Mercatus Site Feed

Keith Hall Discusses Employment after Graduation on Fox 5

Keith Hall — Thu, 16 May 2013 14:10:20 -0400

Video

Doing Bad by Doing Good, Why Humanitarian Action Fails Book Panel

Christopher Coyne, Peter J. Boettke — Wed, 15 May 2013 11:32:45 -0400

Video

Optional Medicaid Expansion: Considerations Facing the States

Charles Blahous — Wed, 15 May 2013 17:46:59 -0400

Video

Across the country, state governments have been considering whether to expand Medicaid coverage as envisioned by the Affordable Care Act (ACA or "Obamacare"). To help break down what's at stake, a new video—based on a recent study by Mercatus Center scholar Charles Blahous—reviews the key factors states must consider in this complex decision.

The video breaks down some of the key factors states must consider including:

How did the Supreme Court decision on the ACA change the calculus on Medicaid for state governments?
What is the difference between the law's new health exchanges and its Medicaid expansion? Who is eligible for each?
Can governors and state legislatures be confident that the federal government will be able to follow through on its promises for more Medicaid funding?

Public Debt Under Various FY 2014 Proposals

Veronique de Rugy — Mon, 13 May 2013 23:09:35 -0400

Publication

The president and numerous politicians claim that the United States does not have an immediate crisis in terms of debt. The president has gone so far as to say, "In fact, for the next 10 years, it's gonna be in a sustainable place."

The recent release of budget plans for fiscal year 2014 makes a proper perspective of projections of public debt even more important. This week’s chart shows the debt held by the public as a percentage of the gross domestic product (GDP) under various budget proposals.

Debt would end up equaling 73 percent of GDP by 2023 under the president’s plan. Projected debt under the Senate Democratic plan is only three percentage points below the president’s at 70 percent of GDP (blue lines). That figure nearly aligns with the Simpson-Bowles’s bipartisan plan (purple line), which projects debt at 69 percent of GDP, and stands substantially higher than the 55 percent target of the House Republican budget (red line).

The CBO projects that debt will equal 77 percent of GDP in 2023 under current law (orange line)—far above any of the budget plans. Changes to these laws, such as removing spending cuts from sequestration, will result in debt held by the public soaring to 87 percent of GDP by the end of 2023, as shown in the CBO alternative scenario (green line).

It’s hard to see how any of these budget plans represent a serious attempt to cut the debt, as most of the plans only leave us where we are today, if not worse off. Even the Ryan plan, which promises a 55 percent debt-to-GDP level by 2023, rests on optimistic GDP growth and revenue projections while failing to fully address the unsustainability of the current entitlement programs. The Ryan plan repeals Obama's health care law, but it pushes off urgent Medicare reforms until 2024 and leaves Social Security untouched.

These plans prove that Washington lacks the commitment necessary to address the true drivers of the debt: spending for entitlement programs and interest costs on the debt itself.

Five Reasons to Keep Government Out of Internet Governance

Eli Dourado — Mon, 13 May 2013 17:22:03 -0400

Expert Commentary

Starting on May 14, the International Telecommunication Union – an agency of the United Nations – is kicking off a meeting for governments and telecom companies to discuss "international Internet-related public policy matters." Up for debate are six draft opinions on various aspects of Internet policy, but the unifying question is: how much should governments (and intergovernmental organizations) involve themselves in the building and running of the Internet? Under the current system, governments do very little – and the Internet has flourished because of it.

Here are five reasons we should resist giving governments a bigger role in Internet governance:

1. Censorship: Some governments want to be more involved in managing the Internet so that they can better monitor who is saying what online. Reporters Without Borders lists five governments that it classifies as "State Enemies of the Internet," and there are several more that are nearly equally as repressive. A greater role in managing Internet resources, such as IP addresses, would make it even easier for these governments to monitor and censor speech online.

2. Technical expertise: Under the status quo, decisions about Internet governance are cooperatively made by some of the most talented network engineers around. The bottom-up, peer-production model of Internet standards-setting selects for the best ideas from this pool of great technical minds. In contrast, if these decisions were made by government bureaucrats, the quality of the engineers would go down and the decision-making process would be politicized. The Internet would likely be less robust and secure if governments and intergovernmental organizations like the U.N. were in charge.

Interstate Protectionism and the Dormant Commerce Clause

Jason Sorens — Fri, 10 May 2013 16:10:19 -0400

Expert Commentary

All 50 states ban the direct sales of motor vehicles from manufacturers to consumers. The politics of this regrettable policy are clear: auto dealers are powerful political players in every state, while only a few states actually have manufacturing facilities. Banning direct manufacturer sales benefits dealers while hurting manufacturers and consumers.

State governments continue to insert themselves into the contractual relationships between car manufacturers and dealers, typically to the ostensible benefit of the latter. The New Hampshire Senate recently passed a bill regulating the terms and conditions of dealer contracts with manufacturers, prohibiting manufacturers from requiring dealers to alter the appearance of their showrooms, for instance. (Disturbingly, the state director of Americans for Prosperity in New Hampshire supports the bill.) The bill is actually unlikely to change any “balance of power” between automakers and auto dealers. Automakers will simply respond by vetting potential dealerships far more closely and perhaps charging higher franchise fees. The onus of this response is likely to fall more on new dealerships than on incumbents. So the real losers from the bill are going to be potential entrants into the car dealer industry and, of course, consumers.

