Streetwise Professor

January 17, 2018

No Yodeling Required!: Swiss Sanity on Citizenship

Filed under: Economics,Politics — The Professor @ 7:39 pm

Not long after finishing my immigration post, I came across this article that cracked me up:

Dutch vegan who applied for a Swiss passport has had her application rejected because the locals found her too annoying

Nancy Holten, 42, moved to Switzerland from the Netherlands when she was eight years old and now has children who are Swiss nationals.

However, when she tried to get a Swiss passport for herself, residents of Gipf-Oberfrick in the canton of Aargau rejected her application.

I guess they can’t kick her out, but they can deprive her of citizenship.  (And “Oberfrick”–heh.)

This is an amusing illustration of a broader Swiss principle: who gets to be Swiss depends on their contribution to Switzerland, and their ability to integrate with those already there.  A more serious illustration comes from a recent change in Swiss citizenship law:

On 20 June 2016, the Swiss Parliament voted on the new Swiss Citizenship Act, which will come into force together with the relevant Ordinance on 1 January 2018. The main aim of the new law is to limit the issuance of Swiss citizenship to well-integrated foreign nationals only. Furthermore, the Citizenship Act also aims to harmonise the residence requirements and implement into a law the authorities’ practice. [Emphasis added.]

. . . .

Under current law, the basic requirements to obtain Swiss citizenship can be summarised as follows: a. The applicant must have resided a minimum of 12 years in Switzerland (of which at least three years within the five years prior to the application) and a certain amount of time (usually between two to five years) in a specific canton and in a specific commune prior to being able to apply. Shorter periods apply to certain categories of applicants aged between 10 and 20 years for whom the years spent in Switzerland between their 10th and 20th birthdays count double in the calculation of the 12- year period required at the federal level. b. The applicant must prove that he/she is well integrated in Switzerland. As per the current practice of the Swiss authorities, the following requirements usually need to be fulfilled: the applicant must have a clean criminal record, prove that he/she fulfils all financial obligations, in particular with respect to tax payment, has a good reputation, has a good knowledge of a Swiss national language (i.e. French, German or Italian), has a basic knowledge of Swiss geography and history, and knows how the Swiss political system functions. c. Additional requirements may need to be met according to the respective cantonal and/or communal laws.

. . . .

Only applicants holding a C-type permit (permanent residence permit) may apply for Swiss citizenship (currently, holders of B-type residence permits may also apply). The applicant must have resided a total of 10 years in Switzerland (not 12 years as today). The ordinance to the SCA now details the concept of ‘good integration’. According to the ordinance, an applicant is deemed as being well integrated if he/she:

• has good oral and written language skills in one of the national languages;

• respects the public order and security;

• respects the Swiss federal constitution;

• participates in the economic life or undergoes education, i.e. the applicant is employed or attends a school/university;

• ensures that his/her family members are integrated;

• is not a threat to the internal and external security of Switzerland;

• is familiar with Swiss living conditions.

Applicants with a criminal record or who are dependent on Swiss social welfare will most likely be rejected.

Indeed, regarding the last point, the new law precludes citizenship for those who have been on public assistance in any time in the past three years.

Fortunately, it appears that yodeling is not a requirement!

Note that none of these criteria are based on nation of origin.  There will no doubt be a relationship between the likelihood of meeting these criteria, and whether one emigrates from a s***hole, but the law does not discriminate or create quotas on the basis of national origin (which is likely by itself to be a very crude proxy for ability to contribute, and which is part of US law primarily as the result of ethnic politics).

Certain aspects of the Swiss naturalization system are not practical for the US.  In particular, the role of cantonal and communal authorities in authorizing citizenship (as the Annoying Dutch Vegan found out to her chagrin) is a non-starter here.  This conflicts with the US Constitution, and is at odds with the much greater mobility of Americans vs. Swiss.  But the principle of conditioning citizenship on integration, fluency in a national language, non-dependence on public assistance, lack of a criminal record, etc., is certainly possible in the US, and makes sense.  It is certainly a more rational and sober policy than one that revolves around nauseating pap about “dreamers” and the like: whenever a debate centers on agitprop and euphemisms you know it is fundamentally dishonest and manipulative.

You can’t paint the Swiss as mouth-breathing populist, nationalist wackos: if anything, they are a little too control-freakish for me (and most Americans, I’d wager).  Indeed, the Swiss have been very successful at balancing a deep integration in the world economy and international institutions with a pride in their own national traditions and mores, and a desire to preserve them.  They have avoided many of the problems that somewhat similar nations (notably Sweden and the Netherlands) have experienced with their immigration policies. (There’s nothing like Malmo or Gothenburg or Rotterdam in Switzerland.)  The Swiss have struck a reasonable balance between openness to foreigners and national pride, and are not consumed by the neurotic complexes and self-loathing that have paralyzed many Swedes, Dutch, Germans, etc. (and the governments of these nations).

Switzerland therefore represents a plausible example/role model for a reasoned immigration debate in the US. Yet it is almost never mentioned here.

And it’s not just immigration.  The Swiss health care system has much to recommend it–far more than the dysfunctional system that prevails in the US.  The Swiss model would be a great starting place for a transformation of US healthcare.  I’d prefer an even more market-based system, but politics is the art of the practical, and I realize that my ideal is not gonna happen. But the Swiss model meets many of the goals of the left in a much more efficient way than our current system, and certainly dominates monstrosities like the UK or Canadian systems.

It would be impossible–and indeed, highly objectionable–to try to make the US like Switzerland. For myriad reasons. But there are some things we can take from Switzerland, or should at least consider seriously. Not that I’m holding my breath.

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January 15, 2018

Holegate

Filed under: Economics,Politics,Uncategorized — The Professor @ 8:30 pm

A few comments on ShitholeGate.

First, I dunno if Trump said it. It sounds in character, but the sources for it (being anonymous and/or Dick Durbin) are hardly unimpeachable.

Second, there must be a shortage of fainting couches, smelling salts, and pearls for clutching in DC and media land, given the collective swooning and shock at the thought that a president used a four letter word.

Uhm, LBJ anybody? Nixon?

Third, there are logically coherent and logically incoherent objections to what Trump allegedly said about questioning the wisdom of admitting more people from shitholes than non-shitholes (e.g., Norway–though at one time, my ancestors apparently disagreed!)

The logically coherent objection is: “Yes, these are horrible, abjectly miserable places, which is why we should take in people from them, on humanitarian grounds.”

The logically incoherent objection is: “How dare you call them shitholes! They are wonderful places full of wonderful people! But we are rescuing people from lives of misery by taking in the poor and huddled masses from these places.” If they’re so great, why the intense desire to leave?

Suffice it to say, the logically incoherent objection has been the dominant narrative on the left.

The logically coherent objection creates its own issues: logical coherence is necessary for it to be a reasonable policy position, but by no means sufficient.

One of the issues is: what is the limiting principle? Or is there none?: do you favor no restrictions on immigration whatsoever? If that’s your position–be open about your support for open borders. Don’t try to have it all ways.

If you do favor restrictions, what criteria will you apply for determining who can immigrate to the US? What are the benefits? The costs? What is the incidence of those costs and benefits? Again, be open about it–speaking in gauzy generalities is dishonest, and makes it impossible to evaluate your position.

