Calling a Cost a Cost: NY Anti-Free Speech Edition

Seems the State of New York is going to the Supreme Court for another of its protectionist regulatory policies. Yesterday the US Supreme Court granted a petition to hear the case of Expressions Hair Design v. Schneiderman. As the WSJ explains, at issue is whether New York’s regulations concerning credit-versus-cash retail prices constitute a First Amendment speech violation.

The problem stems from the fact that the State of New York has attempted to have its cake and eat it to by ignoring economic rcredit-card-1520400_1280ealism and prohibiting retailers from calling a cost a cost. The State prohibits retailers from charging customers a fee for using a credit card, but allows retailers to give customers a discount if they use cash. A group of hair salons, led by Expressions Hair Design, sued the state for infringing on its right of free commercial speech. The salons won their initial case, which was reversed on appeal. Now SCOTUS will have an opportunity to weigh in.

The Cost of Using Credit
From an economic perspective, the issue is fairly simple. Credit card companies charge vendors a fee every time a consumer pays with plastic. How much depends on the credit card company, whether the transaction is run as debit or credit, and the amount of the transaction. But typically, the fee is around 2-4% of the amount of the purchase. This reduces the amount of revenue retailers receive when the customer uses plastic. Put another way, when customers choose to use plastic, it raises the retailer’s cost of doing business for that sale.

In a free economy, retailers could choose one of three options: 1) force the credit card user to pay the additional transaction fee, which raises the price at the point of sale, 2) charge the same price for all buyers, implicitly charging cash users more for the product to subsidize the costs of the plastic users, or 3) pass the transaction fee savings on to cash users by giving them a discount. The only economic difference between 1 and 3 is what the sticker price is relative to the price actually paid. In #1, credit card users pay more than the sticker price; in #3, cash users pay less than the sticker price. In #1, the credit card fee is made explicit by adding it on just for those consumers who use plastic. In #3, the sticker price includes (i.e., hides) the cost of using a credit card and by default is the price everyone pays unless they are aware of the cash discount. In either case (1 or 3), the retailer is price discriminating between cash and plastic users. Or the retailer could simply post two sets of prices, one for credit and one for cash, which would then beg the question of “why the difference?” And that is where the NY regulations become a problem.

The NY regulation prohibits retailers from choosing #1 but allows them to choose #3. In other words, the regulation allows retailers to price discriminate, but only if they present it as a discount for cash users rather than a surcharge for credit card users. In short, NY allows the exact same price discrimination between two sets of consumers, but restricts the speech of retailers in how they are allowed to describe that price difference. As Expressions Hair Design argues in their complaint, this places a burden on the business in how it is allowed to explain or justify what is otherwise a perfectly legal two-price pricing system since the regulations make it illegal for employees to explain that the difference between the cash price and the credit price is due to the cost of the credit transaction. It would be like passing a law prohibiting a restaurant from explaining the cost of its steaks went up relative to its pork chops because the price of beef rose.

Framing matters
Why would the State of New York prohibit credit card surcharges but not prohibit cash discounts? Consumers respond to price signals, so how those signals are presented matters. If consumers are charged an extra fee for using their credit card, it makes the cost (price) of using the credit card very obvious to the consumer and she is more likely to change her behavior by using cash instead. This would be bad for the banks that make a significant amount of money on credit card swipe fees. Not surprisingly, banks support laws prohibiting explicit credit card surcharges. However, as noted in #2 above, charging cash and plastic users the same forces cash users to subsidize the purchases of plastic users, which also tends to penalize lower income persons relative to wealthier shoppers. So allowing retailers the opportunity to provide cash discounts is socially superior to not allowing differential pricing. However, the NY’s prohibition on calling a cost a cost and explaining the price difference for what it is, is not only an infringement on speech, but unjustifiable as anything other than an attempt to mislead consumers and protect credit card issuers.