These are not the only examples of “state protectionism,” in which state governments adopt laws meant to reduce competition from out-of-state businesses for the benefit of local incumbents. Some states still prohibit certain out-of-state direct-to-consumer wine shipments. Regulatory barriers can accomplish the same ends. States have widely varying regulations on insurance products, making regulatory compliance a huge barrier for a company trying to market a standard policy in multiple states. For a long time, major life insurance companies lobbied Congress to adopt a national life insurance regulatory regime, pre-empting state laws. They were opposed by local life insurance agents, for whom knowledge of and compliance with distinctive state regulations were a significant source of competitive advantage. In the end, no national legislation materialized, but Congress authorized the formation of an interstate compact, essentially a contract among consenting states that sets up a single insurance regulator. More than 40 states have joined the Interstate Insurance Product Regulation Commission, which regulates life insurance and annuities.

Such state protectionism potentially runs afoul of the so-called “dormant commerce clause” of the U.S. Constitution. The commerce clause allows Congress to regulate trade among the several states. By implication, then, states are presumptively prohibited from burdening interstate trade, unless authorized by Congress. Unfortunately, courts have been reluctant to scrutinize state economic regulations that have an essentially protectionist character, although especially blatant discrimination against out-of-state imports has been overturned.

Beyond judicial intervention, however, another solution may be the interstate compact. The U.S. Constitution requires Congress to authorize interstate compacts, though, and given Congress’ dysfunctionality, that is often a tall order. Moreover, topic-by-topic compacts will fail to achieve the comprehensive results that something more along the lines of a World Trade Organization analogue would. For instance, few states would want to join a compact dedicated solely to liberalizing the rules on auto sales. The dealer lobby is too strong in most places. But they might have an interest in joining a compact setting up an Interstate Trade Organization to liberalize rules on many different kinds of commerce. In that context, “exporters” might gain enough political influence to outweigh the demands of “import-competing” industries. The key is the ability for state governments to make policy “trades” across different dimensions, increasing the scope of the interstate organization’s remit. A state might “lose” (politically) on one dimension, like direct auto sales, but gain on another dimension of greater importance to its own export industries, like direct wine sales. As Koremenos, Lipson, and Snidal (2001: 770) note in their article, “The Rational Design of International Institutions”:

Sometimes two seemingly unrelated issues are linked. A trade issue, for example, may be linked to a security issue to facilitate agreement and compliance. Or a side payment may be offered, as when the Nuclear Nonproliferation Treaty offered the transfer of peaceful nuclear technology to states that agreed to forgo nuclear weapons. Such side payments are clear evidence that scope is being manipulated to facilitate cooperation.

Koremenos et al. conjecture that the “scope” of an organization increases with the heterogeneity and number of the members and the severity of the “distribution problem” (for instance, prisoner’s dilemmas as against coordination games) and of the “enforcement problem” (how to punish defectors). For state governments engaging in protectionist policies, just as for national governments doing the same, all of these problems loom large. Therefore, wide scope is likely to be important for any organization dedicated to trade liberalization.

Beyond Unemployment: The Full Labor Market Picture of Ohio

Keith Hall, Robert Greene — Fri, 10 May 2013 13:06:18 -0400

Publication

Much like the rest of the United States, Ohio’s economy was severely affected by the Great Recession and is recovering very slowly. Long periods of unemployment experienced by many jobless Ohioans have caused unprecedented disengagement from the labor force. These disengaged workers—those without jobs and not actively searching for work—no longer participate in the labor force and are not counted as unemployed. If participation in the labor force by Ohioans today were at the same level as before the recession, Ohio’s unemployment rate would be significantly higher. Ohio’s decline in labor force participation has particularly harmed the labor market for Ohioans 34 and younger and has outpaced the national average. To improve Ohio’s labor market, policymakers should consider reducing the state’s regulatory and tax burdens, which may be hindering economic recovery and job creation.

How Labor Force Participation Affects Unemployment in Ohio

From the end of 2007 until the end of 2009, Ohio lost over 400,000 nonfarm payroll jobs.[1] Nonfarm payroll jobs data function as an indicator of nonfarm private sector employment.[2] This rapid two-year decline represented an over 7.7 percent loss of total jobs—a noticeably more severe drop than the national two-year decline of roughly 6.3 percent.[3] Although Ohio has seen steady job gains over the last four years, the state’s job losses since the recession began greatly exceed the national average (see Graph 1).

Ohio’s labor force participation rate—the percentage of the population aged 16 and older with employment or without it but actively looking for employment—has fallen consistently since the beginning of the recession (see Graph 2) and remains near its 30-year low.[4] In recent years, Ohio’s decline in labor force participation has occurred at a faster pace than the decline of the national average (see Graph 2). As a result, Ohio’s labor force participation rate—which previously ran 0.5 to 0.8 percent in excess of the national average for years—has finally come into convergence with the national average of 63.7 percent.