A related issue is that those who object to, or even have reservations about, open borders or even relatively liberal immigration policy are routinely excoriated as racists and bigots. Yes, some are. But many are not, even though they have a strong preference for traditional American culture which is deeply rooted in European cultures and ethnicity. Do you believe that is a legitimate preference?  If not, do you advocate the rejection of democratic means to decide immigration matters because those with illegitimate views might prevail? Further, African Americans are to a large extent more opposed to immigration than white Americans. Is that due to racism? Or is it a telling indication that the views on immigration also (and arguably primarily) fall along economic/class lines?

This touches upon another element of incoherence in the immigration debate: assimilation. Many (and arguably most, now) advocates of liberal immigration policies are hostile to the notion of assimilation, again imputing racist motives and cultural bigotry to those who believe that current immigrants should assimilate the way that their grandparents and great-grandparents and generations before them did. But hostility to assimilation and hostility to those who favor assimilation means that it’s OK for some (immigrants) to prefer their own culture, ethnicity or race, but it’s not OK for others (the native born) to do so.

This is another variation on the incoherence of identity politics. The most ardent advocates of identity politics scorn intensely those who feel that their identity is threatened by mass immigration, especially mass immigration without assimilation. In the identity politics animal farm, all identities are equal, but some are more equal than others.

Along these lines, it is pretty apparent that the political elites who are most ardent in support of very liberal immigration policies are those who are least likely to be disclocated by large flows of immigrants, and may indeed benefit from it. Those they scorn–many of whom voted for Trump–are the ones most likely to be adversely impacted, either economically or socially/culturally.  Ironic coming from people who are also likely to claim that they favor redistribution in order to reduce economic inequality.

Personally, I confess to some ambivalence on these matters. The libertarian in me favors free movement of people. At the same time, I recognize the Friedman/Richard Epstein point that the welfare state means that immigration is not the result of mutually beneficial bargains entered into without coercion: immigration attracted by the potential to obtain benefits funded by coercive taxation is problematic indeed. (Friedman and Epstein object to the welfare state in large part because it makes unrestricted immigration infeasible.) Furthermore, I understand the importance of social trust and communication and coordination due to shared assumptions and beliefs, and how those can be facilitated by some homogeneity in ideals and culture and background. Relatedly, a democratic polity operating on a principle of consent has to give preference to current citizens.

Immigration has always been a fraught issue in the US, although the intensity of views about it has waxed and waned over time. Our handling of the issue has never been perfect, but I think that (a) the US historically did a better job of it than any country in history (certainly modern history), and (b) we handled immigration best prior to the rise of the welfare state, and when assimilation was a widely shared ideal. Those conditions do not prevail now, which makes me much more cautious, and indeed skeptical, about relatively untrammeled immigration. As a result, I think it’s fair to ask: how many should we accept from where?, and shouldn’t we be more skeptical about mass immigration from countries that are vastly different economically, culturally, and socially?

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January 10, 2018

Red on Red: Simpson vs. Browder

Filed under: Politics,Russia — The Professor @ 7:02 pm

Some time back I promised a post on Bill Browder. A hectic schedule and the holidays intervened, so though I’d collected loads of material, I didn’t have time to write a post. Events from yesterday–namely the release of the transcript of Fusion GPS head Glenn Simpson’s interview with Congressional investigators–make this timely, so I’ll try to summarize what I have concluded. Oddly, one conclusion is that when it comes to Bill Browder, Simpson and I are of like mind. On other matters no–but even there Simpson’s Browder testimony shows precisely why his opinions on Trump are suspect.

As for Browder, here are my conclusions in somewhat abbreviated form.

First, Browder assiduously cultivates the image that Diogenes’ search for an honest man would have ended had the old Greek met one Bill Browder. But in fact, his honesty, integrity, and scruples are highly questionable indeed.

The essence of the Browder as Hero narrative is that he was a lone crusader for honest business practices in Russia, and that he fought a corrupt and brutal establishment. In retribution, the establishment stole one of his companies in order to defraud the Russian government, and killed Browder’s loyal employee, Sergei Magnitsky when he had the temerity to challenge them. Bill Browder, martyr by proxy.

A review of his actual business dealings in Russia strongly suggests a very, very different story.

For one thing, Browder was engaged in the voucher privatizations of the 1990s. These were, without cavil, among the most monstrous acts of mass theft and fraud in modern economic history. They were the primitive capitalist accumulation that built many modern Russian fortunes (and filled more than a few graveyards). Any Dudley Do-Right who tried to operate in that environment would have been ground to dust within weeks, if not days. It was an extreme Darwinian environment in which the most unscrupulous and often most brutal prevailed. If Browder survived that–and indeed thrived–draw your own conclusions.

For another, Browder’s initial partner in Hermitage Capital Management (his investment vehicle in Russia) was Edmund Safra. Safra’s sketchy dealings are legendary. He always dismissed allegations about his shady business practices as antisemitic, but there are many other Jewish financiers who have not attracted the same criticism. Further, Safra was involved (through his Republic Bank) in a mysterious scheme to jet billions of dollars in cash to Russia during the 1990s–it was dubbed “the money plane.” Just what went on there is unknown, but it doesn’t pass the smell test.

Safra died under bizarre circumstances in Monaco in 1999. An ex-Marine who served as his nurse was convicted of murder, but few find that story plausible, or complete. One of the competing theories is that he was killed by the Russian mob. (There are so many suspects, that maybe the true story is something along the lines of Murder on the Orient Express–everybody did it.)

Regardless, voucher privatizations plus Safra is hardly the CV of a commercial saint.

Browder also claims that he tried to bring honest corporate governance to Russia. He points to his attempts to change Gazprom as an example.

A different story is far more plausible: Browder’s investment in Gazprom was an arbitrage play, pure and simple. Due to restrictions on foreign ownership of Gazprom’s Russian shares, those shares sold at a substantial discount to the ADRs traded outside of Russia. Browder found a way–legal he says, illegal say the Russians–to buy Gazprom Russian shares. This allowed him to capture the big discount.

Putting the legality of the structure that he used to buy the shares aside, making an arb trade like that can be very profitable, and thus very attractive. That’s why Browder and his investors wanted in. Given the farcical prospects for actually changing Gazprom’s governance, I’m pretty sure that the Corporate Crusader act that Browder put on was just a cover for his more mercenary motives.

And this is a general impression that I come away with after reading a lot about him. The whole Last Honest Man in Russian Investing shtick was a canny PR ploy that allowed his backers to distance themselves from the tawdry (and worse) reputation that investing in Russia had at the time. Browder was their beard that allowed them to pretend that they were in an honest relationship.

Browder has been prosecuted by the Russian government, both for tax violations and his purchase of Gazprom shares. He portrays these prosecutions as vengeance for his crossing the wrong people in his crusade for honest business practices in Russia. I have no doubt that his prosecution might have been selective, and indeed driven by vengeance–but maybe not as revenge for his honesty, but for his taking from the wrong people. Further, even if the prosecutions were selective (i.e., others doing the same but not prosecuted) and driven by vengeance, that doesn’t mean they weren’t justified–and perhaps even just.

I don’t have the basis to opine on the legality of the structure of his Gazprom purchases. But I can say that the Russian accusations regarding tax violations seem very plausible. These involved setting up companies that received tax breaks for hiring disabled veterans, but the Russians colorably show that he did no such thing.

