Net Neutrality: Degradation For All

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The FCC recently voted to reverse its earlier actions on so-called net neutrality, which would have treated internet service providers (ISPs) as “common carriers” and subjected them to detailed federal regulation of their services, pricing, and profits. Many believe net neutrality would ensure a sort of fairness and nondiscrimination on the internet, but it is actually a destructive regulatory regime under which certain firms are allowed to extract economic rents from the efforts of others. Warren Meyer has a nice take on this at Coyote Blog:

Net Neutrality is one of those Orwellian words that mean exactly the opposite of what they sound like…. What [it] actually means is that certain people … want to tip the balance in this negotiation towards the content creators ….  Netflix, for example, takes a huge amount of bandwidth that costs ISP’s a lot of money to provide. But Netflix doesn’t want the ISP’s to be be able to charge for this extra bandwidth Netflix uses – Netflix wants to get all the benefit of taking up the lion’s share of ISP bandwidth investments without having to pay for it. Net Neutrality is corporate welfare for content creators.

I made the same point almost three years ago in “The Non-Neutrality of Network Hogs“. Meyer emphasizes that in the net-neutrality fight, the primary tension is between content creators and ISPs (and transport providers), but it is like any other battle to capture the gains from a vertical supply chain. Think of suppliers of goods versus shippers, for example, or traditional publishers versus delivery services, or oil extraction versus refining. Ultimately, all of the various parties must cover their costs in order to survive, and obviously each would like to capture a larger share of the value from its stage of the production process. In a series of arms-length transactions, one might assume that their shares would correspond roughly to the value they add to the final product, but things are more complicated than that. Much depends on the competitive state of the market and on the cost structures faced by different parties.

While the ISPs are often said to exercise monopoly power, there are few if any local markets in which that is actually the case, even in rural areas. Almost everywhere in the U.S., local internet markets could be better described as oligopolistic: there are at least a couple of rival firms (and alternatives for consumers), even if the technologies are sometimes radically different, so some competition exists. The same is true of the internet backbone.

Obviously, content providers compete with one another in a large sense, but many popular forms of content are unique and consumers demand access to them through their ISPs. Therefore, some content providers exercise a degree of monopoly power. And they might also require a lot of bandwidth.

The nature of the costs faced by ISPs and content providers is quite different. The latter have a much lower proportion of fixed costs than ISPs, who must invest in network capacity. Ultimately, the costs of providing that capacity must be priced. At first blush, it seems natural for users of capacity to be billed proportionately, but allocating those costs over customers and over time is a complex undertaking. Like all problems in economics, however, network usage involves a scarce resource. A large increment to demand can lead to network congestion and higher costs, not only directly to the ISPs but to users experiencing a degradation in the speed and quality of their service. ISPs have traditionally had the flexibility to negotiate with large content providers, reaching mutually agreeable terms. That’s what brought us to the state of today’s internet, and most observers would say that it’s pretty damn good!

It is the network that makes all of these wonderful services possible. The ISPs provide and maintain that network, and they must provide for expansion of that network as traffic grows. It is important that ISPs have adequate incentives to do so. However, the form of regulation to which so-called common carriers are subjected is known historically for its failure to provide good incentives. That history goes back as far as 130 years in transportation and about 80 years in telecommunications. This is why many analysts, and FCC Chairman Ajit Pai, contend that common carrier status for ISPs, and “net neutrality”, would lead to shortfalls in network capacity and a deterioration in the quality of service. It would also reward large content providers (think Netflix) in the short term at the expense of ISPs, essentially giving the former access to the existing network at less than cost. That’s the whole idea for industry advocates of net netrality, of course. But in the end, net neutrality is a shortsighted goal, even for the content providers.

The content providers have made every effort to propagandize the public, stoking fears that the ISPs are treating certain kinds of traffic unfairly. Without net neutrality, would ISPs unfairly discriminate against certain kinds of content? Or against certain types of users? Price discrimination is one of the primary criticisms of the presumed behavior of ISPs in the absence of net neutrality. Economist Bronwyn Howell points out that price discrimination is not unusual, however, and is not necessarily undesirable. Indeed, consumers of internet, telephone, mobile, and cable TV services seem to prefer certain forms of price discrimination! Consumers with heavy usage who purchase flat rate monthly internet access pay a lower charge per Gb than light users. Consumers who purchase “bundles” of internet and voice service may benefit from price discrimination relative to those who choose not to bundle their services. Strictly usage-based pricing would prevent price discrimination on this basis, but few would advocate the abolition of bundled offers, which provide benefits in terms of flexibility of use and predictability of cost, yielding net welfare gains for many consumers at no incremental cost to others. Like all voluntary trade, these are positive sum transactions: consumers capture more  “surplus” value while ISPs earn a greater contribution to the fixed costs of the network.

When ISPs charge a data rate based on usage, consumers face a positive marginal cost on incremental data. As usage increases, its marginal value to the consumer declines; the consumer will not use data beyond the point at which its value equals the data rate they pay. That places a cap on consumer surplus (the area above the price and below the consumer’s demand curve). When the consumer faces a zero marginal cost (an unlimited data plan), their usage rises to the point at which its marginal value is zero. The total amount of “surplus” in that scenario is larger, and it is possible for an ISP to split the gain with the consumer by offering a price for unlimited usage. Thus, as long as the network capacity is in place, both parties are made better off! If not, the practice can lead to congestion, but competition for users often dictates that such packages be offered.

Especially in the presence of positive network externalities, it makes no sense for the ISPs, as a group, to price users or traffic out of the market, unless they are punished for doing otherwise at below cost. As always, pricing is an exercise in balancing costs with the benefits to potential buyers. It should remain a private and unfettered exercise ending only in trades that are mutually beneficial.

And what of network capacity and the big content providers? At the “price discrimination” link above, Howell says:

… available bandwidth allowed Netflix to happen, not the other way around. But now, as Netflix comes to dominate existing bandwidth, leading to higher costs, it is causing externalities (delays) and higher costs (ISP fees are now rising in real terms in some markets) to pay for new capacity.

