Subsidies Make Businesses Weaker

The technical arguments against the Export-Import Bank are provided in this excellent summary by Veronique de Rugy. However, one argument against Ex-Im and other business subsidies is not stressed enough in policy debates: subsidies weaken the businesses that receive them.

Subsidies change the behavior of recipients. Just like individual welfare reduces work incentives, corporate welfare dulls business competitiveness. Subsidies give companies a crutch, an incentive not to improve efficiency or to innovate, as I noted here.

Yesterday, I looked at Chapter 1 of Burton and Anita Folsom’s new book, Uncle Sam Can’t Count, which examines federal fur trading boondoggles of 1795-1822. 

Now let’s look at Chapter 2, which focuses on the steamboat industry of the 19th century. The historical lesson is clear: subsidies make companies weak, inefficient, and resistant to innovation.

Here is a thumbnail sketch of the Folsoms’ steamboat story:

  • In 1806 New York gives Robert Fulton a legal monopoly on steamboat travel in the state. Breaking this misguided law, a young Cornelius Vanderbilt launches a competitive service in 1817.
  • The U.S. Supreme Court strikes down the New York law in 1824. The effect is to usher in an era of steamboat innovation and falling prices for consumers.
  • Vanderbilt launches many new steamboat routes whenever he sees an opportunity to drive down prices.
  • With subsidies from the British government, Samuel Cunard launches a steamship service from England to North America in 1840. In response, Edward Collins successfully lobbies Congress to give him subsidies to challenge Cunard on the Atlantic route. With this unfortunate precedent, Congress proceeds to hand out subsidies to steamship firms on other routes.
  • By the 1850s, Congress is providing Collins a huge annual subsidy of $858,000. Irked by the subsidies and Collins’ inefficient service, Vanderbilt builds a better and faster ship and launches his own Atlantic service.
  • In 1856 two of Collins’ inferior ships sink, killing almost 500 people. Collins builds a new ship, but it is so shoddy that it is scrapped after only two trips.
  • Congress finally realizes that the aid to Collins is damaging, as it has spawned an inferior and mismanaged business. Congress cuts off the subsidies in 1858. Without subsidies, Collins’ steamship company collapses.
  • Vanderbilt also out-competes subsidized steamship companies on the East Coast-to-West Coast route through Central America.
  • In England, an unsubsidized competitor to Cunard—the Inman Line—is launched and begins out-competing and out-innovating the subsidized incumbent.
  • The subsidized Cunard and Collins aim their services at the high-end luxury market. The more efficient and unsubsidized Vanderbilt and Inman focus on driving down prices for people with more moderate incomes.
  • Government subsidies “actually retarded progress because Cunard and Collins both used their monopolies to stifle innovation and delay technological changes in steamship construction.”

Government subsidies have similar negative effects today, whether it is subsidies to energy companies, aid to farm businesses, or the Ex-Im program.

The difference is that in the 19th century Congress eventually cut off subsidies when the damage became clear, as it did with steamship subsidies in 1858 and fur trading subsidies in 1822. Maybe I’m overlooking something, but I can’t think of a business subsidy program terminated by Congress in recent years, or even in recent decades.  

Bus Shelters for the Poor, Trains for the Rich

Low-income residents of the Twin Cities can rest easy, as planners at the Metropolitan Council, the area’s regional planning agency, are proposing a regional transit equity plan. According to the Metropolitan Council’s press release, this equity plan consists of:

  1. Building 75 bus shelters and rebuilding 75 existing shelters “in areas of racially concentrated poverty”; and
  2. “Strengthen[ing] the transit service framework serving racially concentrated areas of poverty” by building bus-rapid transit and light-rail lines to the region’s wealthy suburbs.

Bus shelters for the poor, light rail for the rich: that sounds equitable! Of course, the poor will be allowed to ride those light-rail trains (for example, if they travel to the suburbs to work as servants), just as the well-to-do will be allowed to use the bus shelters. But for the most part, the light rail is for the middle class.

As with most American urban areas, Twin Cities poverty is concentrated in the core cities. Minneapolis and St. Paul have less than a quarter of the region’s population but more than half of the poor and more than 60 percent of the poor blacks. On average, 23 percent of residents of Minneapolis and St. Paul are in poverty, compared with just 7 percent of their suburbs.

Kennan on Iraq, June 1944

Cato hosted a discussion of The Kennan Diaries today. Editor Frank Costigliola read the following entry, from June 1944, which George Kennan wrote during a three-day stop in Baghdad, on his way to Moscow. I can’t help but hear echoes of Colin Powell’s infamous pottery barn warning, and other cautionary notes that went unheeded in the weeks and months before the invasion of Iraq in 2003. And, as further evidence that we haven’t learned the right lessons from Iraq, there are still those wishing that we had never left Iraq, or that we should go back in. They might ponder these words from a man who knew little about Iraq, but who knew his own country all too well.

