Rent-seeking diary: State dealer franchise laws and Tesla

By now you’ve probably heard that last week the New Jersey Motor Vehicle Commission passed a rule stipulating that automobile sales in the state cannot be direct-to-consumer, and must instead take place via dealer franchises. Tesla Motors was the clear target of this regulation, with its innovative electric vehicles and direct-to-consumer sales model. New Jersey is not the first state in which this regulatory tangle is occurring; last summer Tesla ran into dealer franchise law hurdles in Virginia and New York, as I discussed here in July.

The SF Gate blog post above notes:

Tesla said the administration had “gone back on its word,” claiming two top Christie aides had agreed not to move forward with the regulation. …

But a Christie spokesman rejected the accusations of a double-cross. The regulation, he said, won’t prevent Tesla from seeking legislation to allow direct sales in New Jersey.

Note that the political establishment response is to engage with the political process to get legislation passed to allow direct sales. What would such engagement entail? Will it entail the kind of crony relationships that have led to the entanglement of so many businesses and politicians in the past — will Tesla have to find its own politicians to fund in the hopes of a favorable legislative outcome? If so, that will vindicate my sad statement last July:

When innovative and environmentally correct meets the crony corporatism of existing legislation, is the entrenched incumbent dealer industry sufficiently politically powerful to succeed in retaining their enabling legislation that raises their new rival’s costs?

In New Jersey, it appears that the answer is yes, at least for now, as established car dealers cling to their old business model and hope to avoid being disintermediated. Tesla has thus far avoided the crony trap, and has instead focused on relabeling their New Jersey showrooms as “galleries” while encouraging customers to purchase the vehicle online. Will that legalistic sleight of hand suffice to enable an end-run around status-quo-protecting obstacles?

Alex Tabarrok discusses the Tesla-New Jersey case today, and analyzes it very usefully with a brief history of the evolution of state dealer franchise laws and how they served as a Coasean solution to an incentive problem:

Franchising rules evolved in Coasean fashion so that manufacturers could not expropriate dealers and dealers could not expropriate manufacturers. To encourage dealers to invest in a knowledgeable sales and repair staff, for example, manufactures promised dealers exclusive franchise (i.e. they would not license a competitor next door). But with exclusive franchises dealers would have an incentive to take advantage of their monopoly power and increase profits by selling fewer units at higher profits. Selling fewer units, however, works to the detriment of the manufacturer and the public (aka the double marginalization problem (video)). Thus the manufactures required dealers buy and sell a minimum quantity of cars, so-called quantity forcing. Selling more units is exactly what we want a monopoly to do, so these restrictions benefited manufactures and consumers.

Here Alex’s account dovetails with the history that Elon Musk provided in his open letter to the people of New Jersey on Friday:

Many decades ago, the incumbent auto manufacturers sold franchises to generate capital and gain a salesforce. The franchisees then further invested a lot of their money and time in building up the dealerships. That’s a fair deal and it should not be broken. However, some of the big auto companies later engaged in pressure tactics to get the franchisees to sell their dealerships back at a low price. The franchisees rightly sought protection from their state legislatures, which resulted in the laws on the books today throughout the United States (these laws are not present anywhere else in the world).

Musk’s letter is well worth reading in its entirety, as an eloquent and well-argued statement about regulatory and legislative entry barriers that enable incumbent firms to raise the costs of their rivals. He also provides a thoughtful and economically sophisticated (and accurate, I think) explanation for why they don’t want to sell Tesla vehicles through established dealers.

Here Alex adds another political economy detail of the economic leverage of the franchise dealers in the states — they provided jobs and their sales generated a large share of a state’s sales tax revenue, so politicians found it in their interest to shore up the state-level dealer franchise laws to protect the dealers. Thus a set of laws that initially benefitted both producers and consumers has evolved into industry-protecting regulation.

