The Economics of the Saudi’s “Take-the-Money-and-Run” Strategy

As the Financial Times reported on 12 July, Saudi Arabia’s oil-output reached record highs in June 2016. Increasing production 280,000 barrels/day to 10.6m b/d, Saudi Arabia has once again waved off OPEC’s request not to glut the market with oil. 

As it turns out, economic principles explain why the Saudis began, in late 2014, to pump crude as fast as they could – or close to as fast as possible. In fact, there is a good reason why the Saudi princes are panicked and pumping. 

Let’s take a look at the simple analytics of production. The economic production rate for oil is determined by the following equation: P – V = MC, where P is the current market price of a barrel of oil, V is the present value of a barrel of reserves, and MC is the marginal recovery cost of a barrel of oil.

To understand the economics that drive the Saudis to increase their production, we must understand the forces that tend to raise the Saudis’ discount rates. To determine the present value of a barrel of reserves (V in our production equation), we must forecast the price that would be received from liquidating a barrel of reserves at some future date and then discount this price to present value. In consequence, when the discount rate is raised, the value of reserves (V) falls, the gross value of current production (P – V) rises, and increased rates of current production are justified.

When it comes to the political instability in the Middle East, the popular view is that increased tensions in the region will reduce oil production. However, economic analysis suggests that political instability and tensions (read: less certain property rights) will work to increase oil production.

Let’s suppose that the real risk-adjusted rate of discount, without any prospect of property expropriation, is 20% for the Saudis. Now, consider what happens to the discount rate if there is a 50-50 chance that a belligerent will overthrow the House of Saud within the next 10 years. In this case, in any given year, there would be a 6.7% chance of an overthrow. This risk to the Saudis would cause them to compute a new real risk-adjusted rate of discount, with the prospect of having their oil reserves expropriated. In this example, the relevant discount rate would increase to 28.6% from 20% (see the accompanying table for alternative scenarios). This increase in the discount rate will cause the present value of reserves to decrease dramatically. For example, the present value of $1 in 10 years at 20% is $0.16, while it is worth only $0.08 at 28.6%. The reduction in the present value of reserves will make increased current production more attractive because the gross value of current production (P – V) will be higher.

 

So, the Saudi princes are panicked and pumping oil today – a take the money and run strategy – because they know the oil reserves might not be theirs tomorrow. As they say, the neighborhood is unstable. In consequence, property rights are problematic. This state of affairs results in the rapid exploitation of oil reserves.

Why Tax Credits Aren’t Controversial & Why They Should Be

Ah, tax credits. The answer to all of our environmental, social, and urban cares. Or so they say.

This spring, Senator Maria Cantwell (D-WA) and Senator Orrin Hatch (R-UT) cheerfully joined forces to expand the Low Income Housing Tax Credit (LIHTC) program. Their bill was subsequently referred to the Senate Finance Committee, which Hatch chairs. LIHTC provides select developers with tax credits for building affordable housing units, and the newly minted Affordable Housing Credit Improvement Act of 2016 would enlarge the LIHTC program by 50%, which puts the program at about $11 billion annually. If it’s anything like previous expansions of the program, it will surely draw broad bi-partisan support.

This brings us to a rather heartwarming aspect of tax credit programs more generally: tax credits appeal to democrats and republicans alike. In an age of acute political polarization, such collaboration seems to be the essence of civility and fraternization that the American public so longs for. Or is it?

Enter the alternative hypothesis: tax credits get a free pass because people think that tax credits are free. Unfortunately, as Milton Friedman said, TANSTAAFL, or “there ain’t no such thing as a free lunch,” and someone, somewhere paid for that hotdog and chips. So the question is who’s paying for tax credits?

The answer – if you’re not utilizing the credits – is probably you. That is because although select businesses or individuals are writing off taxes owed, the total U.S. tax burden is consistent or growing. Unlike across-the-board cuts that reduce taxes for everyone and are designed to support economic growth, LIHTC and other tax credit programs choose special businesses or individuals to reduce taxes for. So in the absence of reductions in spending, you’re just moving the money around, akin to any other direct subsidy (e.g. ethanol). When Uncle Sam needs to collect, the American tax payer is still on the hook.

Of course indirectly, we all “pay” for tax credits due to the slower economic growth caused by the misallocation of capital.

What’s more, tax credits operate outside of the annual Congressional appropriations process, and do not appear as an expenditure on the federal budget. In other words, a tax credit program may be completely ineffective at accomplishing program goals and never warrant so much as a side-eye come budget season.

This is particularly problematic for LIHTC, which National Bureau of Economic Research, Journal of Housing Economics, and Journal of Public Economics studies all found subsidize affordable units by displacing affordable units that would otherwise be provided by the private market. Economist Ed Glaeser agrees: “current research finds that LIHTC is not very effective along any important dimension—other than to benefit developers and their investors.” In other words, rather than improving welfare, LIHTC may actually just improve corporate welfare.

