Monday, November 26, 2012

Shabbat 54b: Judaism Isn't an Opiate of the Masses

"Opiate of the masses." That is what Karl Marx famously called religion. Religion leads to passivity because at least from what Marx could observe, people accept the way things happen as "G-d's will." "Why help out others when this what G-d wishes to be?" Judaism outright rejects that premise, and today's Daf Yomi portion, Shabbat 54 is a friendly reminder of that fact:

כל מי שאפשר למחות לאנשי ביתו ולא מיחה נתפס על אנשי ביתו באנשי עירו נתפס על אנשי עירו בכל העולם כולו נתפס על כל העולם כולו

Anyone who had the capability to effectively protest the sinful conduct of the members of his household and did not protest, he himself is apprehended for the sins of the members of his household and punished. If he is in a position to protest the sinful conduct of the people of his town, and he fails to do so, he is apprehended for hte sins of the people of his town. If he is in a position to protest the sinful conduct of the whole world and fails to do so, he is is apprehended for the sins of the whole world.

At this point, this blog entry more about preliminary thoughts than anything else. First is the continuing dichotomy between individualism and communitarianism in Jewish thought, which is something with which I struggled during this past Yom Kippur. There is plenty that Judaism has to say about individual sin. However, Judaism goes beyond regulating individuals in a politically libertarian manner. What this Talmud portion is saying is that we are also responsible for those around us. We're meant to do mitzvot such as give tzedakah and perform acts of loving-kindness (גמילות חסדים).  Although the Talmudic sages do not cite any Biblical verses for this parable, my educated guess is that Leviticus 19:16, the verse about standing idly by the blood of your neighbor, would come into play.

For being written about two millennia ago, I am surprised as to how global the thinking was. The first thing is the hierarchy presented here: home, town, and then the world. Given the complexities of globalization, I would expect a more nuanced hierarchy, but the idea is to help those closest to you and expand your assistance from there. I am impressed that Chazal makes a call for helping on a global level.

I think the repetition of "if he is in a position" is important because it's a conditional clause. To what extent are you obligated to help in avoiding sin? Globalization is a double-edged sword. On the one hand, we can relay information faster than ever. On the other hand, we receive too much information, and thus become all too easily aware of the plethora of problems that plague this world. Does that give us an out? Nope! As Pirkei Avot 2:16 states, just because we are not meant to finish our task does not mean that we desist from it. We need to pick causes that are within in our sphere of influence, and if they are not within our sphere of influence, we try to bring it within that fold. It is difficult to choose causes and figure out how to best help out. I hope to find a way to prioritize it all and actualize. But I do know one thing: Judaism teaches us that life is not a spectator sport. We are meant to be active participants in the game called "life" until it's over.

Thursday, November 22, 2012

The Carbon Tax: Not All It's Cracked Up to Be

I knew that policies such as tax increases and spending cuts were being discussed in the "fiscal cliff debate," but only very recently did I find out that a carbon tax was part of the debate. Why would climate change become a part of the debate? Aside from Hurricane Sandy, the answer is that politicians would expect revenue windfall to deal with fiscal woes. This led me to wonder whether the carbon tax would be effective.

The carbon tax is a Pigovian tax levied on the amount of carbon emitted in order to reduce carbon emissions. I have expressed skepticism about anthropogenic global warming, but over time, that position becomes harder to justify, so for the purpose of this blog entry, the assumption made is that man-made global warming is real and needs to be addressed.

As shown in the graph below, the idea is that the free market encourages individuals to produce more carbon via their energy consumption than is socially optimal. The consumer of energy is not bearing the real cost of emitting carbon into the atmosphere. The carbon tax raises the price of consuming carbon-based energy so that the consumer faces the full social costs. In addition to addressing and discouraging a negative externality, the idea is to incentivize investment in alternative energy, which would not only be great for the environment, but would help with long-term energy concerns. There is also the previously mentioned benefit of collecting revenue for the government. Arguably, one can contend that the carbon tax is simpler, more effective, less corruptible, and more transparent than cap-and-trade (that debate can be explored here and here). Voilà, the argument for a carbon tax in a nutshell.

