Want to Reduce Inequality?

For liberals who want to reduce inequality, the answer is simple: Reduce the number of burdensome regulations, according to a Mercatus Center article.

The article, using an example of an entrepreneur who has created a popular phone app, makes a convincing case against regulation.

The app’s creator will earn profits over time as the app’s popularity and sales increase. However, her profits will eventually decline due to the process of creative destruction: a newer, better app will hit the market that pulls her customers away from her product, erodes her sales and forces her to adapt or fail. The longer she is able to differentiate her product from others, the longer she will be in business and the more money she will earn. … A lack of competition stretches out a firm’s life cycle since the paucity of substitutes makes it costlier for consumers to switch products if the value of the firm’s product declines.

Indeed, regulation–especially regulation that inhibits market entry–exacerbates inequality by dampening competition and allowing entrepreneurs to dominate a market longer than they would in a world with no or reduced regulation. The article continues:

Maintaining market power for a long period of time by restricting entry not only increases corporate profits, it also allows doctors, lawyers, opticians, and a host of other workers who operate under a licensing regime that restricts entry to earn higher wags than they otherwise would.

Occupational licensing is a huge problem. Indeed, lawyers and doctors–using laws that require inordinate amounts of education–artificially reduce the supply of doctors and lawyers, which increases their pay. Even if you favor occupational licensing for doctors and lawyers,  licensing for hair braiding is clearly ridiculous. In fact, the percentage of the workforce that is required to have licensing rose from 5% in the 1950s to 20% by 2000 and 29% in 2006. A lot of fields, as a result, have been closed to low-skilled workers, which makes it harder for them to rise above poverty. These laws protect the entrenched laborers and quash the newcomers; in other words, they worsen inequality.

The Mercatus article continues:

Throughout America’s history the economy has been relatively dynamic, and this dynamism has made it difficult for businesses to earn profits for long periods of time; only 12% of the companies on the Fortune 500 in 1955 were still on the list in 2015. In a properly functioning capitalist economy, newer, poorer firms will regularly supplant older, richer firms and this economic churn tempers inequality. … But this dynamism may be abating and excessive regulation is likely a factor. For example, the rate of new-bank formation from 1990 – 2010 was about 100 banks per year. Since 2010, the rate has fallen to about three per year. Researchers have attributed some of the decline of small banks to the Dodd-Frank Wall Street Reform Act, which increased compliance costs that disproportionately harm small banks. Fewer banks means less competition and higher prices.

While some degree of inequality will always exist in a capitalist economy, especially in a society like ours which is (historically, at least) hyper-meritocratic, there would always be a churn. People would rise and fall, and there would always be a degree of dynamism. But as regulation is hampering competition, fat cats have the ability to get fatter without adding anything to society. Ironically, regulations meant to curtail their power have actually increased it by wiping out their competition.

America deregulated throughout the 1980s and 1990s. We were more prosperous as a result. Now, the issue isn’t even about becoming wealthier; it is about defeating the entrenched upper-class and unleashing competition into the market place. The answer isn’t more regulation. It’s less.

Boston University Study Says Regulation INCREASES Corporate Profits

Bernie Bros, listen up: Federal Regulations increase corporate profits. Unfortunately, Sandernistas refuse to acknowledge the true source of the problem–big government–in order to simply focus on “soaking the rich,” which would have deleterious impacts on our economy.

According to a recent Boston University study, “since 2000 much of the rise in profits is caused by growing political rent seeking.”

For those who don’t know what rent-seeking his, here is a definition: “Rent-seeking is the use of the resources of a company, an organization or an individual to obtain economic gain from others without reciprocating any benefits to society through wealth creation. An example of rent-seeking is when a company lobbies the government for loan subsidies, grants or tariff protection. These activities don’t create any benefit for society; they just redistribute resources from the taxpayers to the company.”

So how do more regulations enable rent-seeking behavior? Simple. The bigger the government, the more incentive a company has to invest in the government.

A more complex tax system works in favor of established businesses because smaller businesses and upstarts cannot afford to hire lawyers and accountants to sift through the rules, whereas big companies do have those resources.

Regulations benefit large companies as they can afford to not only incur the costs, but also have the influence to decide how they are written. Regulations harm small businesses that cannot incur the costs and, oftentimes, are written in ways meant to reduce competition from new up-and-comers.

Sandernistas, take note: Citizens United is not the source of the problem–big government is. And this is no longer just theory; there’s now evidence to prove it.

Has Financial Regulation Made the Financial Sector More Stable?

President Obama, in the wake of the financial crisis, passed a multitude of financial regulations aimed meant to reduce the risk of future financial crises. Paul Krugman, of course, gave Obama a raving review. He wrote:

Did reform go far enough? No. In particular, while banks are being forced to hold more capital, a key force for stability, they really should be holding much more. But Wall Street and its allies wouldn’t be screaming so loudly, and spending so much money in an effort to gut the law, if it weren’t an important step in the right direction. For all its limitations, financial reform is a success story.

