The Chaplain and the Comedian

Thankfully, the government shutdown is now over and we have at least a temporary deal on the debt limit. This is an answer to many fervent prayers, not least of all Senate Chaplain Barry Black. For those who have not seen it, below is a pretty good round-up of Chaplain Black’s prayers for the government shutdown:

And now here is SNL’s humorous impression of the chaplain in action:

 

A.K.

Read the Old Stuff

Old Books

Here’s a quotation to ponder this weekend:

Every age has its own outlook. It is specially good at seeing certain truths and specially liable to make certain mistakes. We all, therefore, need the books that will correct the characteristic mistakes of our own period. And that means the old books. All contemporary writers share to some extent the contemporary outlook—even those, like myself, who seem most opposed to it. Nothing strikes me more when I read the controversies of past ages than the fact that both sides were usually assuming without question a good deal which we should now absolutely deny. They thought that they were as completely opposed as two sides could be, but in fact they were all the time secretly united—united with each other and against earlier and later ages—by a great mass of common assumptions. We may be sure that the characteristic blindness of the twentieth century—the blindness about which posterity will ask, “But how could they have thought that?”—lies where we have never suspected it, and concerns something about which there is untroubled agreement between Hitler and President Roosevelt or between Mr. H. G. Wells and Karl Barth. None of us can fully escape this blindness, but we shall certainly increase it, and weaken our guard against it, if we read only modern books. Where they are true they will give us truths which we half knew already. Where they are false they will aggravate the error with which we are already dangerously ill. The only palliative is to keep the clean sea breeze of the centuries blowing through our minds, and this can be done only by reading old books. Not, of course, that there is any magic about the past. People were no cleverer then than they are now; they made as many mistakes as we. But not the same mistakes. They will not flatter us in the errors we are already committing; and their own errors, being now open and palpable, will not endanger us. Two heads are better than one, not because either is infallible, but because they are unlikely to go wrong in the same direction. To be sure, the books of the future would be just as good a corrective as the books of the past, but unfortunately we cannot get at them. C.S. Lewis’ “Introduction to Anthanasius’ On the Incarnation”

 

A.K.

 

The Truth About Subsidies: Part 3

To conclude my subsidy blog posts this week, I will be talking about a common argument in favor of subsidizing companies based on “infant” status.  The subsidy blogs were motivated by a comment on my Recycling post suggesting that businesses cannot grow and prosper without some subsidies to which I disagreed. The first of my subsidy posts explained one common argument in favor of government funding for an activity based on whether it can be classified as a public good. I explained how recycling cannot be classified as both nonexcludable and nonrivalrous.  The second post explained that subsidies may be justified if there is a divergence of private and social benefits and the transaction costs are too high.  However, it is unclear that recycling has a different social benefit compared to a private benefit and thus that argument cannot justify recycling deserves government subsidies.

 

The third argument rests on the idea that new industries need time to establish and find economies of scale.  Not only do industries need time, but the idea is that if we want diversified industries and not have to rely on other countries for goods we must take the time to develop.  This argument was also hinted at by Jan in one of the comments on the first blog post.  Further, A.K. probed at this idea (and me) on this argument in his follow-up post after The Truth About Subsidies: Part 1.  In fact, he states:

“If all of the relevant costs are incorporated into the price mechanism (an assailable proposition), then the greater cost associated with recycling a plastic bottle versus producing one from virgin resources is per se evidence that recycling is actually counterproductive to the goal of resource conservation. If the price mechanism argument holds up, we should not merely oppose subsidization of recycling, but oppose recycling itself! This argument would hold so long as the relative cost dynamics hold.

But here’s another challenge, Danielle. Can we argue that we need the subsidy to help the recycling industry grow, become more sophisticated, and reverse the cost dynamics over time? “The recycling industry is an infant and needs time and support to become self-sufficient.” (emphasis added)

Particularly in the case of recycling, the infant argument would suggest that older competitors (trash collectors) have had time to attain economies of scale, while new industries with perhaps high fixed start-up costs have a difficult time competing due to these high costs.  This idea is a protectionist one and often the argument for quotas/tariffs on other countries.  New industries may also be at a disadvantage due to not having the necessary skills and knowledge to compete.  One may think of recycling as a relatively new business that only has been around for the  last couple of decades and knowledge on how to run a recycling center and build new equipment is also relatively new.