One other theme I’ve noted in the discussion of Tesla’s reaction to New Jersey cronyism is to criticize Tesla for the benefits it derives from government protection. Tesla’s business intersects with government programs in three areas: (1) taking a DOE-guaranteed loan of $465 million during the financial crisis, which has been paid back in full (and was smaller than the multi-billion-dollar loans to the Big Three); (2) the federal $7,500 income tax credit to individuals purchasing electric vehicles, from which all manufacturers of electric vehicles benefit and which is probably not decisive at the margin for Tesla’s high-income target customers; (3) revenue arising from the existence of a regulation-generated market for vehicle emission credits (ZEV) credits in California, in which Toyota and Nissan also sell ZEV credits to GM and Chrysler. I expect that being practical and not leaving money on the table is a sufficient motive to induce Tesla’s management to engage in those programs. But these benefits from government social engineering and regulation differ in kind from the kind of industry-protecting regulatory cronyism evident in New Jersey (and Texas, and other states forbidding direct-to-consumer car sales).

Saving the elephants and World Wildlife Day

The United Nations has declared March 3 to be World Wildlife Day. It’s a good opportunity to reflect on the problems of wildlife poaching, which, as Ashok Rao wrote recently, is a moral, social, and political problem.

But, as Virginia Postrel pointed out in her then-NYT Economic Scene column in 2000, it’s also an economic problem, a problem of institution-driven misalignment of incentives. The challenge is to have local community-based institutions that create long-run economic incentives to preserve, or even increase, the wildlife population:

Institutional experiments that give local people a financial stake in wildlife have had some striking successes, particularly in Zimbabwe. There, the government in the mid-1980’s began the Communal Areas Program for Indigenous Resources, better known as Campfire. The program gave local districts wildlife-management authority in communal areas outside the national parks. In some cases, the local districts devolved control further, down to groups as small as 200 villagers. …

Under Campfire, the local authorities worked with outside experts to determine, for instance, that the area could maintain a sustainable elephant population by hunting two elephants a year. Residents would then contract with a safari operator and split the fee of around $25,000 an elephant paid by the hunter. In most cases, the villagers also got the meat from the elephant.

But even such innovative economic thinking has its limits. Both neoclassical and institutional conservation models share an underlying assumption: that the government respects the rule of law and the goal of conservation.

Along the same lines, Arancha Gonzalez writes in today’s Wall Street Journal that Legal Trade Can Save Endangered Wildlife:

Giving rural communities the right economic incentives is critical to protecting wildlife. This is difficult in countries with weak governance and high levels of poverty. Trade bans are often undermined by strong incentives to supply the market demand for the animals and the products that can be harvested from them. Bribes and intimidation from poachers and illegal wildlife traders erode such incentives even further.

And, as Doug Bandow observed in The Freeman last week, a legal market for ivory may be the best way to maintain elephant populations, by creating incentives for people to have elephants around:

Some activists appear to believe that it simply is morally wrong to trade in animals, or at least elephants. But markets have been used elsewhere to help save endangered species.

CITES points to a number of examples. Once-endangered vicunas “are managed through captive breeding and non-lethal harvests from wild populations.” In China, “tigers are being farmed with the intention of supplying tiger parts in the future.” Moreover, “The legal trade in crocodiles is one of the success stories in CITES history which shows species recovery as a result of trade.”

Why not elephants too?

The current system formally treats elephants as sacred, thereby leaving them for dead. Markets would treat elephants as commercial, thereby keeping them alive.

Joel Mokyr on growth, stagnation, and technological progress

My friend and colleague Joel Mokyr talked recently with Russ Roberts in an EconTalk podcast that I cannot recommend highly enough (and the links on the show notes are great too). The general topic is this back-and-forth that’s been going on over the past year involving Joel, Bob Gordon, Tyler Cowen, and Erik Brynjolfsson, among others, regarding diminishing returns to technological change and whether we’ve reached “the end of innovation”. Joel summarizes his argument in this Vox EU essay.