The comparatively rapid labor force disengagement in Ohio has meant a falling unemployment rate without a significant increase in employment. The unemployment rate is the number of persons as a percentage of the labor force actively looking for employment. When unemployed persons give up looking for work, they no longer are counted as part of the labor force. The unemployment rate therefore decreases not only when unemployed persons are hired, but also when then they simply give up searching for work.

The effect of declining labor force participation on unemployment in Ohio appears to be substantial. The state’s official unemployment rate peaked at 10.2 percent in 2009 and has since fallen steadily to its current official level of 7.2 percent (see Graph 3). However, if Ohio’s labor force participation rate had remained at its 2007 level of 66.8 percent (see Graph 2), then the state’s unemployment rate would be 11.5 percent (see Graph 3).[5]

Where the Jobs Have Been Lost

The number of private sector jobs in the United States remains 2.8 percent below the number of jobs in 2007 (see Graph 4). In Ohio, there are 4.7 percent fewer private sector jobs compared to the number in 2007. Different industries have experienced varying degrees of severity of job loss. Since 2007, Ohio has experienced a 14.9 percent decline in the number of manufacturing jobs and a 20 percent decline in the number of construction jobs. Job losses in Ohio since 2007 have outpaced the national average in the following sectors: trade, transportation, and utilities; manufacturing; leisure and hospitality; information; financial activities; government; and other services. Only two sectors in Ohio—mining and logging, and education and health services—have experienced significant job gains since 2007.

Young Ohioans have been particularly hard hit by the poor labor market since 2007 (see Graph 5). Between 2007 and 2012, labor force participation for 16- to 19-year-olds in Ohio declined almost 9 percent. For 20- to 24-year-olds, it declined almost 2 percent. For 25- to 34-year-olds, it declined roughly 3 percent. Yet for those 65 and older, labor force participation has increased 3.6 percent. Unemployment rates by age group display a similar trend (see Graph 6). The unemployment rate of those 34 and younger exceeds the statewide average, while the unemployment rate for those 35 and older rests below the statewide average.

Explaining and Reversing the Trends

In 2011, Ohio’s real economic growth—1.1 percent—lagged behind the national average of 1.5 percent.[6] This sluggish growth has meant that Ohio’s labor market recovery has also been slower than the national average. Ohio’s comparatively strict labor regulations and high taxes may be hindering its economic growth and thus also its labor market recovery. The National Federation of Independent Business’s most recent quarterly survey of small businesses found taxes and regulations to be the two most important problems facing businesses.[7] In the Mercatus Center’s recent Freedom in the 50 States Index, William Ruger and Jason Sorens found Ohio’s tax burden to be the thirteenth heaviest in the United States, and its regulatory burden is higher than nearby Michigan, Indiana, and Wisconsin.[8] They recommend that the state lower taxes, adopt regulatory policy reforms, and follow neighboring Indiana and Michigan in adopting a right-to-work law. Further research would increase understanding of the effects that regulatory and tax reforms would have on Ohio’s labor market.

Conclusion

Although Ohio’s unemployment rate does appear to be declining, the rapid and continuing fall in the labor force participation rate indicates that many Ohio workers are continuing to disengage from the workforce. This trend of widescale worker disengagement—not of labor market improvement—is driving down Ohio’s unemployment rate. Ohio’s unemployment rate would be 11.5 percent with a prerecession labor force participation rate. The labor market recovery in Ohio is far from complete and has been far from equal between age groups. The decline in labor force participation and the increase in unemployment for Ohioans under 35 years old is particularly troubling. Ohio’s job gains have in large part occurred from jobs in education and health services—sectors highly influenced by government. In most other sectors, Ohio’s recovery has underperformed the national average and significantly fewer jobs exist than before the recession. Ohio policymakers should examine ways to reverse these troubling trends. Modifying Ohio’s regulatory environment and tax regime may be a good place to start, as doing so could help Ohio stimulate more private sector job creation.

Endnotes

^{1. US Bureau of Labor Statistics. There were approximately 5.418 million Ohio nonfarm payroll jobs in December 2007. In December 2009, the number of Ohio nonfarm payroll jobs had declined to 5.002 million.}

^{2. US Bureau of Labor Statistics Glossary, http://www.bls.gov/bls
/glossary.htm (accessed May 6, 2012). According to the US Bureau of Labor Statistics, nonfarm payroll excludes payrolls from farm, government, private household, and some nonprofit employment.}

^{3. US Bureau of Labor Statistics. There were approximately 138.042 million US nonfarm payroll jobs in December 2007. In December 2009, the number of US nonfarm payroll jobs had declined to 129.373 million.}

^{4. US Bureau of Labor Statistics. In 1984, Ohio’s labor force participation rate was 63.6%, making the 2012 rate of 63.7% Ohio’s second lowest labor force participation rate of the last 30 years.}

^{5. This is, in effect, assuming that many of the discouraged jobless that are not counted as unemployed are part of the labor force despite a lack of current, active job search.}

^{6. Bureau of Economic Analysis, US Department of Commerce, “Widespread Economic Growth Across States in 2011,” June 2012, http://www.bea.gov/newsreleases/regional/gdp_state/gsp_newsrelease.htm.}

