The Costs of Rent Seeking and Crony Capitalism — Tesla edition

Last week I posted at Truth On The Market about an attempt by some Missouri legislators and the Missouri Auto Dealers Association to sneak by language in an unrelated bill to effectively ban Tesla Motors from selling their cars directly to Missouri consumers. Never mind that Tesla already invested in a service facility in St. Louis and claims to have plans for one in Kansas City, creating at least a couple dozen jobs or so. Using the standard Missouri legislature economic multiplier, and that’s got to be worth at least another 1,000 jobs created! (just kidding)

In my post, I wrote that the auto dealers’ ploy “is classic rent-seeking regulation at its finest”. A reporter from asked me what I meant by rent-seeking. There are various definitions, but it all boils down to seeking or taking advantage of political privilege or regulatory favoritism to generate extra profits (typically at the expense of disadvantaged competitors or consumers). In this case, it’s seeking regulations that would eliminate competition from automakers selling directly to consumers, thereby forcing the automakers to use independent dealers who could then take their cut from the sale of the vehicle…and, in all likelihood, increase the cost of new cars (and therefore, used cars as well) to consumers.

But the costs of rent-seeking go beyond just the increased cost to consumers due to reduced competition. It has a much more pernicious effect. When policy makers (legislators or bureaucrats) dole out rent-creating laws and regulations, it creates even more demand from other companies or industries that want their own political perks, tax breaks, subsidies, and other such regulatory favoritism. In other words, it creates a whole culture of crony capitalism–where policy makers sell and businesses buy laws and regulations that tilt the capitalist playing field to benefit the favorites, rather than letting market forces sort out the most efficient, most productive, and most desired by consumers.

As political humorist P.J. O’Rourke quipped, “When buying and selling are controlled by legislation, the first things to be bought and sold are legislators.”

Regarding Tesla, my colleague from the MU Law School and fellow TOTM blogger, Thom Lambert, and I published an op-ed in the Kansas City Star this week calling out the Republican-dominated Missouri legislature to live up to their claims to support innovation and entrepreneurship in the state and to put a stop to the rent-seeking crony capitalism. Check it out.

Could the Financial Crisis Happen Again?

That will be the topic of a seminar featuring Dr. Randy Kroszner this Friday here at the University of Missouri-Columbia. Randy is the Norman R. Bobins Professor of Economics at the University of Chicago Booth School of Business and he served as a Governor of the Federal Reserve System from March 2006 to January 2009.  While on the Federal Reserve Board, he served as chair of the committee on Supervision and Regulation of Banking Institutions. Consequently, he has first-hand knowledge of why and how the Fed sought to address the unfolding financial crisis, and some inside perspective on how the regulatory monstrosity known as Dodd-Frank–elements of which are still being sorted out and implemented–may or may not help prevent a recurrence of the financial crisis.

The seminar will be in the Moot Courtroom of the MU Law School (ground floor of Hulston Hall) at 3:00PM Friday, April 4. The seminar is going to be a kind of “fireside chat” format to open, followed by a time for Q&A from the audience. There will be a public reception afterward. The talk is hosted by the MU Liberty & Justice Colloquium. If you’re in the Columbia area, you may want to check it out.

Open Letter On New Jersey’s Tesla Distribution Ban

Geoff Manne, one of my colleagues at Truth On The Market, spearheaded an open letter explaining why New Jersey’s ban on direct distribution of automobiles (specifically, in this case, Tesla Motors) is bad public policy. The letter is signed by over 70 economists and law professors, including yours truly.

I’m no fan of the industrial favoritism Tesla has received via it’s government bailout or consumer subsidies (like so many other alternate-energy car makers). But two wrongs don’t make a right. And while Tesla Motors is the immediate target of this ban, the ban is really on a business model that threatens traditional auto dealership networks. As we explain in the letter, shutting down consumer access to innovative automotive products as a protectionist measure for brick-and-mortar dealerships is simply bad policy.

Head over to TOTM to see Geoff’s post and to read the full letter.