A win for the auto cartel, a loss for Missourians

The Missouri Auto Dealer Association (MADA) has been exercising its political muscle for at least a couple years to protect its antiquated state-supported cartel over new car sales. It seems they have finally succeeded in court where their lobbying efforts have failed. In an opinion  last week by Cole County Circuit Judge Daniel Green, the court ruled that Missouri state statutes governing automobile distribution prohibit Tesla from operating its own retail stores in the state.

The case, which the MADA filed against the Missouri Department of Revenue, contested the State’s issuance of two franchise dealer licenses to Tesla for Tesla to open its own “franchise” retail stores. Basically, Missouri statutes have implemented a circular argument that prohibits auto manufacturers from owning new vehicle dealerships. § 301.550.3 RSMo specifically limits new car dealers to being franchises, statutorily side-stepping the possibility of a non-franchise new car dealer. The court essentially argued (perhaps rightly) that Tesla’s self-dealing of the franchise to itself was merely a rhetorical ploy to circumvent this failure of the statutes to allow for non-franchise dealers. However, even if that side-step were permissible, § 407.826.1 RSMo specifically prohibits auto industry franchisors from “owning or operating a new motor vehicle dealership in this state.”

Judge Green’s opinion basically means the laws of the state of Missouri preclude the possibility of any auto manufacturer selling its cars in Missouri directly to consumers. While Tesla can continue to operate its two service centers in the state, it cannot make car sales there. Instead, the company must continue to sell to Missourians over the internet with a point-of-sale in another state. (So much for more sales jobs.)

I and others have written previously (here, here, and here) why bans on Tesla’s direct-to-consumer sales model are bad for consumers and for society in general. This most recent ruling in Missouri just highlights how fundamentally flawed the regulation of commerce can be. Missouri’s laws, to the extent they ever made sense, are rooted in an antiquated industry and technological setting. Advancements in information technology alone have undercut many, if not all, of the economic justifications for an auto manufacturer to use a franchised distribution system. Laws that were written to protect franchisees in a 1950s-era distribution system do nothing now but raise consumers’ costs and thwart technological and organizational innovation that make everyone better off. Everyone, that is, except the franchised auto dealer cartel that sees all too clearly how little value it now adds in the sale and distribution of new cars.

Hopefully Missouri’s legislature will have the gumption to fix the flaws in its statutes that limit all new car retailers to “franchises” and instead let auto manufacturers (or any other manufacturer) choose the model they find best for themselves and their customers.


Database of Federal Regulations

Omar Al-Ubaydli and Patrick McLaughlin (both at George Mason University) have an article in the most recent issue of Regulation & Governance documenting their RegData database, which “measures [federal] regulation for industries at the two, three, and four-digit levels of the North American Industry Classification System.” While any attempt to quantify regulations is fraught with problems, as the authors note in their paper, their text-based approach would seem as good a method as any (and superior to some) for providing a numerical measure of regulation that could be used for empirical research. And what’s even better, the data are freely available here. The abstract of the paper reads:

We introduce RegData, formerly known as the Industry-specific Regulatory Constraint Database. RegData annually quantifies federal regulations by industry and regulatory agency for all federal regulations from 1997–2012. The quantification of regulations at the industry level for all industries is without precedent. RegData measures regulation for industries at the two, three, and four-digit levels of the North American Industry Classification System. We created this database using text analysis to count binding constraints in the wording of regulations, as codified in the Code of Federal Regulations, and to measure the applicability of regulatory text to different industries. We validate our measures of regulation by examining known episodes of regulatory growth and deregulation, as well as by comparing our measures to an existing, cross-sectional measure of regulation. Researchers can use this database to study the determinants of industry regulations and to study regulations’ effects on a massive array of dependent variables, both across industries and time.

Now, if only there was such a database of State-level regulations.

Do Medical Marijuana Laws Increase Hard-Drug Use?