In the case of LIHTC and other tax credit programs, regular budgetary oversight would provide an opportunity to determine whether there is a better use for our collective resources, whether the program is achieving its objectives, and whether the country has the political will to continue supporting the program. Yet tax credit programs are protected from these basic questions by their very design.

And that is why tax credits are a problem. But out of sight on the federal budget outlay, out of mind. In the meantime, Congress will continue to play a cute little bipartisan game until American taxpayers get suspicious about all of that celebrated bipartisan collaboration happening in Washington. 

Why Unemployment Is Lower When Immigration Is Higher

“We are going to have an immigration system that works, but one that works for the American people,” Donald Trump told the Republican National Convention last week. “Decades of record immigration have produced lower wages and higher unemployment for our citizens.” But the candidate is wrong in two respects. First, the United States has not seen “record” immigration in recent years, and second, higher immigration is not associated with higher unemployment. Immigrants are heralds of growth, not portents of economic disaster. 

Recent immigration is no record

The amount of immigration to the United States can be measured in two ways. The most obvious is the absolute number of people receiving permanent residency in the United States. By this measure, the peak year was 1991 with 1.8 million. Even by this measure, Trump is wrong. Rather than “decades of record immigration,” out of the top ten highest levels of all time, five occurred since 1990 and five before 1915.

But measuring immigration in terms of the absolute number of permanent residents is narrow and misleading. The biggest problem is that it implies that a million immigrants entering China, with a population of 1.4 billion, would have the same effect on employment as a million entering Estonia with a population of 1.2 million. Clearly, to understand the impact of immigration, you need to control for the size of the destination country.

Table 1: Top Ten Immigration Rates and Immigration Levels 1820 to 2014

  Year Rate   Year Number
1 1854 1.61% 1 1991 1,826,595
2 1850 1.59% 2 1990 1,535,872
3 1851 1.58% 3 1907 1,285,349
4 1882 1.50% 4 2006 1,266,129
5 1852 1.49% 5 1914 1,218,480
6 1907 1.48% 6 1913 1,197,892
7 1853 1.43% 7 2009 1,130,818
8 1849 1.31% 8 2005 1,122,257
9 1881 1.30% 9 2008 1,107,126
10 1906 1.29% 10 1906 1,100,735
Present 2014 0.32% Present 2014 1,016,518

Source: Department of Homeland Security. “2014 Yearbook of Immigration Statistics.”  

By this measure, that “record year” of 1990 comes in 52nd overall. Rather than decades of record immigration, we see decades of below average immigration. Indeed, per capita immigration during the current decade is almost 30 percent lower than the historical average, and five times less than the record rates in the 19th and 20th centuries.

Financial Deregulation? Don’t Bank on Brexit

On June 23, Britain voted by a margin of 52 to 48 percent to leave the European Union (EU). Much ink has already been spilled on the policy implications of that vote and, indeed, its long-run consequences may prove quite profound. When it comes to financial regulation, however, it is difficult to see any significant changes emerging in the short- to medium-term. There are a couple of fundamental reasons for this.

The first stems from the fact that the British financial sector is desperate to maintain its current access to the European Economic Area (EEA), also known as the “single market.” As things stand, a process known as “passporting” allows British financial firms to do business throughout the single market, whether on a cross-border basis or by establishing branches, without having to get separate regulatory approval in every jurisdiction. This arrangement is important to the industry and — given that financial services produce 8 percent of the UK’s output — the British government is likely to make its continuation after Brexit a priority.

But how can they bring that about? The most straightforward path is for Britain to leave the EU, but remain a member of the EEA. This approach, often referred to as the “Norway option,” would see Britain exit the EU’s centralized political institutions, while still participating fully in its “four freedoms” — that is, the free movement of goods, services, capital, and people. There is much to commend such a settlement, as I’ve written before. But if it did come to pass, Britain’s financial sector would clearly be subject to EU rules in much the same way as it is now.

There’s also a political problem with EEA membership: namely, it wouldn’t allow the British government to pursue its stated aim of controlling immigration from the EU. That suggests that the obvious alternative — a bilateral, post-Brexit trade treaty — might be the more likely outcome of Britain’s eventual withdrawal. Such a treaty could, theoretically, protect the British financial sector’s passporting rights. However, the quid pro quo for market access of that sort would undoubtedly be regulatory equivalence — that is, the European Commission would have to deem British regulation equivalent to EU rules before any passporting could take place. The handful of existing EU directives that provide “third country” financial firms access to the single market work in precisely this way. Ultimately, then, there are unlikely to be any major reforms to British financial regulation so long as the British financial services industry maintains access to the single market.

Free Speech and the University of Cape Town

Cato adjunct scholar Flemming Rose who recently won the 2016 Friedman Prize for Advancing Liberty has been disinvited from speaking at the University of Cape Town in South Africa. The academic freedom committee of the university had asked Rose to give the annual TB Davie Academic Freedom Lecture. The Vice Chancellor of the university rescinded the invitation. He argued that Rose’s lecture might divide the campus leading to protests and even violence. He also said having Rose “might retard rather than advance academic freedom on campus”. The last statement will remind many people of Doublespeak.