 

In a great article on infant industries related to international trade by Forbes they explain 3 main reasons why mature industries have a competitive edge over infant industries. I will sum them up briefly:

  1. Mature industries have trade secrets or patents that allow them to produce efficiently. (This is probably not as applicable to recycling as it is to different countries that may have a favorable patent over another country.)
  2. The mature industry has the correct environment or domestic infrastructure that allows it to efficiently produce a product. (This can be applicable to recycling if you think that access to machines and efficient processes will come over time.)
  3. Mature industries have a knowledgeable workforce and infant industries have employees that need time to acquire skills. (Definitely applicable in any new industry.)

However, there are some problems with giving infant industries, like recycling (if you think it should be considered an infant industry), subsidies.

 

One problem with giving firms’ subsidies under the notion that an “infant” firm needs time to grow into “adulthood” is that once firms obtain government subsidies they are reluctant to give them up.  It is like a parent who gives their child allowance and then one day cuts them off.  The child rarely accepts this without pouting, kicking or screaming—firms are the same. Further, some of these infant industries never actually grow and become cost effective, because they just use their political favor to keep collecting subsidies to offset costs.  These payments allow them to keep operating where in absence of them firms wouldn’t be efficient enough to stay in business.

 

Another problem that is caused by using subsidies to fund infant industries is that companies could abuse this privilege (i.e. rent-seeking) and simply claim that they need subsidies to grow their company.  It can become difficult to determine which industries (wind power, recycling, solar panels) actually have high costs and thus ‘need’ subsidies to have time to grow and compete with other energy competitors or whether they are just seeking government favor and monies. Determining which firms/industries deserve the money becomes a tricky question.

 

Lastly, the third problem that I can see is that subsidies change the relative pricing in the marketplace in favor of industries that get the subsidies.  The price mechanism changes with a subsidy and it makes the entrepreneur more likely to enter into the recycling business versus the trash collection business if recycling is subsidized (which it is).  It provides an incentive for workers to favor becoming educated in recycling versus trash collection when otherwise this may not be the case.

 

Subsidies help “infant” industries grow their business from a cost-intensive one to one that is self-efficient and profitable even without subsidies in some cases.  However, in other cases businesses may take advantage of subsidies and lobby politicians to keep subsidies even when they are no longer needed.  Further, these political connections may not provide the right incentives for firms to become efficient and some never do, yet still receive money.

 

One prominent Harvard economist published a paper on infant industries in relation to an argument for tariffs and quotas in international trade.  He finds that, “the decision to protect the industry should depend on the industry’s learning potential, the shape of the learning curve, and the degree of substitutability between domestic and foreign goods.”  This solution seems to be ideal in that each industry/firm is different and some can use help/time to become cost efficient producers.  However, this paper is theoretical and perhaps not really practical.  To know which industries actually have “learning potential” and determine a proper metric to measure this would be difficult at best.  Further, it may be also difficult to know the exact degree of substitutability between environmental goods (like recycling and trash collection) and thus how could the government ever efficiently allocate subsidies?

 

So, in some cases subsidies will help a business prosper and some they don’t. Does that mean we should have subsidies for infant industries?  To me, it depends on the role one feels the government should play in our lives.  If one believes the government is needed to help businesses grow and to allow for industry diversification then perhaps subsidies are warranted.  If one believes the government distorts relative prices with subsidies and allows for suboptimal job and resource allocation that would not occur in absence of subsidies then subsidies are not wanted.  Again, this depends on what you believe is the proper role of the government.

 

I, for one, prefer the private market to decide where resources are allocated.

The Truth about Subsidies: Part 2

To follow up with part two in my response to the statement that “businesses need some subsidies to grow and prosper” I am going to talk about private and social costs. (Part 1 defined public goods and stated why recycling is not a public good.

Often times people assume that private goods must be public, to help out the greater good.  The arguments follow like this: “I don’t want pollution in the air to kill the trees that help me breathe. The government must make sure trees stay alive.”; “Recycling is environment friendly, so the government should fund this. I want clean water to exist when my children become adults.”  Both of these arguments may give you the warm, fuzzy feeling inside, but alone, these do need qualify the need for public assistance for road building or recycling.  In the absence of being a public good then, what qualifies these goods for public assistance?