^{7. William C. Dunkelberg, Holly Wade, “Small Business Economic Trends Monthly Report,” National Federation of Independent Business, March 2013, http://www.nfib.com/Portals/0/PDF/sbet
/sbet201304.pdf.}

^{8. William Ruger and Jason Sorens, Freedom in the 50 States (Arlington, VA: Mercatus Center at George Mason University, March 2013).}

The SEC's Cross Border Regulatory Creep

Hester Peirce — Wed, 08 May 2013 09:36:41 -0400

Expert Commentary

Last week, the Securities and Exchange Commission proposed its cross-border security-based swaps rule under Dodd-Frank with great fanfare and a unanimous commission vote. Many outside the SEC have deemed the proposal a success, presumably because it is not as bad as the approach taken by the Commodity Futures Trading Commission that has angered regulators the world over. Exceeding the CFTC's low bar is a pretty poor metric for assessing regulatory success.

Dodd-Frank prohibits the SEC from applying its rules to security-based swaps businesses conducted "without the jurisdiction of the United States," except to the extent the firm violates SEC rules designed to prevent evasion of Dodd-Frank provisions. The SEC's proposed approach strays from the statute's territorial limitations and instead employs a nebulous approach based on conjecture about whether particular activities will be "conduits of risk into the U.S. financial system." As a consequence, the proposal departs from SEC precedent in selecting which market participants and transactions to regulate. Although the SEC's desire to safeguard the U.S. financial system from risks of foreign origin is understandable, its proposal is impractical and not respectful of other countries' very rigorous ongoing regulatory efforts.

The proposal, which offers detailed consideration of numerous, complicated cross-border implementation questions, is lengthy-the Web version is 650 pages, almost as long as Dodd-Frank itself. It proposes a framework governing the application of U.S. security-based swaps markets rules to international swaps transactions and foreign market participants. The proposal tells firms how to figure out if they need to register and which transaction-level and entity-level requirements apply once they are registered.

The proposal allows firms to apply for permission to bypass certain requirements on the basis of so-called substituted compliance, the centerpiece of the proposal. If the SEC signs off on substituted compliance for one firm in a foreign jurisdiction, all firms in the same jurisdiction will be permitted to comply with their home country rules instead of the SEC's rules. The catch is that firms have to obtain separate approval for each of four categories of regulations, and the proposal leaves the SEC the option of ignoring these categories and applying substituted compliance on a rule-by-rule basis. Moreover, the proposal tells one category of foreign market participants-major security-based swap participants-not to even bother applying for substituted compliance because the SEC doesn't know enough about them.

Substituted compliance will impose tremendous initial burdens on the SEC staff as they try to assess requests from firms eager to avoid having to comply with duplicative, and perhaps conflicting, regulatory regimes. Firms will also incur great costs to figure out which requirements apply to which transactions. If other countries follow suit, the costs and complexities will be even greater. Until a firm succeeds in obtaining a substituted compliance approval from each country with any potential tie to its security-based swap transactions, it would be forced to comply with every one of those countries' rules-rules that may be incompatible with one another. The SEC considered and rejected an approach that would have been easier to administer and easier for market participants to comply with, namely allowing "substituted compliance across the entire set of security-based swap requirements with respect to regimes that have implemented regulations consistent with the overall objectives of the G20 commitments."

The SEC's creep across the border is less dramatic than the CFTC's leap, and its proposal reflects a greater respect for important procedural issues such as economic analysis, meaningful opportunity for public comment, and thoughtful consideration of alternative approaches. Nevertheless, the SEC has avoided criticism of its security-based swaps rulemaking so far by being not quite as unreasonable as the CFTC. It's time to start applying a tougher standard to the SEC's efforts.

Capitol Hill Campus: The Pathology of Privilege: The Consequences of Government Favoritism

Matthew Mitchell — Tue, 14 May 2013 15:59:41 -0400

Events

Despite the ideological miles that separate them, activists in the Tea Party and Occupy Wall Street movements agree on one thing: both condemn the recent bailouts of wealthy and well-connected banks. But when it comes to government-granted privileges to particular firms or industries the bailouts were just the tip of the iceberg. What are some of the other ways that governments play favorites? And what are the consequences of economic favoritism?

For answers to these questions and more please join the Mercatus Center at George Mason University’s Capitol Hill Campus for a discussion outlining the negative consequences of policies that favor some firms over others.

This discussion will focus on the main points highlighted in Dr. Mitchell’s Pathology of Privilege paper:

• Types of privilege

• The economic and social costs of privilege

Space is limited.

The event is free and open to all congressional and federal agency staff. This event is not open to the general public. Food will be provided. Due to space constraints, please no interns. Questions? Please contact Erin Connolly, Event Associate, at econnolly@mercatus.gmu.edu or (703) 993-9913.

The Slow Recovery's Impact on Families

Veronique de Rugy, Keith Hall — Wed, 08 May 2013 10:45:46 -0400

Publication

Unsurprisingly, the slow recovery has been particularly hard on families. New data released last month by the Bureau of Labor Statistics show that 8.4 million families had at least one unemployed member. That makes the family unemployment rate 10.5 percent, well above the average national unemployment rate of 8.1 percent in 2012. Some 20 percent of families had no one working in 2012, a number that includes both the unemployed and looking for work and the jobless and not looking for work. The statistics are grim when we look at families with children under 18 years old, where 12.2 percent have no one working.

