Posts Tagged ‘Regulation’

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Reasons to end the War on Drugs. Now.

April 20, 2012

Lynne Kiesling

Today in Forbes Art Carden has an essay arguing that we should end the War on Drugs and make marijuana legal, now. He’s right. Here’s why.

  • As Art argues, the War on Drugs is a policy poster child for unintended consequences, because the inelastic demand for the regulated good means that stronger enforcement leads to more profits from selling the good. The War on Drugs increases drug dealer profits.
  • Because of those profits relative to other alternatives, the War on Drugs just doesn’t work. An example: here in Chicago we had a recent spate of unusual gun violence, and even though new police chief Garry McCarthy said last year that he thought the War on Drugs was ineffective, after this violent weekend he joined mayor Rahm Emanuel in promising more vigorous and aggressive enforcement and targeting of drug transactions. Note at the head of the lede that Mick Dumke says “The first time I heard a police officer argue that the war on drugs wasn’t working was in 1994.” Law Enforcement Against Prohibition has been saying it since 2002.
  • The War on Drugs violates the fundamental individual right that humans have of self-ownership; individuals have the right to choose their own actions without interference as long as their actions do not violate the fundamental individual rights of others.
  • The War on Drugs has created horrific law enforcement violations of individual rights: police brutality, increased police militarization, no-knock raids resulting in property destruction and death of innocent citizens when they get the wrong addresses, civil asset forfeiture rules that police departments have incentives to exaggerate so they can sell assets to raise revenue. The actions that the police rationalize using the War on Drugs increasingly are the actions of a police state.
  • The War on Drugs has virtually eliminated the constitutional protection of individual rights against unreasonable search and seizure, and is seriously eroding judicial due process rights.
  • The War on Drugs has costly and socially corrosive blowback in other areas. If you think that the invasive actions of the TSA are solely related to the War on Terror, you haven’t been paying attention. When the TSA crows about its “successes” in airport security, they are often items of “contraband”. The War on Terror is in part a red herring for the War on Drugs, and the two combine to give law enforcement officials substantial discretion in the militarization, unreasonable search, etc. mentioned above.
  • The War on Drugs has destroyed the fabric of urban families and communities much more than drug use would, through the disproportionate incarceration of young African American men (see above point about how regulation increases the profits from the drug trade).
  • In addition to the immorality of the War on Drugs described above, as a matter of public policy it fails benefit-cost analysis. Jeffrey Miron estimates the net effect annually of reducing enforcement, legalization, and taxation of marijuana to be $15 billion — an increase in tax revenue of almost $7 billion and a reduction in enforcement costs of $8 billion. The net social savings from extending legalization to other drugs is even larger. Think about the other uses of those resources — revenue for deficit reduction, reallocation of law enforcement activity to some other area where it may actually have meaningful beneficial impacts (like, say, intelligence gathering, community development, cops walking the beat).
  • The beneficial budgetary effects and reduced social corrosion that Miron suggests have actually happened recently in Portugal, which has liberalized its drug trade and consumption, with net beneficial financial and social effect.
  • The hypocrisy of the War on Drugs is astounding, particularly the president’s recent heavy-handed opposition to legalization after his admission in 2004 that the War on Drugs is a failed policy. In the face of the fact that the health effects of alcohol are more negative than of marijuana and the fact that general social mores have moved so that more than half of the U.S. population believes that marijuana should be legal, this hypocrisy is downright absurd.

Nick Gillespie says it well in this reason.tv video:

We cannot afford the War on Drugs, either morally or economically. End this costly, ineffective, corrosive policy. Now.

 

Posted in Economics, Liberty, Regulation, Uncategorized | Tagged , , , | 3 Comments »

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Learn Liberty video: should government regulate monopolies?

March 21, 2012

Lynne Kiesling

I am happy to say that Learn Liberty has published another video that we did together. This one is a short one in which I talk about government regulation of monopolies, essentially laying out Schumpeter’s argument that when entry costs are low, monopolies do not persist because monopoly profit serves as a lure to entice entrepreneurs and innovators to create new value propositions (“new combinations”, in Schumpeter’s words) that break down market barriers and definitions.