The Russians also allege that he was in fact involved in the tax fraud that resulted in Magnitsky’s death. This allegation is far more speculative, and perhaps libelous–but it is not totally lacking in plausibility, especially in light of Browder’s track record.

Since getting kicked out of Russia in 2005, and since Magnitsky’s death, Browder has spent his life crusading against Putin and the Russian government. The centerpiece of his campaign is the alleged involvement of Russian government officials (tax officials mainly) in the theft of $230 million in tax refunds fraudulently obtained from a Hermitage company seized by the Russians, and the death of Magnitsky while in custody in an investigation of the theft.

Here it is evident that Browder’s relationship with the truth is, well, situational and transactional. The best evidence of this is his deposition in the Prevezon case in New York. Browder tried mightily to avoid being served, and here is one place where Browder and Simpson intersect: Simpson was part of the effort to serve Browder, on behalf of his (indirect) client, Prevezon CEO Denis Katsyv.

During that deposition, Browder admitted repeatedly that he had no evidence whatsoever to back some of his most lurid and damning allegations against those he alleges were complicit in the Russian tax fraud and the death of Magnitsky. For instance, he has claimed repeatedly that he could trace the ill-gotten gains from the tax fraud to specific individuals. In the deposition, he admitted he could not.

(Here Browder has something in common with dossier assembler Christopher Steele. Once in court testifying under the penalty of perjury, Steele was at pains to admit that the claims in the dossier were unsubstantiated, in contrast to his hair on fire representations to the FBI.)

This is particularly outrageous given the fury with which Browder attacks anyone who questions his dealings or veracity.

So my conclusion is: Browder is a con-man and a liar. If he tells you the sun rises in the east, buy a compass and wait for sunrise.

Glenn Simpson of dossier infamy is of the same opinion. Simpson did a deep documentary dive on Browder for Prevezon’s lawyers, Baker Hostetler, and came to many of the conclusions I outline above, and some more to boot. If you read the transcript of Simpson’s interview (not testimony) before Senate Judiciary Committee investigators, you’ll see what Simpson dug up and the basis for his conclusions.

Well, doesn’t this mean that I therefore have to give credence to Fusion GPS’s research on Trump? Quite to the contrary: the difference in the methods in the Browder and Trump matters is striking. When investigating Browder, Fusion GPS did a deep dive on documentary evidence in the US, Russia, and presumably Cyprus (where Browder registered companies). (See pp. 41-49 of the transcript. Simpson is so detailed in his description of what he did in the Browder investigation that the lawyer questioning him said “Thank you for the narrative answer.” LOL.)

In contrast, with regards to Trump, Simpson et al (a) read some books, and (b) commissioned the Steele investigation, which apparently just involved in talking to people (just who is a complete mystery) who passed on unverified and unverifiable gossip. The basis for Simpson’s claim that Trump had Russian mafia connections is that Trump had connections with Felix Sater who allegedly had connections with the Russian mob: similarly Paul Manafort.

Thus, whereas the foundation for Simpson’s opinions on Browder is rock-solid, that for his opinions on Trump are charitably described as quicksand.

Simpson’s statements also call into question his honesty. When asked when he had any Russian-speaking employees, he mentioned one guy–who happened NOT to be Nellie H. Ohr, wife of ex-DOJ Associate Deputy AG. We now know that Mrs. Ohr worked for Fusion. Sean Davis said on Twitter that this was an “interesting omission.” I said it was an interesting perjury.

Simpson also insinuated that the FBI had an independent source to justify FISA-ing Trump campaign personnel–and that this guy was a walk-in. When the transcript was released, a “source close to Fusion GPS” said nope. Never happened. He was referring to Papalopolous. Another strike for his credibility.

Simpson strains credulity past its breaking point when he claims that even though he had dinner with Natalia Veselnitskaya the night before and the night after her meeting with Trump Jr., the subject never came up (she was at the other end of the table, he doesn’t speak Russian and she doesn’t speak English–even though they apparently could communicate well enough for her to get him to help her obtain a visa). Simpson claims to have been shocked at the news. Please. Big investigative reporter turned PI/opposition researcher has no clue about a bombshell meeting even after spending hours with some of the principals? He didn’t even bother to ask through a translator (who Veselnitskaya must have had along) “hey, Natalia, whatcha been doing in New York?” Please.

So my rule for Simpson is the same as for Browder: unless he has the documents to prove it, don’t believe a word he says. He will distort the truth to advance his agenda.

The most entertaining part of this is the red-on-red nature of the battle. Heretofore Browder has been something of a hero among the anti-Trump set (yeah, I’m looking at you, Michael Weiss) because he is ardently anti-Putin, and Trump is supposedly Putin’s bitch. But Simpson has even better anti-Trump bona fides, for the dossier is directly anti-Trump, whereas Browder’s  anti-Putin stance is anti-Trump only via (an alleged) transitivity.

So given a choice between Browder and Simpson, most of the anti-Trumpers are going with Simpson, and either explicitly or implicitly dumping and dissing Browder.

Karma, Bill. Karma.

Browder being Browder, he will no doubt go after Simpson with all guns blazing.

I’m stocking up on the popcorn.

The left and the media (I repeat myself, yet again) may end up ruing their choice. Given the extremely dubious nature of the dossier and those who funded, created, and disseminated it, and the very great likelihood that it was used as the basis to engage in counterintelligence surveillance of Trump campaign personnel, I believe that the dossier will likely prove the greatest political boomerang in modern political history, and will end up braining those who threw it (which includes the Clinton campaign, Fusion GPS/Simpson, the FBI and other US intelligence agencies, the media, and the “Resistance”). And if this happens, Bill Browder will be little more than collateral damage.

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December 27, 2017

Vova the Squeegee Man

Filed under: Economics,Politics,Russia — The Professor @ 4:21 pm

My old buddy Vova is making a rather forced and pathetic attempt to persuade rich Russians to repatriate the money they have invested (squirreled away) overseas:

President Vladimir Putin is using the threat of additional U.S. sanctions to encourage wealthy Russians to repatriate some of their overseas assets, which exceed $1 trillion by one estimate.

I call the attempt forced and pathetic precisely because Putin feels obliged to try to persuade, rather than dictate. And because he is offering inducements:

Putin said on Monday that Russia should scrap the 13 percent profit tax on funds repatriated from abroad and renew an amnesty from penalties for businesses returning capital.

And because he’s raising the bogeyman of western sanctions (from the Bloomberg piece):

“We and our entrepreneurs have repeatedly faced unjustified and illegal asset freezes under the guise of sanctions,” Peskov said on a conference call Tuesday. “The president’s initiative aims to create comfortable conditions for businesses if they want to use this opportunity to repatriate their capital.”

Heretofore, sanctions have limited the ability of the affected entities to tap western financing: they have not involved expropriation or the kind of piratical corporate and government behavior that has been seen in Russia. Investments abroad remain abroad despite the more hostile environment to Russian money in the west because it is still safer than it would be in Russia. That’s why Vova has to beg and bribe to try to get Russians to repatriate. And previous efforts have hardly been successful:

Russia rolled out a similar amnesty program during the worst of the conflict in Ukraine, which coincided with a plunge in oil prices that triggered the country’s longest recession of the Putin era. That 18-month initiative, the results of which haven’t been disclosed, “didn’t work as well as we’d hoped,” Finance Minister Anton Siluanov said. Unlike that plan, this one waives Russia’s 13 percent tax on personal income, according to Dmitry Peskov, Putin’s spokesman.