Craigslist Takes Upstart Competitors to Court

Jerry Brito — Tue, 07 May 2013 09:12:14 -0400

Expert Commentary

Classified-ads site Craigslist is a big, fat bully. That’s the conclusion many in tech policy circles have come to after a federal court ruled last week that the company can carry on with a suit against three smaller competitors. In Craigslist’s shoes, however, you might resort to bullying, too.

The defendants—3taps, PadMapper, and Lovely—have built their businesses by using Craigslist advertisements without permission. 3taps operated Craiggers, essentially a copy of Craigslist with an alternative interface that made navigating classifieds easier. As the site’s tagline put it, “Craigslist data, better than Craigslist!” PadMapper andLive Lovely take listings and display them on maps, which also makes it easier to search and browse ads.

Many of those critical of Craigslist focus on the fact that the defendants are making Craigslist’s better by offering features the company has so far refused to offer.

In an open letter to Craigslist founder Craig Newmark, Steve Schultze of Princeton’s Center for Information Technology Policy wrote that he was “at a loss about why Craigslist is taking such a scorched earth tactic against a site that appears to help more people find Craigslist postings.” And congressional-staffer-turned-copyright-activist Derek Khanna wrote that “instead of innovating, [Craigslist] has chosen to go after new market participants that have wanted to use Craigslist’s data on classified postings.”

In some respects, Craigslist had this backlash coming because it has long branded its service as something of a for-profit non-profit not averse to sharing. The site’s icon is a hippy peace symbol, and it operates not under a “.com,” but instead a “.org” domain, which it says “symbolizes the relatively non-commercial nature, public service mission, and non-corporate culture of craigslist.” Newmark has long held that the $1 billion company is not motivated by profit. So it’s little surprise that as the company has moved to fend off competitors that use its data without permission, tech elites have developed a negative perception of Craigslist best articulated by The New York Times: “It has dug an effective moat by cultivating an exaggerated image of ‘doing good’ that keeps its customers loyal, while behind the scenes, it bullies any rivals that come near and it stifles innovation.”

Yet it’s pretty easy to see why Craigslist should care that others are building on top of and extending its service. What makes the company so valuable is its strong network effect. People go to Craigslist because that’s where the people are. If it loses that, it loses its business.

PadMapper aggregates and presents listings not just from Craigslist, but from other apartment listing sites as well, including Apartments.com and Rent.com. This is great for users because they only need go to one site to browse all the listings across multiple databases. It’s bad for Craigslist, however, because it makes it less of a focal site. Such aggregators make it less important that an apartment be listed at Craigslist specifically as long as it is in the aggregated list.

PadMapper also offers listings of its own listings through its PadLister service. This means that PadMapper relies on the network effects that Craigslist has developed in order to draw in an audience, and then promotes and sells its own listing service to that audience. While that business model is certainly innovative, and may not violate copyright, it doesn’t sit well, either.

Craigslist disrupted the newspaper industry by decimating traditional classifieds. It did this by offering a better alternative to its competitors that attracted consumers away from newspapers. Craigslist didn’t copy newspaper ads to jumpstart its operation, just as Facebook didn’t jumpstart its network by copying over MySpace accounts. That’s true innovation: taking command of the network effect by offering a superior product. So shouldn’t we expect the same from new entrants in the classifieds space?

Some don’t think so. 3taps, for example, is pretty clear that it thinks data about classified ads should be “public property.” In several white papers that do violence to economics the company proposes a “data commons” and also calls for “exchange neutrality,” the idea that sites like eBay, Craigslist, Monster.com, and Match.com would have to make their users postings available for anyone else to take and use on their own sites because “[s]ociety at large, not just a few, should benefit from the coming breakthroughs in availability of exchange-related information.” It’s not clear what incentive new or existing posting services would have to operate or innovate if they were forced to give up any possibility of exclusive use of data.

This is not to say that Craigslist’s claims in court are all correct. The company should fail on its copyright claims. For one thing, a site like PadMapper only copies facts about a listing (i.e. 3 bedrooms, 800 sq. ft., $2,000 a month, etc.), and mere facts are not subject to copyright. Additionally, as the court ruled last week, in order to exclude others Craigslist would need an exclusive license to listings from its users, a high bar that it likely hasn’t met and can probably never meet. Additionally, Craigslist brought actions under the Computer Fraud and Abuse Act. This is problematic because, if successful, the charge would equate with hacking some common practices of many Internet users, such as using proxy servers.

It’s unfortunate that Craigslist has sought to rely on such claims to protect itself, but one can understand why it might have thrown the kitchen sink into its lawsuit. The common law legal theories otherwise available to it, like trespass to chattels and misappropriation, are controversial and somewhat untested in the Internet space. Perhaps this will be the case to flesh them out.