Those of you with an electricity/natural monopoly background will notice that I assiduously stay away from economies of scale and subadditivity of costs as a cause of monopoly formation. Couldn’t keep the video at 3+ minutes if we opened that Pandora’s box!

The Learn Liberty page for the video also has a description and some discussion of the issues.

Posted in Economics, Regulation | Tagged , | Comments Off

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Innovative retail competition: is it finally starting … and in Chicago?

March 21, 2012

Lynne Kiesling

This may be the beginning of what I’ve been arguing for over the past decade plus … today in Smart Grid News, Jesse Berst reports that Constellation Energy has teamed up with Best Buy to enable customers to come into the store, switch their retail provider, and buy home energy management devices (see also the brief note in the Chicago Tribune). Jesse observes that

It has been fascinating to watch power retailing develop in areas such as Texas and the United Kingdom. In the early days, we thought it would be all about price. As it turns out, price is important but it is just the table stakes. To become a market leader, you have to establish brand trust. You have to bundle the power with other products or benefits. And you have to make that bundle ultra-easy to find and purchase.

Absolutely correct. This is the kind of Schumpeterian retail innovation that is a value-creating hallmark of competitive rivalry.

At first blush it also has some similarities with mobile phone retailing — I presume that the retail provider to which a customer can switch is Constellation, and not Direct Energy or any of the other retail providers in the Illinois residential market. I’ll be interested in seeing if Best Buy is willing to make similar arrangements with those retailers. If their contract with Constellation precludes such arrangements, then we run into the murky area of whether or not exclusive dealing contracts are anti-competitive. But if, say, Target strikes a deal with Direct Energy, and Costco and Walmart get in on this innovation, then the retail landscape really starts to look like mobile communications retailing, and things get very interesting.

Note also that this type of market channel is a way for consumers to learn, which is a crucial process in the liberalization of retail sales in an industry that has been vertically integrated and regulated for over a century. Regulation defines product characteristics and boundaries and thus determines the type of product that the consumer is purchasing, so for over a century residential customers haven’t had to think about what they are buying and whether there are ways for them to get more value out of the transaction and relationship. They had no choice, so why give it any thought? Now starts the process of individuals learning how and why they may create more and different value from changing their retail relationship and changing the technology they use in the purchase and management of the electricity they consume.

As it happens, the Best Buy in this pilot is my neighborhood store, so I’ll check it out and report back what’s interesting and important. Free the electricity consumer!

Posted in Economics, Electricity | Tagged , , , | 1 Comment »

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How fear affects policy: Adam Thierer on technopanics

March 14, 2012

Lynne Kiesling

Fear is a strong motivating factor, having evolved over millennia as we have protected ourselves against predators. Fear supports self-preservation by making us risk-averse and cautious. But such a deep, visceral, evolved emotion does not always serve our long-term objectives of thriving; it leads to maximin outcomes, and it is often mismatched to the actual threats to our self-preservation. As our environments change around us, we can fear things we shouldn’t and may not fear things that we should; we overthink everything and tend toward a “precautionary principle” approach, making us risk-averse and cautious.

I think such fear is a component in the persistence of regulation when it’s maladaptive to technological change, so I was happy to read Adam Thierer’s new Mercatus working paper, Technopanics, Threat Inflation, and the Danger of an Information Technology Precautionary Principle. Adam lays out a framework for analyzing fear-based attitudes toward technology and technological change that’s informed by economics, sociology, psychology, and rhetoric. He tackles the question of why, and how, participants in public policy debates use appeals to fear to sway opinion toward anticipatory regulation and forms of censorship:

While cyberspace has its fair share of troubles and troublemakers, there is no evidence that the Internet is leading to greater problems for society than previous technologies did. That has not stopped some from suggesting there are reasons to be particularly fearful of the Internet and new digital technologies. There are various individual and institutional factors at work that perpetuate fear-based reasoning and tactics.

He analyzes the use of “appeal to fear” and “appeal to force” logic in the construction of arguments in favor of regulation and censorship, focusing on case studies of online child safety and violent media and online privacy and cybersecurity. In deconstructing these arguments he identifies four ways that fear can be a myth: it may be empirically unfounded and lacking evidence, other variables may be more important in affecting behavior than the feared variable, not all individuals have the same reaction to the feared variable, and other approaches than regulation exist that can mitigate the consequences of the feared variable (pp. 5-6).