Joel is an optimist, and does not believe that technological dynamism is running out of steam (to make a 19th-century joke …). He argues that technological change and its ensuing economic growth are punctuated, and one reason for that is that conceptual breakthroughs are essential but unforeseeable. Economic growth also occurs because of the perpetual nature of innovation — the fact that others are innovating (here he uses county-level examples) means that everyone has to innovate as a form of running to stand still. I agree, and I think as long as the human mind, human creativity, and human striving to achieve and accomplish exist, there will be technological dynamism. A separate question is whether the institutional framework in which we interact in society is conducive to technological dynamism and to channeling our creativity and striving into such constructive application.

The peanut butter Pop-Tart is not an innovation

Today’s Wall Street Journal has an article about the use, overuse, and misuse of the word “innovation” in modern business, particularly with respect to consumer products. The number of instances of S&P 500 CEOs using the word in their earnings calls has doubled since 2007. Sadly, this misuse and overuse threatens to remove all meaning from the word. Witness the example offered in the article’s title: Kellogg’s new peanut butter Pop-Tart, which Kellogg executives tout as one of the most important innovations of 2013. Peanut butter filling instead of cherry or strawberry or chocolate, an innovation? Really?

Next time your boss starts droning on about innovation, it might be helpful to stop and analyze: Is she talking about building the next iPod or the next Pop-Tart? Does “innovate” mean just “stay competitive”? And if so, where is the innovation in that? …

In this context, to innovate can often mean falling short of the word’s Latin roots (of “new creation”). It’s more modest: simply keeping pace with rivals.

They used to call it competitiveness—a word fraught with the implication that others might win. Now it has been elevated to innovation, a more regal way to describe what business has always done: Adapt.

That’s a great point, and it’s a point that Schumpeter and Austrian economists have made for over a century — there are many different ways that firms adapt to the effects of rivalry in markets, and one of them is innovation. But, you might reply, Schumpeter emphasized the role of product differentiation in lessening the effects of rivalry, by making your new product less substitutable for the existing competitor products, and isn’t a peanut butter Pop-Tart an example of product differentiation? (Technically speaking, my answer to that question is no, but that may be me being pedantic, which is what I do …)

That’s where an old post from Roger Pielke Jr. is helpful:

In recent comments I was asked about what I mean when I use the term “innovation.”  I use the term as Peter Drucker did:

Innovation is change that creates a new dimension of performance.

Roger tweeted the link to that old post in response to the WSJ peanut butter Pop-Tart article today. Does Drucker’s definition help; is it “operationalizable”? Only if you define “sell more peanut butter Pop-Tarts” as the new dimension of performance!

“That—that—is what we are for: voluntary associations, in all their richness and bewildering complexity”

The above is a quote from Duke political economist (and friend of KP) Mike Munger, who also blogs at Kids Prefer Cheese and Euvoluntary Exchange, and is a frequent guest on EconTalk. Mike’s written a thoughtful and interesting reflection in the Freeman on what libertarians stand for. In many ways it’s a riff on Toqueville and his analysis of American society, which remains fresh and relevant today in Mike’s view (and mine). While it’s eminently quotable, please do read the whole thing, especially if you don’t identify as a libertarian. Mike’s insights might change your thinking about what libertarians do stand for.

Why is he bothering to reflect on what libertarians stand for?

The government is not providing the basic services that our more idealistic fellow citizens expect, and they want to know why. The things they think they wan [sic]—healthcare, pensions, schools, the war on terrorism, and the war on drugs—are a litany of failures. We don’t need to pile on and say we’re against those things. We need to offer an alternative.

In other words: What positive, optimistic alternative vision of society (yes, of society, the social thing, where you actually talk to other people and work together) can we offer? Unless we can answer that, the next question will be, “Why don’t Libertarians care about real people?”