By billing itself as a public service, Craigslist certainly put itself in a position to be at the short end of the PR stick now that it’s acting like it cares about its market dominance. Despite this hypocrisy, and despite the fact it’s using some bad legal theories to advance its claims, we shouldn’t give up on the healthy notion that if others want to displace Craigslist, they should do so by building their own user base. It’s the least one can expect from an innovator.

To Fight Pandemics, Reward Research

Tyler Cowen — Tue, 07 May 2013 09:07:10 -0400

Expert Commentary

That frightening word “pandemic” is back in the news. A strain ofavian influenza has infected people in China, with a death toll of more than 25 as of late last week. The outbreak raises renewed questions about how to prepare for possible risks, should the strain become more easily communicable or should other deadly variations arise.

Our current health care policies are not optimal for dealing with pandemics. The central problem is that these policies neglect what economists call “public goods”: items and services that benefit many people and can’t easily be withheld from those who don’t pay for them directly.

Protection against communicable diseases is a core example of a public good, as is basic scientific research, which can yield new ideas that may be spread at very low additional cost. (In contrast, Medicare, which is publicly financed, has some elements of a public good, but any particular expenditure tends to benefit an individual receiving treatment, rather than being spread over a number of beneficiaries.)

One obvious step forward would be to exempt biomedical research from cuts of the current federal budget sequestration. Research and development grants are a way to pay potential innovators up front — an important move, as an innovator can’t always charge high-enough prices for the value of its remedies when they’re actually needed.

If a pandemic became a major issue in the United States, demand for remedies would surge far beyond the level associated with a typical seasonal flu outbreak, and permitting high prices would be unpopular — and perhaps unfair. The threat of contagion also makes it crucial to spread the net of protection as widely as possible, which again suggests low prices.

Yet it is crucial to have some reward system in place for medical innovators. Well in advance of a pandemic, research needs to be done, and vaccine capacity and drug distribution facilities need to be built up. In the H.I.V./AIDS crisis, for instance, the United States was caught flat-footed — and an appropriate response has taken decades, in part because we were not prepared. Without government financing for such public goods, the capacity wouldn’t be there if a new pandemic produced a surge in demand. This would amount to an institutional failure.

The government could also take another, more unusual step: it could promise to pay lucrative prices for the patents on drugs and vaccines that prove useful in dealing with pandemics. The point of buying the patent is to distribute the remedy, if needed, as widely and as cheaply as possible. If the pandemic never occurs, the reward wouldn’t have to be paid. But the very promise of such a reward might induce suppliers to take the risk of increasing capacity in advance.

Without such a government promise, private patents could easily lead to very high prices and limited distribution, as has already occurred for some cancer drugs, which are being sold to patients for more than $100,000 a year.

If anyone doubted a government pledge to pay big money for the rights to remedies, the patent’s value could be established by a competitive auction. Michael Kremer, a Harvard economics professor, outlined the procedure for such an auction in his research paper“Patent Buyouts.”

The government should resist the strong temptation to skimp on rewards. Many health care breakthroughs come through university research programs and government grants, but bringing an innovation to fruition and managing wide and rapid distribution usually requires the profit-seeking private sector. In any single instance, the government could save money by confiscating rights, but in the longer run this would discourage the search for additional remedies.

If anything, the American government — or, better yet, a consortium of governments — should pay more for pandemic remedies than what market-based auctions would yield. That’s because, if a major pandemic does arise, other countries may not respect intellectual property rights as they scramble to copy a drug or vaccine for domestic distribution. To encourage innovations, policy makers need to bolster the expectation of rewards.

How many drugs should we cover with such prizes, and then distribute free or at minimal charge? It’s an interesting but perhaps insoluble moral question. But in the meantime, economics can offer practical advice. If the remedy is a public good, as is the case in fighting a communicable disease, the value of widespread treatment will make cheap distribution a good idea.

Unfortunately, the United States lacks strong political coalitions for many beneficial public health measures. The Democratic Party has focused on insurance coverage and Medicaidexpansion as political issues, while often wishing to lower prices of drugs or to weaken patent protection. The Obama administration’s new budget lowers spending onpharmaceuticals by an estimated $164 billion over 10 years, mostly through bargaining down Medicare drug prices. That makes it hard for the Democrats to embrace lucrative rewards for pharmaceutical companies or vaccine producers.

Nor can we expect much on pandemic preparation from the current Republican Party, which has been focusing its fiscal conservatism on discretionary spending. That means disproportionate cuts for public health and research and development. This decision can be seen as at odds with a true conservative philosophy, which usually embraces the provision of public goods like a strong military and general national security. Such goods can also serve the purpose of protecting against bioterror.

Over all, the American government seems to be turning its back on its traditional role of producing and investing in national public goods. If there is any consistent tendency in recent government spending, it is that spending on entitlements like Social Security and Medicare — which provide mostly private benefits — is rising and that investment and spending on national public goods is falling.

As a budget category, “government consumption and gross investment” is a proxy for many kinds of public goods spending. As a share of gross domestic product, it has fallen to less than 19 percent, from a peak of 24 percent in the 1980s, with no expected reversal in sight. Yet total government spending is expected to increase because of income transfers and entitlements. Neither political party seems able to halt that logic or even cares to make an issue of it.