According to a recent study by Yu-Wei Luke Chu in the Journal of Law & Economics, the answer is not just “No,” but that medical marijuana laws may actually decrease heroin use as consumers substitute the legal marijuana for heroin. Below is the abstract:

Medical marijuana laws generate significant debate regarding drug policy. For instance, if marijuana is a complement to hard drugs, then these laws would increase the usage not only of marijuana but also of hard drugs. In this paper I study empirically the effects of medical marijuana laws by analyzing data on drug arrests and treatment admissions. I find that medical marijuana laws increase these proxies for marijuana consumption by around 10–15 percent. However, there is no evidence that cocaine and heroin usage increases. From the arrest data, the estimates indicate a 0–15 percent decrease in possession arrests for cocaine and heroin combined. From the treatment data, the estimates show a 20 percent decrease in admissions for heroin-related treatment, although there is no significant effect for cocaine-related treatment. These results suggest that marijuana may be a substitute for heroin, but it is not strongly correlated with cocaine.

Thursday’s Interesting Reads

A couple of interesting articles came across my screen today.

The first, by Alex Tabarrock over at Marginal Revolution, corrects a popular misconception about the relative bargaining power of workers. He points out the problems (both conceptually and factually) in framing employment issues as “firm versus worker,” which focuses on the threat of worker unemployment. He also shares a nice chart from the St. Louis Federal Reserve illustrating how this perception of employers having control over employment relationships is quite incorrect. One of my favorite lines/points:Buyers don’t compete against sellers, buyers compete against other buyers (and sellers compete against other sellers). See how that’s important in this context.

The second, by Andrew Flowers at FiveThirtyEight Economics, reports on a recent study by Montazerhodjat and Lo (MIT) that argues how the Food and Drug Administration (FDA) should change its one-size-fits-all approach for approving drugs to take into account the opportunity cost of making the wrong decision. This idea isn’t at all new to economists. Currently, the FDA uses the same standard for all drugs, regardless the severity of the consequences of making the wrong decision (in the trade-off between Type 1 and Type 2 errors). Montazerhodjat and Lo’s study (available here) is pretty technical, but Flowers’ piece does a great job of summarizing the economics and the results in a much more lay reader-friendly way.

Happy reading!

Markets, Incentives and a Krugman (et al.) Fail

Pity the poor teenager taking an AP Economics course whose father is an economist. Especially when the local school district has adopted a text that is based on Paul Krugman’s Economics (3rd ed., coauthored with Robin Wells). Even more especially when the father-economist has a fundamental disagreement with much of what Mr. Krugman has become since surrendering his academic credentials for political punditry. Yeah, that’s my lucky kid.

So of course, I had to thumb through the text. I suppose I shouldn’t have been too surprised to find on only the third page of Module 1 a gross error in explaining the trouble with command economies. After explaining the failed history of command economies, the text asserts (p. 3):

At the root cause of the problem with command economies is a lack of incentives, which are rewards or punishments that motivate particular choices.

Where to start? How about with the simple fact that incentives always exist, no matter the type of economy. And there were plenty of incentives in the former Soviet Union (the textbook example of a command economy–literally in this case). I remember the late Nobel Prize-winning economist James Buchanan sharing the story of his visit to Moscow shortly after the fall of the Soviet empire during which he was surprised to learn of a market for burned out light bulbs — because people could use them to steal working light bulbs from their workplaces when they couldn’t get light bulbs in the stores. People responding to incentives. It’s The Basics 101. The problem with command economies is not a lack of incentives–but a lack of incentives that are based on the wants of consumers themselves and a lack of incentives for innovation or efficiency. In short–the absence of the incentives created by a free market economy.

More importantly, the focus on incentives misses the point in a way that has significant implications for what the text goes on to say about economic policy. At the root of the problem with command economies was the lack of information available to decision-makers about the wants and desires of an entire population of individual consumers with different tastes and preferences and about the conditions of scarcity and desires in dispersed local markets across the society’s economy. As F.A. Hayek (another Nobel Prize winner) explained, the fundamental role of markets is to discover and reveal information based on the complex interactions of individuals across product types and geographic space.These interactions result in prices that reflect the relative scarcity and value of goods across society. Those prices create incentives, and those incentives are fundamentally important in guiding individuals to use their resources in ways that innovate, create value, and serve consumers. But the incentives are secondary–derived from the information discovery role of the market that cannot be replicated in a command economy.