I have been making this argument to my colleagues with respect to energy and environment policy for some time. I team-teach a sustainability course with a geologist and a philospher, both of whom are politically Progressive and have typically advocated large-scale top-down regulation and government control to address global warming. As they have seen the reality of using political institutions to make collective decisions, they have expressed frustration; as they have heard my lectures on public choice and political economy and read some of the political economy literature on environmental regulation, they have expressed some ideas similar to what Mike said above.

So I’ve been focusing on alternatives — liberty allows for experimentation and for individuals to make choices that express their environmental values. The more of those experimentation and expression processes we foster, the more likely we are to devise lower-carbon ways to achieve what we want to achieve. That’s one application of the vision that Mike describes.

But a lot of people don’t think about the connection from liberty to experimentation to thriving, and default to expecting “the government” to solve collective problems. In general, people pay too much attention to politics:

If citizens ignored politics, things wouldn’t be so bad. But we are worried that our excessive focus on politics will cause us to ignore society and each other. If we fail to connect as social beings in complex reciprocal exchange relations, modern “democratic” life becomes anomic and mean, just as Tocqueville foresaw.

That—that—is what we are for: voluntary associations, in all their richness and bewildering complexity.

If you want to go out and persuade some people to work with you, and all voluntarily work for the benefit of each, then that is libertarian social change. If someone wants to opt out and form a different association, they are free to do so. And that’s a good thing because you get diverse experimentation in problem solving.

And I really like his conclusion, which makes me feel happy, large, empowered, and connected (four feelings I never experience in political collective action):

Libertarians are for voluntary action, always. It is because we are for society—a vibrant, active society—that we resist the expansion of state power.

It is because we are for giving people a chance to reach their full potential that we doubt the motives and effectiveness of government. Political coercion corrupts the human spirit; political leaders tell us they take our wealth for our own good, and political processes straitjacket independent thought—the essence of liberty.

We are for individuals, working together in complex, interconnected organizations they have designed in their efforts to solve problems.

We are for liberty, for celebrating the infinite and infinitely varied capacities of the human mind. Libertarians are for a limitless sense of the possible, for the idea that for a society of truly free and responsible citizens, nothing is impossible.

Alexis Madrigal: Why are gasoline prices falling?

Freshly returned from a few months spent with his new baby (congratulations!), Alexis Madrigal at the Atlantic wonders why gas prices are falling in the US. He notes that the national average is the lowest it’s been in almost three years.

He identifies a few factors that influence gas prices, most notably world oil prices. These prices have fallen, due both to demand and supply factors, and most importantly how higher gas prices induced consumers to change their behavior:

But they [gas prices post-Arab spring] couldn’t go too high because, at least here in the U.S., demand has softened. Americans are buying (slightly) more fuel-efficient cars, on average. And younger people are driving less.

Which is all a pretty rational response to the big run up in gas prices during the mid-2000s.

He then points out (courtesy of Brad Plumer) something that shows just how complex the dynamics are in gasoline markets — gasoline and diesel are joint products, so to produce more diesel you get more gasoline. Diesel is in high demand in Europe, thanks in part to the economical and energy-efficient, yet also sassy and full of fun, TDI diesel engines from Volkswagen and Audi (and it’s an interesting question to ask why US regulations still provide such barriers to TDI diesel, but I’ll leave that as an exercise for the reader ;-0 ). If you are refining diesel in the US to export to Europe, you will increase the supply of domestic gasoline, shifting the supply curve out. In the face of that softened demand, that’s going to mean lower prices.

A couple of neat points, but this post is mostly an excuse for me to say how glad I am that Alexis is back from paternity leave! I missed his writing.

History of thought course video: Hayek and the knowledge problem

Not surprisingly, given the title of this blog and the focus of my research, the last video in the series for my history of economic thought course provides an introduction to Hayek and the knowledge problem.

