Topic: Regulatory Studies

Even Leftists Recognize that Over-Regulation Is Hindering U.S. Competitiveness

A report commissioned by New York Senator Charles Schumer and New York City Mayor Michael Bloomberg concludes that over-regulation is harming American competitiveness, with New York City being disproportionately impacted.

The most intriguing proposal in the report is the call for an optional federal charter for insurance companies. These companies currently are chartered by states, and state politicians abuse this process with mandates and other forms of regulation. An optional federal charter (similar to what exists in the banking sector) would force competition among regulators and create incentives for a more sensible system. That’s the good news.

The bad news is that the report also expresses sympathy for global regulations, which almost surely would mean politicians and bureaucrats insisting that all nations accept excessive regulation. Indeed, the International Organization of Securities Commissions (IOSCO) already is trying to impose a one-size-fits-all system on the world – an approach that would penalize jurisdictions with dynamic financial service industries, such as Hong Kong, Bermuda, and Cayman Islands (see here and here for more information). reports on the new study:

United States Senator Charles E. Schumer and New York City Mayor Michael R. Bloomberg have released a report which warns that New York could lose its status as a global financial market within a decade without a major shift in public policy. Schumer, a New York Democrat, and Bloomberg, together with New York Governor Eliot Spitzer, warned that New York’s financial markets, stifled by stringent regulations, and high litigation risks, are in danger of losing businesses and high-skilled workers to overseas competitors, relegating New York to regional market status and adversely impacting the US economy. …Senator Schumer and Mayor Bloomberg commissioned the joint report, “Sustaining New York’s and the US’s Global Financial Services Leadership,” which sets out a series of recommendations to counter emerging threats to the United States’ position as the world’s financial leader, with a two-tiered package of national and local measures aimed at removing impediments to financial services competitiveness both domestically and internationally. The report warned that the United States would miss out on between $15 billion and $30 billion in financial services revenues annually by 2011 if the current situation goes unchanged. According to the joint report, while many of the causes are due to improved markets abroad and sophisticated technology that has virtually eliminated barriers to the flow of capital, a significant number of the causes for America’s declining competitiveness are self-imposed. …The report also noted that a complex and sometimes unresponsive regulatory framework has not only prompted many foreign firms to stay out of the US markets, but also is forcing more business overseas because of the complexity and cost of doing business in US financial markets regardless of where they are located.

Taxing the Future

Today’s New York Times reports that Illinois is seriously considering selling off its state lottery and converting the future cash flow into a current lump sum plus a smaller cash flow over the next 75 years.  Gambling, of course is not an economic development strategy.  Excess profits exist only because the state restricts entry.  Like the mercantile regimes of old, the state is raising cash by selling off its monopoly.

Given the numbers in the Times, I conducted some present value calculations.  The sale is projected to result in a cash flow of $200 million per year for 75 years to the state (current profits are $430 billion).  The remaining cash flow goes to the winning bidder.  The reported estimated bid for this franchise is approximately $1 billion.  That suggests a return on investment of 20% per year compounded over 75 years.  Seems rather steep to me.  A 5% return would result in a much higher bid of $3.9 billion.

If the $1 billion is an accurate reflection of what an auction would yield, then the market is telling us that there is large risk to investing in a business whose only asset is state restrictions on entry.  This is particularly true because of the possibility not only of actual physical entry in Illinois, which is less likely, but entry through the internet.

Gambling markets are not the only markets whose source of profits is state enforced entry restriction.  Some years ago Richard Sansing and I studied the difference between the lease prices and sale values of taxi medallions in New York City (Journal of Policy Analysis and Management volume 13 issue 3 (1994) pp. 565-570).  We found that the market acted as if there was a 5% chance of deregulation in any year (i.e. the market was pricing the asset as if its cash flow would be zero in year 21).