Free Trade and Democracy

Xuepeng Lui and Emanual Ornelas have a rather interesting paper in the current issue of American Economic Journal: Macroeconomics (Vol 6, No 2) examining the relation between participation in free trade agreements (FTAs) and the sustainability of democracy. Using hazard and duration models, and accounting for endogeneity of the dynamics, they find that participation in FTAs is positively related to democratic stability. The authors’ findings suggest the bi-lateral nature of FTAs, rather than just a unilateral free-trade regime, make credible the rent-dissipating effects of free trade and reduce incentives to subvert the democratic regime. The authors further show that the adoption of FTAs does not appear to be influenced by how democratic trading partners are, but FTAs do appear to be used as defensive measures by less stable democracies. It’s a thoughtfully done piece that illustrates the interactions of socio-political and economic institutions. The abstract follows:

We study the relationship between participation in free trade agreements (FTAs) and the sustainability of democracy. Our model shows that FTAs can critically reduce the incentive of authoritarian groups to seek power by destroying protectionist rents, thus making democracies last longer. This gives governments in unstable democracies an extra motive to form FTAs. Hence, greater democratic instability induces governments to boost their FTA commitments. In a dataset with 116 countries over 1960-2007, we find robust support for these predictions. They help to rationalize the rapid simultaneous growth of regionalism and of worldwide democratization since the late 1980s.

The Blockbuster Lesson for Higher Education

I currently have the…pleasure?… of serving on a campus committee that’s charge ostensibly is “to advise the vice chancellor for Administrative Services on the facility needs of the campus.” This is my second year (of a three-year term) on the committee. At one of our meetings last year, as we were being briefed on several planned construction and remodeling projects, I raised the question, “Has anyone considered that we may be acting like Blockbuster in an age of Netflix? Given trends in higher education, with increasing use of online technology, does it make sense to continue investing so much in brick-and-mortar facilities?” Few seemed to understand (or appreciate) my question, and it went largely unaddressed.

Earlier this week, I ran across an article by Clayton Christiansen and Michael Horn in the New York Times arguing that online education is going to be an agent of transformation in higher education. They argue that most traditional higher education institutions are, at best, reacting to online education in the same way sailing ship companies reluctantly adopted steam engine technology by just supplementing their sailing vessels with a steam engine, rather than embracing the new technology and replacing their sailing ships with steamships. Yes, that is precisely the way most universities–including mine–seem to be reacting to online education. I sent a link to the article to my fellow committee members, reminding them of my comments last year about Blockbuster.

It seems that, in the minds of some at least, advising the vice chancellor on the facilities needs of the campus does not include taking into account the potential changing nature of higher education and its implications for the facilities needs of the campus. Such a “bigger picture” is beyond our pay grade. Not surprisingly, I suppose, those observations were shared by administrators who sit on the committee. I was referred to our University’s fairly fresh “strategic plan,” which itself ignores the external higher education environment in which we operate. Point made.

But then, the real irony of the story. Within hours of these email exchanges, DISH Network announced they are shuttering the remaining Blockbuster stores in the US and shutting down Blockbuster’s mail-order deliver service. The company that, in its heyday, revolutionized the video rental industry is now dead; a victim of ignoring what it perceived to be an inconsequential technological change. As Larry Downes and Paul Nunes share in their Harvard Business Review blog today, Blockbuster became a casualty of “Big Bang Disruption.”

I doubt my committee colleagues noticed the announcement. If they did, I’m sure most disregarded it as purely coincidental and not relevant to our work–if they even connected the dots. And yet the questions remain for traditional universities and colleges, including mine:

  • Are we ignoring a big bang, disruptive technology in online education? (For a nice piece arguing yes, see Alex Tabarrock’s “Why Online Education Works“)
  • Are we still investing in long-lived brick-and-mortar assets that are likely ill-suited to compete in the future market for higher education?
  • Do we recognize that our market niche, if we are to have one at all, will likely be less about selling higher education than about selling a collegiate experience?
  • What kind of facilities are best suited to serving that market?

But those aren’t questions for me or this committee. Above our pay grade. Not what the kind of question the facilities committee should be asking. I wonder who in Blockbuster was similarly dismissed?


Optimal Contract under Moral Hazard and Soft Information

Guillaume Roger has an interesting paper in the current American Economic Journal: Microeconomics looking at the case in which the agent must self-report the ex-post performance outcome. This is a worthwhile extension of the typical principal-agent model, since in many real world cases there is information asymmetry ex post between the agent (who has better information on actual outcomes) and the principal. The abstract follows:

I study a model of moral hazard with soft information: the agent alone observes the stochastic outcome of her action; hence the principal faces a problem of ex post adverse selection. With limited instruments the principal cannot solve these two problems independently; the ex post incentive for misreporting interacts with the ex ante incentives for effort. This affects the shape and properties of the optimal contract, which fails to elicit truthful revelation in all states. In this setup audit and transfer become strategic complements; this is rooted in the nonseparability of the problem.