Focusing government on the production of public goods may sound like a trivial issue, too obvious to be worth a mention. But, in fact, we have been failing at it, and the consequences could be serious indeed.

Ask the Experts: Unemployment

Keith Hall — Tue, 07 May 2013 09:03:31 -0400

Expert Commentary

Need to Know on PBS interviewed Mercatus Center's Keith Hall and the Roosevelt Institute's Mike Konczal

This week the focus of our program is on unemployment and what having long-term unemployed workers means for our economy. April’s job numbers, released today, have many optimistic about a turn-around in our economy. 165,000 jobs were added this month and the unemployment rate dropped to 7.5 percent from 7.6 percent in March. The New York Times spoke with Steve Blitz, an economist with ITG, who is quoted saying, “It’s back to normal for this cycle, this number is back to the mainstream of what we’ve seen in this recovery.” However, Mr. Blitz also noted, “many of the new jobs were in lower-paying sectors like retail and food services.”

This surge of employment in low-skilled industries does not address the drought of American mid to high-skilled workers, who have not been able to fill vacancies in sectors such as manufacturing and high-tech. In this week’s program, Rick Karr introduced us to a program in Seattle by The National STEM Consortium, an alliance of ten community colleges in nine states, that works to (re)train workers for high-demand, mid-skill technical careers. The Consortium seeks to stem the tide of an increasingly chronicled inhibitor to the recovery: the skills gap. We spoke with experts on the issues surrounding American workers’ ‘skills mismatch’ back in February. In this edition of Ask the experts, we’ve consulted two of the nation’s leading economists on the stubborn problem of American unemployment and what fixes we might attempt to lower the rate.

How can we (or should we) incentivize or educate small businesses to train potential workers who may not have the precise skills businesses are looking for but who have been in the workforce before?

Keith Hall: The magnitude of the labor market challenge that we face is much too large to be primarily a worker skills problem. We are over 10 million jobs below the employment rate we had prior to the start of the recession. First and foremost we need a much stronger economic recovery. The best thing we can do to help is listen to small business concerns and reduce the huge economic policy uncertainty that exists for them. For example, the National Federation of Independent Business conducts a monthly survey of small business owners. When asked to list their single most important problem, “taxes” and “government regulations and red tape” have consistently ranked first and second – even ahead of “poor sales.” A distant seventh on the list of concerns is “quality of labor.”

One reason the magnitude of the employment problem is under-appreciated is that the unprecedented disengagement from the labor force has made the official unemployment rate a poor indicator of the recovery. For example, the unemployment rate peaked in October of 2009 at 10.0 percent. That month, the employment rate (the share of the population with employment) was just 58.5 percent. Although the unemployment rate today is much lower (7.5 percent), we are still at a very low 58.6 percent employment rate. This has occurred because we’ve averaged 132,000 new jobs per month since then – only enough to keep up with our growing population; and that means nearly 100 percent of the unemployment rate drop was from a decline in labor force participation, not from job creation.

Unemployment among youth is a particularly difficult, systemic problem. According to the Bureau of Labor Statistics, in July 2012 the youth unemployment rate was 17.1 %. Some have said job creation and apprenticeships are potential tools to curbing this issue. What do you think is the most prudent course to address this specific age group’s unemployment?

KH: The problem of high youth unemployment is not necessarily an indication of anything lacking in education or skills. Basic job creation will help the most and increased use of apprenticeships to keep youth engaged in the labor market may contribute as well. In a sense, youth are taking a double-hit from this recession.

First, their unemployment rate rose more than it did for the rest of the labor force, and as a result they are over-represented in the number of long-term unemployed. When employers cut jobs, they do what they can to let attrition reduce employment levels and don’t generally layoff more than they need to. This leaves fewer open positions for new graduates.

Second, experienced workers have been much less likely to shift jobs as they normally would to advance in their careers. Older workers have even delayed retirement as their wealth has taken a big hit from the recession. This may continue to severely impact younger workers for years. According to the Bureau of Labor Statistics, two-thirds of new jobs are replacement jobs. This means that even when younger workers find jobs, many will likely remain behind in their careers and suffer from years, or even decades of lower earnings growth as they have fewer opportunities for advancement.

Some argue that it is not simply structural unemployment that is preventing the unemployed from getting jobs because all types of workers are still unemployed. Is this a far assessment of the long-term unemployment problem?

KH: Yes it is. Economic data indicates that most of the current unemployment remains because of the very slow economic recovery. After the recession officially ended, the economy grew 2.4 percent in 2010. In 2011, growth slowed to 2 percent and in 2012 it slowed further to just 1.7 percent. Historically, economic growth of just 1.7 percent is consistent with only about 120,000 new jobs per month – well below the actual 183,000 monthly average we had last year. Productivity only grew 0.7 percent as businesses held on to workers despite weak sales. The labor market has actually been out-performing GDP growth.

Historically, long-term unemployment follows a predictable business-cycle pattern; rising months into a recession and remaining elevated well after a recession. The explanation for the latter is that we need above average economic growth to fuel much stronger job growth than we’ve experienced to see a significant reduction in the number of long-term unemployed. It may well be the case that we will have a rise in structural unemployment later on, but we won’t know that until we have a much more robust economic recovery. In any event, increased government spending on worker training is likely to have very little payoff when there is such modest job creation.