Adam introduces the phenomenon of the “technopanic”, which is “… a moral panic centered on societal fears about a particular contemporary technology” (p. 7). Because culture often evolves more slowly than technology, as we are adapting culturally to the new technology we can see these panic phenomena, which can result in demonizing the technology and can lead to calls to “do something”, typically some form of control-based anticipatory regulation or censorship. A crucial part of manipulating individual attitudes to tap into fear and create advocacy for and acceptance of such regulation is what Adam calls “threat inflation”:

Thus, fear appeals are facilitated by the use of threat inflation. Specifically, threat inflation involves the use of fear-inducing rhetoric to inflate artificially the potential harm a new development or technology poses to certain classes of the population, especially children, or to society or the economy at large. These rhetorical flourishes are empirically false or at least greatly blown out of proportion relative to the risk in question. (p. 9)

Allowing threat inflation and technopanics to drive policy outcomes is socially corrosive and wasteful; it diverts resources from their higher-valued uses in dealing with actual risks rather than inflated ones, and it creates an environment of suspicion and social control, particularly censorship and information control. After analyzing six factors that create conditions favorable for the development of threat inflation and technopanics regarding Internet technology (nostalgia, special interests, etc., well worth reading in detail), he proposes two categories of policy response that we should pursue instead of prohibition and anticipatory regulation: resiliency and adaptation. We build resiliency to threats through education, transparency, labeling, etc., and we adapt to living with risk through experimentation, trial-and-error, experience, and social norms. These two are complementary; information-sharing about best practices can shape social norms and get people to change their behavior without regulation. For example, I don’t sign my credit cards, but instead write “CHECK ID” in the signature line and present a photo ID when using them. Having store clerks and other shoppers witness my behavior to protect my identity may lead to their replication of it, and has led over time to a change in behavior (remember back in the 1990s when they used to write your phone number on the receipt? Yikes! But that behavior’s gone extinct.).

We cannot eliminate risk through resilience and adaptation, but we can’t eliminate it through regulation either. Better to have strong, flexible, adaptable institutions and practices that enable us to continue thriving in unknown and changing conditions, while we enjoy the substantial benefits of technological creativity. While I heartily recommend Adam’s paper to you all as a good and thought-provoking read, he also summarizes it in this recent Forbes column.

I would extend Adam’s argument to apply to two case studies. The first is smart grid technology. Fear-based arguments abound in electricity, usually grounded (pun intended!) in the physical reality that electricity is dangerous. But after a century of economic regulation to serve particular social policy objectives, fear-based arguments also show up in arguments against moving away from the status quo both technologically and more economically in general; in my experience these fear-based arguments are used most to advocate for the status quo on behalf of low-income consumers and the elderly, and for that reason I find the use of fear-based arguments heart-wrenching, because when they succeed they deprive vulnerable populations of the benefits of innovation. Another current example is the arguments that digital meters, which transmit data using radio frequency wireless networks and thus emit low-level electromagnetic fields, are making people sick. Despite the absence of any scientific evidence consistent with this hypothesis, California and Maine are using these fear-based claims as a basis for allowing customers to opt out of having a digital meter installed (I have other analyses of this phenomenon, but that’s for another time …).

The second case is threat inflation and the exaggeration of fear to extend the security state. Each of Adam’s six factors contributing to threat inflation is applicable to the growth of the security state — nostalgia, pessimistic bias, “bad news sells”, the political power of the military-security-industrial complex, and so on. The persistence of threat inflation enables these special interests to use fear-based arguments to perpetuate the false belief that we are under constant, persistent threat beyond the actual threat level; this false belief creates the incentives in politicians to “do something” so that they don’t appear “soft on terror” and therefore risk not getting reelected; that political incentive enables security and defense companies to lobby politicians to buy their cutting-edge technologies at very great taxpayer expense to demonstrate to voters that they are “doing something” (even though the technologies have high false positive rates, can be fooled easily, and are more for symbolic security theater than for addressing the most relevant risks that we actually do face).

In both cases, a resiliency-oriented public policy approach would be a substantial improvement on the control-oriented regulation that is not focused on the most meaningful or relevant threats, be they health threats, economic threats, or security threats, from technological dynamism.