[The Iraqi] people has now come just enough into contact with Western life so that its upper class has a thirst for many things which can be obtained only in the West. Suspicious and resentful of the British, they would be glad to obtain these things from us…

If we give them these things, we can perhaps enjoy a momentary favor on the part of those interested in receiving them. But to the extent that we give them,…we acquire, whether we wish it or not, responsibility for the actions of the Iraqis. If they then begin to do things which are not in our interests, which affect the world situation in ways unfavorable to our security,…we then have ourselves at least in part to blame, and it is up to us to take the appropriate measures.

Are we willing to bear this responsibility? I know, and every realistic American knows, that we are not. Our Government is technically incapable of conceiving and promulgating a long-term consistent policy toward areas remote from its own territory….

Those few Americans who remember something of the pioneer life of their own country will find it hard to view the deserts of Iraq without a pang of interest and excitement at the possibilities for reclamation and economic development. If trees once grew here, could they not grow again? If rains once fell, could they not again be attracted from the inexhaustible resources of nature? Could not climate be altered, disease eradicated?

If they are seeking an escape from reality, such Americans may even pursue these dreams and enter upon the long and stony road which could lead to their fruition. But if they are willing to recall the sad state of soil conservation in their own country, the vast amount of social improvement to be accomplished at home, and the inevitable limitations on the efficacy of our type of democracy in the field of foreign affairs–then they will restrain their excitement at the silent, expectant possibilities of the Iraqi desert, and will return, like disappointed but dutiful children, to the sad deficiencies and problems of their native land.

 

Police Misconduct — The Worst Case in June

Over at Cato’s Police Misconduct web site, we have identified the worst case for the month of June.  Police officer Ronald Harris tried to rob a woman at the Memphis International Airport.  This was an extraordinary theft.  Harris was trying to steal a bag from an employee of St. Jude Children’s Hospital who was, in turn, delivering the bag to a family. The bag was a gift from the Make-A-Wish Foundation—the organization that grants wishes to terminally ill children.  The bag held several St. Jude t-shirts and a $1500 credit card for the family to use for travel.  Harris followed the St. Jude employee into the airport and then struck a member of the family who tried to stop him from stealing their wish away.  Harris has been suspended pending an investigation and faces a long list of charges. Police misconduct is never good, but plotting to steal the wish from a terminally ill child and their family is just really low.

Full story here.

New York Caps Uber “Surge” Pricing

Yesterday the New York attorney general reached a deal with the company Uber to cap its “surge” pricing during emergencies. The company, which uses an app to summon cars via a user’s smartphone, uses an algorithm that increases prices during periods of high demand, including emergencies and bad weather, to encourage more of its drivers to work. The agreement was reached in accordance with the City of New York’s law against price gouging, passed in 1979.  

Was the agreement a good idea?  In the cover story of the Spring 2011 issue of Regulation, Texas Tech researcher Michael Giberson examines the role of high prices and the resistance to them during emergencies.

Many people object to high prices during emergencies. The use of high prices by Uber after Hurricane Sandy prompted a Time writer to describe Uber’s pricing as “economically sound, ethically dubious.”  Michael Sandel, professor of government at Harvard, is quoted in the Regulation article saying “A society in which people exploit their neighbors for financial gain in times of crisis is not a good society… . By punishing greedy behavior rather than rewarding it, society affirms the civic virtue of shared sacrifice for the common good.”

In response, Giberson argues “If it is admitted that giving merchants the freedom to pick their own prices does a better job than alternative ways of getting goods and services to where they are needed, then interference with that pricing freedom … harms precisely those persons who have been already harmed by the disaster, a result that suggests neither shared sacrifice nor promotion of a common good.”  In addition, he argues it is unfair to “place a particularized obligation to sacrifice on a discrete segment of society, namely merchants. Addressing the particular hardships faced by the poor during emergencies is a task better left to government agencies or charities.” 

Price gouging laws are an attempt to deny the economic realities of emergency situations. Price gouging laws reduce the incentives to provide needed goods and services in areas affected by emergencies and disasters. The cap on Uber’s surge pricing may make its customers happy now, but they may not be so happy when they wait hours for an Uber during the next blizzard, thunder storm, or other disaster. The writer concluded that “Price gouging might, at least in theory, help shrink lines and reduce shortages. But I think most people would rather wait in line than have someone make a windfall profit off their desperation.”  With this agreement we will conduct the experiment to test his theory.

For more on Uber, see the recent blog posts by Cato’s Matthew Feeney and this article from the Summer 2013 issue of Regulation. 

Federal Follies 200 Years before Ex-Im

Anyone who thinks that Washington waste is something new should examine the history of the Bureau of Indian Affairs (BIA). This essay discusses the mismanagement, corruption, and failures of the BIA since it was created in 1824.

