Tag: market failure

The DUI Externality

In January, I published “How ‘Market Failure’ Arguments Lead to Misguided Policy.” One major criticism I had of the way “externalities” are talked about in public debate was policymakers ignoring that supposed “corrections” for these “market failures” could induce behaviors with their own external costs.

Consider a bill proposed in the Oklahoma house by Rep. Merleyn Bell (D-Norman).

She is concerned about the costs emanating from driving under the influence (DUI) of alcohol. She wants to raise funds to subsidize deterrents, such as stop-checks on roadways. But rather than raise alcohol taxes, which would affect all consumers, she wants to “price in” the externality by imposing costs on those travelling at times when people are more likely to drink. The way she suggests doing so is baffling, however: adding a 20 percent supplement to rideshare surge pricing for companies such as Uber and Lift. Surge pricing, of course, tends to occur at weekends and after sports events and concerts.

Now, it doesn’t take a genius to work out a big problem here.

Raising the price of using ride-share services will reduce the quantity of ride-share services demanded. On the margin, that probably means fewer ride-share drivers themselves under the influence of alcohol. But I suspect those whose livelihoods depend on driving are among the least likely to DUI in the first place.

No, the overwhelming effect of raising rideshare surge prices will be to deter consumers from using those services. That means those who’ve been out drinking for the weekend will be more likely to drive themselves home or get in the car of someone else who has been drinking, increasing the risk of DUI-related costs and negating any deterrent from the spot-checks.

The Case for Economics When Considering Alcohol Tax Levels

“It’s time to raise the alcohol tax,” declared Vox author German Lopez back in December.

Now let me state upfront that I am not confident I know what the correct tax rate on alcohol should be. Lopez may well be right about their being a rational case on economic grounds for an increase based on high-quality, robust analysis. But his article does not make a reasoned case satisfactorily, nor does it link to such analysis.

In fact, it came to my attention as I was finalizing my new paper “How Market Failure Arguments Lead to Misguided Policy” (released today). And I’m convinced his piece is a classic of the genre. This article aims to highlight some of the key objections I have to his approach, which is increasingly common in public debate.

The traditional economic case for alcohol taxation

Libertarian theory aside, the classic case for taxing alcohol will be familiar to those with basic economic knowledge. Alcohol consumption is believed to impose, on net, external costs on people other than drinkers themselves.

When deciding whether to drink, individuals are thought to only consider the balance of private costs (the money it costs to drink, the hangover, the risk of disease or accidents for them etc) and the private benefits of consumption (the confidence, the enjoyment of the taste, the benefits to them of socializing etc).

But clearly, alcohol consumption can have external effects. The costs of alcohol-related crime and driving under the influence are borne by others. There may be net external costs relating to health care, too, given alcohol-related diseases and incidents could necessitate higher taxpayer subsidies or insurance premiums (though, applying such logic consistently, one would have to net off any “savings” that alcohol consumption might deliver in terms of lower Social Security and Medicare payments from reduced longevity).

The economic case for a tax then is this: if we observe net external costs associated with alcohol consumption, then allowing a free market would lead to higher levels of consumption than optimal. If a tax can be imposed that equates roughly to the marginal external costs of consumption, then drinkers are faced with a price reflective of the true costs of their actions.

Due to the “Law of Demand,” the amount of alcohol consumption will fall to the level at which marginal social costs equate to marginal benefits as this tax is imposed. Some of the negative external costs will occur less often, as will some of the private costs. Society as a whole will be better off because the tax means prices now reflect the true cost to society of the product’s consumption.

In order to make the case for a hike in alcohol taxes then, Lopez simply needed to present clear evidence that current tax rates on alcohol are too low to account fully for the external costs of consumption we see. His line of reasoning does not make this case.

On Behavioral Economics

Scott Sumner had a wonderful post on Econlog last week. He was responding to an Atlantic article lamenting behavioral economics not taking a prominent role in introductory economics courses.