Posted in Economics, Electricity, Regulation, Technology | Tagged , , , , | 5 Comments »

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Green energy paradox: Hotelling’s exhaustible resource and consequences of improving the alternatives

February 24, 2012

Michael Giberson

The “green power paradox” grabs Hotelling by the ankles, turns him upside down, and shakes the change out of his pockets.

Harold Hotelling’s classic article, “The Economics of Exhaustible Resources,” observes that the owner of an exhaustible resource stock always is making choices in the shadow of the future. If the owner produces and sells a bit today, that necessarily involves sacrificing the opportunity to produce and sell that bit in the future. Given that the resource is exhaustible, we expect the price to increase as the stock of resources nears exhaustion. The resource owner’s choice, then, is whether to sell at a low price today or a higher price tomorrow.

Hotelling’s mathematics says the resource price will tend to increase at the rate of interest, at least under certain conditions (The intuition: if the rate of price increase is below the rate of interest then it will pay to produce more quickly now; if the  price increases are any faster then it will pay to produce more slowly. The adjustments will tend to keep the rate of resource price increases in line with interest rates.)

The green paradox emerges when, in a world of exhaustible energy resources, a new renewable energy supply is introduced. Suddenly, the heavy hand of the future is lifted a little. Therefore, even as the exhaustible energy resource dwindles, no longer can the owner expect ever rising prices. In fact, as the technology of the renewable energy resource improves, the price of all energy resources should drop.

In a world of constantly improving renewable energy technology, the owner of an exhaustible resource may be choosing between a low price today and an even lower price tomorrow. The implication: produce and sell now, before the price drops again!

Paradoxically, government promotion of alternative energy technology as a means to fight global warming may be encouraging the rapid exploitation of fossil fuels!

(This is my optimistic, Julian Simon-esque version of the Green Paradox, with resources becoming cheaper over time. A similar pessimistic version can obtain if owners of an exhaustible energy resource expect that regulatory controls on production will become increasingly onerous over time. Produce now while the controls are light instead of keeping your resource in the ground where future regulations may insist it stay.

And finally, if you are a combination resource optimist and a regulatory pessimist, then you ought to stop reading this post right now and go drill, baby, drill!)

SEE: Hans-Werner Sinn, The Green Paradox, MIT Press (2012). Related Sinn: “Greenhouse gases: Demand control policies, supply and the time path of carbon prices.“

HT: Marginal Revolution.

Posted in Economics, Energy markets, Environmental policy | Tagged , , | 9 Comments »

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Breaking news: State regulatory procedures do not favor consumers

December 22, 2011

Lynne Kiesling

As is the vernacular these days, your response to the title of this post is probably “I know, right?” Or, if you prefer sarcasm, you may say “no, really?” This is the conclusion of an all-too-rare piece of investigative journalism from Dan Garino at the Columbus Dispatch:

Ohio’s unique system for setting electricity rates has created a quagmire of regulations that have benefited industry over consumers. …

The rate increases stem from a complex regulatory approach unlike any other in the country, one that combines elements of both regulated and free-market systems.

Beyond that, The Dispatch found during a yearlong investigation that the state’s regulatory structure misses what many observers see as the underlying problem: Utility companies have tremendous political power that tends to overshadow consumers’ needs in the process.

This lengthy article goes into detail on the legislative history of electricity restructuring in Ohio and the political economy of utility lobbying of legislators, as well as the role of the Public Utility Commission as regulator in this hybrid restructured state. If you are interested in electricity or the political economy of regulation, it’s a worthwhile read — a case study in public choice theory.

In its early years of restructuring, Ohio was held out as a leader with strong potential for consumer-oriented retail competition, but over time that competition has not emerged. One of Ohio’s institutional innovations was “aggregation”, or allowing municipalities to act as a retail aggregator on behalf of a set of customers, in that case its residents. But Ohio’s legislators and regulators did not pay adequate attention to the unintended consequences of the political compromises they made that would continue to serve as entry barriers to potential retail competitors, including aggregation.