Note that the mere threat of western sanctions has not been enough: hence the tax waiver.

Insofar as piratical corporate behavior is concerned, I give you Igor Sechin, ladies and gentlemen. What do you think is more intimidating, Sechin plotting–and the system cooperating–to jail a troublesome minister for eight years, or what the US and Europe have done to sanctioned entities? Or his serial extortions of Sistema, which recently agreed to an “amicable” settlement with Rosneft/Sechin? Said “amicable” settlement involved the former paying the latter $1.7 billion dollars to settle a suit . . . over what is rather hard to say. I still don’t get the legal theory under which Rosneft even thought it was entitled payment for Sistema’s alleged past wrongs. Given that this occurred mere days after Putin called for an amicable settlement, it is pretty clear that he was taking Sechin’s side and telling Sistema to cave–and do so with a smile.

This is why Russian money will stay out of Russia, Putin’s pleas notwithstanding.

Another story gives you a partial explanation for Putin’s neediness: “Russia’s Reserve Fund to be fully depleted in 2017.” The rainy day fund is empty, and the outlook remains cloudy.

Thus, for all the hyperventilating about Putin the Colossus, the objective basis for his power is shaky indeed. He can be a pest and troublemaker, but he lacks the economic heft to be much more. Yet for selfish political reasons, Democrats, NeverTrump Republicans, and the media inflate his importance daily. Enough. Putin is rattling his tin cup, hoping that some rich Russians will drop some rubles into it. Maybe if the tax inducement isn’t enough, he can squeegee their windshields.

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December 26, 2017

Agency Costs: Washington’s Augean Stables

Filed under: Economics,Politics,Regulation — The Professor @ 6:09 pm

In news that definitely added to my holiday cheer, a gloomy New York Times moaned that “[m]ore than 700 people have left the Environmental Protection Agency since President Trump took office, a wave of departures that puts the administration nearly a quarter of the way toward its goal of shrinking the agency to levels last seen during the Reagan administration.”

Given that the EPA is one of the most malign agencies in DC, every subtraction is an addition to America’s wealth–and no, this will not detract markedly, if at all from environmental quality. Or at least, any loss in environmental quality would not have been worth the cost necessary to achieve it.

The most signal achievement of Trump’s first almost year has been on the regulatory front. (The recent tax law arguably pips that.) The metastasizing regulatory/administrative state under both the Bush and Obama administrations is a detriment to prosperity, and in particular to the dynamism of the American economy. It is the engine of European-like sclerosis, and it badly needs to be brought under control.

Trump has begun–and only that–the task of cleaning this Augean Stables on the Potomac. The bureaucrats are none to happy, and are fighting back, mainly through classic bureaucratic guerrilla warfare. Unfortunately, they have advantages in this form of combat, and any progress will be achieved slowly, and only through unceasing effort. Those appointed to lead the agencies are often at a disadvantage in taming those who work for them even when they have a will to do so, and what’s more, all of the mechanisms of capture are at work here, meaning that agency political appointees are constantly at risk of going native.

The administrative state is a threat to prosperity and liberty, and a Constitutional anomaly, not to say monstrosity. Administrative agencies combine executive, legislative, and judicial functions, thereby threatening the separation of powers and associated checks and balances which are intended to prevent any single branch of government overawing the others. Indeed, in many respects the administrative state has become an independent branch of government, though not one formally established by the Constitution.

Moreover, it is not subject to the normal mechanisms of accountability. Yes, it is formally subject to Congressional oversight and some presidential control, and hence indirectly subject to the electorate, but due in large part to the scope and intricacy of the regulators’ responsibilities, there is a huge principal-agent problem: agency costs (as economists use the term) are a major issue with federal agencies. It is very difficult for Congress or the White House to control regulators. Further, information asymmetries make it inefficient to utilize high-powered incentives to get regulators to implement the wishes of those who formally control them. Civil service protections insulate bureaucrats from personal accountability for all but the most egregious misconduct (and sometimes not even then).

There is also a strong bias towards expanding agencies’ power. Several factors work in this direction, and few in the opposite way. Empire building is one such factor–regulators have a strong preference to expand their power. Congressional committees that oversee agencies also gain political power when the influence of their charges expand. (This shares some similarities with a mafia protection racket.) Government agencies attract people who are ideologically predisposed to expansive exercise of government power.

These asymmetries lead to a ratchet effect. Statist administrations–notably Obama’s, but to a considerable degree Bush’s as well–find allies in the administrative state who eagerly push their agenda. (Look at the CFTC in the Gensler years.) Less statist ones–like Trump’s–face a wearying battle of attrition to undo what had been put in place by previous administrations (and Congresses).

Legal precedents only make things more difficult. The Chevron doctrine (derived from a 33 year old Supreme Court decision) requires federal courts to defer to the judgments (I would not say expertise) of regulatory agencies in matters of statutory ambiguity and interpretation. This exacerbates greatly the agency problems, because since Congressional “contracts” (i.e., laws) are inherently incomplete (they do not specify regulatory actions in every state of the world), such ambiguities and necessities of interpretation are inevitably legion. And under Chevron, the federal courts can do little to rein in an agency. (Justice Gorsuch has criticized Chevron, and hopefully soon there will be an opportunity to reverse it or narrow it substantially.)

The administrative state is a progressive–and Progressive–creation. It reflects deep suspicion and skepticism about private ordering, and a belief in the superior knowledge and moral superiority of an expert class who should be protected from popular whims and passions, as expressed through election results, because those whims and passions are not the reflection of wisdom, knowledge, or dispassionate analysis. (If you want a sick laugh, look at Tom Nichols’ bleatings about expertise at @radiofreetom on Twitter.)  In the progressive worldview, the lack of democratic accountability is a feature, not a bug. Leave these people alone. They know better–and are better–that you!

The strongest case for some insulation of administrative agencies from more intrusive control by the Constitutionally-recognized branches of government is that this facilitates credible commitments: market participants, and citizens generally, know there will be some stability in rules and regulations, and can plan accordingly. But given the tendency to expand the scope of regulations, this translates into stability of overregulation.

There’s also something, well, Russian about a highly bureaucratic state, largely run by an unelected nomenklatura. Read Tocqueville’s descriptions of 19th century Russia and the 19th century US, and you’ll see that the administrative state leans far more towards the former than the latter.  I would also note that the bureaucracy is one of Putin’s strongest political pillars.

So the news that a few bureaucrats at the EPA are so disenchanted by Trump that they’ve up and quit is encouraging, but it’s at most a small victory in a big war. I have been encouraged by few other wins (e.g., on net neutrality), but the most I hope for is an elimination of some of the most egregious excesses of the Obama (and to a lesser degree Bush) years. The overall trend is towards a more powerful, insular, and unaccountable administrative state, much to the detriment of America’s freedom, dynamism, and prosperity.

 

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December 21, 2017

Not Exactly What I Asked Santa For, But I’ll Take It

Filed under: Derivatives,Economics,Politics — The Professor @ 10:13 pm

Miracle of miracles, Congress has passed, and Trump will sign (perhaps after the New Year) a tax bill. It’s hardly perfect, but it’s an improvement on the existing system, and is about the best we could expect to get in the current political climate.

