Tag Archives: Regulation

Unreasonable expectations: why government constantly fails us.

    The extent of government’s ability to act effectively is rather limited. It is not that government as a concept is inherently flawed or unable to function at any level. Instead, it is the expectations of its constituents that are the drivers of its inevitable failure in many of the tasks it endeavors upon.

     For example, government can effectively reduce the opportunity cost of a choice for its citizens, but it cannot cure social problems stemming from the choices people make. An opportunity cost is a concept from economics which basically states that for every task a person engages in there is something else they cannot be doing with their time. For example, if you mow grass for an hour, the opportunity cost of that choice might be an hour writing the great American novel (assuming you are capable of such a accomplishment). Let us estimate that your novel would take 100 hours to produce, then for each hour you mow grass you effectively “pay” 1/100th of the value of your novel. If said novel would net you $500,000 in profits, then your cost to mow grass (outside of fuel and equipment) would be $5,000. So, you would be much better off paying the little kid down the street $25 to mow your grass.

      Now, let’s apply this concept to regulatory government action. I will concede that, from a theoretical standpoint, it is much less costly to society if we “hire” an agency of people to check, for example, the solvency of financial companies. This agency could compile and publish information as to their effectiveness. They can be specialists that understand the industry and have an aptitude in their selected field. This agency would relieve us of the opportunity cost of having to learn the “ins and outs” of finance and researching every company when making any financial choice. Overall productivity rises because people can more easily determine which companies and products are relatively “better” and thus spend more time maximizing their own output based on their individual aptitudes.

     The problem with this is that humans hardly apply things within the constraints of theoretical effectiveness. Where government fails is that people want government to solve societal “problems,” instead of merely making information more accessible. They want government to keep companies from compensating certain employees too much or selling products that they (voters) think are too risky. Of course, they like the return while the products are on the upside; they just deplore the downside risk that affects them on the backend of the transaction.

     Additionally, there is a selection problem where people who wish to be politicians or government officials can often fancy themselves equalizers. Exacting what they deem to be justice from one entity for the “benefit” of the consumers or voters. Whether it is the voters or the employees of agencies driving these irrational expectations of government makes no real difference. Government is simply not up to the task without eliminating the human component of every decision. They cannot control the supply side of these transactions they deem dangerous or too risky, they must also impact the demand side of the equation. In essence, they must attempt to stop people from “hurting themselves.” Human desires and the balancing of risk and safety vary greatly from one person to the next and it is this which causes government to be ineffective. And, be certain, it is America’s risk tolerance mixed with liberty which has enabled us to be as prosperous as we are.

      Government cannot protect people from themselves or eliminate every risk inherent in life. Government can be a conduit of information, but can never (nor should it) eliminate the desire of people to make choices or engage in risk. We benefit much more from the risk tolerance of humans than we suffer from it. If risk aversion was the default human position, humans would have starved long ago in caves; paralyzed from the fear of predators.

       Over time, government becomes a haven for the risk adverse; both in employment and in voting. Those people on both sides of the proverbial aisle are driven by risk aversion and politicians motivate their voters by highlighting risk and danger. If you are on the right, the risk that someone may do something you do not think is “right” engenders the fear that society will suffer because your moral code was deviated from. On the left, if people are not nannied continuously throughout life, they will be unable to find happiness or will inevitably become victims. Incidentally, both situations are premised on adherence to some subjective moral code.

       Essentially, many people vote on the premise that government will not merely be an efficiency enhancer; instead, government will be an enactor of some “justice” where the only thing they can be sure of is they will be the beneficiary and society will somehow be improved because people are constrained in the fashion they know is best. People have often restated the phrase that government is a “necessary evil,” but lack perspective of why this was originally said. Government is a necessary evil because of the principle of the opportunity cost. Anytime we assume government can solve our individual or societal problems, we set it up for failure and us up for disappointment. Not to mention we yield to it the essential liberty that has enabled us to improve the overall human condition through technological and economic progress.