Should the ISPs charge all customers higher rates in order to manage growth in traffic and fund new capacity? How can they allocate costs to the cost-causers? Usage-based data rates are one simple alternative. Tiered rates would act to minimize the extent to which light users are penalized. ISPs have also negotiated with individual content providers directly, reaching agreements to compensate ISPs for access to their customers. Tim Wu, the Columbia Law professor credited with coining the term “net neutrality”, was quoted at the last link bemoaning these types of deals:

‘I think it is going to be bad for consumers,’ he added, because such costs are often passed through to the customer.

Well, yes! Netflix charges its customers, and it will attempt to recover these payments for network capacity. Streaming is an integral component of the service they offer, and they cannot do it without the ISPs. Would Wu propose that the pipes be provided at less than cost?

Some have said that it is more economically efficient for ISPs to charge users directly for incremental short-run network “externalities” caused by large data demands. (Conceptually, it is better to think of these costs as long-run marginal costs of network expansion.) It may be that a tiered rate structure can approximate the optimal solution, and packages are often tiered by download speed. Nevertheless, passing costs along to large content providers is a viable approach to allocating costs as well.

Another argument is that small content providers cannot afford these payments. However, if they don’t generate a significant amount of traffic, they probably won’t have to negotiate special deals. If they grow to require a large share of the “pipe”, it would indicate that they have passed a market test. Ultimately, their customers should pay the costs of providing the capacity in one way or another.

Net neutrality and regulation of ISPs is the wrong approach to encouraging the growth and value delivered by the internet. It would stifle incentives to provide the needed capacity and to develop new network technologies. We certainly didn’t get here by treating the ISPs like public utilities. Rather, the process was facilitated by the freedom to experiment technologically and contractually. ISPs are well aware that the value of their networks are enhanced by ubiquity. Affordable access to a broad share of the population is in their best interest. In the end, consumers are sovereign and should be the sole arbiters of the value offered by ISPs and content providers. Regulators will promise to protect us, but the inevitable result will be a market hampered by rules that degrade the network, leading to substandard service and a less vibrant internet.

Administrative Supremacy, Lost Checks and Balances

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The two-for-one regulatory order issued by the Trump White House in January raises some practical difficulties in implementation. It requires that federal agencies eliminate two regulatory rules for every new rule promulgated, both in terms of the number of rules and any incremental regulatory costs imposed. Two out for every one in. Questions surrounding the meaning of “a regulation”, how to define incremental costs, and whether a particular rule is actually mandated by legislation are not trivial. Nevertheless, the spirit of this order is admirable and it serves as the leading edge of the Administration’s attempt to roll back the scope and impact of excessive government authority.

The cost of regulation is vast. Economists at the Mercatus Center at George Mason University have estimated the total cumulative cost of regulation in the U.S., finding that regulation has reduced economic growth by 0.8 percent per year since 1980. Without the additional regulatory growth since 1980, the U.S. economy would have been about 25 percent larger than it was in 2012. That’s a $4 trillion shortfall, or roughly $13,000 per person.

While regulation and administrative control over the private economy takes an increasing toll on economic growth and human welfare, the problem goes beyond economic considerations: administrative agencies have “progressively” usurped not just legislative but also judicial power. The concentration of executive, legislative and judicial power constitutes a “fourth branch of government“, a development inimical to the principles enshrined in our Constitution and a prescription for slow-boil tyranny. It facilitates rent seeking and corporatism just as surely as it creates a ruling class of individuals who act on their personal and arbitrary inclinations. We are ruled by men backed by police power, not impartial laws.

Glenn Reynolds writes that unelected rule makers and central planners are able to manipulate decisions across a broad swath of the economy and society. He quotes a new book by Philip Hamburger of Columbia Law School called “The Administrative Threat“:

Government agencies regulate Americans in the full range of their lives, including their political participation, their economic endeavors, and their personal conduct. Administrative power has thus become pervasively intrusive. But is this power constitutional?

A similar sort of power was once used by English kings, and this book shows that the similarity is not a coincidence. In fact, administrative power revives absolutism. On this foundation, the book explains how administrative power denies Americans their basic constitutional freedoms, such as jury rights and due process. No other feature of American government violates as many constitutional provisions or is more profoundly threatening. As a result, administrative power is the key civil liberties issue of our era.

Two previous posts on Sacred Cow Chips have dealt with Hamburger’s work. The first, “Hamburger Nation: An Administrative Nightmare“(1) provides the following explanation of his position:

Hamburger examines the assertion that rule-making must be delegated by Congress to administrative agencies because legislation cannot reasonably be expected to address the many details and complexities encountered in the implementation of new laws. Yet this is a delegation of legislative power. Once delegated, this power has a way of metastasizing at the whim of agency apparatchiks, if not at the direction of the chief executive. If you should want to protest an administrative ruling, your first stop will not be a normal court of law, but an administrative review board or a court run by the agency itself! You’ll be well advised to hire an administrative attorney to represent you. Eventually, and at greater expense, an adverse decision can be appealed to the judicial branch proper.

The exercise of rule-making authority, and even extra-legal legislative action by the administrative state, has economic costs that are bad enough. Hamburger also emphasizes the breakdown of the separation of executive and judicial powers inherent in the enforcement and adjudication of disputes under administrative law. This was the subject of the second Sacred Cow Chips post referenced above: “Courts and Their Administrative Masters“. It reviewed an unfortunate standard established by court precedent involving judicial (“Chevron”) deference to administrative agency fact-finding and even interpretation of law. While the decisions of administrative courts, which are run by the agencies themselves, can be appealed to the judicial branch, such appeals often amount to exercises in futility.

“…courts apply a test of judgement as to whether the administrative agency’s interpretation of the law is “reasonable”, even if other “reasonable” interpretations are possible. This gets particularly thorny when the original legislation is ambiguous with respect to a certain point.

…the courts should not abdicate their role in reviewing an agency’s developmental evidence for any action, and the reasonability of an agency’s applications of evidence relative to alternative courses of action. Nor should the courts abdicate their role in ruling on the law itself.