RIP Professor Ronald H. Coase, 1910-2013

Professor Ronald H. Coase passed away earlier today at the age of 102 in Chicago, IL (USA). Coase won the Nobel Prize in Economic Science in 1991 for his contributions to the fields of law and economics and his work on transaction costs and property rights.

Professor Coase’s contributions revolutionized economics and law. As profound as his insights was the simple approach with which he encountered reality; challenging the assumptions and conventional wisdom of the established literature by holding up a light to the real world. His seminal paper on transactions costs (The Nature of the Firm, 1937) began with two simple and corollary queries: If markets work so efficiently, why is so much economic activity ‘managed’ outside of the market mechanism under the rubric of “the firm”?  If firms are more efficient means of organizing economic activity, then why not manage all economic activity centrally?

To these questions Coase brought to bear the framework of marginal analysis that characterizes modern economic theory. His answer, that there are costs to using the market mechanism (transaction costs) that can be circumvented up to a point by managerial fiat within the firm, continues to underlie most of the modern theories of organizational economics. The boundary of the firm, Coase explained, is determined by the relative (marginal) cost of organizing one more resource via market transactions versus the (marginal) cost of doing so through managerial control.

The second of the two papers for which Coase was awarded the Nobel Prize focused on the nature of harms in property law cases and its implications for understanding the importance of property rights (The Problem of Social Cost, 1960). Coase highlighted the reciprocal nature of harm in the case of property disputes (and externalities in general): A finding in favor of one party necessarily harms the other, thus raising the question of relative economic efficiency–that is, the solution to the problem should consider the net social cost of finding in support of one party or the other, rather than focusing on some perception of unilateral causation.

In The Problem of Social Cost, Coase explained that if markets were costlessly efficient, parties to an externality/property dispute would be able to negotiate a Pareto superior solution to reallocate property rights to their highest-valued uses. Thus, the initial allocation of property rights would be irrelevant, since parties could arrive at privately negotiated solutions costlessly (or at very low cost). This idea was paraphrased and labeled by George Stigler as “The Coase Theorem,” although this was not at all Coase’s point. Quite the opposite. Coase argued that because transaction costs are positive, one cannot necessarily rely on privately negotiated transactions to achieve Pareto superior reallocations. Therefore, the design and enforcement of property rights is extremely important for economic outcomes. Moreover, Coase argued, one must consider the net social benefits of any attempts to reallocate property rights rather than assuming that any “solution” is necessarily preferable to the status quo–whether it be a market-based solution or a government-imposed solution.

Coase’s career was defined by challenging the common assumptions–and often overlooked assumptions–of economics. If economists are to describe and refer to “firms”, they should have a definition of what is meant by a firm and a reason for its existence in the economic landscape. If economists are going to address externalities, then they should recognize the nature of reciprocal harm in dealing with those externalities and the costs–as well as benefits–or proposed solutions. Assumptions of public goods and natural monopolies were bugaboos Coase dispelled by pointing to counter-examples–exceptions which debunked the rule. The case of The Lighthouse in Economics (1974) is but one example of such. When I last visited with Coase a few years ago, he was still working on another such example in the private water supply system in London in the early 1900s (a utility often argued to be a natural monopoly). Coase also offered a simple, yet profound at the time, understanding of the nature of durable goods monopolies and the way they compete with themselves (Durability and Monopoly, 1972).

I first met Coase as a graduate student at Washington University in St. Louis. I later got to know him much better while working at the University of Pittsburgh and eventually with the creation of the Contracting and Organizations Research Institute at the University of Missouri. Professor Coase generously funded CORI in its early days as we endeavored to create a library of contracts that could be used to study how businesses structure their transactions with one another and to further explore the factors affecting the choice of organizational form. Coase came to Missouri in 2001 and spoke to the need of economics to change. True to his lifelong approach, Coase stated, “We need empirical work which actually changes the way we look at the problem.”