 

Inefficiency…the real beneficiary of trade protection

      While politicians—particularly Donald Trump—are busy promoting how protectionist trade measures will help our economy, the reality is that all of us lose when we turn our backs on free trade. Well, not all of us. There is one group that benefits…the inefficient (not to mention those politicians). And they win at the expense of everyone else.

    Inefficiency is the primary beneficiary of trade protection. [Inefficiency is defined in two ways according to dictionary.com: 1. not efficient; unable to effect or achieve the desired result with reasonable economy of means; and 2. lacking in ability, incompetent.] However, so many of us get caught up in nationalistic sentiment to realize what is abundantly clear. The popular mantras include Americans “losing” their jobs to sweat shops and foreigners; companies “outsourcing” phone centers; or auto manufacturers shipping those poor union member’s jobs south of the border. All bunk. Let me give you an example that might help clear things up because the emotion has been removed.

     Let’s say in your town you have an intersection with two gas stations. At the QuickUp—yeah, I made that up all by myself—the employees are friendly, the facilities clean, the beer extra cold, and the pumps always give you a receipt instead of having to “see cashier” (I hate that…if I wanted to “see cashier” I would not have swiped my card!). Across the way, at the Sucks2B-N the store lives up to its namesake; the facility is filthy, the bathrooms are always closed, and the employees view you as an inconvenience to their normal texting routine.

      Now, not surprisingly, the QuickUp sells more gas and has better profits than the Sucks2B-N which is clearly unfair…right? So, to keep Joe the crackhead, Rebecca the part time meth-cooker, and Jim (the owner with a gambling problem) from losing their jobs, the local government institutes some “trade protection.” Basically, if you want to stop by the QuickUp, you have to pay a tax of 5%; that way we do not lose valuable jobs in the community, because if the Sucks2B-N closes, those three people will be unemployed, right?   After 6 months people are still going to the QuickUp—because that’s how bad the Sucks2B-N sucks to be in—prompting local government to increase it to 35% to ensure success.

     As expected, people are largely unable to afford to go to the QuickUp and a significant portion shifts to the cheaper Sucks2B-N.   Joe, Rebecca, and Jim are all better off now and have secure jobs. While the QuickUp, with a staff previously at 20, now has only 8 employees left (that means we are down 11, by the way). But, on the bright side, we get 4 jobs “back” with the addition of new employees which have been hired at the Sucks2B-N (it is easier to provide crappy service as it turns out…who knew).

      Here is the bonus though. In economics, it has been empirically proven that in the light of high tariffs (trade protection) the domestic producers raise their pricing to be more in line with foreign producers’ new pricing which includes the tax. Because Sucks2B-N follows predictably with what economics has long known, the people of your town can afford less ice cream for their families and two more jobs are lost at the parlor (11-4+2=9 jobs lost to save 3…hmmm). And that example could potentially apply to any type of good. In fact, other employers have to buy fuel at the more expensive price therefore they have less money for raises and increased benefits. In the light of reduced sales in other market segments, the local government takes in less tax revenue. In short, everybody in town has essentially paid a tax—in the form of higher prices and reduced future wages—to ensure that Joe, Rebecca, and Jim stay employed…still feeling warm and tingly inside? The “Inefficient 3” (catchy, I know) has been relieved of the consequences of inefficiently operating a gas station and you have received the bill. Both trade protection and the gas station example are, for all intents and purposes, wealth redistribution; a very costly form of redistribution at that. This kind of redistribution has much higher transaction costs than simple welfare leading to an increased magnitude in the future through the compounding effect.

       We must always keep in mind that if production of a good goes elsewhere, there is a reason and we, the consumers, have made that choice. Consumers make choices based on cost and quality that drives producers (i.e. businesses and corporations) to change their production methods and sources. And this is okay. Does this mean some people lose their jobs…certainly; but people lose their jobs all the time for inefficiency, we only seem to mind when it is to someone that is not an American citizen. Additionally, the amount of future production (read as consumption and the ability to have “stuff”) goes down making us all relatively poorer to subsidize—or benefit—a few. In fact, anyone that truly favors trade protection should thank the next fast food employee that screws up their food, or the next server that brings the appetizer after the entrée. Or the next car salesman that sells them a lemon…so on and so on. At least be consistent and support inefficiency directly in all its forms.