This paper on Judicial Deference to Agencies by Evan D. Bernick of Georgetown Law makes the case that judicial deference is a violation of the constitutional separation of powers, concluding that:

… in cases involving administrative deprivations of core private rights to ‘life, liberty, or property,’ fact deference violates Article III’s vesting of ‘[t]he judicial power’ in the federal courts; constitutes an abdication of the duty of independent judgment that Article III imposes upon federal judges; and violates the Fifth Amendment by denying litigants ‘due process of law,’ which requires (1) judicial proceedings in an Article III court prior to any individualized deprivation of ‘life, liberty, or property’; and (2) fact-finding by independent, impartial fact-finders.

Inez and Jarrett Stepman in Townhall note that there are almost three million well-paid federal employees with job security that would make most private sector workers envious.

Though the abolishment of the spoils system [which allowed civil service hiring and firing based on political party] was meant to mitigate corruption and incompetence, it has resulted in a toxic combination of enhanced agency power and an entrenched civil servant class with its own institutional—and frequently political—interests, virtually unaccountable to the president or any other elected official.

The Stepmans discuss legislation that might stem the usurpation of lawmaking power by the administrative state. They are convinced that the administrative state must be reigned-in. Ironically, expanded executive authority means that the process of reversal is not that difficult in many cases. By way of example, here’s a piece on the ease of undoing certain Obama era regulations. Executive orders, or “the pen and the phone” in Obama’s charming parlance, lack legitimate legislative authority and can be reversed by new executive orders. I firmly believe that reversing the earlier orders is the right thing to do at the moment, but the unchecked authority that makes it possible (and the supremacy of the administrative state) is a source of economic instability, and it must end. Eric Boehm makes this point eloquently in Reason at the last link above:

New policies that affect wide swaths of the economy and reshape entire business models should go through Congress, or at the very least should be subject to the public rulemaking process. Guidance documents and other ‘dark matter’ regulations that by-pass those processes can be un-made as quickly as they were made, leaving businesses to deal with an ever-changing and unpredictable regulatory state that does not really help anyone, no matter which side you’re on in any individual policy fight.

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(1) The principle title “Hamburger Nation” was intended as a play on Glenn Reynolds’ paper “Ham Sandwich Nation: Due Process When Everything Is a Crime“, in which he discussed the judicial implications of over-criminalization and regulatory overreach.

 

Paris Climate Dance: a Concon

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Ah, Paris, we bid you adieu. For both scientific and economic reasons, the Paris Climate Accord is pure numbskullery. We should all be grateful that President Trump has decided to revoke the expensive promises made by Barack Obama under the agreement in a willful effort to appease the world’s rent seekers.

From a scientific perspective, the accord’s prescriptions are premised on a partial effect: absent any feedbacks, carbon emissions would raise the atmospheric temperature slightly. But feedback effects are massively important, as anyone familiar with the climate models’ terrible track record of predictive performance might guess. Water vapor, cloud formation, wind currents, and the response of the Earth’s biomass are just some of the effects that impinge on the relationship between atmospheric carbon and temperatures. In addition, carbon forcings are relatively minor compared to the energy impulses delivered by natural sources, including solar activity and the Earth’s varying axial tiltPaleoclimate data shows that the world has been this warm before, and warmer.

The economic case against the Paris Accord is even stronger. The very idea that authorities would impose huge material sacrifices on mankind in an effort to prevent a threat for which the evidence is so weak should give pause to any rational individual. Beyond that, however, the real function of the accord was not so much carbon mitigation as it was a shift in the distribution of wealth. This quote of Steven Allen, in a scathing assessment of the agreement, is instructive (forgive his mid-sentence switch to sarcasm):

Mainly, it’s about taking money from taxpayers and consumers and businesspeople and electricity ratepayers and giving it to crony capitalists, and taking money from people in relatively successful countries and giving that money to rich people in poor countries, to the benefit of members of governing elites who support the Paris deal for the good of humanity and not at all because they expect to line their pockets with it.

World carbon emissions were expected to keep rising at least through 2030 under the agreement. The subsidies it promised to crony capitalists in the renewable energy industry were to generously fund technologies that are not economically viable without government support, to the detriment of relatively clean-burning fossil fuels, not to mention nuclear power. The U.S. promised to reduce absolute carbon emissions, but the world’s greatest emitter of carbon dioxide, China, promised only to seek to limit emissions per unit of GDP, but not until sometime down the road. That means China’s level of emissions might not reverse, given the rapid growth of the Chinese economy. India’s commitment is similar. And Russia promised a reduction relative to a depressed 1990 level of emissions, which means they have plenty of room for growth.

As for the U.S., where absolute carbon emissions have been decreasing since 2007, the Paris Accord relied on so-called “voluntary” limits to be imposed by federal mandates. Financial demands were made by developing countries under the deal: $100 billion per year. And who would pay for that? Taxpayers in the developed countries, of course. One can only imagine the lust of unaccountable third-world officialdom for those funds. Thus far, the U.S. has paid only $1 billion into the so-called Green Climate Fund, and at least half of that was taken from a State Department account from which disbursal did not require Congressional approval.

Jeffrey Tucker, who is anything but a fan of Donald Trump, minced no words in his assessment of the Paris “treaty”. Here are a few selected quotes:

The Paris Agreement is a ‘voluntary’ agreement because its architects knew it would never pass the US Senate as a treaty. Why? Because the idea of the agreement is that the US government’s regulatory agencies would impose extreme mandates on its energy sector: how it should work, what kinds of emissions it should produce, the best ways to power our lives (read: not fossil fuels), and hand over to developing world regimes billions and even trillions of dollars in aid, a direct and ongoing forcible transfer of wealth from American taxpayers to regimes all over the world, at the expense of American freedom and prosperity. …

The exuberant spokespeople talked about how ‘the United States’ had ‘agreed’ to ‘curb its emissions’ and ‘fund’ the building of fossil-free sectors all over the world. It was strange because the ‘United States’ had not in fact agreed to anything: not a single voter, worker, owner, or citizen. Not even the House or Senate were involved. This was entirely an elite undertaking to manage property they did not own and lives that were not theirs to control. …

The Paris Agreement is no different in its epistemological conceit than Obamacare, the war on drugs, nation-building, universal schooling, or socialism itself. They are all attempts to subvert the capacity of society to manage itself on behalf of the deluded dreams of a few people with power and their lust for controlling social and economic outcomes.