Hayek’s work in the 20th century explored a range of ideas, one of the most important of which was the argument that the fundamental economic challenge in a society is the coordination of plans and actions among agents in an economy, all of whom have diverse goals and make choices based on their own perceptions and private knowledge. The knowledge problem has implications for questions from the socialist calculation debate of the 1920s and 1930s to the modern policy analyses of the regulatory state.

Perverse outcomes of water subsidies

I’m intruding on David Zetland’s turf, but in this 2012 Guardian article from 2012 Roger Cowe makes some compelling arguments about why agricultural water subsidies lead to perverse outcomes, do not help the poor, and waste a precious, scarce resource. Water is the only industry in which regulation more perversely stifles self-organizing processes for managing scarcity than electricity. His conclusion is apt:

Like most other perverse subsidies, the goal of improving access to water is not at issue. The perversity arises because making water cheap, especially to crop farmers, leads to excessive use and unintended, environmentally harmful consequences. And the poor, who are often the main targets of subsidies, typically don’t benefit. Irrigation benefits landowners rather than their tenant farmers. And surprisingly, consumption subsidies do few favours for poorer families.

Appreciation of Ronald Coase

Ronald Coase passed away yesterday, four months shy of his 103rd birthday and working right up to the end. An archive search here shows how deeply Coase’s work influences Mike’s and mine, and we are not alone — Coase was one of the most influential economists of the 20th century, an influence made even more striking by the fact that it derives from relatively few publications. Few, but subtle and nuanced, and blockbuster. I cannot think of any aspects of my research that his work has touched, and his method of analyzing and thinking through problems also informs most of my teaching and research, and writing more generally.

Some appreciations of Coase come from Peter Klein, Geoff Manne, Jonathan Adler (on Coase and Ellickson and on Coase and externalities, the second being a must read), Todd Zywicki (making the essential point about the subtlety of Coase’s argument that costs are reciprocal), and Northwestern’s own Kevin Bryan. David Henderson also excerpts a quote of Coase’s that I find particularly inspiring in suggesting how we should engage in economic analysis:

Testable predictions are not all that matters. And realism in our assumptions is needed if our theories are ever to help us understand why the system works the way it does. Realism in assumptions forces us to analyze the world that exists, not some imaginary world that does not.

Given the recent debate around “economath” and the Rosenberg/Curtain NYT commentary about economics not being a science because it fails to generate testable predictions (which is a very narrow and not widely-held definition of science, I think), Coase’s observation is apt — strong assumptions to enable excessive formalism in our theory formation reduce our ability to use our models to understand how the world works, and that’s a tradeoff that we confront constantly.

I honor Coase’s long, richly-lived life, and the important new ways of thinking about and understanding the world that his work has enabled.

UPDATE: Pete Boettke and I were clearly working in parallel, and he posted this excellent observation about Coase’s contributions to new institutional economics and robust political economy at the same time I did. Pete also points to the 1959 FCC paper, which I think is one of Coase’s best and is quite underappreciated for many reasons (and I’ve written about a lot here before, particularly regarding modern spectrum policy).

Public Choice Theory: Skwire’s First Law

Some time last spring, my friend and occasional KP contributor Sarah Skwire formulated on Facebook what’s now dubbed “Skwire’s First Law”, and we’ve been using it, kicking its tires, and discussing it all summer. In a timely manner (given what we’ve learned this summer about widespread, unwarranted government surveillance and the impending likelihood that yet another president will engage in yet another international military action without Congressional authorization), Sarah has formalized and expanded upon Skwire’s First Law in a Bleeding Heart Libertarians post today:

Accidentally invented by me on Facebook a while back, named by my co-blogger Steve Horwitz, and picked up–to my great diversion–by a crew of Facebook friends, Skwire’s law is simply stated thusly:

Politicians are asshats.