Why is this such an important distinction? Because of the way the text goes on to describe the objective of policy making. After (fairly accurately) explaining how prices create incentives, the authors state (p. 3):

In fact, economists tend to be skeptical of any attempt to change people’s behavior that doesn’t change their incentives. For example, a plan that calls on manufacturers to reduce pollution voluntarily probably won’t be effective; a plan that gives them a financial incentive to do so is more likely to succeed.

The implication? All we need to do is create incentives (implicitly, in the form of taxes, fines or subsidies) to create financial incentives for manufacturers (or people) to do what we want them to do. But this line of argument ignores the more fundamental question of determining whether the plan makes social or economic sense in the first place. What is the economic basis for whether we uses fines or subsidies and how large they should be? At what point, if any, would doing nothing be economically more efficient than doing something? By taking away the fundamental information function of the market and jumping immediately to incentives, we skip the whole messy discussion of the information requirements by legislators, bureaucrats and policy makers in coming up with “the plan” to begin with. All we need to do is trust the omniscience and beneficence of policy makers to know what the “right price” is–and to set arbitrarily the incentives to get the outcomes we want. But that’s exactly why command economies fail.

The root problem of a command economy is not that there are no incentives, but that there are socially inefficient incentives. The incentives are socially inefficient because it is impossible for a central authority to know the value individual citizens place not only on existing goods and services, but on the latent value of potential goods and services that can only be discovered by innovation and experimentation–and a central planner cannot think beyond her own imagination in the realm of possibilities. And it’s not only true of Soviet-style planned economies, but of any central decision-making authority–including the US federal government–even in the context of a heavily market-dominated economy.

Note: AP Economics students (and teachers), remember….the correct answer on the test may not be the right answer in reality. Answer the questions from the textbook based on the information in the textbook. But in your real life as a consumer of information and participant in the market place of ideas and politics, be sure to get to the fundamentals rather than the superficial.

We’re From The FCC and We’re Here To Help

“We’re from the government, and we’re here to help.” Yeah, you know that punchline, right?

I saw a report from NPR that FCC Chairman Tom Wheeler had decided to do just that in the dispute between Dish Network and Sinclair Broadcasting. As reported in the Wall Street Journal yesterday, Dish blacked out some 150 local stations owned or operated by Sinclair as a result of their ongoing distribution contract renegotiation dispute. The blackout affects some 5 million consumers in 79 markets.

Enter Chairman Wheeler to the rescue. Per the NPR article,Wheeler stated “We will not stand idly by while millions of consumers in 79 markets across the country are being denied access to local programming.”

Just one problem: Consumers are not being denied access to local stations–particularly to local news, weather and information on their local NBC, ABC, CBS and Fox affiliates. These affiliates are required–by the FCC–to provide free digital broadcasts, meaning consumers are perfectly able to access these stations for relatively modest investments in a digital antenna for their television. Moreover, in most markets Dish is not the sole distributor of paid-access television, meaning consumers also have the option of switching to a different television service provider. Indeed, as reported by both NPR and the WSJ, Dish is already hemorrhaging subscribers in large part due to service interruptions that have come to characterize Dish’s negotiating tactics with local station owners. And no doubt Dish has taken that into account in their negotiation strategy with Sinclair.

Where the FCC should act is in clarifying its rules regarding negotiation rights and station ownership. Two weeks before the blackout, Dish filed a complaint with the FCC regarding Sinclair’s negotiating tactics–which revolve in part around whether Sinclair was the property rights to negotiate on behalf of several stations it operates, but does not own. The FCC issued a rule forbidding such negotiations, but Sinclair alleges their operating agreements were grandfathered in. If the FCC were more clear in its rules and interpretations, perhaps the contracting dispute would have resolved itself already without the need for Chairman Wheeler to mount his white horse and ride to the rescue.