As early as 1828, Indian expert H. R. Schoolcraft concluded: “The derangements in the fiscal affairs of the Indian department are in the extreme. One would think that appropriations had been handled with a pitchfork … there is a screw loose in the public machinery somewhere.”

By the 1860s and 1870s, New York Times editorials were railing against the “dishonesty which pervades the whole Bureau,” and arguing that “the condition of the Indian service is simply shameful.”

In their recent book, Uncle Sam Can’t Count, Burton and Anita Folsom describe the failure of a major Indian policy even before 1824. Here is the basic story:

• Unhappy that British fur traders were out-competing American traders, Congress appropriated $50,000 in 1795 to create frontier posts stocked with American goods to trade with the Indians for furs.

• These government-run fur “factories” were supposed to earn a return, but they “were so poorly run that many Indians held them in contempt and refused to trade there.” Congress had to heavily subsidize the system to keep it operating.

• Rather than respond to the market demands of the Indians, as private traders did, the official running the government system, Thomas McKenney, tried to push products on the Indians that he thought they ought to have.

• The government set up its trading posts at substantial distances from Indians. By contrast, private fur trader John Jacob Astor had his agents build close relationships with Indians, and he made trading easy for the tribes.

• Astor instituted pay for performance, while the government paid its fur bureaucrats fixed salaries.

• Astor watched international fur markets closely and adjusted his operations and marketing accordingly. The government ignored markets, and simply dumped furs in Washington for auction.

• Thomas McKenney was embarrassed by the government’s falling market share and the huge success of Astor. So, in 1818, McKenney began lobbying Congress to ban private fur traders. When that attempt at monopolization failed, McKenney lobbied to impose large fees on private traders and to boost taxpayer subsidies for the government system.

• Despite a new fee on private traders in 1820, the government system was falling apart because of plunging sales. An official report exposed the huge inefficiencies of the government system, and Congress finally voted to end it in 1822.

Long before Solyndra and the Export-Import Bank, politicians should have learned some basic lessons about why Washington ought to stay out of business. Unfortunately, each new generation of politicians are tempted to believe that enlightened federal planners can run the economy better than businesspeople and markets. Rather than wasting hundreds of thousands of dollars as it did two centuries ago, Congress blows billions of dollars today on new versions of its fur-trading folly.

Convention Center Boondoggles

Every country wants a national airline, and every city wants a glitzy convention center to bring those free-spending conventioneers to town. But the economic analysis doesn’t hold up well in either case. A new book on convention centers should be required reading for any city council thinking of investing the taxpayers’ hard-earned money in another white elephant. This report by Don Bauder in the San Diego Reader is worth quoting at length:

Would you take advice from a gaggle of consultants whose forecasts in the past two decades have been off by 50 percent?

Of course you wouldn’t. But all around the U.S., politicians, civic planners, and particularly business executives have been following the advice of self-professed experts who invariably tell clients to build a convention center or expand an existing one.

A remarkable new book, Convention Center Follies: Politics, Power, and Public Investment in American Cities, published by the University of Pennsylvania Press, tells the amazing story of how one American city after another builds into a massive glut of convention-center space, even though the industry itself warns its centers that the resultant price-slashing will worsen current woes.

The author is Heywood Sanders, the nation’s ranking expert on convention centers, who warned of the billowing glut in a seminal study for the Brookings Institution back in 2005. In this new, heavily footnoted, 514-page book, Sanders, a professor of public administration at the University of Texas/San Antonio, exhaustively examines consultants’ forecasts in more than 50 cities.

Nashville was told its new center would result in 466,950 hotel room nights; it’s getting around 267,000 — “a little better than half [what was projected],” says Sanders in an interview. Philadelphia isn’t garnering even half the business that was promised.

“Getting half the business [that was projected] is about the norm,” says Sanders. “The actual performance is a fraction of what it is supposed to be.”

Yet, in city after city — including San Diego — self-appointed civic leaders listen to and act on these faulty forecasts. In almost all cases, mainstream media and politicians swallow the predictions whole without checking the consultants’ miserable track records….

How can convention centers get away with such legerdemain? Those in the know shut up, and the press, politicians, and public have neither the time nor the expertise to follow the prestidigitation.

How do the consultants get away with being 50 percent wrong most of the time? In my opinion — not Sanders’s — consultants in many fields are paid to provide answers that the people paying the consultants’ bills want to hear. And the people paying those bills are the business community — using taxpayers’ money, of course.

The worst news: “These expansions will keep happening,” as long as “you have a mayor who says it is free,” says Sanders.

More, much more, in the Reader and of course in the book. Free-market think tanks have been pointing out the bad economics behind convention centers – and publicly funded stadiums – for many years.