What do we want from a tax system, and how does this bill get us closer to that? One goal of the tax system–and the one that I prioritize–is to minimize the deadweight cost of raising the necessary revenue. All real world taxes involve distortions–deadweight losses–because they warp incentives at the margin. For instance, a tax on labor income drives a wedge between the marginal benefit of working an hour (the after tax wage) and the marginal cost (the value of lost leisure). This induces people to work too little and to consume too much leisure (or equivalently, consume too much leisure and too little goods and services) because they don’t capture the full benefit of their labor. Really inefficient tax systems are rife with such distortions. The US tax code provides numerous examples.

Taxes on capital or the returns to capital–taxes on dividends, corporate profits, and capital gains–are highly distorting. Steven Landsberg explains this as intuitively as anyone. The basic idea is that capital taxes are a form of double taxation that distort incentives to save and invest vs. consume. As Landsberg puts it, it is a surtax. With capital taxation, we have an incentive to consume too much and save and invest too little.

For about 30 years, economists have understood that in certain circumstances, the optimal rate of tax on returns to capital is zero. That is, a consumption tax is optimal.

There are caveats to this conclusion. Information-driven considerations can lead to a positive capital tax rate. For example, if people can disguise labor income as capital income to escape the income tax on labor earnings, a positive capital tax can be efficient in conjunction with a personal income tax. Disguising consumption as investment (is a new personal computer an investment or consumption?) can lead to a similar result. Distributive considerations (which inherently involve value judgments, I should note, whereas efficiency considerations do not) can also make it desirable to tax capital.

But even given these caveats, it is almost certainly the case that an efficient tax system imposes relatively low taxes on capital.

This efficiency effect is also related to another (possible) goal of the taxation system–to affect the distribution of income/wealth/consumption. For the impact of the tax on capital returns on investment affects who actually bears the burden of the tax.

This is an example of one of the issues that non-economists have a devil of a time understanding: tax incidence. Who bears the burden of a tax is not necessarily the party on whom the tax is levied. Taxes on labor aren’t necessarily paid by workers. Sales taxes assessed on firms aren’t necessarily paid by those firms. Who bears the tax burden depends on elasticities of supply and demand for the thing that is taxed.

Capital tax incidence is particularly unintuitive because there is a dynamic element to it. But the basic point is that even though a capital tax is formally levied on the owners of capital (or the return streams), over a long enough horizon the burden falls almost entirely on labor.

This is due to the impact of the capital tax on investment mentioned above. Tax capital, you get less investment. With less investment, there is less capital. With less capital, labor is less productive. Lower productivity translates into lower wages. Meaning that even though no supplier of labor writes a check to Uncle Sam to pay for the tax on capital, s/he pays it nonetheless, in the form of lower real wages.

The impact tends to increase over time, because the capital stock does not adjust immediately in response to a capital tax that depresses after-tax returns. But in standard models, the long run equilibrium after-tax return on capital is a constant (determined by the marginal utility of consumption, time preferences, and the long run growth rate of the economy). So if you raise capital taxes, a constant after-tax return requires a rise in the pre-tax return, which requires a fall in the capital stock. That’s what causes wages to fall. And the quicker the capital stock can adjust, the more rapidly the capital tax rise reduce wages.

And of course this works in the opposite direction if you cut capital taxes: the after tax return to capital initially rises, spurring investment, which raises productivity and hence wages.

Indeed, under some fairly standard assumptions, the a cut in capital taxes cause wages to rise more than the lost revenue in capital taxes. Meaning that in the long run, labor pays more than 100 percent of a tax formally levied on capital.

Again, these effects are not immediate, but if you see a surge of investment in the next couple of years, you can surmise that wages will surge too over that time frame.

This result can be expressed in elasticity terms. The supply of capital is perfectly elastic in the long run. Perfectly elastically supplied inputs do not bear any burden of a tax, even if that tax is formally levied on those inputs: instead, the burden is paid by the suppliers of other inputs (e.g., labor) or consumers (in the form of higher prices).

And even to the extent that owners of capital benefit in the short term, they are people too. And yes, many of them are wealthy, but many are workers who are also capitalists due to their participation in pension plans or 401Ks.

The focus of the recently passed tax bill is the reduction of capital taxes, most notably through reductions in the corporate tax rate to 21 percent (from 35 percent–very high by world standards), and through the immediate expensing of some investment expenditures.  This is the main reason the tax bill is a big improvement. Yes, I would prefer a Full Monty consumption tax, but this reduction in capital taxation is a movement towards a more efficient tax system, and one that will increase wages over time more rapidly than under the existing rates.

An efficient tax system should also focus on broadening the tax base and reducing marginal rates, because it is marginal rates that distort decisions to work and save. The current bill does a little on this dimension.

Tax preferences for certain kinds of consumption or investment are also usually a bad idea. The mortgage interest deduction is a classic example of this: the non-taxation of employee health insurance premiums paid by employers is another. The former encourages excessive consumption of/investment in housing. The latter favors employer-provided health coverage, which distorts labor markets (e.g., through job lock).  It also induces overconsumption of health care as compared to other goods and services.

The tax bill trims–but does not eliminate–the favored tax treatment of mortgage interest. So that’s good, but not great. It does nothing  on the health care premium issue, which is unfortunate.

The tax bill also limits corporate deductions of interest payments on debt. This is desirable, because it mitigates the incentive to finance with debt rather than equity. The bill should have gone further.

One largely hidden bad in the bill is the elimination of operating loss carry backs and limits on operating loss carry forwards. I understand the motivation here–it was done to offset revenue losses from other tax cuts. However, this will deter risk taking and lead to more hedging designed to reduce the variability of corporate income solely for the purpose of reducing taxes.

This effect is a little subtle, so I’ll try to explain. With no carry backs or carry forwards, them marginal tax rate when a company loses money is zero, and the marginal tax rate on positive corporate profits is the full corporate rate (now 21 percent). Thus, if a company has a positive probability of losing money, its marginal tax rate is non-decreasing with income, and increasing over some range. Due to Jensen’s inequality, this increasing marginal tax rate means that expected tax payments are increasing in the variance of corporate income.* Thus, increasing risk is costly because it transfers money (on average) to the government. Therefore, firms are more likely to pass up higher returning but riskier projects, and more likely to pay bankers to design hedging products to reduce corporate income volatility (which uses real resources, i.e., causes a deadweight loss), or to engage in diversifying mergers that reduce returns on average but also reduce the variability of corporate income.

In contrast, carry backs and carry forwards reduce the disparity between the marginal tax rate on gains and losses. This means that expected tax payments are less sensitive to the variance of corporate profits, which reduces distortions in risk taking and risk management decisions.

Another negative in the bill is the retention of tax subsidies for electric vehicles and renewables.

But even despite these negatives, all in all, I say two cheers–or maybe 1.5 cheers-for the tax bill. It’s not exactly what I asked Santa for, but it’s better than a sharp stick in the eye.

But from the wailing on the left, you’d think that’s exactly what happened to them. In both eyes, in fact.

The left’s reaction is hysterical, in both senses of the word. It is hysterical in the sense of:

a psychological disorder (not now regarded as a single definite condition) whose symptoms include conversion of psychological stress into physical symptoms (somatization), selective amnesia, shallow volatile emotions, and overdramatic or attention-seeking behavior.