As lovely as all of that sounds, I have my reservations about a carbon tax for a few reasons:
  1. Other effects of taxation. What is implicit within taxing carbon emissions is that factors of production (e.g., labor, capital, and investment) are also being taxed because energy is an input of production. Much like consumers, a majority of producer behavior can be attributed to incentive structure. Much like with protectionism, the carbon tax can either discourage work and investment in this country, or the tax can incentivize companies to outsource to countries with less regulations and taxes, both of which would slow down economic growth. A decrease in GDP growth would not be good for the economy, but cutting back on consumption might not necessarily be a bad thing, so there's a trade-off. Something else to consider is the issue of the tax-interaction effect, which is elucidated upon by economist Robert P. Murphy.
  2. Offsetting costs and revenue neutrality. My objections in the first point can mitigated by offsets by the revenue collected via "pro-growth" policies. Revenues can be used to deal with the debt or they can be used for other public funding. Additionally, the carbon tax can be revenue-neutral, meaning that a carbon can be offset by decreasing [or eliminating] other taxes, such as the corporate tax or the income tax. A revenue-neutral carbon tax is something that conservatives are even willing to get behind. It's all picture-perfect until you run into political reality. This assumes that tax revenue will be adequately appropriated and will not be caught up in politics like other tax revenue. Also, I had similar apprehensions about the prospectives of the value-added tax being revenue-neutral. Especially during a fiscal cliff debate, what is the probability that the government is going to consider cutting taxes to the point where the carbon tax would be revenue-neutral? We have to fund a welfare state with increasing entitlements, so I would safely bet that those odds are low.    
  3. Regulations and expansion of Big Government. Without the carbon tax, the government's next option would be to use the Clean Air Act to regulate carbon. Considering how micromanaging this bill is, effectiveness is in question. The carbon tax would simplify the process. Rather than a plethora of regulations, the carbon tax would directly address carbon emissions without the EPA's involvement. Much like with the second point, my issue here is that the carbon tax would not be in lieu of the EPA, but rather in addition to EPA involvement. Carbon is emitted by oil, coal, and natural gas consumption. Since these three energy sources consist of approximately 83% of energy consumption, it gives the government a carte blanche to regulate many facets of American's lives, which is very disconcerting. 
  4. Elasticities and Deadweight Loss. One of the advantages of the markets is that prices are reflections of supply and demand. This means that the mechanisms in the market can determine a consumer's willingness to pay (WTP), as well as the value of inputs and outputs. When the government levies a Pigovian tax, it has no way of knowing the external cost of carbon (i.e., value of the output) and how much it should tax. For all the government knows, it is overvaluing the emission of a ton of carbon if it taxes too high. Another issue with potentially taxing too high is with respect to elasticity of demand. This is important if your primary goal of the carbon tax is to cut back on carbon emission. If a good is inelastic, such as gasoline, the consumer will be relatively unresponsive to an increase in price, which means that it would take a substantial tax burden to get the desired effect. If the government keeps raising taxes with little change in carbon emissions, not only has the government angered its citizenry, but it also has done very little to cut back on carbon. In addition, both the Brookings Institution and Heritage Foundation express concern for deadweight loss, which means that the inefficiencies and the distortions in the carbon tax are larger than in other taxes. 
  5. Regressiveness of the carbon tax. A carbon tax is a flat tax in the sense that it taxes at a constant marginal rate. However, because the poor spend a higher percentage of its income on such goods as utilities and transportation than the rich do, it has a regressive effect on the poor. This will be compounded by the notion that in all probability, businesses will just pass the cost of carbon onto its customers, meaning that it would not even directly affect the producers. The Congressional Budget Office (CBO) recognizes this and has suggested some policies to keep the overall tax burden progressive. Like our current taxation system, I would expect a bunch of exemptions and loopholes to exacerbate the issues of overburden and inefficiencies that arise.
  6. Free rider effect. It has been called global warming for a reason. The spillover effects of carbon emissions affect the entire world. Therefore, the big emitters have to be on board. If developing countries such as China or India are more concerned with economic development (read: increased carbon emissions) than they are with fighting climate change, it is more challenging, if not downright impossible, of a task. Plus, America has been cutting back on its rates of emissions to the point where the downward trend has resulted in a 20-year low
  7.  Effectiveness of the tax. I started to cover this idea in my fourth point. In addition to dealing with inelastic demands, there is also the question of the extent to which carbon taxes will incentivize industries to invest more in alternative energy. I don't doubt that more expensive fossil fuels will make businesses want to develop green technology faster. Much like with education, throwing money at the problem doesn't automatically solve it, which does nothing to mitigate the high costs of alternative energy in the short-to-medium-term. Although technological process does not have a linear trend, there is only so much progress that can be made. I would opine that the tax doesn't necessarily help with speeding up progress. The increased incentive for industries to invest in green technology is [partially] offset by the revenue it would have acquired had it not been taxed. The carbon tax revenue would help with research and development (R&D) only if the government decides to a) appropriate it to R&D, and b) if the government doesn't get caught up in its inherent efficiencies (better known as government failures). 
Conclusion: If it will take years, or even decades, to wean off of fossil fuels, then punishing Americans  is infeasible without readily available alternatives, thereby making it an ineffective tax (assuming your goal was carbon emission reduction). As brought up in the World Bank's famous Stern Review, the policy that will make or break our efforts on climate change will be in developing technology, which means more R&D. A carbon tax can theoretically fund R&D, but that is not what is worrisome. The Copenhagen Consensus Center (CCC), an international think-tank, came up with a list of the most pressing issues the world faces. Interestingly enough, its panel with well-reknowned economists, thought that climate change was low on the priority list. Even when it looked at the topic of climate change, the carbon tax was ranked as a "very poor" policy. The CCC looks at technologies that would cost a lot less while doing more to solve the problem. As such, my bottom line is that rather than implement a punitive tax, we should focus the discussion of climate change on R&D. If we're going to spend money on the problem, we might as well spend it wisely, right?