The nature of black markets: why making commodities illegal is ineffective.

I think it is important to characterize the commodity in very a generalized manner—at least for now—therefore we will refer to our commodity in question as a widget. Now, it is of no consequence what a widget is because, when analyzing the effects of a black market, the only relevant factor is that widgets were made illegal by lawmakers. It is important to begin with a basic definition of a black market:

“A black market or underground economy is the market in which goods or services are traded illegally. The key distinction of a black market trade is that the transaction itself is illegal. The goods or services may or may not themselves be illegal to own, or to trade through other, legal channels.”

It is important to note that the definition also identifies that the goods (in our example widgets) need not be illegal to own. This refers to situations where taxation or regulations are used to limit, control, or inhibit the trade of a good or service (i.e. high cigarette taxes). However valid this discussion is, it will not be the focus of this conversation as we are assuming our commodity has been made illegal for the sake of simplicity.

Black markets develop because making a product illegal does not cause people to stop using it; instead, it merely marginalizes consumption, the production, and the distribution to those who are willing to accept and operate under greater degrees of risk. I know this may sound a little confusing which is why I created a graphic that illustrates the levels of acceptable risk for different groups of society:

Risk flow chart

In this graphic we can observe that the lower two segments (5 & 6) are those people who enjoy or are comfortable with greater risk levels; next (segments 3&4) we can observe the greatest amount of people as the average level of risk takers which would be generally averse to great risk, but partaking in some low/moderate risk; finally, in our upper two segments (1 & 2) we can see a portion of the population who range from mostly risk averse to almost exclusively averse to risk. This understanding of risk tolerance is important in the realization that making commodities illegal only serves to focus use and production on the risk loving segments which are most likely to partake in other risky behaviors (e.g. crime, violence, etc.) regardless of their use of a certain commodity. This reality is why the argument of illegality for the purpose of public safety is largely invalid.

Let us return to our concept of widgets again. If widgets are made illegal then we have some serious problems: 1) people are still demanding this product (although demand is now almost exclusively coming from groups 5&6 and a small part of group 4) so new producers will enter the market to meet this demand and receive the greater profits now offered by an illegal trade operating at monopoly pricing. 2) By compressing consumption to the risk loving segments we create a self-fulfilling prophesy – that the people using the widget will also be breaking other laws [don’t believe me?…look at why prohibition did not work for alcohol].

We can see a new and growing market segment dominated by those who are more predisposed to risky (read: criminal) behavior. Also, we have reduced competition in the production of widgets which would generally (particularly in a highly criminalized black market) lead to the production of “crappier” products at higher prices. Therefore, the risk factors of our widgets become even greater due to the lower quality. Additionally, in this market with limited competition, lower quality requirements, and huge profit margins we will observe more criminal (mob-like) activities in the production and distribution of our widget. In essence, criminal producers compete with force instead of with price or quality (or both) to gain customers; this has many negative effects on the communities in which these suppliers operate.

We are also presented with a consumption level distortion. The new consumer group—which is also isolated to higher risk tolerances—engages in the same activities they would have likely done anyway; however, now our widgets are given the credit (blame) for these activities. This creates somewhat of a paradox in that the results of prohibition become the best argument for prohibition because the correlation between widget use and other risky/criminal behavior increases due to us arbitrarily slicing segments 1, 2, 3, and most of 4 off of the consumer base. We have not eliminated any undesirable by-products of consuming widgets; we have merely magnified the (rudimentary) perception of the widgets’ effect on producing these negative by-products.