The popular fascination with climate scare stories has provided a useful channel of influence for would-be central planners and redistributionists. These social dementors reject the proposition that science is a process of continuing challenge and testing, thereby subverting the very notion of scientific inquiry. They make the laughable claim that 170 years of temperature data, much of which is quite sketchy, is sufficient to draw strong conclusions about the trends and dynamics of the climate on a four billion year-old planet.

Even worse, the climate alarmists insist that they have a monopoly on scientific knowledge, despite a significant share of skeptics in the climate science community. But in pursuit of that monopoly, the alarmists have gone so far as to undermine the integrity of the peer review process in the climate literature and to manipulate temperature data to exaggerate recent records. They have promoted the false claims that cyclonic storm energy has increased with carbon concentration and that sea levels are rising at an increasing rate. (Coastal property values don’t seem to reflect those concerns.) They would have us confuse actual climate data with model predictions, and they continue to offer prescriptions based on carbon-forcing models after many years of terrible forecast performance. They claim that a small increment (one part per 10,000) to the concentration of a trace atmospheric gas will dominate other forces exerting far greater variations in energy. They ignore the benefits that an increase in nourishing carbon dioxide and warming can provide. And they make the anthropocentric claim that a costly sacrifice by mankind, in an attempt to reduce that trace gas slightly if at all, will pay off reliably by reducing global temperatures, despite the very modest claims on those grounds by the Paris Accord itself.

Here is a link to 17 earlier posts on Sacred Cow Chips having to do with the hypothesis of anthropomorphic global warming, including this one written in late 2015, at the time of the Paris Climate Summit.

Trump Budget Facts and Falsehoods

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The innumerate left is unhappy over cuts in various categories of spending in the budget proposal submitted by the Trump Administration last week. However, they have adopted “talking points” that are incorrect in an effort to rail against the budget. There is no reduction in overall spending in the proposal. Instead, there is a reduction in the growth of total spending. Ryan McMaken calls the mistaken assertions about spending “the media version of ‘cuts’“. The budget plan calls for an increase in total spending of 41% ($1.7 trillion) by 2027, versus 63% ($2.6 trillion) under the baseline (based on current law). Many of the actual cuts and growth reductions are in so-called discretionary spending. However, in one key mandatory component, Medicaid, spending increases by 39% under the plan, or $146 billion, versus 82% under the baseline. That is not a spending cut.

Another issue over which the Trump budget has been attacked is the so-called “math error,” or “double counting” of economic growth, to which former Treasury Secretary Lawrence Summers alluded with apparent delight. The gist of it is that the proposal somehow double-counted the salutary effects of growth in eliminating the projected deficit over the next ten years. In other words, the tax cuts proposed by Trump would be not just revenue-neutral due to stronger growth; they would result in an increase in tax revenue sufficient to eliminate the deficit by 2027.

Thus far, the Trump tax reform plan has been revealed in only a one-page summary released in late April. In static terms, it implied a loss of revenue of $5 trillion over ten years, though the summary left many features unclear. There could be additional provisions to broaden the tax base that might bring the ten-year static revenue loss down to somewhere between $3 and $4 trillion. In dynamic terms, however, the impact of the tax cuts would be smaller. The cuts would stimulate the economy (yes, they would!), but the precise impact on growth is unknown. In the budget, economic growth is assumed to increase from 1.8% to 3.0% annually over most of the ten year period. That has been criticized as unrealistic, but such a boost would likely be enough to make the tax cuts revenue neutral.

Here is a summary of the budget from the Office of Management and Budget (OMB). The tables at the back of the document, on pages 27 and 29, provide enough information on the cumulative ten-year changes to evaluate Summers’ double-counting claim. Keep in mind that his claim applies to changes expressed relative to a baseline. The proposed budget shows a total ten-year deficit projection of $3.2 trillion, compared to baseline of $6.7 trillion. So the deficits are reduced by a total of $3.5 trillion over the full ten years.

Individual and corporate income tax receipts are virtually unchanged over the ten-year period. There’s our revenue neutrality. Other receipts are down by $0.9 trillion, however. Most of that decline is attributed to a $1 trillion “allowance for repeal and replacement of Obamacare”, presumably elimination of taxes on such things as medical devices, Cadillac insurance policies, and fines for failing to comply with insurance mandates. So increased tax revenues do not account for the decline in the budget deficit.

Total cumulative outlays are reduced by $4.6 trillion in the budget proposal relative to the baseline. That more than accounts for the ten-year deficit reduction. Like the policies or not, the decline in spending is sufficient, relative to the baseline, to fully explain the deficit reduction. Yes, the budget assumes that some of the spending reductions are afforded by the faster assumed rate of economic growth, such as welfare payments, but that is not double-counting.

Revenue neutrality of the tax cuts is certainly an assumption worth questioning, especially because the summary of the tax plan gave every impression of abandoning neutrality. Neutrality was probably imposed on the budget plan as a matter of convenience. In a sense, it made the job of presenting the Administration’s spending priorities (like them or not) a cleaner exercise. For another, while budget reconciliation rules do not require the tax plan to be revenue neutral, Senate leaders have stated their strong desire for neutrality. The Trump budget proposal thereby allows Congress’ budget process to get underway while deferring the introduction of a more detailed and potentially controversial tax plan, one that is obviously still in flux and is likely to involve a loss of revenue, even in a dynamic sense.

The assumed change in economic growth is not solely attributable to tax effects, however. It would be reasonable to expect some growth to be driven by deregulation and the “deconstruction of the administrative state“, as Steve Bannon described so eloquently. This intention is embodied in the budget proposal. In that sense, it was unnecessary for OMB to impose revenue neutrality of the tax plan to eliminate the budget deficit over ten years. The economic growth spurred by deregulation would generate some of the extra growth in tax revenue.

I happen to like many of the priorities expressed in the proposed budget, despite the document’s lack of specificity. This includes the deregulatory initiatives, Obamacare repeal and replacement (we’re waiting…), and some of the welfare reform proposals. I am not happy about the scale of the shift toward defense, and I am not happy that government continues to grow in the aggregate. And as for the still-incubating tax reform plan, I like many of the features originally described, though not all.