10-30-2014 Addendum: This study from the Macdonald-Laurier Institute looks at the carbon tax, particularly from the point of view of the tax interaction effect.

1-12-2014 Addendum: The Heritage Foundation recently put out a piece on why carbon taxes aren't a good idea. Worth the read.

Tuesday, November 20, 2012

Defending Israel's Operation Pillar of Defense

It's hard to have watched the news in the past few days and not see something about the current conflict going on in the Middle East. Hamas has barraged Israel with rockets within the past year, but that barrage has increased substantially in November. It was refreshing to see the U.S. Department of State condemn Hamas' actions and German Chancellor Angela Merkel's affirmation of Israel's right to self-defense, but unsurprisingly, the United Nations has not denounced the terrorist organization via a UN Security Council Resolution. What does Israel do in response? It begins with killing Hamas military chief Ahmed Jabari on November 14, Since then, Israel has primarily through air strikes in what has been labeled "Operation Pillar of Defense" (עמוד ענן), and in turn, Hamas has escalated its attacks in what it has labelled "Operation Blue Sky" (السماء الزرقاء). A detailed historical account of the Israeli-Arab conflict would be helpful and more prudent. There is so much material to cover in such a small space, and in the interest of time, I provided this very brief explanation as to what has transpired between Israel and Gaza.

The question still remains: if peace is to be embodied within the political philosophy of libertarianism, how can I, as a libertarian, begin to justify what is taking place in the Middle East? I can first respond by saying that what is going on between Israel and Gaza is a military conflict. When you have an organization such as Hamas that is hellbent on your destruction, it makes the situation anything but ideal. Hamas has reneged on its ceasefire from the Gaza War. In 2012 alone, it has fired nearly 2,000 rockets into Israel, which doesn't even count the other rocket launches between Israel's withdrawal from Gaza in 2009 and the end of 2011. The fact that Israel held back from retaliating from attacks that put nearly half of its population at risk for that long of a period is flabbergasting, as well as being able to attest to Israel's self-restraint.