Why are states selling assets for their cash flows?  Spending a billion dollars now rather than $630 million every year (the current profits of the lottery) allows today’s politicians to appear generous.  But my suspicion is that they are taxing the only thing left to tax i.e. people in the future.  My colleague Jagadeesh Gokhale’s work in entitlement reform argues that Social Security and Medicare are policies that redistribute from all future generations to current and past generations.  Politicians do this because the future is the last unorganized group in society.  I think some of the same politics are behind the Illinois lottery financial proposal.  But ironically the inability of the political system to credibly commit to future policies reduces the value of the sale to the current era because the market includes political risk in its valuation.         

Those Who Sell Out Will Eventually Be Punished

In a sick way, I’m enjoying the debate over price controls for prescription drugs under Medicare Part D. Of course, I don’t want Congress to dry up the stream of drugs that will keep me alive and vigorous when I’m a geezer. It’s just … what were the Republicans and the drug companies thinking when they created Part D? What did they think would happen? Did they really believe that, if they’d create this program, Congress would never impose price controls?

As I argued on TV today, Part D has Congress buying — through the middleman of the private drug plans — a product with high research and development costs and low marginal costs. And Congress buys those drugs for a politically powerful group of citizens (the geezers). That kind of setup cannot last. The temptation for Congress to pay nothing more than the marginal costs will be inexorable, because doing so pleases constituencies that are paying attention (seniors and current taxpayers) and harms only those constituencies that are either unpopular (drug manufacturers) or else aren’t paying attention (future seniors, including those not yet born).

The writing is on the wall. It may not happen this year, but unless we scrap Part D, sooner or later we will get price controls on seniors’ prescription drugs.

So let’s scrap Part D.

What? You’re a Republican who voted for Part D, against conscience and better judgment?? And now you’re afraid to scrap Part D for fear of (gasp!) flip-flopping or offending the geezers?? Then start talking about fundamental Medicare reform, buddy. And start now.

Cloned Food 101

The FDA’s Center for Veterinary Medicine recently issued three documents related to cloned foods:

  • “Animal Cloning: A Draft Risk Assessment”
  • “Animal Cloning: Proposed Risk Management Plan for Clones and Their Progeny”
  • “Guideline No. 179: Guidance for Industry Use of Edible Products from Animal Clones or Their Progeny for Human Food or Animal Feed” 

These are drafts open for comment until April 2, 2007.

The FDA concluded that, while there were little data, the data available indicated that “SCNT [somatic cell nuclear transfer, i.e., cloning] results in an increased frequency of health risks to animals involved in the cloning process, but these do not differ qualitatively from those observed in other ARTs [Assisted Reproductive Technologies] or natural breeding.” Furthermore, “[e]xtensive evaluation of the available data has not identified any food consumption risks or subtle hazards in healthy clones of cattle, swine, or goats.” 

In short, unless the comments provided within the next three months indicate otherwise, food from cloned animals will be on the market in about a year and require no additional labeling to distinguish it from food products from non-cloned animals.

Keeping the Facts Straight   Most objections to “cloned foods” stem from a misunderstanding of the technology and its ramifications:

  • First, not the food, but the animal used to produce the food is what is cloned.  Potentially, the actual clone could be used as food but, since it costs $15,000 to $20,000 to produce a clone, it is usually only the clone’s milk or offspring that are intended for the food market.
  • Cloning is not a form of genetic engineering. The DNA provided by the animal being cloned is not altered. Cloning is a form of assisted reproduction that creates an identical twin at a later time. Any accidental alteration of the DNA results in death of the clone usually in the lab, but occasionally one survives through gestation and birth, but not beyond the perinatal period. Thus, all clones that have the potential of entering the food supply or of being bred are genetically identical to the animal that was cloned.
  • Food from clones poses no more risk to the consumer than the animal being cloned. The susceptibility to disease or other conditions that may disqualify clones from food production is no greater than that of the original animal. Thus, the fact that an animal is a clone poses no unique risk to the food supply.
  • The first sheep (Dolly) was cloned in 1996. The first cow was cloned in 1998 and the first pig in 2000.
  • In 2001, the FDA decided to study the issue of food from cloned animals and asked the food industry not to introduce any food produced by clones or their progeny into the market. The FDA’s notice of publication that accompanies the afore-mentioned drafts requests that this “voluntary moratorium” continue.
  • It is possible that some cloned animals or their progeny have already entered the food supply, but there is no definitive evidence that this has happened.
  • The FDA has asked for a “voluntary” moratorium because, under current law, the agency probably doesn’t have the authority to ban foods made from clones. Unless Congress amends the Federal Food, Drug, and Cosmetic Act (FFDCA), this will continue to be the case regardless of what the FDA decides when it publishes its final rule.
  • The milk and beef from cloned cows is indistinguishable from that produced by other cows. It’s not adulterated; there are no additives. The following is an oversimplified description of federal law,  but should shed some light on why the FDA is proceeding as it is. Basically, federal law (the FFDCA) presumes that unadulterated food is safe. The FDA has the authority to regulate the use of additives and to require accuracy in labeling. Labeling may be regulated to assure that the identity of the food is correctly represented (margarine is not butter) and that potentially harmful additives or allergens are indicated on the label. Food from cloned animals simply does not differ from regular food in any manner that justifies regulation under the FFDCA.
  • It is time to give some clarification regarding the phrase “genetic engineering.” Genetically engineered animals have been genetically altered, not just reproduced. Under a broad definition of “genetic engineering”, all animal husbandry that involves changing the genetic makeup from one generation to the next involves genetic engineering. In this sense, each time a breeder chooses a mate for an animal, he is engaged in genetic engineering. This type of genetic engineering actually takes place through selective reproduction. A newer type of genetic engineering, which is what most people mean when they use the term, refers to genetic alterations made by man not through selective breeding but through selecting the actual specific genes that will be combined. This can also involve taking out or adding genetic material, including the addition of genetic materials from different breeds, species, phyla, or even kingdoms. The resulting animal or plant is called “transgenic” if foreign DNA is integrated into the genome.
  • There are over a billion acres of land, most of it in the United States, planted with strains of transgenic crops. These crops, for the most part, are corn, soybeans and cotton.
  • At this time, there is only one transgenic fish approved for sale in the United States, and it is an aquarium fish, not for human consumption. There is, however, a petition pending with the FDA to approve a transgenic salmon, and it will be labeled as such if it is approved.
  • The Center for Food Safety and several other consumer groups have filed a Citizen Petition with the FDA encouraging the agency to regulate cloned foods as new animal drugs. Under the FFDCA, drugs require pre-approval for safety and efficacy before being marketed. This is quite a stretch. The relevant part of the FFDCA definition of a “drug” according to the petition is “any articles (other than food) intended to affect the structure or any function of the body of man or other animals.” It is further worth noting that genetically modified foods, including transgenic animals, require pre-market approval by the FDA because they are considered as containing “food additives.” This actually makes some definitional sense since genetic material is added or changed to create a genetically modified plant or animal. But, this same logic does not hold for cloning.

The conclusion I draw from these facts is that the FDA should not be involved at all in regulating food from clones or their progeny. Under existing law, the FDA doesn’t have the authority to regulate food from clones even if there were a safety issue. 

Regarding labeling — that issue will take care of itself without FDA interference. If there is enough public concern that food produced from clones or their progeny is unsafe, then producers of organic foods will start specifying “Not from cloned animals” on their labels in the same way they have advertised “Not from animals treated with hormones or antibiotics.” 

The Center for Food Safety claims that “63% of Americans would not buy cloned food, even if FDA deemed the products safe.” They present these data from a 2005 poll as an argument for regulation. I think such poll results only justify purchasing stock in organic food companies that promise not to sell products from cloned animals — but not government intervention.