The argument for public assistance for goods depends on if there are high transaction costs in defining property rights when there is a difference between private and social cost.  The words I just mentioned are economic words that are typically explained in an Introductory Microeconomics course, so let me briefly review the meanings.

Private costs are those for a producer of a good. These costs include the capital equipment, labor and inputs.  External costs are not reflected on an income statement or in a consumer’s decision.  Social costs are both the private + external costs for a good and service.

Private costs to firms or individuals do not always equate with costs to society for a product or activity.  If the costs do not equate there is said to be an external cost.  An example would be in producing cans of beer at the Anheuser-Busch plant in New Jersey there is a cost to production to firms (aluminum, wheat for beer etc.) and the cost of buying the cans of beer to consumers. Consumers buy beer, because they like it.  However, there is an external cost to society when producing cans (pollution from the production plant enters the air and affects the nearby homes that surround the plant).  Consumers do not take this necessarily into account when buying beer, nor do firms take this into account when producing beer.

When there is an external cost that means the price of the service is too low or there is too much production of the service.  To ensure we, as a society, are producing at an efficient rate of output and at the correct price we must take into account these external costs.

The way to “make up” for these external costs, such as the pollution in nearby neighborhoods or dirty water in a lake due to landfill runoff, would be to define clearer property rights. (If you ever heard of the word externality, it comes directly from ‘external costs’.) Simply, a property right involves the right to use a good, earn income from the good and to transfer the good to others. If someone owned the lake that was being polluted into, easily the lake owner can negotiate with the landfill owner and charge a “fee” for the landfill owner to pollute into the lake. The transaction cost, which in this case is the cost of determining the proper “fee” for polluting into the lake, is relatively low. The lake owner can call the landfill owner and negotiate or go to court to fight the landfill owner for proper monetary damages.  There is no need for the government to intervene by closing down landfills if the private market can come up with an efficient, acceptable solution to both parties.

However, in the case of some environmental problems, such as pollution, it is difficult to determine who has property rights on air.  It is hard to define who has those rights and hard to enforce those rights.  Also, there are high transaction costs in organizing the parties damaged by pollution (i.e. mostly everyone) to negotiate with everyone who pollutes (i.e. most businesses and most people).  It is only in this case that there should be government regulatory solutions.

Needing government regulatory solutions when it is hard to define clear, property rights is not to say that many industries should be subsidized. Often times taxing the polluter to pay damages to those affected, cap and trade solutions, ban on high air emissions etc. may be the most efficient ways to decrease the production or increase the price of the good so that private cost= social cost. Subsidies encourage a greater production of a good, so subsidies are the corrections made if there is a positive externality (positive external costs) or in which social benefit > private benefit.

For example, society values schooling much more than maybe a private individual does.  I may only value getting educated until I am 10, because I never plan on working in a business. I may just want to work on a farm and basic skills taught in the classroom may not be what I feel is important.  However, society may prefer people to get educated until they are 15-18 (this varies per state).  This is because society wants everyone they meet, regardless of job, to have a basic understanding of math, reading, science and our country’s history.  When I walk into the grocery store, I want my checker to be able to understand how to make accurate change, etc.  This is not to say that someone cannot learn this by age 10, but at some age cutoff, society prefers people to be more educated than less.  To make up for this external cost, albeit a positive one, the government funds education.  This helps those with low incomes afford to send their children to school, whereas in the absence of public funding, those who do not have the money may drop out by age 10 or even earlier.

Subsidies can help to equate private benefit to social benefit, but it is not clear that recycling is a good in which private benefit and social benefit are different and thus should be subsidized.  In fact, it is not clear HOW society truly benefits. Scientists claim that recycling saves the earth, but how would the earth really be in absence of forced environmental policies like recycling? We can speculate, but it is hard to truly measure the counterfactual.  Further, the private cost to me to recycle is my taxes (or my penalty for not recycling in some states) and the time spent sorting recycling material.  I am not sure there is much of a social cost to recycling if you assume that we pay taxes for recycling whether people use it properly or not.  It is not clear that there is a divergence in private cost and social cost, so if there is an argument for government assistance, such as subsidies, it must appear on the benefit side.