Many believe that the Administration’s economic growth assumptions are unrealistic, and many dislike the spending priorities. Those cannot be used as excuses for mischaracterizing the proposal, however. Reductions in some spending categories occur only relative to the baseline growth path. They are not real cuts in spending. Likewise, Summers’ double-counting allegation is false. The recovery of tax revenue via economic growth is not double counted, and there is no “math error”. The proposed reductions in spending relative to the baseline more than account for the deficit reduction. I suspect that Summers’ motives were strictly polemic and not grounded in a careful examination of the budget proposal. He is not innumerate. What’s worse, a number of economists swallowed the “double-counting” story hook, line, and sinker.

The Renewable Energy Jobs Hoax

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James Taylor at Forbes reveals the dishonest math behind the claim that renewable energy generates more jobs than “conventional energy”, i.e., fossil fuels. It’s a simple trick, as Taylor explains:

“… renewable energy advocates create the broadest possible definition of workers ‘supported’ by the solar power industry, falsely claim that the solar power industry ’employed’ all these workers, and then compare that to the narrowest possible definition of just a single segment of workers ‘directly’ employed in the ‘extraction’ component of the much larger natural gas industry.

Taylor notes that, “In reality, renewable energy isn’t even in the same universe of job creation as conventional energy.” He goes on to cite the report on which these claims are based and picks it apart. The renewable energy job assertions are obviously self-intereseted, as rent seeking lobbyists know that the political class is dominated by easy marks for renewable energy wonder-stories.

Of course Taylor is correct that the claims about renewable energy jobs are false in the aggregate sense. However, it might or might not be true in the marginal sense, and that’s clearly the sense in which the claim is intended to be taken, despite the fact that the data used is not marginal in nature. If true, it’s not a selling point for renewable energy subsidies because “more jobs” represents a greater marginal cost.

And that brings us to an even more critical issue missed by Taylor: public policy should not be based on the objective of direct job creation. Jobs are a cost, not a benefit. We value the finished goods, not the inputs required to produce them. If you don’t quite get that, imagine two bids for the construction of new kitchen in your home. Same plans, same completion date, similarly brilliant customer reviews of the competing contractors. Without knowing the actual bids, if one contractor tells you it’s a three-man job and the other says it’s a four-man job, you’ll be pretty certain which bid you’ll want to accept.

Ah, but you say, that’s not a fair comparison, because I’m paying for it. Yes you are, just as taxpayers (and more generally society) must pay for the subsidies that lobbyists wheedle out of politicians. Or you say, Ah, but we want more renewable jobs because we want renewable energy, ’cause it’s just right. Maybe, maybe not, but if that’s so, then the idea that the cost is higher because more jobs are required per unit of energy is not a good rationale.

It’s often the case that public policy aimed at “creating jobs” is not accompanied by higher output, lower prices, or even… more jobs! For example, tariffs on foreign goods give an advantage to American producers, but at the cost of job losses in import industries and higher domestic prices that harm consumers more broadly, and thereby reduce jobs. When certain industries or firms are subsidized by the government, the taxpayer is harmed directly, not to mention suppliers of alternatives. This is true at the local and national levels: politicians love to talk about job creation when they offer incentives for new facilities or relocations to their jurisdictions, but these subsidies may put other local firms at a competitive disadvantage and leave taxpayers holding the bag for public services supplied to the recipient firm. When government undertakes large taxpayer-funded infrastructure projects, which might or might not boost productivity, the taxes are damaging and the projects are often poorly planned and lack effective cost controls. Jobs are not a reason to support such projects.

Similar points have been discussed in the past here on Sacred Cow Chips, with links to articles emphasizing the distinction between direct jobs created and economic welfare like this one. “Jobs” should never be a policy objective in and of itself. As Tim Worstall explains in a brief review of Mark Zuckerberg’s recent commencement address at Harvard, jobs simply are not the point! Policy must have a better rationale than the high cost of the labor input!

Markets and Mobility

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Government aid programs tend to perform poorly, especially in developmental terms. In the U.S., anti-poverty programs keep the poor running in place, at best. Yes, they provide minimal income, but they seldom offer a way out and usually discourage it. Moreover, the administration of such programs diverts a significant share of funds to well-heeled civil servants and away from the intended recipients. Foreign aid programs are probably even worse, functioning as catch basins for funding corrupt officials. Progressives, in particular, persist in taking the paternalistic view that we must rely on government action to “care for” and “protect” the poor, able or not. Markets, on the other hand, are held to offer no promise in fighting poverty. In fact, the general assumption made by the progressive left is that markets exploit them.

The truth is that markets offer great promise for encouraging economic mobility. Arnold Kling offers a good conceptual construct in a recent post: while humans are often subject to irrational tendencies in their assessment of choices, their interactions in markets offer a way of smoothing irregularities and disparate bits of information, providing useful signals about the availability of resources and demands for their use. The result is a flow of information that best signals opportunity. Kling calls the process of market interactions the “collective mind”. Rather than encouraging individuals to fully participate in effective markets, free of intervention, we instead deny them the best opportunities for gain. The notion that the poor must be “protected” from markets is embedded in policies like wage and price controls, benefit mandates, overtime rules, drug laws, occupational licensing, and innumerable other harmful regulations. The poor should have the unfettered ability to avail themselves of the social efficiencies of Kling’s collective mind.

Last Thursday, Don Beaudroux’s “Quotation of the Day” was taken from an essay by Ludwig von Mises in which he characterized private property in a market economy as “property by consumer consensus”. In other words, consumers reward sellers who create value, and those rewards accumulate in the form of private property. Likewise, consumers punish poor performance, which has a cumulative negative impact on one’s ability to accumulate or hold onto private property. The benefits conferred by consumer preference do not stop with the owners of the firm. Others productively affiliated with the firm also reap gains in rewards, allowing them to accumulate private property. And of course, consumers are the beneficiaries in the first place: in their judgement the firm delivers value in excess of price. The key here is that free market rewards and penalties are deserved and based on productivity in meeting desires, and only the market can distribute property so efficiently. The able poor can certainly add value and thereby accumulate property, if only given the opportunity.