Scott’s key point was that many insights in behavioral economics are intuitive, while important economic concepts are not. In a world in which there is so much misunderstanding about trade, migration, the price mechanism and much else, the real value added of introductory economics comes in giving students the toolkit to “think like an economist.” Hence, it makes sense to spend more time teaching standard micro over human heuristics and biases.

I couldn’t agree more. But there is perhaps another point Scott could have made.

Though behavioral economics is interesting and can have beneficial applications to our own life and in policy areas where clear defaults must be set, leaning so heavily on human irrationality in introductory courses risks behavioral economics becoming a kind of “Market Failure version 2.”

What I mean by that is that, absent a thorough treatment in courses with applications about trade-offs, unintended consequences, or case studies, the risk of throwing out basic economics so early in favor of declaring “humans are irrational” is that policy debates become even more heavily weighted towards unthinking intervention to “correct” for our supposed biases.

As with market failure, the undercurrent of lots of behavioral economic contributions – the throwaway implications – are that government intervention is needed to fix the biases of behavioral consumers. Intervention is often thought implicitly pareto improving over non-intervention (helping behavioral consumers without harming others.) But there are at least six reasons why this may not be the case (even if we see what we consider evidence of behavioralism):

1)      Behavioral consumers (BCs) might themselves respond “behaviorally” to interventions or nudges designed to help them, potentially leaving them worse off (e.g. drug prohibition, payday loan restrictions, some smart disclosures on credit costs).

2)      Seemingly behavioral decision-makers may, in fact, be acting rationally, especially given the costs associated with accessing information or switching (e.g. in credit card markets and in relation to fuel economy).

3)      Interventions to correct for irrational decision-making by BCs may impose substantial costs on others, maybe even failing a reasonable overall welfare evaluation (e.g. autoenrollment often comes with lower default savings rates, caps on payday loan interest rates can reduce services for non-BCs too).

4)      Developing policies to correct the biases of BCs may distract attention from policy approaches that are welfare-improving for all groups (e.g. opt-out organ donation vs. organ markets, environmental behavioral approaches vs. more direct tax incentives).

5)      Interventions can increase the complexity of economic decision making or worsen inaccurate perceptions of risk (e.g. disclosure laws, overdraft protection).

6)      Interventions can undermine the “ecological rationality” of the market, dampening incentives to learn from mistakes or for entrepreneurs to deliver new protections for BCs.

Yes, behavioral economics is an important body of economic knowledge. But putting irrationality front and center of very introductory economic courses would both constrain time from teaching more difficult economic concepts, and worsen economic policy debates absent teaching the difficulties associated with correcting perceived biases through interventions or nudges.

Against A Highly Regressive “Meat Tax”

Some economists want to make it more expensive for the less well-off to enjoy a clear revealed pleasure: eating red and processed meat.

The average household in the poorest fifth of the income distribution dedicates 1.3 percent of spending towards it. That’s over double average household spending in the richest quintile. Yet meat is now a new “public health” target. Once, lifestyle controls stopped at smoking and drinking. They recently expanded to soda and even caffeine. Now, even the hallowed steak is not sacred.

Last week, a report by University of Oxford academics calculated supposedly “optimal tax rates” on red meat (lamb, beef and pork) and processed meats (sausages, bacon, salami etc.) For the U.S., the recommend rates were as high as 34 percent and 163 percent, respectively. Such taxes, the report claims, could save 52,500 American lives per year.

To an economist, this approach might make theoretical sense. If the World Health Organization is right that eating meat increases risk of heart disease, cancer, stroke and diabetes (in some cases, very much disputed claims), then consumption could increase healthcare costs. Some of these costs will be borne by others, through higher government spending or healthcare premiums. Imposing a tax equal to the true external costs of the next steak, lamb chop or burger patty one eats forces consumers to face the full social costs of their eating decisions. In turn, then, the tax will somewhat reduce consumption to a supposed “optimal” level.