Nonetheless, even if there is a divergence in benefits such that it requires a subsidy to equate private and social benefit do the benefits truly outweigh the cost of the higher taxes and increased regulation for recycling? I am not sure there is clear consensus that this is true.  Ronald Coase in his article, “The Firm, The Market, and the Law”, writes

The concept of “externality” has come to play a central role in welfare economics, with results which have been wholly unfortunate. There are, without question, effects of their actions on others (and even on themselves) which people making decisions do not take into account. But, as employed today, the term carries with it the connotation that when “externalities” are found, steps should be taken by the government to eliminate them. As already indicated, the only reason individuals and private organizations do not eliminate them is that the gain from doing so would be offset by what would be lost (including the costs of making the arrangements necessary to bring about this result). If with governmental intervention the losses also exceed the gains from eliminating the “externality,” it is obviously desirable that it should remain. (emphasis added)

More on Recycling

Recycling Globe

A very interesting discussion on recycling has broken out it seems. It started when that firebrand, Danielle, posted “RECYCLING WASTES RESOURCES, NOT SAVES”, which she has recently followed up with “THE TRUTH ABOUT SUBSIDIES: PART 1”, the first in a three-part series, at my provocation. That she would throw herself into it with such vigor reminds me of G.K. Chesterton who wrote one of his most famous books in response to a critic. In the introduction to that book Chesterton quipped that if certain points required elaboration, “Mr. G.S. Street has only to throw me another challenge, and I will write him another book.” Love It!

I am still fairly agnostic on the issue of recycling, so I’ll play devil’s advocate here. One might say that “recycling” as a mere service performed in our market economy is a private good because its provision is both excludable and rivalrous, as Danielle has stated clearly. But how does one respond to the claim that recycling, in as much as it contributes to a clean environment, is a classic public good, the environment being both nonexcludable and nonrivalrous?

Or the argument might be stated in game theoretic terms: All members of the community have an interest in conservation of natural resources both to sustain present enjoyment and health and to maintain resources for posterity. Such conservation requires that individual consumption of goods be engaged with an eye to that end. Individuals, recognizing that their own contribution to the overall goal (in our case, recycling) is negligible, are likely to contribute to a suboptimal degree. Such an individual might reason that his own contribution to the overall goal is personally costly, but only trivially related to the attainment of the goal and might decline to contribute. If he declines to contribute but a sufficient number of others do contribute, he will still enjoy the benefits of the goal being achieved. On the other hand, if he contributes and a sufficient number of other people do not, his contribution would be futile. Either way, many individuals may decline to contribute to a goal they all share and thus the goal is not achieved–a tragedy. So why not use a commitment device whereby some small portion of tax revenue is allocated to subsidize the provision of this service to the degree necessary to shift the balance toward the achievement of a goal each member of the community values but is otherwise unlikely to instantiate?

I suppose the above arguments rest on the crucial assumption that recycling is an efficient method to achieve conservation goals. This assumption is challenged by Danielle’s quotation from the Cato paper:

 the price mechanism is used to divide scarce resources among people. If new plastic bottles are cheaper than using recycled plastic it is because less resources are used.  Forcing citizens to recycle means that we are using more resources than if we used virgin products.

If all of the relevant costs are incorporated into the price mechanism (an assailable proposition), then the greater cost associated with recycling a plastic bottle versus producing one from virgin resources is per se evidence that recycling is actually counterproductive to the goal of resource conservation. If the price mechanism argument holds up, we should not merely oppose subsidization of recycling, but oppose recycling itself! This argument would hold so long as the relative cost dynamics hold.

But here’s another challenge, Danielle. Can we argue that we need the subsidy to help the recycling industry grow, become more sophisticated, and reverse the cost dynamics over time? “The recycling industry is an infant and needs time and support to become self-sufficient.”

Thoughts?

 

A.K.

The Truth About Subsidies: Part 1

In a comment by Jeff Mayowitz on one of my most widely read posts on Recycling, he stated that:

 “ I’d argue that businesses cannot grow and prosper without some government subsidies. Government subsidies have helped build our infrastructure, helped maintain our roads, bridges, tunnels, seaports…[etc.]…. and government subsidies are to thank.”

Later in his argument he states that,

“I agree that recycling is far from perfect. But government subsidies have helped improve upon it. In my opinion, it is better to subsidize the recycling industry than to continue to subsidize the oil industry that continues to see record profit. “

I feel it is important to bring up these two points in his comment because subsidies, in general, and its relation to environmental policy are two arguments that I feel are widely misunderstood in society.  First, I disagree with that businesses CANNOT grow and prosper without some government subsidies, because in most cases they can and do.   In order to fully respond however, I am going to explain why and when subsidies are warranted in a three-part series.