Jeffrey Tucker has stated that “Only Markets Can Win the War on Poverty” (ellipses are my edits):

The default state of the world is grueling poverty, universal insecurity, and short lives. When governments do come along, they nearly always serve themselves first. … Capitalism made huge progress toward the conquest of poverty. For the first time in history, the productive resources of society turned from serving mainly the elites toward serving the common person. This change alone began to flip the power narrative of social evolution.

And this revolution continued for two some two-hundred years, during which time the average life span expanded dramatically, infant mortality collapsed, incomes rose, and the great project of universal ennoblement achieved an unprecedented boost. And this trend continues today wherever markets are given freedom to function, property rights are secure, and people can associate and trade without molestation by the elites. … In short, capitalism made huge progress toward the conquest of poverty.

Markets are not harmful to the poor. To the contrary, as Tucker says, they have helped lift billions out of poverty around the globe. But government increasingly plays the role of big provider and arbiter of what can and can’t be traded, by whom, and at what price. The suspension of the market mechanism by this process denies the poor the opportunities made possible via participation in free markets, whereby Kling’s “collective mind” processes massive quantities of information and acts upon it spontaneously. But the “collective mind” concept, as a description of market interactions, is too simple: we know that individuals act on the signals provided by the market and are rewarded based on how effectively they do so. There is no doubt that the poor can do that too. It’s time to cast aside the paternalistic and destructive notion that the able poor must be insulated from markets.

The CBO’s Obamacare Fantasy Forecast

Today the Congressional Budget Office (CBO) released its report, or ‘score’, on the version of the American Health Care Act (AHCA) that recently passed in the House of Representatives. It is similar in most respects to the CBO’s score of the earlier version of the bill that never came to a vote. This time, the CBO reduced by one million its estimate of the number of Americans that it projects would lose insurance coverage relative to the status quo (Obamacare). The new estimate is just as unrealistic as the first, for the reasons discussed in an earlier post on this blog:

Sacred Cow Chips

The Congressional Budget Office (CBO) is still predicting strong future growth in the number of insured individuals under Obamacare, despite their past, drastic over-predictions for the exchange market and slim chances that the Affordable Care Act’s expansion of Medicaid will be adopted by additional states. Now that Republican leaders have backed away from an unpopular health care plan they’d hoped would pass the House and meet the Senate’s budget reconciliation rules, it will be interesting to see how the CBO’s predictions pan out. The “decremental” forecasts it made for the erstwhile American Health Care Act (AHCA) were based on its current Obamacare “baseline”. A figure cited often by critics of the GOP plan was that 24 million fewer individuals would be insured by 2026 than under the baseline.

It was fascinating to see many supporters of the AHCA accept this “forecast” uncritically. With the AHCA’s failure, however, we’ve been given an opportunity to witness the distortion in what would have been a CBO counterfactual…

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Ex Ante Agreements, Ex Post Gripes

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Anyone signing a contract better know the terms to which it binds them. They sign voluntarily and do so because they believe it has value. They are presumed to understand what they are obligated to pay and when; what they are entitled to receive, when, and under what circumstances; what actions (and non-actions) are required of them to “perform” under the contract; and what recourse they have should the counter-party fail to perform. The value they perceive upon signing is always based on an expectation. Sometimes, that expectation summarizes risks they are paying to avoid, even as a counter-party is more than willing to carry the risk. The contract is signed and everyone is happy… enough.

Health insurance is an example to which I’ve dedicated ample space over the past couple of weeks (see the links in the left margin). Obviously, one buys health insurance before knowing an entire series of outcomes. The contract specifies what kinds of expenses the insurer is obligated to pay. Insurance is a highly complex product, and so an insurance policy or contract must be relatively complex, as the cartoon above suggests. In a well-functioning market, however, the insured pays a premium no higher than they consider worthwhile. Everyone would like to pay less, but absent a government mandate (heh!), no one is obligated to buy.

The ink is dry and life goes on. The premium is paid, health needs arise, costs are incurred, and sometimes those costs exceed a limit (the deductible) above which the insurer is obligated to pay at least a portion.

A calamitous health event typically brings heavy costs, and this possibility is exactly why people buy coverage, and it is exactly why insurers demand sufficiently stiff premia. These things happen to a fairly predictable percentage of an insurer’s  customers, but with enough variance to make the cash flows risky. As a backstop, insurance contracts sometimes include limitations on total lifetime benefits or on payments for certain kinds of treatments. Pre-existing conditions are a prominent example of limiting the risks that enter the risk pool, but there are other possible limitations on treatments and other aspects of care. While these are known upfront, disastrous health outcomes and their financial consequences are not.

An increasingly common refrain is that no one should profit from an individual’s acute health care needs, and that health insurers do just that. For logical consistency, this same complaint should be leveled against doctors, nurses, paramedics, hospitals, medical equipment manufacturers, and pharmaceutical companies. They all earn income by providing for health care needs, whether medical or financial, and income is income, after all. Whether that income is a wage or a profit is irrelevant. They are both forms of compensation for the use of resources. The major difference between insurers and the other income-earners is that insurers handle the financial risk of potential health care needs and pay when those needs arise, within and up to policy limits.

The crux of the complaint, however, is that insurers can deny claims, thus protecting their profits. Certainly there are claims denied for which the rationale can be disputed. Just as certainly, a financially prudent insurance company must impose some limits on the benefits offered by their policies. These limitations might preserve profitability, but they also protect the contingent benefits of other insureds as well as the solvency of the carrier. Those objectives are not independent.

The insurance buyer reveals the value of the contract ex ante, but sour grapes are easily conjured ex post if a claim is denied, no matter the agreed-to provisions of the insurance contract. The insurer is under no greater obligation to pay costs in excess of policy limits than the doctor, the nurse, or the man in the street. Yet insurers take special blame when inadequate coverage is an issue, whatever the reason.

Hospitals and physician practices sometimes provide uncompensated care. There are also a number of support organizations for severely-ill but inadequately insured patients. So, private charity is one answer to the dilemma of extreme health-cost outcomes. Public aid is another, and the appropriate breadth of the state’s role in cases of pre-existing conditions and extreme individual health care costs is a legitimate question.