Especially the “shallow volatile emotions, and overdramatic or attention-seeking behavior” parts. Several Democrats (notably Nancy Pelosi) referred to the tax bill as “Armageddon.” Talk about overdramatic hyperbole. A common shriek (especially on Twitter) is that the tax bill will KILL thousands (or is it millions?) of Americans. People on the left seem to be in a competition to show who can be the most OUTRAGED OVER THIS OUTRAGE.

A good deal of this idiocy reflects a basic misunderstanding of tax incidence (which I discussed above). The left confuses who writes the tax check (corporations) with who actually foots the bill (in the medium and long run, wage earners). Another good deal of this idiocy reflects the bill’s limitation on the deductibility of state and local taxes, which hits high tax states like New York, New Jersey, Connecticut, and California–which also happen to be solidly Democratic. So this is a matter of whose ox is gored.

This is rather amusing, because these same Democrats claim to favor making the rich pay more taxes. But not their rich people, who will be hit hardest by the limits on SALT deductibility. I guess income redistribution should be achieved by taxing all those rich rednecks in Mississippi more heavily.

The left’s reaction is hysterical in the other sense of the word, meaning “extremely funny.” The reaction is so overwrought, so over-the-top, so disproportionate, so emotional, and so lacking in intellectual seriousness that it makes me laugh.

And I guess that’s another reason to support it. If those people think it’s horrible, it must be pretty good, right?

In all seriousness, evaluating the bill using some basic economics rather than what you might learn in primal scream therapy, it’s not bad, especially considering the source–a dysfunctional ruling class in DC. It mitigates some of the worst inefficiencies in the existing tax code. It could go further, but the fact that it goes anywhere at all is rather amazing, and a welcome holiday present.

*For those who said “WTF?” when they read “Jensen’s inequality” perhaps an example will help. Consider a company that has two investment opportunities. One pays $100 for certain. The other pays -$100 with a 50 percent probability, and $310 with a 50 percent probability. The expected return on the risky project is actually higher ($105 vs. $100), so from an efficiency perspective, that’s what we’d like the company to choose.

But it won’t if the corporate tax rate is 35 percent on gains, but the firm receives no payment from the government if it loses money: this means that the marginal tax rate on gains is positive, but the marginal rate on losses is zero. With this tax system, the after-tax return of the certain project is $65. The after tax return of the risky project is .5x-$100+.5x.65x$310=50.75.

The difference here is that the expected tax payment is higher when income is riskier. The expected tax payment in the certainty case is $35. In the risky case, it is .5x.35x$310=$54.25.

Carry backs and carry forwards allow the company to use the losses to offset gains in other years. If the firm faced the same payoff structure year after year, it could always carry back or carry forward the -$100 losses from bad years to offset gains in the good years. Thus, tax payments in the good years would fall to .5x.35x$210=$36.75, and its average after tax return would be $105-$36.75=$68.25>$65. So the company would take the project with the higher return.

Of course, the distortion attributable to the elimination of carry backs and limitation on carry forwards is greater, the higher the corporate tax rate. Thus, the reduction in the statutory rate to 21 percent dampens the effect of the reduction in the carry backs/forwards. But since the corporate tax rate is still positive, risk taking and risk management decisions are still distorted.

 

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December 3, 2017

Please Reconcile This: The Kremlin Is Hermetically Sealed to Outsiders, But They Told All to Christopher Steele

Filed under: Politics,Russia,Uncategorized — The Professor @ 7:45 pm

This article caught my eye last week: “At the epicenter of the Russian election manipulation story, reporters can’t report.”

As tensions rise, Ferris-Rotman finds reaching sources inside the government all but impossible. She says foreign correspondents based in Moscow can’t just pick up their phone and text or call an official.

“Russia is a very closed place,” she says. “It’s not like the U.S. where, you know, over years or over some time you can develop a source in the White House — someone who you can trust and that you trade information with. Basically (the Kremlin) is a sealed up institution and there’s no way for us to get into it. “

The Kremlin is a “sealed up institution,” but we are supposed to believe that Christopher Steele was able to get multiple sources within the Kremlin to repeat highly sensitive conversations involving the highest personages in the Kremlin, including Putin himself.

The dossier itself is bad enough, but its handling in the US–specifically by the FBI and the intelligence community–is downright sinister. This is even more evident after it was revealed that the FBI agent who was responsible for handling the dossier was a pro-Hillary/anti-Trump partisan who was fired by Mueller for exchanging anti-Trump texts with his lover, also an FBI agent. (Not that Mueller told us that this was why he was fired when it happened months ago. I guess he didn’t have time because he was so busy leaking.) Moreover, this same individual allegedly has been interfering with the House Intelligence Committee’s attempts to get to the bottom of the story of the dossier.

But there’s more: the same FBI official led the investigation of Hillary’s emails.

As the expression goes: the fix is in! Although here, it is necessary to use the plural: the fixes are in!

Boy, if only there was a Republican attorney general who could get control of a rogue FBI and get some answers about the dossier–how it was obtained, and how it was used by the FBI.

 

 

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Flynnsanity

Filed under: Politics,Russia — The Professor @ 7:29 pm

Friday was a bonanza for dry cleaners, as the media and the political class collectively wet themselves in glee at the news that ex-National Security Advisor Michael Flynn plead guilty to lying to the FBI.

Alas, their fondest desires ran well ahead of the reality–which is the norm for this lot.

As was the case with Manafort, Flynn plead guilty to lying but not to any underlying crime, least of all a conspiracy with the Russians. The most reasonable inference for this is that there WAS no underlying crime and no conspiracy.

Indeed, Flynn will testify that he lied about two conversations with the Russian ambassador, Kirlyak, neither of which was illegal or even unethical.

In the first conversation, he spoke not just to Kirlyak, but to the ambassadors of every nation on the United Nations Security Council, including Senegal, Egypt–and wait for it–Ukraine. The subject was not Russia, but the stink bomb of an anti-Israel resolution that the outgoing Obama administration supported  but the incoming Trump administration opposed.

And it was the incoming Trump administration, because this conversation took place in December, 2016.

Flynn allegedly contacted the ambassadors at the direction of Jared Kushner.

So this contact is about Israel, not Russia. Flynn talked to Russia only because Russia was on the UNSC. As it (or the USSR) has been since its creation in 1945.

But the breathless media coverage was almost all headlined “Flynn spoke to Russia,” insinuating that his plea showed that Trump was canoodling with Putin.

In econometrics, omitting variables leads to biased inferences. Here, omitting that Flynn also spoke to every other nation on the UNSC about an issue that had noting to do directly with Russia definitely led to biased inferences. And that was exactly the intention, which demonstrates the bad faith of virtually the entire journalistic establishment.

The other conversation was about Russia directly. Specifically, Flynn asked Kislyak that Russia not overreact to Obama’s out-the-door sanctions on Russia. Trump wanted to avoid an escalatory dynamic, which is perfectly reasonable, especially given the fact that Obama almost certainly levied these sanctions with the intent of making life difficult for Trump.

Since these events happened after the election, they did not advance the collusion narrative. The media and the political class dealt with this in two ways.

First, they just lied. Brian Ross of ABC News reported–and the rest of the media repeated–that Flynn was going to testify that he had spoken to Russians during the campaign. WRONG. He will merely say that the Trump team had discussed plans to improve relations with Russia post-election. Big difference.