Fortunately, this injustice has prompted several principled defenses of free speech.

Kenan Malik, an English writer and broadcaster, who gave the TB Davie lecture last year, makes the case for open debate and defends Rose.

Nadine Strossen, a former ACLU president and current law professor at New York University, quickly provided a comprehensive critique of the decision. Professor Strossen adds her comments about Flemming Rose that she gave at the Friedman Prize dinner.

Ronald K.L. Collins, a law professor at the University of Washington who runs the First Amendment News blog, has challenged an administrator at the University of Cape Town to reply to these critiques. Collins has done the right thing: a bad decision has led to critical speech which now invites a response.

Finally, Flemming Rose himself has replied, citing his recent defense of free speech for radical imams: “A more diverse society needs more free speech, not less.” He continues:

It’s really a sign of poor judgment and bad academic standards to disinvite me on the basis of what other people say about me, when I have published a book that covers my own story, which tells how my views on politics were formed and analyses the history of tolerance and free speech. The book is not only focusing on Islam. I write about the Russian Orthodox’ Church silencing of criticism, Hindu-nationalists attacks on an Indian Muslim artist and so on and so forth. Why use second-hand sources when you can read the primary source in English and make up your mind?

Why not indeed? Rose’s book, The Tyranny of Silence: How One Cartoon Ignited a Global Debate on the Future of Free Speech published by Cato in 2014 may be found here or at your local bookseller.

 

Don’t Ground “Uber in the Sky”

Last year, a company called Flytenow was poised to revolutionize air travel by allowing private pilots already going to a destination to share their costs with would-be travelers—kind of like a college rideshare bulletin board, but on the Internet. The service would pair pilots with potential passengers, for a small fee no greater than the cost of fuel. It’s been called “Uber in the sky.” But in December, Flytenow shut down after the U.S. Court of Appeals for the D.C. Circuit upheld the Federal Aviation Administration’s determination that the service must obtain the highest levels of licensing, akin to what major airlines and their pilots secure.

The FAA decided that these pilots were not simple private individuals sharing cost, but were “common carriers,” subject to heightened liability and expensive professional licensing. Common carriers—like buses, trains, and commercial airlines—have been treated specially in the law since medieval times, and they differ from Flytenow’s online bulletin board.

As Flytenow seeks review in the Supreme Court, Cato Institute, joined by TechFreedom, has filed an amicus brief in support.

First, “common carriage” is a term defined by common law, stretching back to way before the founding of the FAA—indeed hundreds of years before the Wright Brothers—and the FAA’s interpretation here directly contravenes that established meaning. One glaring consistency across the last 600 years of common law is that the carrier must hold itself out for indiscriminate public hire. Flytenow pilots, as a matter of right, can turn down any passenger for any reason (or no reason) and thus are by definition not common carriers. This alone is reason enough to reverse the court’s decision and overturn the FAA ruling.

But second, and more basically, the D.C. Circuit granted very broad deference to the FAA’s interpretation of what constitutes common carriage, despite that being a term defined at common law. Courts often defer to an agency’s expertise in a particular subject matter—which essentially means that the agency’s decision is usually upheld under some “deference” framework. But according to the Supreme Court’s ruling in Texas Gas Transmission Corp. v. Shell Oil Co. (1960), when an agency interprets the common law, a reviewing court shouldn’t simply defer to the agency’s interpretation.

Enough! America Must Distance Itself from Its Rogue Turkish Ally

The recent abortive military coup in Turkey has led not to a restoration of democracy and the rule of law in that country, but to an acceleration of already worrisome trends toward a dictatorship with Islamist overtones.  When the would-be junta made its play for power, the Obama administration quickly expressed support for President Recep Tayyip Erdogan’s beleaguered government, as did most of Turkey’s NATO partners.  When the coup attempt collapsed, leaders of those governments breathed a sigh of relief that the Alliance did not have to confront the embarrassment (or worse) of a member state governed by a military dictatorship.

That sense of relief was short lived.  In a matter of days, Erdogan purged not only hundreds of high-ranking military officers, (a step for which there was at least reasonable justification), he went after other institutions that had long impeded his attempts at increasingly autocratic rule.  Nearly 3,000 judges were removed and arrested.  He even fired 21,000 teachers from the country’s school system.  The extent and speed of the systematic purge confirms that Erdogan simply used the attempted coup as a pretext for a plan long in place.  The United States now confronts the problem of a NATO ally that is a dictatorship in all but name.

The frustrations with Turkey should have been building for years, if not decades.  After all, U.S. officials were under pressure to look the other way as Turkey invaded Cyprus in 1974 and continued to illegally occupy the northern portion of that country ever since.  Washington offered no more than feeble protests when Ankara established the puppet Turkish Republic of Northern Cyprus in the occupied territories and moved in tens of thousands of settlers from the Turkish mainland.  Such indifference makes U.S. expressions of outrage over Russia’s annexation of Crimea seem more than a little hypocritical.

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