In terms of the PUCO regulatory procedures and the processes through which debate and discussion are supposed to happen, the article makes a lot out of the unanimity of the Commission’s decisions, but does not dig into the very formal (and formulaic, I think) procedures for filing comments on cases. That process, and its positive and negative consequences, is in and of itself worthy of a lengthy analysis; because of that process, most issues that the commissioners have are likely to be resolved before the ultimate vote, so unanimity is not that surprising. It’s not unique to Ohio, though.

I don’t want to comment on the particulars of Ohio, but I think that most of the states that have implemented regulatory restructuring have a similarly tortured legislative and regulatory story to tell. This Franken-restructured status arises out of a politically-motivated desire to “ring-fence” competition, to capture the benefits of utilities being able to purchase power in competitive wholesale markets, but to control and manage the retail market in ways that create the (realistic, IMO) impression that retail customers are still subject to the regulated monopoly. Ohio’s record on that front is not good, but Ohio is not alone in that camp.

Posted in Economics, Electricity, Regulation | Tagged , , | 1 Comment »

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“Market failure”: you keep using that term. I do not think it means what you think it means.

December 8, 2011

Lynne Kiesling

Steve Horwitz’s column in The Freeman today is a great explication of why the phrase “market failure” is so problematic, and so often misused and abused in public policy analysis when employed to criticize market outcomes. Steve does a good job of explaining the origins of the phrase in the standard textbook case of “perfect competition”: in equilibrium that simple benchmark model, resources are allocated to their highest-valued use, all Pareto-improving trades have occurred, and while firms have earned inframarginal profit, the marginal profit at the equilibrium level of output is zero. More simply, all gains from trade have been exploited and no one has left any money on the table. Thus, the argument goes, in applying that model to reality when we see outcomes that deviate from that and do have misallocation or some unrealized gains from trade, the logical conclusion is that the market has failed to enable agents to achieve that optimal outcome.

Steve highlights two reasons why this interpretation is incorrect; the first reason is a misunderstanding of the nature of competition and the market process as it operates in real conditions of the knowledge problem, imperfect foresight, differentiated products, small numbers of agents, etc. People making the above critique of markets expect a threshold of unrealistic perfection, and consequently make an unfair comparison of a simplified benchmark model with the complications and nuances of a real-world application. I encounter this argument all the time in electricity regulation, which is predicated precisely on this type of false, over-simplified argument, and has a century’s worth of regulatory institutions built upon the false presumption that achieving such a static outcome in reality is possible.

One thing I particularly like about Steve’s argument is how he points out that these cognitive-epistemological characteristics of the real world are features, not bugs, with respect to how market processes create value and gains from trade:

… these sorts of imperfections (a better term than “failure”) are not only part and parcel of real markets; they also are what drive entrepreneurship and competition to find ways to improve outcomes.  In other words, what markets do best is enable people to spot imperfections and attempt to improve on them, even as those attempts at improvement (whether successful or not) lead to new imperfections.  Once we realize that people aren’t fully informed, that we don’t know what the ideal product should look like, and that we don’t know what the optimal firm size is, we understand that these deviations from the ideal are not failures but opportunities.  The effort to improve market outcomes is the entrepreneurship that lies at the heart of the competitive market.

Thus the value of markets is not that they will achieve perfection, but that they have endogenous processes of discovery that enable people to correct the market’s imperfections.  Just as it’s the very friction of the soles of our shoes on the floor that enable us to walk, it is the imperfections of the market that encourage us to find the new and better ways to do things.

He then counters a second aspect of the “market failure” argument: this argument is typically coupled with a recommendation for some form of government intervention or regulation to “correct” the perceived failure. But if market processes in realistic contexts have imperfections, don’t government intervention and regulation have imperfections too? The relevant comparison is between the results of market institutions and government institutions in realistic contexts, not in simplified blackboard theory.

I would add a third point to this analysis. Often when I encounter the “market failure” argument I make a quick riposte of “markets don’t fail, they fail to exist”, which is the Coase/transactions cost response. Transactions costs interfere with the ability of parties to find mutually beneficial trades, thus impeding optimal resource allocation and the creation of maximum gains from trade. Transactions costs lead to missing markets, as in the case of environmental pollution and other common-pool resource situations. This driver of so-called “market failure” complements Steve’s process-oriented argument and reinforces his points … and it implies that one high-priority objective of public policy should be to reduce transactions costs, not to impose regulations that are intended to “correct” market failures but have little realistic hope of doing so effectively.