Why is this important? First, there are little to no positive effects of making products illegal beyond people making themselves feel better that they may have coerced others into not engaging in an activity this other person condemns [think Michael Bloomberg and soft drink sizes]. Second, by isolating supply to risk loving individuals we fuel illegitimate activities and isolate supply into the hands of people willing to exercise the most risk. Not only have we criminalized users, we have laid the foundation to launch a whole new and highly profitable enterprise that relies on criminal activity and violence as the primary means to restricting market entry. This incorporation excludes traditional competitive means (product differentiation and price) in favor of force, violence, intimidation, and a new criminal recruitment system resulting in social problems in these communities as well as losses in property values, tax revenues, and legitimate employment opportunities.

Gun rights advocates make this argument quite accurately and succinctly when they state that: “making guns illegal would only keep them out of the hands of the law abiding population who do not commit crimes anyhow.” This is a very astute observation. Unfortunately, this same group often fails to realize that the same is true for our widget example, or drugs, or prostitution, and was found empirically to be true with alcohol. Making any of those things illegal did not eliminate the use of them; it merely marginalized use and created a criminal enterprise where one did not previously exist. Does prohibition result in decreased use?…only a little because, if the product is inherently risky, a vast majority of the population will avoid it anyway. Does prohibition make society safer? No, in fact the evidence would indicate the opposite.

So, why does our society struggle with this idea? Because liberty is scary to so many people! Of course, liberty—like so many other things—is really only a good idea for ourselves, not for others. The false premise that one group of people has the responsibility or authority to try and save others is preposterous and, I would argue, excludes the people who hold that idea from having any real profound understanding of the concept of Natural Rights or the ideas that our founders held so dear in creating this greatest of countries. The land of the free has become the land of the busybodies, intent on utilizing their votes to gain access to the force that government wields to make individuals “mind” them. I do not wish to have a nanny state economically nor do I wish to have one for individual choices. Incidentally, one thing everyone should keep in mind, you do not get one of those without the other.

Unions are cartels that should be subject to anti-trust laws

        Most people are familiar with the general idea of anti-trust laws and proceedings; but, as with many things the devil is in the details. A major problem that underscores this greater issue is a lack of understanding of the exact nature of labor. People often think of labor and capital as having a protagonist/antagonist relationship and this misconception is quite profitable to labor leaders and their political allies. However, the pervasiveness of this misconception does great harm to those who directly control labor—individuals; particularly those individuals who have the lowest skill levels which are most often the poor, minorities, and young people. People see laborers as having no leverage in the business relationship and thus assign laborers a more limited value.

        First of all, there are two primary factors of production: labor and capital. Labor is the efforts of people in producing goods and services for trade. Capital describes the accumulation of machinery and tools (often thought of monetarily) that are used in the production process. Neither factor holds a distinctive advantage over the other as a general rule, but differing circumstances can tip the scales of control to one or the other.

        This can be seen throughout history and even today. For example, there was a period in time when labor was so highly demanded (thus, labor held the advantage) that employers would wait outside of prisons to hire people as they were released. In the modern day, people who hold strong skills in computer programming or web design (etc.) can command significant salaries and benefits. These are not the instances that the media and politicians focus on; instead they choose to highlight the false narrative of the minimum wage and the “plight” of entry-level, low wage workers. This misses the reality of the damage done by labor unions by creating a sleight of hand, parlor trick.

         We—rightly—prosecute the collusion (cartelization) of business (owners of capital) if they join together to fix prices or production levels in a manner to extract much higher profits from the market than the competitive (more often the monopolistically competitive) value of their outputs. However, when it comes to labor unions, who collude openly on a national scale and across industry sectors (e.g. SEIU and AFL-CIO), we see that not as being an extortion of the consumer as we do in the capital example. Instead, we see labor unions—simply groups of individuals colluding to monopolize and thus increase their market power artificially—as merely protecting their members from an otherwise predatory institution. This is not the reality when it comes to mega-unions. The reality is that they are utilizing their control of one of the two primary factors of production in the same way businesses do when they collude; therefore consumers pay significantly higher prices which would resemble monopoly level pricing.