In the end, private health insurers provide a valuable service by pooling and carrying the financial risk of health care events faced by individuals. Health insurance profits as a share of owner’s equity have fallen well short of market-wide averages in recent years (see my last post), though I regularly hear outrageous claims about excessive profits in the industry.

It’s not unusual for a buyer to feel remorse after signing a deal, but in cases of health coverage shortfalls, one could say that the insured bet too little or qualified for too little, or one could say that society doesn’t set aside enough resources to adequately care for the sick. However, one cannot say that the resources dedicated to arranging private coverage deserve no reward, or that the business should be pillaged on account of certain policy limitations, or that the future claims of other policyholders should be hijacked. Those who proclaim such nonsense are guilty of severe ethical misjudgment.

Good Profits and Bad Profits

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Toles-on-Regulatory-Capture

There are two faces of profit. It’s always the fashion on the left to denigrate profits and the profit motive generally, as if it serves no positive social function. This stems partly from a failure to examine the circumstances under which profits are earned: is it through competitive performance, innovation, hard-won customer loyalty, and the skill or even luck to spot an underpriced asset? Such a “good” profit might even exceed what economists call a “normal profit”, or one that just covers the opportunity cost of the owners’ capital. On the other hand, profit can be derived from what economists call “rent seeking”. That’s the dark side, but the unrecognized spirit of rent seeking seems to lurk within many discussions, as if the word profit was exclusively descriptive of evil. The “rent” in rent seeking derives from “economic rent”, which traditionally meant profit in excess of opportunity cost, or a “supra-normal” profit. But it’s impossible to know exactly how much of any given profit is extracted by rent seeking; a high profit in and of itself is not prima facie evidence of rent seeking, even though we might argue the social merits of a firm’s dominant market position.

Rent seeking takes many forms. Collusion between ostensible competitors is one, as is any predatory attempt to monopolize a market, but the term is most often associated with cronyism in government. For example, lobbying efforts might involve favors to individuals in hopes of swaying votes on regulatory matters or lucrative government contracts. Sometimes, a rent seeker wants lighter regulation. At others, a rent seeker might work the political system for more regulation in the knowledge that smaller competitors will be incapable of surviving the heavy compliance costs. Government administrators also have the authority to change fortunes with their rulings, and they are subject to the same temptations as elected officials. In fact, in the aggregate, administrative rule-making and even enforcement might outweigh prospective legislation as attractors of intense rent-seeking.

Rent seeking is big-time and it is small-time. It takes place at all levels of government, from attempts to influence zoning decisions, traffic patterns, contract awards, and even protection from law enforcement. When it’s big time, rent seeking is the very essence of what some call corporatism and more generally fascism: the enlistment of coercive government power for private gain. A pretty reliable rule is that where there’s government, there is rent-seeking behavior.

Otherwise, the profit motive serves a valuable and massive social function: resources are attracted to profitable uses because they signal the desires of potential buyers. In this way, profits assure that resources are drawn into the most-valued uses. The market interactions between new competitors, drawn by the prospect of profits, and willing buyers leads to a self-correction: supra-normal profits get competed away over time. In this way, the spontaneous actions of voluntary market participants lead to a great achievement: all mutually beneficial trades are exhausted. Profit makes this possible in the short-run and it assures that trades evolve optimally with changes in tastes, technology and resource availability. By comparison, government fares poorly when it attempts to plan outcomes in the short- or the long-run. Rent seeking is an attempt to influence and even encourage such planning, and the profits it enables impose costs on society.

Good and Bad Profits In Health Insurance

I’ve written a few posts about health insurance reform recently (see the left margin). Health care is scarce. If relying on government is the preferred alternative to private insurance, don’t count on better access to care: you won’t get it unless you’re connected. Profits earned by health insurance carriers are roundly condemned by the left. It is as if private capital utilized in arranging coverage and carrying the risk on pools of customers deserves zero compensation, that only public capital raised by coercive taxation is morally acceptable for this purpose. But aside from this obvious hogwash, is there a reason to question the insurers’ route to profitability based upon rent seeking?

The health insurers played a role in shaping the Affordable Care Act (ACA, i.e., Obamacare) and certainly had hoped to benefit from several of its provisions, even while sacrificing autonomy over product, price, coverage decisions, and payout ratios. The individual and employer mandates would force low-risk individuals to purchase extensive coverage, and essential benefits requirements would earn incremental margins. Sounds like a nice deal, but those policies were regarded by the ACA’s proponents as necessary for universal coverage, stabilizing risk, and promoting adequate coverage levels. There were other provisions, however, designed to safeguard the profitability of insurers. These included an industry risk adjustment mechanism, temporary reinsurance to help defray the cost of  covering high-risk patients, and so-called risk corridors (also temporary).

As it turned out, the ACA was not a great bet for insurers, as their risk pools deteriorated more than many expected. With the expiration of the temporary protections in Obamacare, it became evident that offering policies on the exchanges would not be profitable without large premium hikes. A number of carriers have stopped offering policies on the exchanges.

It should be no surprise that health insurance profitability has been anything but impressive over the past three years. The average industry return on equity was just 5.6% during that time frame, and it was a slightly better 6.2% in 2016, about 60% of the market-wide average. It’s difficult to conclude that insurers benefitted greatly from rent seeking activity with regard to the ACA’s passage, but perhaps that activity had a sufficient influence on policy to stabilize what otherwise might have been disastrous performance.

The critics of insurance profits are primarily interested in scapegoating as a means to promote a single-payer health care system. While some are aware of the favors granted to the industry in the design of the ACA, most are oblivious to the actual results. Even worse, they wish to throw-out the good with the bad.

The left is almost universally ignorant of the social function served by the profit motive. Profits stimulate supply, competition and innovation in virtually every area of economic life. To complain about profits in general is to wish for a primitive existence. Unfortunately, the potential for government to change the rules of the market makes it a ripe target for rent-seeking, and it creates a fog through which few discern the good from the bad.