Austrian economist Steve Horowitz published an article today about the Israeli-Palestine conflict from a libertarian standpoint. While I don't agree with everything he had to say, I certainly agree with many of his general points. He brought up a point where Israel shouldn't accept American foreign aid. While I haven't done extensive research on the general effects of foreign aid, I was interested to find a study by the free-market, Israeli think-tank called Jerusalem Institute for Market Studies (JIMS) published on the inefficiencies of foreign aid. That doesn't negate an argument against what Israel is doing, but rather questions its method of funding.

One of his good points Horowitz brought up is that "simple libertarian moral ethics do not apply to this conflict," and arrives to his main point, which was "there is only one state in the Middle East that rests on broadly liberal values, and that is Israel." Israel is not an apartheid state by any means, but rather is a liberal state with democratic institutions. The Palestinian Authority is an authoritarian regime that consists of two oppressive entities: Gaza and the West Bank.

Prior to attacking terrorists, Israel sends Palestinian citizens leaflets warning them of when and where they will attack so that the IDF can avoid civilian casualties (Have you heard of any other military force doing this ever?). Israel does everything it can to protect its citizens. What does Hamas do? It repeatedly fires rockets into Israel and provokes Israel by attacking civilians in a deliberate manner. When Israel decides to retaliate, it has to target Hamas' weaponry. Hamas strategically places its rocket launchers and the terrorists it hides in densely populated civilian areas. As precise as the IDF tries to be with its attacks, this tactic purported by Hamas guarantees maximum civilian casualties. Not only does Hamas show disdain for its own citizens by putting them in the line of fire, but it also renders a lopsided casualty count.

I can hear someone ask "Well, what about Israel? They have to take their fair share of the blame." I hear the words "fair share" and I get somewhat of a gag reflex because what the heck does that even mean in the first place? Does this mean I defend Israel in every policy that it enacts? Of course not! Government is run by human beings, and human beings make mistakes. I am perfectly capable of criticizing Israel when criticism is due. If I couldn't openly and fairly be an "equal opportunity critic," blogging wouldn't be fun, and it would hardly be objective. However, we are talking about the difference between the democratic, free state of Israel versus the totalitarian entity known as Hamas. There is no moral equivalency, and anyone who attempts to do so, especially in the name of moral relativity, lacks anything resembling a moral compass.

Without getting bogged down in history, Israel is a nation-state that has legitimately acquired the land, have its acquisitions legally recognized by the United Nations, and has fought multiple defensive wars to keep that land. Israel has put more than enough effort into fairly securing that land. As such, it has the right to self-defense, as it is afforded by the UN Charter, Article 51. If libertarianism allows for self-defense on an individual level, why shouldn't we allow for that on the international level? If any other country were attacked with hundreds of missiles, it would rightfully be called self-defense because the country is trying to prevent civilian casualties in its country. When Israel does it, well, it's a whole different story marred with double standards.

I would love for the day when Hamas, and even Fatah, are committed to peace. A permanent ceasefire would be great. Enough blood has been shed in this conflict, and quite frankly, warfare is a lousy and inefficient way to allocate limited resources. As nice as it would be if everyone could "just get along," we do have to concede to reality. It's still Hamas' raison d'être to wipe Israel off the map. Fatah cannot even recognize Israel's right to exist. It's hard to criticize Israel not creating a long-term solution when its supposed "partners in peace" are not remotely committed to the idea of peace. It's a tricky situation and I know there are no easy solutions. Until the diplomatic circumstances are more conducive to a long-lasting peace, I'm afraid that Israel will have to justifiably continue with its Operation Pillar of Defense because it's the best option out of a bunch of unsatisfactory options.