Yet, in reality, the presence of external effects is no slam-dunk to justify taxes. One must also consider costs, unintended consequences and the ability of government to assess risk and harm accurately. In these areas, the meat tax advocates appear off-base. The result is their proposed tax rates look way too high, even in theory, and it’s doubtful they are the best means of improving economic welfare.

First, the methodology appears to add up healthcare costs from extra meat consumption as if they are all costs imposed on others. But at least part of extra healthcare or medication costs of meat-eaters affected by disease would be personally financed, rather than funded through higher insurance premiums, or Medicaid or Medicare spending.

Health Policy Topics in New, Online Version of The Encyclopedia of Libertarianism

The Cato Institute’s Libertarianism.org web site has released a new, online version of The Encyclopedia of Libertarianism.

The Encyclopedia offers “a general guide to the social and political philosophy that today goes by the name of libertarianism,” including several chapters of interest to health policy scholars:

Let’s Not Lose Sight of a Real Education Market

Over the last few days Jay Greene, the Fordham Institute’s Kathleen Porter-Magee, and several other edu-thinkers have been arguing about whether national curriculum standards would destroy a competitive market in education, and a market that already provides the uniform standards Fordham wants Washington to impose. But let’s be very clear: We haven’t had a real market – a free market – in education for a long time.

Sadly, I’m afraid Jay started this whole mess, though he certainly knows what a free market in education would look like and I don’t think he intended to confuse the issue.  Indeed, he doesn’t use the term “free market,” but mainly writes about the “competitive market between communities.” His argument is that Americans over time picked standardized curricula and schools by moving to districts that provided such things. He is no doubt at least partially right, though the case is hardly open and shut. Indeed, there is strong historical evidence that district consolidation and uniformity was often pushed on small districts from outside, especially in urban areas. It is also quite possible that many people moved to districts with uniform offerings not in search of such offerings, but in search of something else that happened to coincide with them. Most notably, industrialization brought many people to cities in search of employment, and school uniformity often came with that. Finally, the economist whose work inspired Jay’s post notes that while he believes small rural districts died largely due to residents abandoning them, he concedes that there is a “lack of direct evidence connecting rural property values with local decisions about consolidation.”

Those caveats aside, Jay’s point is a still good one that I have made before, most notably when discussing schooling and social cohesion: People will tend to have their children learn many ”common” things because that is the key to personal success. People will learn what they need to in order to work effectively and successfully in society.  Moreover, people will simply tend to gravitate toward things that work.

So the main problem in the Greene-Fordham debate is not that Jay’s points are necessarily wrong, it’s that “competitive market between communities” is too easily misconstrued as “free market,” and it fails to acknowledge the gigantic inefficiencies that come from government monopolies, whether controlled at the district, state, or federal level. Those include the massive, expensive waste that fills the pockets of special interests employed by the system; constant conflict over what the schools will teach; and at-best very ponderous competition – if you want a better school you have to buy a new house – that quashes crucial innovation and specialization. Worse yet, it leads to the following kind of crucial, damaging misunderstanding by Porter-Magee:

For more than a decade we have been conducting a natural experiment where we let market forces drive standards setting at the state level. The result? A swift and sure race to the bottom. A majority of states had failed to set rigorous standards for their students—and had failed to create effective assessments that could be used to track student mastery of that content. In fact, the whole impetus behind the Common Core State Standards Initiative was to address what was essentially a market failure in education.

This is wrong, as they say, on so many levels!

First, we do not have real market forces anywhere at work in the current, NCLB-dominated regime. Using the quick list of market basics that John Merrifield lays out in his Policy Analysis on school choice research, a truly free market needs ”profit, price change, market entry, and product differentiation.” None of these are meaningfully at work in public schooling, with profit-making providers at huge tax-status disadvantages; public schools artificially “free” to customers; high legal barriers to starting new institutions that can meaningfully compete with traditional public schools; and requirements that all public schools teach the same things, at least at the state level. 