     Furthermore, just as other monopolies who do not enjoy regulatory protection by government which controls market entry, they induce others to enter the market and capture their market share by offering superior products at lower prices [note: natural monopolies that do not rely on regulatory control of market entry do exist; however, they are quite rare]. The effects of the monopoly, outside of government intervention, are often limited in their scope. We can see the results of this in the automobile market where, as trade restrictions relaxed (which is good for the US consumer), the foreign car producers began to rapidly grow against the domestic ones which were plagued by higher than natural equilibrium labor costs and diminishing relative quality (as a way to fight costs) versus the competition. The eventual result was that all those people who owned and controlled the labor factor of production in the car market and enjoyed higher than appropriate levels of profits (pay and benefits) ended up dropping their long run incomes to zero as new competitors entered and captured market share. From a labor perspective, these new market participants would include southern state workers who drew in production facilities as well as foreign workers (via outsourcing).

      Additionally, areas densely populated with people who enjoyed this monopoly level pricing for their labors collapsed as the monopoly structure of their labor force declined. Their government, bloated on the excess of extracting unrealistic levels of profits in their labor force from other areas in the country, could not sustain the drop in tax revenues and have essentially become ghost towns (Detroit’s population in 1950 was 1.8 million and is approximately 700,000 today). Also, the greater than equilibrium labor cost overall in markets like Detroit due to unionization of the auto industry crowded out other industries making Detroit perilously dependent on one industry.

        The real long-run winners in the equation have been the labor unions themselves (not their members) and the politicians who have enjoyed control of their votes and contributions for many years. The losers in the short run were workers that did not gain entry into those industries and, in the long run, all the people of areas once dominated by big labor production. People often say that unions were once a good thing and that somehow is supposed to justify the existence of mega union entities; however, I find that logic to be severely flawed. Instead, I argue that unions are still positive things when they are constrained to plant (or perhaps firm) level entities. This reduces large scale collusion while granting the owners of labor a more even position in the negotiating process without giving them unfettered control of the production of certain markets completely. Owners of a particular firm control all of the capital for that firm, but no single laborer controls all of the labor for a firm; therefore, an alliance of firm level labor can be positive without being punitive to consumers or damaging to the industry sector. Also, compulsory inclusion in unions should not exist because this removes the competitive nature of markets which allow a fair blend of profits to capital and labor simultaneously, while ensuring maximum marginal value to the consumers.

Regulation Is Not Our Salvation

        There is much talk of regulation and the need for it in every aspect of our “dangerous capitalistic” society; however, there is seldom talk of what regulation is and of what precisely it accomplishes. Ironically, the very people who exhibit the greatest disdain for “big business” are often the most ardent supporters of regulation (besides the big businesses themselves, of course). Democrats, and statists of all parties, are particularly interested in imposing regulations for the stated purpose of controlling the “animal instincts” of the free market. These are the same people who often deride big business publicly for taking advantage of consumers and keeping the “little man” down. And this is where it becomes interesting.

          What if I were to tell you that regulation is largely designed to do that very thing and that the politicians who both advocate and introduce regulation understand very clearly that it will remove competition by restricting new market participants? I know, I know–many people out there will be shaking their heads in outright refusal of this assertion. I can just hear it now: “we need government to protect us from big corporations”; or “that’s not what the news said”; or “Obama said we deregulated too much.” Food for thought, though: big opponents of airline deregulation were the (big) airlines and the big opponents of trucking deregulation?…you guessed it, the (big) trucking companies. That, by the way, is not an isolated situation.

          Now, before people start into the irrational argument that I hate all regulation or that I am an anarchist; try to refrain from acting arbitrarily dramatic, ‘cause it just ain’t true! Here is an example of the real world scenario and why most regulation is not only supported by “big business,” but also why they (and their lobbyists) write a significant amount of the legislation.

          Let us assume that I am a builder of houses in a small economy with a relatively static population (a miniature US, for example). I am the only builder of houses as I have been an innovator in early house building technology. Let us also assume I hired you to work for me as my helper and you worked your way up to foreman over some amount of time. At this point you realize that you know everything you would need to provide the same service that I do, but feel you can do it more cheaply (because I am operating as a monopolist and thus my pricing is artificially high). So, you strike out on your own and begin competing with me. This does not please me for obvious reasons.