[Thanks to Aeon Skoble for the Princess Bride hook I used in the title.]

Posted in Economics | Tagged , , | 7 Comments »

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Exelon’s John Rowe and Google’s Eric Schmidt: Truth to power?

October 24, 2011

Lynne Kiesling

Here’s an interesting juxtaposition of two prominent executives performing sound public choice analyses, and I think they complement each other, at least in my work! This weekend’s Wall Street Journal featured an interview with Exelon’s John Rowe, A Life in Energy and (Therefore) Politics. Exelon is the third largest investor-owned utility/generation owner in the country, with one of the largest nuclear generation fleets outside of France. Between the growth of Exelon through mergers and the provenance of Commonwealth Edison (a substantial chunk of Exelon) as Samuel Insull’s pioneering origins of the electricity industry, Rowe has experienced many of the crucial business and policy aspects that have characterized this industry for the past century.

And for my part he pretty much nails the public choice analysis. In discussing the politics of electricity in general, and in particular Exelon’s support of active federal carbon policy:

In a visit to The Wall Street Journal’s offices recently, Mr. Rowe was eager to strip the altar of green jobs—and the many other political pieties that distort the energy industry, even a few that he says belong to the Journal editorial page.

“The utility business is a funny business and almost no one in any political authority in either party really believes in orderly markets in electricity,” Mr. Rowe says. …

The reason for this seeming contradiction—between simultaneously supporting free markets and interventions like an economy-wide CO2-reduction plan—is that “we’re always being asked to do things that are in our view bleeding crazy,” as he’ll go on to explain.

For starters, the anti-market demands made on Mr. Rowe are bipartisan.

He discusses the cost differential between, in this instance, wind power and other lower-carbon means of generation, such as natural gas, and the bipartisan political support for wind despite the reality that we get more carbon reduction “bang for the buck” from natural gas. Interestingly, in this interview he does not tout nuclear as the be-all-end-all carbon-free energy approach, given construction costs; he also dismisses clean coal.

Rowe is also an enthusiastic amateur historian, so is very well-versed in the origins of the politicization of the electricity industry:

This political economy is an artifact of the historical electricity market—which, through most of the 20th century, was not really a market at all. Until recently, almost all consumers bought electricity from a monopoly supplier at rates set by the government, with a guaranteed return for utilities. That model eroded amid deregulation in the 1980s and ’90s, and the rise of more efficient wholesale electricity markets and independent generators. Commercial and now even some residential consumers are no longer captive, but the political habits persist. …

Mr. Rowe continues that “Somebody else wants clean coal; it’s a non sequitur and it’s not economic either. Somebody else wants wind or solar, and meanwhile . . . the market says the only thing that makes sense for a decade, maybe two, is for new generation to be gas-fired. Natural gas is cheaper than everything else,” thanks to domestic shale finds via fracking and other factors. “It’s likely to stay that way for a long time—but it isn’t what politicians want.”

I encourage you to read the entire interview; I’ve omitted a very interesting discussion of the debate over the extent to which EPA rules would shut down sufficient coal-fired generation to cause reliability problems, which has been asserted in, for example, Texas (but I don’t see how that makes sense, given the loooooong portion of the generation supply stack that is natural gas).

Rowe’s public choice analysis of his industry is complementary to one offered by Eric Schmidt of Google in this Washington Post interview in early October, on the heels of his first-ever Senate testimony experience (Gordon Crovitz analyzes Schmidt’s interview in today’s WSJ, Google Speaks Truth to Power). It’s an absolute must-read in its entirety, but here’s one piece of sound public choice analysis:

Washington—having spent a lot of time there, I grew up there and have spent a lot of time there recently—is largely defined by detailed analytical views and policy choices that are not very good. You know, each policy choice has a winner and a loser, right? Somebody’s ox is getting gored. They’re complex arguments: They’re economic and political and social, and everyone has an opinion on those. Here, the arguments are, how do we make something that affects a million people? How do we change the economics of an industry?