Moreover, if you want to talk about competition between states – which is more in line with what Jay was discussing – under NCLB all states have faced the same, overwhelming incentives to establish low standards, weak accountability, or both: If they don’t get their students to something called “proficiency” – which they define – the federal government punishes them! In light of that, of course they have almost all set very low “proficiency” bars. But that is about as far from “a natural experiment where we let market forces drive standards setting” as you can get! Indeed, it is a brilliant example not of market failure, but government failure!

Ultimately, Jay’s point is right: People on their own will tend to select educational options that are unifying, as well as gravitate to what appears to work best, so there is no need for the federal government to impose it. Moreover, as Jay points out, there are huge reasons to avoid federal standardization, including that special interests like teachers unions will likely capture such standards. But that problem has been at work with state and local monopolies, and it, along with myriad other government failures, will not be overcome until we have a real market in education – a free market in education.

Higher Education Subsidies Wasted

A study from the American Institutes of Research finds that federal and state governments have wasted billions of dollars on subsidies for students who didn’t make it past their first year in college. The federal total for first-year college drop outs was $1.5 billion from 2003 to 2008.

Due to data limitations, the figures are only for first year, full-time students at four-year colleges and universities. Community colleges have even higher drop-out rates, and part-time students or students returning to college are more likely to drop out. Therefore, the numbers in the report are “only a fraction of the total costs of first-year attrition the nation and the states face.” Moreover, it doesn’t include the cost for students who drop out some time after their sophomore year.

Federal policymakers from both parties are fond of lavishing subsidies on college students. Proponents argue that without federal subsidies, an insufficient number of future workers will possess the skills necessary to compete in a global economy.

However, a Cato essay on federal higher education subsidies argues that students wishing to attend college already have plenty of incentive to save or borrow from private sources:

Supporters of student aid subsidies argue that higher education is a “public good” that would be underprovided in a free market. However, that is probably not the case. People have a strong incentive to invest in their own education because it will lead to higher earnings. Those with a college degree will earn, on average, 75 percent more during their lifetime than those with just high-school degrees. That is a big incentive for people to save or borrow in private markets to pay for their own college costs. There is no “market failure” here.

In fact, higher education subsidies drive up tuition prices:

It is matter of supply and demand. More and more Americans have sought a college education, which has pushed prices higher. Ordinarily, such upward pressure would be restrained by consumers’ willingness and ability to pay, but as government subsidies have helped absorb tuition increases, the public’s budget constraint has been lifted. Peter Wood, a professor at Boston University noted that federal subsidies “are seen by colleges and universities as money that is there for the taking … tuition is set high enough to capture those funds and whatever else we think can be extracted from parents.”

But isn’t it great that Uncle Sam is helping put more young folks in college? Not necessarily:

Many of those additional students may not have been ready, or suited, for college. As evidenced by the rising shares of college students who require remedial work. Further evidence of the problem is that institutions have lowered their standards to adapt to the rise in second-rate students. The American Academy of Arts and Sciences reported that from the mid-1960s to the mid-1990s, college grade point averages grew steadily but Scholastic Aptitude Test scores declined. The share of entering college students who complete degrees has also fallen over the decades. In addition, while college attendance is up, overall adult literacy has barely budged over the last 15 years.

The essay also notes that college students devote 3.2 hours to education on an average weekday, versus 3.9 hours to “leisure and sports,” and that the six-year graduation rate for bachelor’s students is only about 56 percent, indicating that many students are not very serious about education.

Just as housing subsidies incentivized people to purchase homes that they otherwise shouldn’t have, higher education subsidies have incentivized people to go to college who weren’t ready or suited for it. In both cases, the cost to taxpayers has been substantial while the alleged benefits have proven illusory.