While Krugman doesn’t think the regulation went far enough, at least it’s a start. And I actually agree: banks should hold more capital.  Even the Adam Smith Institute–which, just looking at the name, you can guess what their political leanings are–supports higher minimum bank capital requirements.

But, with all of these accomplishments, I wouldn’t call these new regulations “a success story.” Bank capital reserve increases are a positive, but do they outweigh the negatives?

An interesting study by the Federal Reserve Bank of Richmond finds that “61 percent of the liabilities of the financial system are subject to explicit or implicit protection from loss by the federal government.” Why is that a problem?

Because of simple incentives. If your money is insured, you are willing to take more risks with that cash than you otherwise wouldn’t. A risky loan or investment makes more sense if you can expect full or partial recompense from the government than if there were no (or less) insurance overall. If risky investments as a whole begin to go south, the economy will enter a collapse–like we did in 2008. Except this time will probably be worse, as interest rates are already close to zero and the Federal Reserve has fewer tools in its toolbox than it had in 2008.

It is impossible to know which effect will outweigh the other. Capital requirements make crisis less likely; Federal insurance, on the other hand, makes it more likely. Only time will tell whether or not these new rules will have any impact on the rate of financial crisis in this country.

As the evidence on the efficacy of these regulations is somewhat ambiguous, and there are known problems with these laws, we should consider changing–or outright repeal and replacement of–these laws.

Stop Blaming Capitalism For Drug Price Increases

EpiPen has made headlines recently, putting pharmaceutical prices at the top of the political agenda. When Martin Shkreli hiked the price of Daraprim, progressives were outraged. “Capitalism is evil” was the leftist battle cry.

Now, with EpiPen raising its prices, progressive hero Bernie Sanders has criticized the company for valuing profits over people. Hillary Clinton, who comes off as a lifeless and heartless reptilian, even released a statement condemning the price increase.

But does the EpiPen and Shkreli scandal prove that capitalism is destroying our health care system? Ironically, it proves the opposite.

In my first day of introductory microeconomics, the teacher said that greed is never the problem. Whether our government is small or large, socialistic or anarchistic, tyrannical or benevolent, people are always as self interested as they always have been. Of course, we aren’t reptilian beings (like Hillary Clinton), and some individuals do have altruistic streaks. But, the simple fact is, humans usually look out for themselves (and those close to them) over a random person off of the street.

What really makes greed a good thing or a bad thing, the professor said, was institutions. In a world where the government is small and protects us from others–not ourselves–greed works out pretty well. In a world where there is stable money, freedom to trade, and a rule of law, greed works out great.

And we see this with drug prices. The problem is not that EpiPen is greedy or that Shkreli wants to make an extra buck; the problem is that the government has bad institutions–bad policies–that have constricted competition and made it easier for these individuals to hike prices.

A new article in the Wall Street Journal lays it out pretty clearly:

In a health care system notoriously resistant to cost-containment, generic drugs are an exception. Americans enjoy a huge range of generic medicines at-ever declining prices, largely thanks to robust competition among multiple manufacturers.

In 1984, the Waxman-Hatch Act slashed the regulatory hurdles for generic copies of patented drugs. Since then, generics have risen from 19% to 84% of all prescriptions. Their prices have fallen 70% over the past eight years, while branded prices have risen 164%, according to Express Scripts, a pharmacy benefit manager.

The main driver of those price declines is competition. A 2010 study found that within three years of the first generic launch, the average generic has 12 competing suppliers and its price has fallen 94%.

In the generic world of prescriptions, prices have fallen dramatically because of free market competition. The WSJ accompanied this article with the following graph:

Indeed, the generic market has a lot of competition and lower prices. The brand name market has no competition and thus has rising prices. Why is there no competition?

In large part due to the government. We have very strict approval rules, which makes it hard for generics to become commonplace. This is why many economists, like Alex Tabarrok, support reciprocity. What is reciprocity? According to Tabarrok, reciprocity is “if a drug is approved in Europe it ought to be approved here. … [all reciprocity does is allow the importation] of any generic approved as such in Europe to be sold in the United States.”

Essentially, he wants free trade in the realm of drugs to make it easier for more generics to enter the market more quickly, which forces both domestic and brand name medicines competing in the same market to slash costs. Reciprocity would dramatically reduce costs. In fact, Senators Ted Cruz and Mike Lee have been proponents of reciprocity for a long time now.

Of course, we shouldn’t allow reciprocity with every nation. I don’t trust the Chineese or Somalian approval process, for example. But we should make reciprocity agreements–like trade agreements–with nations who have a proven track record of approving safe drugs (e.g. Most of Western Europe, Canada, Australia, Japan, Korea, etc.)

Essentially, if you want lower drug prices, support more competition. The reason EpiPen and Daraprim cost so much is because they have no competitors, which makes it easy to hike the price with no consequences. Induce competition–in other words, let the market work–and drug prices will fall.

Economic Theory Demonstrates the Harms of (Most) Regulation

Economist Scott Sumner, who works at the Mercatus Center and Bentley University, has an interesting new blog post up at EconLog (a blog I highly recommend everyone interested in public policy follow. Sumner, Bryan Caplan, David Henderson, and other amazing economists have excellent sub-sections). Sumner’s post is all about demonstrating why most regulations are counterproductive.