But this is a classic case of Twain’s dictum about a lie getting around the world before the truth got its boots on. And isn’t it funny how all the lies are in the same direction?

This is in fact a huge benefit to Trump, because what better illustrates his assertions that the mainstream media is a firehose of fake news?

Second, they harrumphed about the Logan Act, a likely un-Constitutional historical curiosity dating from January 30 . . . 1799–and which despite its longevity has never resulted in an indictment, let alone a conviction. The law forbids private individuals from negotiating with foreign states in a dispute with the US. About its only relevance to today is that it was adopted in fevered political times (the wars of the French Revolution, which also spawned the infamous Alien and Sedition Acts) which bear some similarity to today’s febrile political climate.

Further, it is common–and indeed imperative–for incoming administrations to establish contact with foreign governments, including–and perhaps especially–those with whom the US is experiencing tense relations. Indeed, the Trump team received permission from the Obama administration to make such contacts, and an administration spokesman said publicly that Obama had no objection to such contacts, including specifically with Russia.

So if anything, the Flynn plea actually substantiates what Trump et al have been saying all along, and provides no evidence of pre-election collusion, let alone an illegal pre-election conspiracy.

The main conclusions here are: (1) Flynn was an idiot for lying about something that was perfectly legal and ethical, and (2) to avoid outbursts of idiocy, when the FBI comes knocking, don’t talk–there’s no upside, and a big potential downside.

As for the conspiracy theory that excites the imaginations of today’s McCarthyites and Birchers, it is a big fat nada. Zip. Zero.

But that will not deter them. They are so invested in this theory that nothing will disprove it in their eyes. They will react exactly the same to the next hyped non-event, and dry cleaners everywhere will cheer.

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November 23, 2017

Igor Is Not Available. Please Leave Your Name and Number, and He’ll Return Your Call as Soon as Possible.

Filed under: Economics,Energy,Politics,Russia — The Professor @ 10:27 pm

Who knew that Igor Sechin was such a shy and retiring type? He has been summoned thrice to testify at the Ulyukaev bribery trial, and thrice he has failed to appear. One time he apparently dodged the summons by hiding in his office, and having his staff refuse to accept it. The other times he has said his busy travel schedule precludes him from attending. He has been summoned yet again to appear on 27 November, but the judge in the case said that Sechin indicates that his schedule wilt allow him to testify before the end of the year.

What will his next excuse be? “Sorry. I’m washing my hair that day”? Alas, “I’m scheduled to have my mullet trimmed” is no longer credible.

So why is Igor so reticent? After all, it is because of him, and a sting in which he participated, that Ulyukaev is in the dock. I discussed the issue with a Russian who follows the situation closely–perhaps too closely for comfort, in fact–and we pretty much agree on three possible explanations.

First, embarrassment. Transcripts, then audio, and now video of the sting have been released. Sechin does not come off well in these, and his offer of sausages in a hamper has become something of a running joke in Moscow. Relatedly, Sechin’s behavior violates the norms of inter-elite interaction (sort of like violating the mafia code), and this is there for all to see.

Second, there have been inconsistencies in the prosecution story. Sechin may dread cross-examination that will expose the episode as entrapment or fraud.

Third, Sechin may be testing the limits of his power and autonomy, or deliberately flouting the rules to show that he is an untouchable.

Will we ever learn the truth? This being Russia, there is considerable room for doubt. But one thing we can be sure is not the truth is that Sechin is a respectable figure. He is either an arrogant thug who operates outside the law–or wants to do so. Or he is a buffoon who played out a charade–badly–in order to punish someone who tried to thwart him.

Come to think of it, I’m going with “both”.

And it is not that Sechin’s performance as head of Rosneft compensates for his buffoonish thuggery (or is it thuggish buffoonery?). Indeed, the last earnings report was a disaster, and there are still many questions about the whole Rosneft-Glencore-QIA-Intesa-VTB-CEFC-Ivan Doesky* deal, and just how money from that deal made it (or didn’t) to the Russian budget to fulfill Putin’s privatization promise.

Rosneft’s stock price has been lackluster, at best. Yet the company has been on an acquisition binge overseas. (And how is that Venezueula thing working out? Pouring money down a corrupt rathole–sheer genius! What strategic vision!)

Things have gotten so bad–and so impossible to ignore–that even Sberbank released a scathing criticism of the company:

In the 64-page research report, dated October 2017, Sberbank’s division Sberbank CIB called on Rosneft to change its strategy “markedly” after the energy company incurred huge debts following an acquisition spree at home and abroad.

“Rosneft has been touting its top-down efficiency effort, complete with Stalinesque tales about employees being confronted with charges of malfeasance at management meetings and marched straight into police custody,” the initial report said.

. . . .

The report’s authors, in a section titled “Rosneft: We Need to Talk About Igor”, also said Rosneft’s powerful Chief Executive Igor Sechin “almost single-handedly sets the company’s strategy”.

They calculated that since purchasing oil and gas producer TNK-BP for around $55 billion in 2013, Rosneft had spent a net $22 billion on acquisitions, “with no clear focus”.

“Assuming he remains in charge, the company will continue to pursue volume growth. In doing so, its heft will push it further out of Russia and perhaps further out of oil. This will only disappoint its shareholders,” the report said.

LOL.

Actually, Sberbank wasn’t laughing, because Igor and Rosneft took extreme exception to the snarky criticism. Sberbank subsequently withdrew the report and reissued it, minus the offending language.

One can imagine what transpired in order to achieve that result.

Thus the management of the world’s largest publicly traded oil company (by volume, NOT by value, to be sure). Run by–indeed dominated by–a strategic imbecile who attempts to compensate for his managerial incompetence by strong-arming his domestic rivals into giving up their resources, and engaging in clownish masquerades to frame up those who have attempted to thwart him.

There are larger lessons here too. Keep Igor in mind whenever anyone shrieks about Putin’s fearsome juggernaut. If the management of a national champion in the largest and most important industry in Russia is any indication, the colossus has feet of clay–and a head of brick.

* And no, Donald Trump is not one of the Ivan Doeskys, dossier notwithstanding. I am referring to the unknown party or parties who (a) chipped in the difference between what Glencore, QIA, and Intesa cop to have paid, and the amount that Rosneft claim to have received, and (b) indemnified Glencore against loss.

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November 22, 2017

Obama Turned the Net Into a Neut: But It’s Getting Better!

Filed under: Economics,Politics,Regulation — The Professor @ 9:52 pm

Few subjects generate such intense reactions as net neutrality. It has become freighted with much emotional baggage, largely because it has been framed–artfully–as a matter of free choice and free speech vs. censorship and control of information by malign interests.

The Trump FCC’s announcement of its plans to reverse the Obama FFC’s 2015 net neutrality rule has led brought the issue–and the Manichean rhetoric–back to the fore.

One would hope that applying some basic economics might shed some light, and cool some of the rhetorical heat. I will give it a go.

The basic economic issue is straightforward. It is basically a matter of price discrimination, a subject that economists have analyzed and understood for years. The crucial feature of net neutrality is its ban on ISPs charging different prices for different types or categories of service. So for example, your Internet provider cannot charge higher prices for more intense consumers of bandwidth (e.g., streaming services).