Ethical Considerations   The ethical concerns addressed here are primarily moral considerations that legitimately could influence actions taken by individual breeders, producers, and consumers, but not legitimately be used to argue for government intervention. Even the FDA agrees with this point. In its proposed risk management plan, the agency states: “The Draft Risk Assessment is strictly a science-based evaluation of animal health and food consumption risks, and the Proposed Risk Management Plan and Draft Guidance for Industry do not address any ethical or other non-science based concerns regarding animal cloning.”

Most ethical objections to cloning and genetic engineering in general come from a fear of the unknown consequences of such technology, a religious or moral objection to tampering with natural reproduction, and/or a concern for preventing cruelty to animals. While all these concerns hold legitimate moral sway with various portions of the population, they are not grounds for government action. We live in a pluralist society and those who disagree on religious or moral grounds with cloning should be free to speak out, boycott, or not participate in the objectionable activity, but those who do not object should be equally free to participate in producing food from clones and/or eating it.

The one legitimate concern I see with cloning is one almost as old as animal husbandry itself. By its very nature, manipulating a gene pool to create certain desired phenotypes creates a homogeneity that can put the whole group at risk. As a 25-year veteran breeder of rare breed dogs and cats, I know first-hand that breeders often attempt to ferment type at the expense of health. A lack of genetic diversity in purebred animals caused by too much inbreeding makes those animals more susceptible to disease, shorter-lived, and more prone to unhealthy offspring. Domestically bred animals loose their genetic resilience when intentional line-breeding or the overuse of certain choice animals makes it difficult to find animals that aren’t related. 

To prevent such homogeneity, some breeders feel it is their moral obligation not to flood the gene pool with one particular genotype. They do this by not breeding two animals related more closely than five generations back or by not breeding their pride stud more than four times a year. Such ethical standards are usually set by individual breeders or private breed associations. Cloning itself is not inbreeding but it can result in flooding a gene pool; for example, there are reports of a farmer who has cloned his prize bull five times already. Now an animal whose genetic material would appear in X number of offspring, will in fact appear in X6 number of offspring. In this way, cloning can over-saturate a gene pool with a particular animal’s genes, making the group more susceptible to intentional or accidental inbreeding and, in turn, genetically weaken the group as a whole. 

Like cloning, genetic engineering could be used to create consistency within a breed, but it also could be used to create diversity. Genetic engineering could help eliminate genetically linked diseases, even those in rather homogeneous groups. It could also be used to create more diversity in ways that help preserve the desired traits without creating too much homogeneity. 

Also, while individual breeds within a species become more homogeneous, genetic engineering could help the number of breeds proliferate — just look at the number of dog, cat, and bovine breeds that exist today. It certainly would be disappointing for those who like the taste of a particular kind of beef to learn that the breed of cattle that produces that beef is failing in part because of too much cloning, but that would not mean the end of all beef or all bovines. It would simply mean regenerating the breed either from a survivor, hopefully genetically engineering out the flaw that caused problems, or altering another breed to have the characteristics that were prized in the breed that failed. 

None of the ethical issues presented by cloning food-producing animals are new. Cloning and genetic engineering only provide new and more effective methods of doing what humans have been doing for millennia  — that is, manipulating the genetic makeup of plants and animals to create better food. Put another way, humans have been tampering with nature, playing God with the creation of animals, and eating their creations for thousands of years. The only thing that has changed is the technology. The goals and the ethical problems inherent in those goals remain the same. And, as is usually the case, the very technology that poses potential problems, undoubtedly also holds the solution to those problems should they arise.