I’m driven to write a bit about Skwire’s First Law today because, like every other day, politicians are being asshats. And I want to talk about how Skwire’s law—though simply expressed—is not merely a sigh of exasperation, a political version of “boys will be boys.” It’s a manifesto condensed into three words.

Saying that politicians are asshats means that you acknowledge the deep truths of public choice theory. It means that even if the occasional politician supports a policy you like or gives a speech you admire, you know enough not to turn him or her into a hero. We can debate, as my friends and I have on Facebook, whether asshats become politicians or politicians become asshats. I don’t think that debate much matters, because I think both parts of it are true. Politics is a machine that turns good people and good ideas into bad ones, and turns bad people and bad ideas into worse ones. Politics is a system that attracts not only people who want to help, but people who want to control. And once those people—good or bad, helpful or controlling—are in the system, they use it to further their ends.

Note in particular the last three sentences, and how they encapsulate the essential implications of public choice theory — in our roles as political actors (here let’s focus on individuals as elected representatives and in regulatory agencies, not as voters), individuals prioritize self interest, broadly defined. This is the extension to the political decision realm of the self-interest assumption in our roles as purposive individuals in other decision settings. Many individual politicians are motivated by good intentions (the “public interest”, making the world a better place, “giving back”, bringing resources to his/her community), and some are also motivated by the desire to control and manage the choices of others and how others live their lives. Public choice theory is general enough to accommodate that diversity of motivation and intent.

More insidiously, though, the fact that political power gives politicians coercive power to make decisions about the resources and the choices of others means that even those who have good intentions and good ideas can, do, and often must use control and coercion to satisfy those intentions and attempt to implement those ideas. Thus even well-intentioned politicians use the system of coercion and control to attempt to achieve their ends. And I hope Sarah doesn’t mind my paraphrasing a Facebook comment of hers on this point, because it’s apt: by definition, politics means using the state’s monopoly on force, and being a politician means that you contribute to decisions that will use that force to enshrine your “honest mistakes or infelicitous actions” in a pretty permanent way in the lives of many, many people, including those the politician says s/he wants to help. If that politician is unaware of that likelihood, or doesn’t care, that’s asshattery. It’s also hubris. And it’s pervasive in politics.

Sarah goes on to point out that this outcome is not accidental or a flaw, although some of us may consider it perverse. Here’s where the study of institutions and incentives becomes important — once these individuals become politicians, they are embedded in a set of institutions that shape their incentives. They face the tragedy of the commons in the federal budgeting process, because to bring resources home to their constituents means either decreasing resources somewhere else that doesn’t matter as much to them or increasing government spending in ways that can unsustainably increase government debt (oh, hey, did you know we’re hitting another government debt ceiling in October?). They trade votes and engage in log-rolling to achieve what they style as “compromise”. The incentives are inherent in the institutions, and they are bad incentives that lead to inferior outcomes and to politicians being asshats. Of course there are nuances and degrees of asshattery, especially if you look on an issue-by-issue basis at the questions you find most pressing. But remember the initial formulation: occasional support that aligns with your preferences does not change the fundamental, underlying institutional incentives.

Note that this asshat designation is not a statement about personal character or merit of the individual politician. It’s a statement about the institutionally-driven incentives facing each individual politician regardless of their motivations or intentions. And that’s what makes it such a pithy and damning statement about the pernicious effects of political decision processes, even (or perhaps especially) political decision processes in what is supposed to be a democratic republic. It is the nature of our political institutions that politicians are asshats, and therefore

[t]hey are wasting your time and your money and your energy. They are allying you with people you hate and with causes you despise and with actions you would never condone.

Don’t wait around for them to save you or the things you think are important. Don’t think you’ve found the politician who can fix your world.

Realizing this nature of political institutions opens up the idea that political processes are not necessarily the only or the best way to approach social conflicts and problems. Thinking about alternatives, about experimenting with different approaches, about the impossibility of doing away with all social problems, gives us opportunities to be creative and to enable other approaches to emerge.