And one of the consequences of regulation is regulation prohibits real innovation, because the regulation essentially defines a path to follow—which by definition has a bias to the current outcome, because it’s a path for the current outcome. …

Come on. Give me a break. The press is so young, they don’t understand the history here. We’re still a small component of what a whole bunch of other companies have done, and certainly most other industries. So I reject all such charges [about the magnitude of Google's lobbying]. And I’m very clear on that because people can’t do math. Take the numbers of the amounts of money that go into the regulated industries of all sorts—and then compare high tech, and compare Google in specific, and it’s miniscule.

And privately the politicians will say, “Look, you need to participate in our system. You need to participate at a personal level, you need to participate at a corporate level.” We, after some debate, set up a PAC, as other companies have. And it’s basically in the interest of our customers to do this, because the government can make mistakes. And for every one of these Internet-savvy senators, there’s another senator who doesn’t get it at all. And it’s not a partisan issue. It’s true in both parties.

This excerpt highlights two timely insights. First, note the “you need to participate in our system” dynamic that defines the corporatist political system. Companies like Google feel compelled to engage in lobbying to rectify what they see as ill-informed political decisions (a reasonable stance, given the lack of technological sophistication in Congress) that would impair their ability to create value for consumers and profit from doing so. Add this incentive to the more cynical and craven one of manipulating the political process and ensuing legislation to favor your company, and you have a range of high-powered and low-powered incentives that drive toward increasing corporatism in politics.

Second, note his observation that “… one of the consequences of regulation is regulation prohibits real innovation, because the regulation essentially defines a path to follow—which by definition has a bias to the current outcome, because it’s a path for the current outcome.” This is the clearest articulation I’ve seen of a hypothesis that I’m currently working on with respect to electricity regulation (here’s the complementarity between the two analyses). Regardless of industry, regulation does specify a path to follow, and it’s a backward-looking definition. Combine Schmidt’s observation with the summary of the history of electricity regulation from the Rowe article, and you get a potent combination leading to technological inertia … which, when you’re talking about an industry that enables and is the driving force of a lot of our productivity and lifestyle, is a costly impediment to economic growth.

Combining these two interviews shows the breadth and depth, and costliness, of today’s corporatist regulatory and political environment.

Posted in Economics, Electricity, Regulation, Technology | Tagged , , | 3 Comments »

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A political economy model for Occupy Wall Street

October 10, 2011

Lynne Kiesling

What’s a political economy-oriented economist to make of Occupy Wall Street? So far I’ve found two complementary commentaries that reflect my analysis of the deeply flawed policies of the past couple of decades that have enabled the crony corporatism that seems to be at the core of the protest (just in my phrasing it that way you can see what my model is). The first is summarized in this Venn diagram from James Sinclair, in his insightful post about the false dichotomy between Occupy Wall Street and the Tea Party:

His entire analysis is worth reading (and is consistent with this excellent investigative citizen journalism from the protest in New York, thanks to Nick Gillespie for the link), concluding with

In other words, aren’t these two groups—Occupy Wall Street and the Tea Party—raging against different halves of the same machine? Do I have to draw a Venn diagram here? …

Yeah, I’m oversimplifying, but only a little. The greatest threat to our economy is neither corporations nor the government. The greatest threat to our economy is both of them working together. There are currently two sizable coalitions of angry citizens that are almost on the same page about that, and they’re too busy insulting each other to notice.

Hitting a complementary note (and hitting the nail on the head, from my perspective) is Sheldon Richman at the Freeman, noting that Wall Street couldn’t have done it alone:

To: Occupy Wall Street:

Wall Street couldn’t have done it alone. It takes a government and/or its central bank, the Federal Reserve System, to:

  • Create barriers to entry for the purpose of sheltering existing banks from competition and radical innovation, then regulate for the benefit of the privileged industry;
  • Issue artificially cheap, economy-distorting credit in order to, among other things, give banks incentives to make shaky but profitable mortgage loans (and also to grease the war machine through deficit spending);
  • Make it lucrative for banks – and their bonus-collecting executives — to bundle thousands of shaky mortgages into securities and other derivatives with the knowledge that government-sponsored enterprises Fannie Mae and Freddie Mac and other companies, all subject to powerful congressmen looking for campaign contributions, will buy them after a government-licensed rating cartel scores them AAA;
  • Inflate an unsustainable housing bubble by the foregoing and other methods, enticing people to foolishly overinvest in real estate.
  • Work closely with lending companies to establish a variety of programs designed to lure people with few resources or bad credit into buying houses they can’t afford;
  • Attract workers to the home-construction bubble, setting them up for long-term unemployment when the bubble inevitably bursts;
  • Implicitly guarantee big financial companies and/or their creditors that if they get into trouble they will be rescued;
  • Compel the taxpayers to bail out those companies and/or creditors when the roof finally falls in.