Thursday, November 15, 2012

Spontaneous Order: Its Wonders and How Market Failures Limit It

I've heard enough people opine that capitalism is messy because it's unregulated, and thus chaotic. "The economy should be like a well-oiled machine," they think. "If we [the government] can manage things from central headquarters, it will work perfectly," so thinks the anti-capitalist/pro-government individual. The issue with this line of thinking is that the economy is not a single, large machine that can be fixed if we just replace a certain cog (think of how Keynesians approach the idea of aggregate demand). The marketplace is actually an ecosystem in which consumers and producers interact. In a [relatively] free society, that means doing so voluntarily, which leads to the idea of spontaneous order, i.e., out of seeming chaos comes the emergence of order from multiple, intertwined economic interactions. If anything has illustrated the concept of spontaneous order well, it is the short essay I, Pencil by Leonard E. Read. The Competitive Enterprise Institute recently created a short video summarizing the general idea behind this essay:

On the whole, the idea works brilliantly, both in theory and in practice. However, being a graduate-level student of public policy has made me realize that although it is easier to think in absolutes, the world rarely, if ever, functions in absolutes. This next part is going to drive the self-identifying Austrians/anarcho-capitalists/"hard libertarians" crazy: market failures exist. You read that right. I am a capitalist who realizes that market failures exist. Considering that humans, who are by definition fallible individuals who make irrational, ill-informed, and/or ignorant decisions, interact in the markets, it makes sense that free markets, by extension, would be imperfect.

Market failures exist in four primary forms: negative externalities, natural monopoly, public goods, and information asymmetry. Most public goods are not purely public goods and can, at least in theory, be privatized. As Thomas DiLorenzo points out, natural monopolies might not have even existed in practice, and even if they have existed, they would be considered exceptions to the norm. Internet has been the single greatest invention to counteract information asymmetry.

The only market failure left is the idea of negative externalities, which would by far be the most justifiable reason for a government to intervene in the first place. The reason I would call government intervention "justifiable" because being able to do whatever you want is not the sole value of libertarianism, albeit liberty is an exceptionally important and weighty factor in libertarian thought. There is also the matter of the axiom of non-agression, which states that as long as you don't harm another individual in the process, you are free to do whatever you want. Mainstream libertarianism recognizes this limitation to one's freedom. Negative externality is the fancy economic term for when an individual or entity violates the axiom of non-agression.

The classical example of a negative externality is that of pollution. A factory dumps a bunch of pollutants in the water and contaminates the water supply. In a free-market scenario, the company would not bear any of the cost while those who drank the aforementioned water would be exposed to contamination. The only way I would justify government intervention in such a case is the following were true. First, the market produces such a weak response, or even a non-response, to the problem, especially if the status quo is unacceptable (e.g., pollution causes irreversible damage to either the ecosystem or human beings). Second, the government would be the only entity to prevent such a violation of the non-agression axiom. In the case of water pollution, both hold true. The market has no viable short-to-medium-term solution (developing greener technology would be considered long-term), and the government can impose a Pigovian tax to retard, if not downright stop, the pollution. This is a realistic situation that libertarians such as myself don't like, but nevertheless reluctantly agree that the government needs to intervene because that's the reality of the situation.

In case it hasn't been made clear, an example such as the modest Pigovian tax on pollution is by far an exception. The only time to accept government intervention is when there is evidence of a market failure, the market cannot solve its own failure, and the government intervening, however imperfect it might be, is the best option to increase net benefits, both individually and socially.

I would like to conclude with two points. The first is to those who would like to call me a "statist" simply because I begrudgingly recognize that government does have a role to play, even if it's limited. The Founding Fathers recognized this reality, as did figures such as Milton Friedman and Adam Smith. If you look at the entries for my blog, I have overwhelmingly either called for deregulation or straight-up privatization.