Despite being one of the most cited economists of the 20th Century, I believe the significance of Coase’s work is still under-appreciated. Much of what is written about Coase’s work now still misinterprets, misconstrues or misapplies the fundamental nature of his arguments. In attempt to formalize or integrate pieces of his theories into modern economics, the essence of it is often lost–or simply overlooked. I tried to articulate some of that in a chapter I wrote about Coase’s theoretical contributions to Oliver Williamson’s Transaction Cost Economics, published inThe Elgar Companion to Transaction Cost Economics which I co-edited with Peter Klein. I look forward to doing more work along those lines.

Though I have not had much contact with Professor Coase over the past few years, it was inspirational knowing that even in his advanced years he was attempting to complete several research projects he had laid out. He once told me that it would take him until he was 112 years old to complete everything he had lined out at that point. That work may now never be done.

The economics profession is a bit more dismal with his passing, but his legacy lives on for those who continue to question and to change the way we look at the problem.

Godspeed, Ronald.

Some Tips For The College-Bound

So you’ve bought the tv, refrigerator, microwave, and futon. You have your new laptop and you’ve ordered your textbooks. You’ve filled out your government-subsidized student loan forms, contacted your 529-plan administrator, or just straight-up wrote a check for your fall tuition bill. You’re ready to embark on your college career. Here are some tips on how not to have wasted all that effort, courtesy of the USA Today College edition online:

1) 6 Things You Should Say To Your Professor — Yes, your professor wants to hear from you, and wants to know you care and take responsibility for your own education. And yes, the personal interaction does make a difference come the end of the semester. So when you communicate with your professor, do so wisely.

2) 5 Things You Should Never Say To Your Professor — Like I said, when you communicate with your professor, do so wisely.

3) 5 Things To Remember When Emailing Your Professor — When visiting face-to-face isn’t possible for whatever reason, you may have little choice but to use email. You wouldn’t believe the negative impression you can make via email. Don’t do it.

4) Your Guide To Surviving Group Projects — Group projects can be a pain; dealing with slackers, relying on others to get their work done well, etc. But life is full of group projects. That’s why we assign them. The people whom you hope will hire you almost universally want you to be able to work in a group setting. If you’re in my AGEC 4971 class this fall, I suggest you take this post to heart.

There are many other tips to be offered and each professor is a little different, but I don’t think you can go wrong if you follow the suggestions above.


Regulating The (FTC) Regulators — TOTM Symposium

My colleagues at Truth on the Market are hosting a blog symposium today on the topic of regulatory restraint. From Geoff Manne’s introductory post:

Last month, FTC Commissioner Josh Wright began a much-needed conversation on the FTC’s UMC authority by issuing a proposed policy statement attempting to provide some meaningful guidance and limits to the FTC’s authority. Meanwhile, last week Commissioner Maureen Ohlhausen offered her own take on the issue, echoing many of Josh’s points and further extending the conversation. Considerable commentary—and even congressional attention—has been directed to the absence of UMC authority limits, the proper scope of that authority, and its significance for the businesses regulated by the Commission.

There is a great line-up of participants and the symposium is sure to spark some interesting debates and insight. Definitely worth following for the next couple days.

Truly Investing In A College Education

Monday I wrote about a proposal in the State of Oregon to adopt an investment-style model for financing college costs at Oregon’s public universities that would allow students to attend with no up-front cost, but would require students to commit to paying a percentage of their future earnings over a number of years. In that post I highlight some concerns about how such a program would/should be structured, but don’t confuse that with thinking the program is a bad idea. In fact, it’s a proven concept–at least when the people running it have a strong incentive to make sure it works.

There is actually at least one for-profit business that provides exactly the kind of college investment funding that the Oregon proposal considers…and it has been operating for over a decade.The company (Lumni) was highlighted in a May 2011 New York Times op-ed along with a follow-up piece. Moreover, Lumni has thus far proven a financial success for students and for investors (yes, it’s an actual investment company), despite the fact that it focused primarily on investments in Latin America, where one might expect it to be more difficult to enforce long-term investment contracts, particularly of the “venture capital” type. Lumni now also offers contracts in the US.

I am not endorsing Lumni and I would caution anyone to do their homework before entering into such a contract with any company, but the longevity of the company suggests that such an investment model for college costs is not only viable, but viable for the private sector. Which may beg the question of whether a State or its universities should be trying to manage such an investment operation themselves.