Sumner uses a simple example: Imagine if the government were to pass a pro-consumer regulation and ban ATM fees. This, according to Sumner, would be counterproductive.

Banks will see this as a cost increase, and pass the cost on to consumers in other ways. Can I be sure this will occur? No, but it’s very likely. Suppose I told you that Congress passed a 10-cent increase in the gas tax. What would you expect to happen to gas prices at the pump? Most people would expect a 10-cent increase. In fact, the oil industry is perhaps the industry where taxes are least likely to be passed on to consumers. That’s because the supply of oil is less elastic that the supply of almost any other good, including banking services. So if you think gas taxes are passed on to consumers, then you should be even more certain that I’m right about the elimination of bank fees being passed on to consumers in other ways, such as fees on deposits, or lower interest rates on deposits. …

If consumers pay less in one place and more in others, does the regulation actually hurt consumers? Yes it does, because it also hurts bank efficiency. Eliminating ATM fees will reduce the profit maximizing number of ATMs, which will make banks less efficient. Since tellers cost more than ATMs, the cost increase passed on to consumers will be larger than the saving from ATMs.

Now, this logic applies to most regulations. But note the word “most.” Indeed, Sumner concedes that this logic does not apply to regulations that are meant to address market failures, like “monopoly power, externalities, and information asymmetry.” So some regulations are necessary.

But the logic does apply to regulations liberals love, like overtime pay.

Sumner ends with a plan to reduce regulation. He closes with, “We’d be better off passing a law sun-setting all regs, and the entire Federal tax code, in 2025. Then give Congress the next 9 years to set about re-passing all the regs and taxes that actually make sense.”

Interesting idea, but it’s dangerous. I think it puts too much faith in Congress to do the right thing. Not only that, but it assumes members of Congress won’t make the same mistakes they’ve already made. If history serves as any guide, I suspect they would pass new laws that are just as bad, if not worse. But there’s some food for thought.

The Real Issue with Campaign Finance Reform

Bernie Sanders and Hillary Clinton constantly talk about campaign finance reform and overturning Citizens United, the infamous Supreme Court case that allows individuals and corporations to give unlimited campaign donations as long as it is done indirectly through a Super PAC. But Sanders and Clinton get it all wrong.

Now, there is no doubt that corruption exists in our government. Politicians vote “yes” and “no” on bills all the time in order to placate their donor base. For this reason, the argument for restricting campaign donations are seductive. However, we run into legitimate problems when we attempt to restrict campaign spending, like how Citizens United finally put an end to the two party party duopoly over campaign contributions and how campaign contributions are a form of political speech protected by the 1st amendment.

Beyond those two issues, there are other problems with campaign finance reform, such as the evidence suggesting restrictions on donations benefit incumbents at the expense of the challenger, meaning democracy may be limited after reform (also see the duopoly link, which argues Citizens United increases democratic diversity), and research by the Mercatus Center suggesting campaign finance reform does little to reduce corruption.

Either way, let’s assume Clinton and Sanders have it right: Campaign contributions are pernicious and the Citizens United ruling unjust. Is the case for campaign finance reform strengthened? Not really.

Economist Dan Mitchell has an interesting blog post up which I will excerpt below. I highly recommend readers go and check it out.

Mitchell quotes a NY Times article called the “Conservative Case for Campaign Finance Reform.” Here’s the crux of the argument:

big money in politics encourages big government. Campaign contributions drive spending on earmarks and other wasteful programs — bridges to nowhere, contracts for equipment the military does not need, solar energy companies that go bankrupt on the government’s dime… When politicians are dependent on campaign money from contractors and lobbyists, they’re incapable of holding spending programs to account. Campaign contributions also breed more regulation. Companies in heavily regulated industries such as banking, health care and energy are among the largest contributors. Such companies donate with the hope of winning narrowly tailored exceptions to regulations that help them and disadvantage their competitors

But, as Mitchell argues, the article misses the point. The NY Times article gets it mixed up. As Mitchell writes:

The sun doesn’t rise because roosters crow. It’s the other way around. What Mr. Painter fails to understand is that there’s a lot of money in politics for the simple reason that government has massive powers to tax, spend, and regulate.
Politicians in Washington every year redistribute more than $4 trillion, so interest groups have an incentive to “invest” money in campaigns so they can get some of that loot. Those politicians have created a 75,000-page tax code that is a Byzantine web of special preferences, so interest groups have an incentive to “invest” money in campaigns so they get favorable treatment. And the politicians also have created a massive regulatory morass, so interest groups have an incentive to “invest” so that red tape can be used to create an unlevel playing field for their advantage.

In other words, we don’t need to get money out of politics; we need to get politics out of money. Even assuming every claim Clinton and Sanders have said is true (and, as I noted above, most of them aren’t), the case in favor of campaign finance reform is weak, at best, and at worst, doing little to solve the problem while trampling on the first amendment rights of thousands of Americans.