C. Boyden Gray on Oil Subsidies

At a high-level, off-the-record meeting concerning energy security that I attended earlier this week in Washington featuring New York Times columnist Tom Friedman, former CIA director James Woolsey, and energy consultant Daniel Yergin, a study came up in the course of discussion that has been bobbling around for a while now just below the radar screen regarding oil subsidies. The study, co-authored by major Republican C. Boyden Gray and published in a conservative law journal out of the University of Texas, alleges that the oil industry is subsidized to the tune of $250 billion a year, and that claim was marshaled to support the case for countervailing ethanol subsidies. If a careful guy like Boyden Gray — no enemy of business community he — has come to this conclusion, then there must be something to it, right? At least, that’s what many of the attendees were telling each other.

Now, this is a pretty remarkable claim given that the most aggressive yet credible oil subsidy estimates I’ve ever seen come from economist Douglas Koplow of Earth Track. He argued in a 1998 study for Greenpeace (not available electronically as far as I know) that total oil subsidies range from $18-40.6 billion if you count not just subsidies targeted at the oil industry but (1) those that help multiple industrial sectors as well, and (2) embrace some pretty ambitious claims about the chunk of defense spending that would disappear if the military’s oil mission were to disappear.

Look, I like Boyden personally. He’s been a generous contributor to the Cato Institute over the years and he’s gone out of his way to help promote many of our scholars here in Washington. But a close look at this paper of his speaks volumes about the poverty of the policy conversation in Washington with regards to energy.

Boyden’s argument boils down to this: chemical substances found naturally in gasoline such as benzene and other aromatic hydrocarbon compounds are imposing severe health costs on society. In a perfect world, the oil companies would have to compensate victims for those harms, but the federal government largely protects those companies from liability. This constitutes an implicit subsidy to the industry.

Boyden alleges that the direct harms from the various toxic emissions from gasoline total about $64 billion a year. But those aromatics also contribute to the formation of particulate matter (PM) in the atmosphere, and the harms from PM that can be traced back to aromatic gasoline emissions totals at least $200 billion a year. Boyden rounds the sum to $250 billion a year (which works out to about $1.78 a gallon in 2005) and argues that “leveling the playing field” would justify an equivalent subsidy to the ethanol industry. Ethanol subsides, he says, amounted to only $1.4 billion a year (the CBO estimate of the lost revenue associated with the federal fuels tax credit which, by the way, represents only a fraction of the total subsidies going to ethanol), so there’s a lot of room left to justify ethanol subsidies to the moon.

Boyden is right that the aromatics found in gasoline impose human health risks, and the regulatory history he tells about how Congress has dealt with this issue in the past is rather good. But his cost estimates relating to these emissions are drawn essentially from the ether.

His $64 billion estimate for the benefits associated with reducing aromatic emissions is simply the costs associated with reducing past industrial toxic air emissions. Huh? How did costs become benefits? Well, there are no independent estimates of the benefits. But the EPA asserts that the benefits from those previous industrial emission reductions exceed the costs so… . Even if the EPA’s claim were correct, there’s no reason to assume that the cost of reducing toxic air emissions from point-sources x years ago has anything to do with the cost of reducing toxic air emissions from automotive tailpipes today.

Boyden’s estimate for the costs associated with PM formation that can be traced back to gasoline likewise emerges from a problematic set of assumptions. He posits that 40 percent of all fine PM mass is carbon based (which seems fair enough) and then assumes that half of this mass (when adjusted for population exposures) can be attributed to gasoline emissions (which is not so fair enough; his own footnote suggests that only 4-33 percent of PM 2.5 can be traced back to tailpipe emissions). Using the benefit estimates associated with ambient PM concentration reductions from the recently established off-road diesel fuel regulations allows Boyden to come up with about $200 billion in benefits, although it’s unclear how he traces those costs to aromatic tailpipe emissions out of the total universe of motor vehicle tailpipe emissions.

I doubt whether anybody who’s citing Boyden’s study with gusto has ever gotten around to reading this particular sentence on p. 52; “We emphasize that these are, necessarily, speculative estimated, based on various heuristic assumptions that cannot easily be proven (or refuted, given basic uncertainties).” I’ll say. Normally, claims that cannot be proven or disproven are called “baseless opinions” (or, alternatively, “religious beliefs”). Let’s posit that we shouldn’t use either as the basis for public policy.