The second is that government failures also exist. The biggest government failure is that bureaucratic agencies do not need to pass a market test to survive. If, or more precisely, when a bureaucratic agency fails or acts in a highly inefficient manner, it is all but certain that a) it will not be punished for making bad choice the way an agent in the private sector, and b) its existence will be perpetuated. Why are there higher inefficiencies in government? Competition forces firms to produce the best product possible at the minimum cost. Public agencies rarely, if ever, face direct competition (e.g., the United States Postal Service), and as such can survive amidst inefficiencies. The public sector is thus disincentivized to innovate and create a better product (read: worse output). There are also issues with valuation of public outputs. The reason that it's more difficult to measure is because in the private market, customers reveal their marginal value by their willingness to pay via purchases. With public agencies, their output is not sold competitively, which means determining input and output values is guesswork. Additionally, ex ante controls also cause inflexibility to innovate because there are protections on civil servants, such as restrictions on how employees are hired, fired, rewarded, and punished, which is another way to say "labor rigidities." There are also issues of electoral cycles causing more myopic views on policy for politicians, not to mention politics (e.g., lobbying, special-interest pandering, rent-seeking) getting in the way of good politics.

If we are going to analyze public policy objectively, we have to recognize that both market and government failures exist. With that in mind, one has to account for both types of failures within a given policy question and figure out which set of failures is worse. To quote Nobel Prize-winning economist Gary Becker, "on the whole, government failure is far more pervasive, damaging, and less self-correcting, than is market failure," and no surprise here, but I agree. Just to list of a few examples out of what can easily become a long list of many examples: anti-price gouging laws, the War on Drugs, funding the arts, the sin tax, minimum wage, affirmative actionprotectionism, the list goes on.

I don't see markets being completely free in the foreseeable future, and I don't think spontaneous order will exist in its purest form, but we should approach it as closely as humanly possible so that we can best benefit from what spontaneous order has to offer.

Thursday, November 8, 2012

How Is France's Credit Risk Looking Right Now?

Rather than focus on the election results like everyone else has been doing since Tuesday evening, I wanted to write about something with an international theme. Today, I would like to focus on France's economy and assess their long-term risk in the financial markets. The importance of France is due to the fact that its nominal GDP is fifth worldwide and second to Germany in the Euro Zone. Although France is not the power it once was under Napoleon, France still has influence in the global markets. If the French economy was dealt a coup, it would affect the Euro Zone, at the very least, and at the most, would adversely affect the global economy. With that to consider, let's take a look a France.

On the whole, France is a country with sound, democratic institutions. Freedom House has given France a superior ranking on its index that measures political and civil freedoms. Even with some issues such as Internet censorship and the burqa ban, France enjoys overall institutional stability, which is great because France's resilience to external shocks and a seemingly stable monetary policy [with the ECB] helps set the minds of investors at ease because instability leads to a more inefficient use of resources. This sentiment is additionally affirmed with France's reasonably high rating on the Corruption Perceptions Index (CPI) or France's overall inflation rate. Even when looking at the credit-default swaps market, France's government bonds hold comparably well to Germany (as of date, 80.05 versus 32.50, respectively), which is a solid indicator of confidence in the French government.