          So, I go see the executive (president/governor) of this “state” we live and work in and I convince him that we should, for the safety of all consumers, get control of the house building market and pass some regulations so that amateur and dangerous new builders do not hurt anyone financially or physically. The executive, not wanting his constituents hurt or angry sees great value in regulation that will control the evil capitalists (besides me, of course as I will be grandfathered in…) and will make one of his major campaign contributors happy. He goes to the legislative branch and convinces them to draft a law; however, how can these lawmakers draft regulations about housing that will safeguard their citizens when they themselves have never built houses? Hmmmm…Wait, they have an idea—they should approach the local expert for help in constructing these regulations. My phone rings and I gladly accept my civic duty of drawing up regulations for housing standards so that I am guaranteed customers…I mean, so that the citizens are safe!

          Now, back to you, my only competitor; if am lucky I can build in professional fees and licensing, insurance, or even capital requirements that create a great enough obstacle to you not being able to continue in the market. If not, I have almost guaranteed that neither of our employees will likely ever be able to afford to compete with us.   Here is the best part, though. Having seen how well the appeal to citizens to safeguard them from “greedy profit-driven” capitalists worked out for his polling numbers; the executive decides to move on to another market segment. Once again, this executive finds great public support (who doesn’t want to be safer) and also finds he has more campaign contributions rolling in from companies which no longer have to fear any significant competition in their field.

     Here is the reality and the bad side of this equation. First, capitalism in this example no longer exists (incidentally, there has not been true capitalism in the U.S. for many decades except perhaps in some isolated market segments). The little man has been effectively “held down” and kept out of the marketplace. Skill, pricing, or a combination of the two is no longer that which is primarily supplied by market participants; instead, the ability to navigate the political waters and afford to pay for these regulatory burdens is what determines market participation.

          Second, the government has created a moral hazard in which the citizenry no longer feels responsible for ensuring quality in the products and services they purchase; additionally, government takes on no liability that the work they attest to (through regulatory obstacles) is of high or even good quality. For example, if you have a house built, it will have to be approved by government inspectors on many occasions for different purposes. However, if that house burns down later from faulty wiring that was inspected; the government that essentially told you it was safe carries no liability. This begs a tangential question: what is the point, exactly?

          Third, in fields that are “regulated” it has been made essentially illegal for people to work. To license something is defined as: the ability to grant a license to (someone or something) to permit the use of something or to allow an activity to take place. If something requires a license, it is otherwise illegal—ergo, it is illegal to work and earn a living if the government does not permit you to do so. Yet another disincentive towards working, just what we need!

          The rise in corporations over the last century is not due to not enough government. Inversely, it is due to too much government. I understand there is a long held belief in most people that government is there to help us, but we must get beyond misconceptions and use logic to approach questions. Whether a politician is well-intentioned or not, regulation still results in the same thing. Also, do not believe the hype that the Bush administration marked the biggest rollback of regulations in modern history—that could not be further from the truth. In fact, if you are a fan of regulation, you should have a picture of “W” over your mantle right next to your picture of Obama.

          If people actually understand what the true effects of regulation are, it is likely that we will tolerate less of it. However, I understand there is a draw in believing in wholesale regulation; the comfort of feeling like someone evil and rich is being halted on their wicked quest for world domination is probably great. But, perception a reality does not make. Regulation is the pet of “big business” that does not wish to compete and colorful plumage which politicians display to prove how “caring” and “egalitarian” they are; both, instead, use it largely as a tool to monopolize market segments and line their own pockets; perverting capitalism into cronyism.

          When you consider the effectiveness of government in solving all our problems you should truly ponder why all of governments “wars” of morality such as the one on drugs and the one on poverty have only resulted in more of both. Certainly, in the thousands of years of human history it is unlikely that humans have only recently gone bad; perhaps, we should realize that government has the anti-Midas effect of turning everything it touches into crap instead of gold.