If Boyden was familiar with the literature on tailpipe emissions, he wouldn’t need to go through such analytic contortions. The man who probably knows more than any other person in the United States about the issues surrounding the environmental cost estimates associated with gasoline consumption is Mark Delucchi, a research scientist at the Institute for Transportation Studies at the University of California at Davis. His own economic calculations based on epidemiological work by others finds that environmental costs associated with toxic air emissions from motor vehicle tailpipes ranges from a lower-bound estimate of $87 million a year to an upper-bound estimate of $1.62 billion a year in 1991 dollars (which translates to $116 million-$2.16 billion in 2005 dollars) – a tiny fraction of the $64 billion estimate coming from Boyden.

Delucchi does not break down the PM emissions associated with gasoline aromatics, but he does report that the environmental costs associated with all the particulate emissions from motor vehicle tailpipes ranges between a lower-bound estimate of 16.7 billion and an upper-bound estimate of $266.4 billion. However, Delucchi reports that “we are uneasy with this result, even as an upper-bound,” because it’s heavily weighted by one study in the literature (Pope et al.) and that study is both anomalous and methodologically problematic. Regardless, keep in mind that Boyden is concentrating his fire not on all the particulate matter coming out of automotive tailpipes, but that subset of particulate matter formed as a consequence of the aromatic emissions. Given the small percentage by weight and volume that aromatics constitute within a gallon of gasoline, it’s clear that Boyden’s estimate is wildly off even if we use Pope et al.

By the way, it’s worth noting that the toxic air emissions associated with ethanol are even greater than the toxic air emissions associated with conventional gasoline, so even if Boyden’s estimates were correct, they do not justify countervailing subsidies for ethanol, the remedy for the problem suggested in Boyden’s paper.

One could spend a lifetime swatting down papers like this. That such weak arguments have no problem gaining currency in Washington demonstrates that policymakers simply cannot differentiate between analytic wheat and chaff. But such is the stuff that policy is made, particularly when the analytic “chaff” is politically convenient.

More Special Rules for Fannie Mae?

A banner headline and photo in the Business section of the Washington Post show former Enron CEO Jeffrey Skilling reporting to prison to begin serving a 24-year term for fraud and conspiracy. (Note that federal sentences don’t allow for much parole; Skilling must serve at least 85 percent of his sentence.) Sidebars depict other jailed corporate executives: Bernard Ebbers of WorldCom, 25 years; Dennis Kozlowski of Tyco, 8 to 25 years; John Rigas of Adelphia, 15 years (being appealed).

On the same page, another story reports:

Three years ago, Fannie Mae assured lawmakers that it had the required capital to cope with a broad variety of business setbacks.

Since 1992, “Fannie Mae has met or exceeded our capital requirements in every year,” Franklin D. Raines, then its chief executive, testified in September 2003. “Indeed, we are one of the best-capitalized financial institutions in the world, when compared to the risk of our business.”

As it turns out, the assurance was false.

Will Raines and other executives face lengthy jail terms for their repeated and massive accounting misrepresentations, which resulted in multi-million-dollar bonuses for the executives? It doesn’t look likely. Criminal charges against the company itself have been ruled out. The government may seek to recover millions of dollars from executives who received massive bonuses on the basis of the manipulated earnings statements, but there seem to be no plans to pursue criminal prosecution of these sophisticated Washington insiders.

There may well be good legal reasons why Enron and WorldCom executives were guilty of crimes punishable by 25 years in jail, while Fannie Mae executives were guilty only of outrageous behavior. But one can’t help wondering if the difference is related to yet another tiny story in the Post’s Business section on the same day: “Fannie Breaks Record On Lobbying Outlay.”

Some background on the fundamental problems with Fannie Mae and other government-sponsored enterprises here.