My confidence wanes a bit when I look at the economic freedom indexes from Heritage/Wall Street Journal and the Fraser Institute, not to mention France's anemic GDP growth. I would summarize France's economic issues into three main issues:
  1. Government spending. France's debt to GDP ratio shot up six percent points during the last two quarters. Currently, France's debt to GDP ratio is at 91%, which is above the Euro Zone average. The increase of government spending is problematic because it signals a lower probability that a country can pay off its debt obligations without doing things like printing more money to create a de facto default, expropriate more property, or raise taxes. Also, if the citizenry demands, or the government continues to provide more welfare-based services, then the amount of government spending will only ascend to insolvent rates. 
  2. Tax Rates. In order to be able to supplement a welfare state, a country needs to tax higher. When looking at the OECD database for tax rates, the value-added tax (VAT) sits at 19.6%, which is above average. Tax revenue as a percent of GDP is 44.2%, which is bothersome because it suggests a lack of financial depth brings brings up issues mentioned in my first point. François Hollande recently unveiled his intent to tax those making more than a million euros at an astonishing 75%. France's above average tax rates are problematic because such levels of taxation greatly diminish, if not outright destroy, incentives to save, invest, or even work.
  3. Labor Rigidities. As if France's fiscal policy wasn't bad enough, there is one last issue that makes the French markets even more problematic: its labor markets. Looking at the Index for Doing Business compiled by the International Finance Corporation and the World Bank, it is not easy to do business in France. Why is that? For one, France's labor laws are based off of Le code du travail, which was first established in 1910 (i.e., their ways of perceiving the labor markets are arcane and obsolete, to say the least). It is impossible to fire an employee at will. Back in 2006, France tried to pass a bill that stated that an employer could fire an employee under 26 years of age if he didn't work out. The result? The bill got rejected. One has to fill out all the proper paperwork immaculately and jump through all of the proper loopholes to get someone fired. It is usually cheaper to keep an incompetent employee on the job than firing him and hiring a new employer. This causes employers in France a huge disincentive to hire new labor, which would explain why it had high unemployment rates even prior to the recession. Not only that, hiring is expensive. France mandates a thirty-five hour work week, which is the lowest amongst developed nations. The French government also mandates that employers give eight weeks of paid vacation. France also has this crazy law where if you hire a 50th employee, there is a ridiculous amount of oversight and bureaucratic intervention. Since the marginal cost to hire a 50th employee is so high, France has a lot of 49-employee companies, and thus would have to endure the cost of creating a new company to get around the loophole. Without a flexible labor market, not only have you made it undesirable to hire more employees, but productivity goes downwards because complying with all these regulations creates inefficiencies in which the money could have been better allocated elsewhere. 
Conclusion: The extent of credit risk is largely, but not solely, contingent upon the future of the Euro Zone. If Greece or Italy tank, there is a good chance of the contagion effect. Euro Zone notwithstanding, there are still internal worries for France. Remember that the French government couldn't fathom the idea that it could lose its AAA+ credit rating, but it did within the past year. Making the recent decision to increase the VAT didn't help, either. The International Monetary Fund (IMF) recently put out a report telling France that, amongst other things, it needs to reform its labor markets if it doesn't want to exacerbate its current situation. I agree with the IMF: it needs to make serious changes to free up its markets. Since there is currently a socialist as the president, that only increases the credit risk because socialism is just a form of credit risk. I do hope that France decides to make some real reforms in order to maintain its institutional stability, but again, optimism is not an indicator of how France's long-term economic status will turn out. Since I do worry about France's economic policies being "on auto-pilot" or worse (i.e., more socialist policies), I would currently have to rank France's overall credit risk somewhere between Low and Medium.

UPDATE, 11/15: The Economist just published an article about France's heightened credit risk. Worth the read.

Thursday, November 1, 2012

How Price Gouging Laws Cause Even More Devastation During Natural Disasters

It's unfortunate to see when natural disasters such as Hurricane Sandy hit, especially when it hits countries that don't have the infrastructure to adequately respond. When these disasters take place, goods and services get more expensive due to scarcity. When a producer raises prices to the point where they are considered unfair or unreasonable, the practice is pejoratively known as price gouging. Since this practice is viewed as a form of exploitation of consumers during a crisis, many states have implemented laws [known as price gouging laws or anti-price gouging laws] that prevent price gouging from taking place. Before jumping on the bandwagon of calling sellers predatory, it would behoove us to first figure out the role of prices, what exactly price gouging laws do, the ethical issues with this practice, and given this information, determine whether price gouging laws are good, negligible, or just a terrible idea.

You think this would be a simple question, but here it goes: What are prices? A price is a market mechanism that relays information, mainly that of supply and demand. In the case of a hurricane striking, one experiences a supply shock, which is a sudden contraction of supply (i.e., there are less goods available than beforehand). As the graph below indicates, that means a sudden increase in prices:

Depending on the nature of a given good, that can also mean an increase of demand (below):

The natural disaster has caused a definite contraction in supply because inventories, vehicles, and infrastructures have been greatly debilitated, if not completely wiped out. In addition,  the demand for at least some of these goods is also going to increase because the consumer has an urgent demand that needs to be fulfilled. The price increase is thus inevitable. Due to the shortage described above, it is a safe bet to say that the quantity of a good before the natural disaster will be less than afterwards (∆Q < 0). The new prices in the short-run reflect scarcity, consumers place higher value on a given good, and based on these incentives and new information, the consumers and producers act accordingly. From a consumer standpoint, because the prices are much higher than one is accustomed to, a knee-jerk emotional reaction of unfairness ensues because they think that prices are the problem when prices are in fact a reflection of the problem.