Although the term “price discrimination” has bad connotations–which net neutrality supporters emphasize–it can be good, and it is difficult to identify conditions in which it is unambiguously bad compared to the real world alternative.

One reason that charging different prices for different types of customers can enhance efficiency–and why suppressing the ability to do so can be inefficient–is that the costs of providing a service can differ between customers. Some customers are more expensive to serve, or demand a differentiated service that is costlier to deliver. Providing the price signals that give the incentive to consume, produce, and invest in capacity efficiently requires price discrimination: higher cost customers should pay more than lower cost customers.

This is an issue in providing Internet services. Some services and users that consume more bandwidth, and impose greater risk of congestion on the system. A pricing structure that does not charge such users/services a higher price to reflect these higher costs induces overconsumption of these services, and imposes costs (e.g., poorer quality of service) on those who do not put such demands on the system. Furthermore, preventing ISPs from charging prices that reflect higher cost distorts their incentives to invest in more capacity, or in technologies and congestion management techniques that ease burdens on the system.

Prohibiting charging prices that vary by type of service or customer therefore results in cross-subsidization (low cost customers subsidize high cost ones), which both transfers wealth and undermines efficient allocation of resources.

Price discrimination can also occur as a result of market power. There are different “degrees” of price discrimination. To keep things simple, the most common kind is “third degree price discrimination”, in which a firm with market power who can segment customers based on their demand elasticities: less price sensitive customers pay higher prices than more elastic demanders.

It is plausible that demand elasticities for Internet services differ, and that elasticity may vary by the type of content, e.g., that the demand for streaming services is less price elastic than the demand for email or cat videos. In this case, charging a different price for streaming services vs. more mundane uses of the Internet could well be a form of 3d degree price discrimination.

It has long been known that the welfare effects of 3d degree discrimination are ambiguous: as compared to a single price for all services/customers charged by a firm facing a downward sloping demand curve, welfare (consumer plus producer surplus) or consumer surplus can be higher of lower with price discrimination. Furthermore, if a firm faces substantial economies of scale, the efficient way of covering fixed costs typically involves 3d degree price discrimination (“Ramsey Pricing”).

So one cannot say a priori that even if price discrimination by ISPs reflects market power, suppressing price discrimination improves welfare: the market power remains, and the ISP might exercise it in a way that causes welfare to be lower than if it exercises it by price discriminating.

Moreover, there is reason to doubt that a predicate for inefficient price discrimination–ISP market power–exists, or is more acute in this market than it is in many other markets where price discrimination is common (and believe me, that is pretty much every market). The days of the “last mile” monopoly are over. A very large fraction of Internet users in the US have access to multiple ISPs. Furthermore, wireless service (4G, and perhaps soon 5G services) competes with traditional cable and DSL service. Between wireless and cable, off the top of my head I can think of 8 providers that I can access. Yes, there is some overlap (e.g., ATT provides both types of service), but the number of choices most Americans have for Internet access is greater than they have for many other goods and services. Meaning that it is unlikely that market power problems are so acute in this market as to justify regulations unheard of in other markets where price discrimination is widely practiced.

I should also note that some kinds of price discrimination can unambiguously improve welfare relative to simple monopoly pricing. First degree (rare in practice) or second degree (e.g., quantity discounts, two part pricing) is superior to simple monopoly pricing. I would wager that some ISPs will adopt such efficiency enhancing price policies if freed from net neutrality restrictions.

Thus, if your concern is that ISPs exercise market power by price discrimination, suppressing price discrimination is not the best way to tackle the problem: attack the market power directly by reducing entry barriers or antitrust actions against ISPs. Furthermore, it is not at all clear that price discrimination in this market is driven primarily by market power, given the competitive conditions in the market. Lastly, and perhaps most importantly, attempting to squelch (at best ambiguously inefficient) market power driven price discrimination also precludes efficiency enhancing price discrimination based on differences in service/customer cost. Doing so imposes substantial costs.

For all these reasons, I conclude that net neutrality is (a) a solution to a non-existent problem, and (b) can do positive harm by preventing the development of efficient pricing systems that give appropriate incentives to consume and invest in system capacity, and to optimize its use.

Another aspect of the net neutrality rule is to prevent ISPs from favoring its content (which it either produces, or buys from others) over that supplied by independent parties.  Again, a necessary condition (but definitely not a sufficient one) for this to be a problem is ISP market power, which as noted above is unlikely to be a particularly serious issue. Furthermore, it is typically not in the interest of a downstream firm with market power to restrict its customers’ access to upstream product. Offering suboptimal product variety reduces the demand for the putative monopolist’s services, which reduces its profit. It is typically more profitable for the monopolist to offer the optimal product variety, and profit by charging a higher monopoly price.

There are some rather contrived models in which vertical restrictions (e.g., tying or exclusive dealing) can be used to lever market power from one good to another: the practical applicability of these models is dubious at best, as some of the modelers themselves acknowledge. But there is also an extensive literature (much of it originating in Chicago in the 1960s, including seminal contributions by my thesis advisor Lester Telser) showing that such vertical restrictions are usually efficiency-enhancing responses to some incompleteness in property rights or information problem. Indeed, in US antitrust law, horizontal restrictions (e.g., cartels) receive far more scrutiny that vertical ones, precisely because academic research on the potential efficiency enhancing effects of vertical restrictions, and the difficulty of using them to increase monopoly power, has informed antitrust policy–under administrations of both parties I might add. (As an aside, this makes the Trump DOJ challenge of the Time Warner-ATT deal somewhat strange, and intellectually at odds with the FCC’s move against net neutrality.)

In sum, I favor jettisoning net neutrality. No, I do not believe that the ISP market is perfectly competitive, but that is a red herring. Even acknowledging the possibility of imperfect competition in that market (although I do believe fear thereof is overblown), net neutrality is not the right way to address it, and indeed, might actually mean that market power is exercised in a way that reduces efficiency. In other words, the Obama FCC wanted to fight ISP market power in the worst way–and it did!

So if net neutrality is an inefficient policy, why did it prevail in the US, at least for a while? That is, what is the political economy of net neutrality?

Well, Chicago has a lot to say about this as well. Indeed, the work of another of my former advisors–Sam Peltzman–is directly on point. Sam’s amazing 1976 JLE article “Towards a More General Theory of Regulation” has an important, but widely overlooked prediction: regulation is likely to occur in industries where there are substantial differences in costs of serving different customers, and that regulated price structures suppress these cost differences. That is, regulated price structures cross-subsidize high cost customers. As Sam put it: “cross—subsidization follows a systematic pattern in which high cost customer groups are subsidized by low cost customers.” And: “The important contribution of politics is to suppress economically important distinctions and substitute for these a common element in all prices.”

That is net neutrality in a nutshell. Put simply, the Obama FCC bought political support Google, Facebook, Amazon, Microsoft, Netflix, et al by implementing a policy that cross subsidized their services. They used the political system to push regulation that suppresses economically important distinctions.

This result is less surprising from a political economy/public choice perspective than the Trump administration’s reversal of net neutrality. My first stab at an explanation is that this reflects the fact that a Trump administration can never expect to obtain political support from these companies, and can doesn’t really have to fear additional opposition: they already hate him with the heat of 1000 suns. So why  not stiff them?

Karma is a bitch, eh?

Now for some laughs!

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