The first part of my response is that there are goods that cannot function successfully without government assistance. These are called public goods.  Let me explain.

Public goods are described as goods that are nonexcludable and nonrivalrous.  Anything that falls under a pure public good is best funded through the government.

Nonexcludable means that you cannot exclude someone from using that good.  Fireworks shows are a great example.  If someone charged customers to put on a firework show in your town, some people might pay to sit on the lawn in the designated space, but it would be difficult to charge the consumers who watch from their own backyards or on the street.  There would be a lot of free-riding (benefiting from the good, fireworks, without paying for the good), so it is unlikely that the person putting on the firework show would even do so in the first place.  He would probably lose more money than he could make, because he cannot exclude anyone from watching the fireworks.

The nonrivalrous part of a public good means that each additional individual using the good does not make the good cost more.  To make that clearer, a rivalrous good is one In which providing a greater amount of a good requires either more of that good to be produced or less available for others.  A nonrivalrous good has neither of these.   Watching a fireworks show does not make the cost increase for the other viewers nor does it make the amount of fireworks run out faster. If a good has these two requirements, nonexcludability and non-rivalry, than to provide an efficient level of the good the government must do it and fund it through taxes

A more popular example of a public good is national defense.  If 100 people in a town paid for national defense if an outside intruder was to do harm on the region surrounding the town, then if an intruder came in everyone in the town would likely benefit from the defense being there, even those that did not pay for defense (nonexcludability). Further, national defense is intended to protect a region (or country) and it does not cost more based upon the people living in that land (nonrivalrous). If you assume that national defense is protecting our country, its land, buildings, resources etc. than each additional person living here benefits if that land is protected and does not add to the cost of defense.  Public local protection, however, is rivalrous in that a larger population requires more police, firemen etc. and it being a “public” good becomes a bit weary.  If national defense were privatized and funded through individuals there would be the issue of a free-rider problem and also, there could be competing “U.S. armies”.  There there would be the issue of which army is supreme in dealing with foreign conflicts, which could perhaps create even more conflict.  Further, if I saw my neighbor not paying for national defense while I did, but he still benefited from me paying this creates an incentive for me not to pay in the future and just “free-ride” off of others that willingly pay.  If this idea persists, eventually no one will pay for national defense which would create larger problems for security.

Another great example of a public good is a lighthouse. A popular, but tedious, economic paper on lighthouses as a public good was written by the late Ronald Coase.

 

lighthouse

Private goods, on the other hand, can function without government assistance.  Environmental companies can get seed money from venture capitalists, hire lawyers to comply with EPA restrictions and create a product that people are willing to buy (like solar panels on houses.)  Now, these companies don’t have to exist, but if there is demand for the product and low costs the incentive of profit will drive entrepreneurs to enter this new business.  There is excludability, such that one can pay for these goods and receive it or one can choose not to and not receive it. There is rivalry in that if someone wants a solar panel it costs more to produce and there are finite resources.

In terms of recycling, it is not a public good.  It is excludable in that if I don’t pay for my containers to be compounded and the materials to be reused I don’t recycle. (Assuming we are not forced via taxes like in most cities and states today.) It is rivalrous in that it does cost more if I chose to recycle and it costs more per each person who wants to recycle.

There are numerous other private goods that one can think of: clothing, video games, cable television, restaurants, books, recycling, highways, train services etc.  Companies producing these goods CAN and DO prosper without government assistance.  Only goods that are “public goods” are more efficiently produced, or would even be produced at all, when public funds are used.  These goods are usually funded through taxes and not subsidies, however.

The Limits of Expertise

expert opinion

A great quotation to ponder this weekend:

Another trait of the expert is his tendency to assume knowledge and authority in fields in which he has no competence. In this particular, educators, lawyers, priests, admirals, doctors, scientists, engineers, accountants, merchants and bankers are all the same–having achieved technical competence or “success” in one field, they come to think this competence a general quality detachable from the field and inherent in themselves. They step without embarrassment into other areas. They do not remember that the robes of authority of one kingdom confer no sovereignty in another; but that there they are merely a masquerade. -Luther Gulick, “Notes on the Theory of Organization” (1937)

A.K.