’t understand it.

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Revisiting Cash for Clunkers

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In 2009, President Obama and the Democrat Congress colluded to pass the Car Allowance Rebate System (CARS)—better known as CASH FOR CLUNKERS. As part of this economic/environmental stimulus program, car buyers who traded-in their gas guzzlers could get a $3500 or $4500 government cash voucher, depending on MPG ratings. The program was supposed to get inefficient polluters off the road and “jumpstart the economy.” Several studies, including one just published by Mark Hoekstra and colleagues at Texas A&M (http://papers.nber.org/tmp/22808-w20349.pdf), should put the final nails in the coffin of this ill-fated idea.

CARS was discussed extensively on this blog. There were several problems from the outset

  • CARS was arbitrary. Only those who owned a vehicle worth less than the $3500/$4500 voucher amount would benefit from the program. Cars worth more could be sold outright or traded anyway.
  • CARS encouraged debt with marginal buyers. By providing an inflated trade-in value of $3500 or $4500, low-income consumers were encouraged to purchase a new car. Dealers and banks are eager to provide financing because the vouchers provided a sufficient down payment, even though low-income buyers were more likely to default down the road.
  • Only certain new cars qualified, so most buyers had to incur debt to benefit. Consumers only received the voucher if they purchased a new car, something less desirable for low-income Americans.

Many on the left (and sadly a few on the right) initially called this program a success because many Americans predictably took the free money. U.S. Transportation Secretary Ray LaHood called it a “wildly successful run.” But clear evidence points to the failure. The Hoekstra study—and others—underscores the flaws.

  • About 677,000 vehicles were sold in the U.S. as part of the $2.9 billion CARS program. Vehicle sales to buyers with marginal incomes rose about 50% during the period, but according to a University of Delaware study, each vehicle traded in actually cost the government a net of about $2000.
  • Some dealers appear to have raised prices on eligible vehicles because the subsidy was sufficient to attract buyers. In other words, part of the subsidy benefitted dealers, not consumers.
  • According to the analysis by Hoekstra and his colleagues, most of the sales were “pulled forward” and would have occurred anyway, and the entire increase due to CARS was actually offset by declines 7-9 months after the program ended. Not surprisingly, U.S. auto sales declined by 23% the following month, led by GM and Chrysler with drops of 45% and 42% respectively.
  • Because CARS encouraged buyers to purchase higher MPG vehicles, most of the cars sold in the program were less expensive, low-margin models. Customers spent about $4600 than they would have if the program did not exist, resulting in an annual decline in auto industry revenues by about $3 billion a year.
  • CARS resulted in an increase in used car prices. Older vehicles with values in the “clunker” range rose in value because they could be exchanged for government vouchers. As more Americans participated in the program, the supply of “cheap cars” declined, raising prices on the market.
  • The program destroyed functioning vehicles. Typically, low-MPG vehicles are not driven as much anyway, but they provide essential transportation to low-income, occasional drivers. These vehicles were eliminated from the market, forcing prospective customers in the used car market to spend more.

CARS was a classic attempt by central planners to “fix problems” in the market, pick winners and losers, and stimulate the economy overall. Washington has passed many such programs, including the infamous “shovel-ready jobs that ended up not being shovel-ready.” Their proponents always claim success when the funds are flowing, but usually disappear when the unintended consequences become apparent. These programs squander tax revenues (or create more government debt) in the short term and disrupt markets over the long term. Fundamentally, they are part of the cronyism that is plaguing our nation.

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FRAT, the Fed, and the Stock Market

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Why does the stock market rise or fall? The prospects of individual firms included in the Dow, the S&P 500, and other indexes move on their own, but up and down swings in an entire index are usually based on broader perceptions about the economy. If reports suggest that people expect a stronger economy, you would expect these indexes to rise. The Fed often inverts this expectation, however, making it more difficult and risky for investors.

For example, if an economic report suggests that businesses expect a more robust economy, markets may actually fall because investors worry that this will bring about inflation and a tighter Fed policy. In contrast, if an economic report suggests weakness, markets can rise because investors anticipate looser Fed policy. Hence, producers in our economy and the investors who provide them with needed capital are often less interested in legitimate market news and more interested in how the Fed will respond to it. Stocks and other securities are only partially market-based, leading to all sorts of misperceptions about how they should be priced and resulting in stock market volatility.

In an efficient market economy, private investment is channelled to the most capable firms, and business and investment decisions are based on market factors. Basing decisions on guesses about government or Fed policy disrupts this process and misallocates these resources. Firms best positioned to deal with government regulations or changes in Fed policy–not necessarily those best able to produce what consumers want–get more resources when this occurs. In this way, central planners in Washington are indirectly picking winners and losers. Ultimately, this hampers the ability of our firms to compete globally, expand their operations, and hire more workers.

Measures designed to limit Washington’s control of our economy are essential if it to be strong over the long term. FRAT is a move in the right direction.

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