No bank or group of banks could do these things on its own in a freed market. It takes a government-Wall Street partnership – the corporate state — to create such misery and exploitation.

So demonstrators, you are right. Something is dreadfully wrong. But your list of culprits is far from complete. So go ahead and protest outside Goldman Sachs and Bank of America. But also spend some time outside the White House, the Fed, the Treasury, and the Capitol Building. Together they are responsible for our current economic woes. These are the entities that control our fate and over which we have no real say. It’s time for things to change.

The freed market is the alternative to what you properly despise.

Yep, that about sums it up.

Posted in Economics, Liberty, Regulation | Tagged , , , | 8 Comments »

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Resiliency comes from more risk of bank failure, not less

September 21, 2011

Lynne Kiesling

In the always-smart-and-interesting City AM paper from London, Anthony Evans makes an important argument that has been overlooked in financial regulation debates: risk of failure is what creates system resilience, and regulation creates brittle monocultures. He writes in the context of last week’s Independent Commission on Banking (ICB) recommendations for creating regulatory divisions between retail banking and investment banking and implementing other structural changes, with the objective of a more resilient financial system. Evans critiques the over-simplified concept of risk that the report employs:

We can’t say that one thing is more risky than another – only that different activities expose people to different types of risk. Bodies like the ICB needs to shift from trying to – impossibly – reduce risk to placing responsibility on those who are choosing between different risks.

For example, ordinary depositors should not be protected from risk – they need to confront it. It can seem counterintuitive, but the genuine threat of bank runs is probably the best disciplinary device to prevent them from happening.

Evans’ argument stems from an assertion that he makes later in his column, that risk cannot be reduced but can only be transferred from one party to another. While I think that assertion is debatable, the important insight from this part of his argument is that resiliency in complex market systems arises from agents having responsibility for losses associated with taking additional risks, in addition to their receiving profits associated with taking additional risks. Breaking that connection among risk, profit, and loss is one of the core causes of the brittleness of the financial system over the past two decades, and the transmission and magnification of those losses.

Evans makes a second important observation: when regulation imposes a higher degree of uniformity in a complex system, it reduces resilience of the overall system by creating separated monocultures:

By making arbitrary decisions about what must stay within fences and what doesn’t, or about the level of equity capital that banks will be required to keep, regulators make banking more homogenous. Banks are already free to set up their own ring fences, and a competitive system would be one where they can experiment with different ones. …

All regulations create clusters of errors – by their nature they harmonise behaviour and therefore increase systemic dangers. Policy efforts need to focus on reducing barriers to exit, making it easier for banks to fail, making the costs of failure more visible and ensuring they fall on those who make bad decisions – bankers, regulators, or even the public.

We see this paradox of control in all forms of economic regulation; in this case in financial regulation, but also in the electricity regulation that is the focus of my attention. Regulators believe that by increasing control, by limiting the range of actions that agents can take in complex systems, they are reducing the risk of bad outcomes. But what they do not realize (or choose to ignore) is, as Evans points out here, that by imposing more top-down centralized control on their actions and interactions, they reduce the incentives of the agents to develop their own forms of individual control based on their local knowledge and their own experimentation. Thus regulation makes this complex system more rigid, more brittle, less resilient, and therefore regulation does not achieve its stated goals.

Note here that I am using the tools and language of complexity science and complexity economics, but you can see in this discussion where moral hazard shows up, where you could talk about the failures of corporate governance (as does Charlie Calomiris), etc. Framing the objective as a resilient system broadens the focus beyond top-down regulation to include the individual, decentralized institutions that can keep dangers from becoming systemic. Thinking about regulation in terms of the locus of control and the consequences of the imposition of control in a complex system is more likely to enable us to incorporate the costs of imposing control into the analysis, and to harness decentralized institutions to enable a more resilient system.

Posted in Complexity, Economics | Tagged , , , | 1 Comment »

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