Let's take a look at what the government attempts to do to mitigate the unfairness. Most states have price gouging laws and they vary from state to state, but the general idea is that the government says that a producer cannot charge over a certain price.  Since one can assume that the price the government sets will be below the market price, it creates a price ceiling:

As can be observed in the price ceiling graph above, Qs < Qd, which is another way to say that price ceilings create a shortage. The textbook example for the effects of the price ceiling is when the United States government imposed a price ceiling on gasoline back in the 1970s, which ended up in people waiting in long lines for gasoline and an inefficient use of resources. How is a shortage created in the first place? If a seller is forced to sell a good a price lower than what the market dictates, the seller would either sell less (depending on size of inventory) or even pull out of the market completely. Since certain sellers respond to these incentives as such, there is less quantity of a good available, thereby exacerbating the situation.

If the government imposes and dictates that the price of a good is just as much pre-disaster as it is post-disaster, the consumer will purchase and use this commodity with no more care than they did prior to the disaster. This eliminates the consumer's incentive to conserve, which is something that needs to be done during a crisis. Without that incentive, goods are consumed all quickly and thus become even more scarce. The idea is that goods in the affected area now are of higher value than they were pre-disaster. Without these laws, consumers are forced to think twice about whether they truly need a good in their time of need. If the consumer truly doesn't think the good is worth the cost, they can either try to find another provider or do without the good. No one is forcing the consumer to buy the good, and the practice of price "gouging" should not be a crime because it's the producer's prerogative to decide what to do with his business. However, if the consumer ends up paying the good, it's because the consumer attaches greater value to purchasing the good than what the customer gives up for that good.

Even if one cannot afford the good, the poorer individuals benefit from the economic system that permits price gouging, and here's how. Another issue is that price gouging laws take out an incentive for another group: producers outside the affected area. If I am a retailer who is observing the crisis, I will notice the potential for windfall profit in the area. What does that mean? The price will signal to me (or the [global] market for the good) that a particular good is especially needed. As a retailer, I have a profit-based incentive to send my goods there in an expedited fashion to make more profit. This mechanism helps incentivize producers to distribute much-needed goods to individuals much faster than if price gouging laws are in effect. More producers enter the market and compete for the business of the consumer by lowering prices. The mechanism of market competition helps lower prices back down to pre-disaster levels more quickly than government intervention. The producers make additional profits and the consumer receives important goods faster while returning the markets to normalcy quicker: a win-win situation. In spite of these price gouging laws, it's how Wal-Mart and other large retailers helped during Hurricane Katrina. It looks like it's even happening now. To mute that signal (i.e., the higher price) only delays a timely recuperation from the disaster.

Matt Zwolinski brings up many good points in the video below, but one of the points of particular interest was asking the question of what is the alternative distribution mechanism under price gouging laws. The answer is that it is based on a first-come, first-serve basis. If you couldn't get in line early enough or didn't have any political or business connections, you're screwed. And if you're poor, you can't even afford the prices of the black market because they're even higher than the "unregulated market," so again, screwed.

Postscript: If the Left-leaning Matthew Yglesias agrees that price gouging laws are a bad idea, not to mention most economists, it's yet another indicator that price gouging laws are a bad idea. The economics of price ceilings point out how price gouging laws cause shortages and delay economic recovery from a natural disaster. Both the consumer and the producer are harmed in the process. And that doesn't even get into things such as what constitutes a "'fair' price", consideration of respect of private property, or what gives the government the right to arbitrarily setting prices when efficiency or rationale are hardly at the forefront of just about any government intervention. It's just another example of when good intentions lead to unintended consequences. When will our politicians learn?