Insurance Subsidies: Taxes vs. High Premiums

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Here’s a question a friend posed: Why do we care whether health care coverage for high-risk individuals is subsidized by taxpayers versus premium payers via common (community) rating in a combined risk pool? For convenience, let’s call those two scenarios T and C. Under C there is no segmentation whatsoever, while T involves a division of individuals into two groups: standard and high risk. Both scenarios involve guaranteed issue, though T assumes that high-risk individuals must purchase their coverage in the appropriate market. I’ll tackle T first because separate treatment of the distinct risk archetypes yields results that are useful as a baseline.

Taxpayers Subsidize Pre-Existing Conditions

Under scenario T, suppose that all standard risks face the same expected outcome in each period. Everyone in that group pays based on their expected health care costs. In the end, some will have greater health care needs than others, but only a few will be truly unlucky, incurring extremely high health care expenses. On balance, the pooling of risk makes the arrangement sustainable. People enter into these contracts voluntarily because they are risk averse. No one forces them; they are capturing value from protection against financial ruin. The paid-in cash can be invested by the plan in the interim between premium and claims payments. The combination of premium payments and investment income must be enough to cover claims and allow the managers of the plan to defray their administrative costs and make a tidy profit. The profit matters because it attracts voluntary resources to bear on the problem of health-expense risk. Therefore, these insurance transactions are mutually beneficial to the insured and the owners of the insurer.

Conceivably, the smaller high-risk group could be handled the same way, as long as their aggregate health care expenses are predictable. Those expenses will be high, however, so the cost of coverage for individuals in such a pool might be prohibitive. One solution is to force taxpayers to subsidize coverage for this group. The transactions in this market are also mutually beneficial to the insureds and the insurers, just as in the market for standard risks. In both cases, the value to purchasers of coverage is no less than the cost of providing it, including compensation for any capital employed in the process.

In the simplified world of scenario T, we have an optimal insurance outcome for both standard and high-risk individuals. The downside is the cost of the subsidies to taxpayers, which distort a variety of incentives, including labor supply, saving and investment. These lead to misallocations, but they are spread across the economy rather than concentrated on the outcomes in a single market. Is this better than simply pooling all risks, as in Scenario C (common rating)?

Common (Community) Rating

Common rating means that all risks are combined into one pool and everyone is charged the same premium. High-risk individuals get to participate just as if they are standard risks. However, because the combined risk pool has greater expected health care costs on average than the standard risk population, the premium must be greater than the one charged to standard risks in Scenario T. Otherwise, the plan could not cover all expenses nor earn a profit. Worse yet, the standard risks now have an incentive to exit the market while high-risk individuals have every reason to leap in. This is called adverse selection, and it leads to the sort of insurance death spiral we’ve witnessed under Obamacare. And not only does the risk pool deteriorate: the incentive to offer coverage is diminished as well. Thus, an entire industry is rendered dysfunctional. Those who wish to pool together voluntarily in order to efficiently hedge their risks are, by law, prohibited from doing so. The next step might well be for government to mandate participation in an attempt to keep the plan afloat.

Those who favor forced redistribution (not my set) might have other reasons to prefer Scenario T, as it creates greater latitude for progressive tax funding of the subsidies. However, the subsidies themselves could be sensitive to income such that the risky but well-heeled pay more.

From a libertarian perspective, Scenario C has obvious drawbacks, starting with the coercion of insurers to provide coverage to the high-risk population at rates that do not compensate for risk. Then, too, the mis-pricing of risk places a burden on individuals of standard risk. With the pooling of all risks, community rating and coverage mandates result in individual and aggregate over-insurance against most types of risk, tying up scarce resources in insurance assets that could be invested more productively in other uses. In addition, resources are absorbed by compliance costs as authorities find it necessary to enforce the many rules made in hopes of proping-up an otherwise unsustainable arrangement.

Then There’s Single-Payer

It’s often argued that going beyond this point in Scenario C to a single-payer system will yield better outcomes at lower costs. Megan McArdle shreds this idea in a recent column: well over 40% of health care spending in the U.S. is paid by government already; the average growth of that share is even higher than private health care spending; the quality of care is often lower in the government health sector, and in any case, single payer systems around the world do not enjoy slower growth in costs. Rather, they started from lower levels of health care costs. Our relatively high level of costs in the U.S. evolved many years ago, before single-payer systems were adopted abroad. We have many more private and semi-private hospital rooms in the U.S., we often have greater availability of advanced technology, and waiting times for care tend to be significantly shorter.

The high standard of living in the U.S., i.e., our level of consumption, explains a lot of the gap in health care spending. Overall, our health care outcomes are good relative to other developed countries. Unfortunately, we’ve also pushed-up costs from the demand side by offering tax subsidies on employer-provided care, and government in the U.S. has had a role in “managing” health care since the time of the Woodrow Wilson Administration, largely to the detriment of cost control. Government control stultifies competition, creating monopoly-like conditions in both insurance and the provision of care. That manifests in higher profits, safer profits, or slovenly performance by organizations and agents that lack accountability to customers and market forces. Costs rise.

Liberty or Coercion

Libertarians will object to the tax in Scenario T, which like all taxation is coerced, but the taxes necessary to pay for adequate coverage for pre-existing conditions is minor relative to the potential costs of distorting the entire health insurance industry, repleat with the costs of government regulation and compliance that entails, and the potential for still more encroachment of government in health care.

Finally, the question posed by my friend about tax subsidies versus common insurance rating was prompted by a presumed “right to health care”. One must ask whether that right is legitimate. Kevin Williamson argues that scarcity interferes with any such claim. More to the point, in a free society, one cannot simply demand health care from another free individual. Our choices for distributing scarce health care fall into one of only two categories: voluntary and coerced. We should always prefer the former, which may take the form of charity or a mechanism under which care is provided via free exchange. The latter works very well when incentives are clear and pricing is efficient. For those who cannot participate in exchange for any reason, including pre-existing conditions that make coverage prohibitive, private charity is an alternative to government subsidies. At a minimum, charity should serve as an important relief valve for the burden on taxpayers. The Left, however, is always quick to condemn private charity as if it is somehow an illegitimate mechanism for solving social problems, but it is often superior to government action.