Konczal: I think this is an incredibly important thing to note. The economy remains weak for those who have jobs in addition to those without them. People with jobs aren’t quitting their jobs to find new ones. They also aren’t receiving raises, sometimes even for the cost of living. People who have only been unemployed for a short period of time still face a weaker job market. And if you look at the long-term unemployed, there’s nothing particularly distinct about them; there aren’t really any specific industries or occupations that are over-represented.

When unemployment hit 4 percent in 2000, a lot of the “problems” of the long-term unemployed turn out to be an illusion, and employers went out of their way to train people or otherwise bring them up to speed.

At this point, is there anything the Federal government can do or has not done so far to address the national unemployment numbers? Is the problem better served on the state level?

KH: While I certainly believe that lack of job creation is the most important economic problem we have, I think that the Federal government needs to focus first-and-foremost on setting the right conditions for private sector economic growth. There is a tremendous amount of economic policy uncertainty at the moment that is undoubtedly helping to hold back job growth. This needs to be resolved.

One thing the Federal government should not do is rush to intervene in labor markets. Training workers for jobs that don’t exist is a waste of taxpayer dollars and can serve to suppress market wages when there isn’t a labor shortage. For example, the Recovery Act Green Jobs Program allocated $500 million to the Department of Labor to prepare workers for careers in energy efficiency. Even after a 2011 Inspector General report recommended that they re-evaluate the program “given the current demand for green job-related skills and the job market for green jobs,” the program continued on to an unsuccessful completion. Last year, another Inspector General report noted that less than 12,000 participants found and retained employment for longer than six months. This is a very poor payoff in a labor market where millions are unemployed.

MK: The biggest problem for the long-term unemployed is just a general lack of jobs, rather than them not meeting the specific needs of employers. At least for the near future, Congress and the Federal Reserve could do more on this front. Certainly, they can ascribe to a “do no harm” approach, and not cut the recovery off before it begins. Further, Congress could pull back on some of the austerity in place for 2013-2014, and the Federal Reserve could commit to a quicker recovery.

Defense Spending and the Economy

Robert J. Barro , Veronique de Rugy — Tue, 07 May 2013 16:45:52 -0400

Publication

While the potential impact of across-the-board federal defense spending cuts on national security may be up for debate, a new study published by the Mercatus Center at George Mason University finds dire predictions of these cuts’ impact on the economy and jobs grossly overblown.

In “Defense Spending and the Economy,” Harvard University professor of economics Robert Barro and Mercatus Center senior research fellow Veronique de Rugy survey existing research on the “multiplier effect” of an extra dollar of government spending on GDP to examine the economic impact of changes in federal defense spending.

The existing studies found that a dollar increase in federal defense spending results in a less-than-a-dollar increase in GDP when the spending increase is deficit financed. Combining this with a tax multiplier that is negative and greater than one, the authors estimate that over five years each $1 in federal defense-spending cuts will increase private spending by roughly $1.30.

Below is a brief overview. To read the study in its entirety and learn more about its authors, please see “Defense Spending and the Economy.”

SUMMARY

Background: The Sequester and Lessons from World War II

As required by the Budget Control Act of 2011, the federal government is scheduled to cut $1.2 trillion [at time of writing] from its current baseline over the next nine fiscal years, starting in March 2013. The automatic spending reductions, through a process called sequestration, are to be divided equally between discretionary defense and nondefense spending categories.

Predictions that the sequester’s defense-spending cuts will have a dire economic impact should be viewed skeptically in light of the nation’s experience with much larger defense-spending drawdowns—including following World War II and the end of the Cold War—neither of which resulted in predicted economic declines.

In 1943, Keynesian economist Paul Samuelson predicted the dramatic drop in federal defense spending and the reintegration of 10 million servicemen into the civilian labor force following the end of World War II would usher in “the greatest period of unemployment and industrial dislocation which any economy has ever faced.” He recommended the government maintain wartime price controls, implement “income maintenance,” and engage in large-scale public works to avert this dire outcome. But the postwar bust Samuelson and many others expected never occurred.

Despite plunging war production and massive discharges of soldiers, the government offered no dismissal pay for soldiers, dismantled direct controls on the private economy, and did not implement any large-scale public works programs.

As Henderson (2010) points out, despite the massive drop in government spending—from 41.9 percent of GDP in FY 1945 to 14.7 percent in FY 1947—unemployment rose only modestly from 1.9 percent to 3.6 percent. Similarly, the economy grew a respectable 3.3 percent annually from 1978 through 2000, even as the share of defense spending dropped from 7.4 percent of GDP to 3.7 percent.

The Spending Multiplier

The spending multiplier measures the effect of an extra dollar of government spending on total economic output, gauged by real GDP.

If the spending multiplier is positive and greater than one, private sector portions of GDP (notably personal consumer expenditure and private domestic investment) increase with an increase in government spending.
If the multiplier is positive but less than one, GDP rises, but not by enough to maintain the private sector portions of GDP, which are crowded out when government purchases increase.
If the multiplier is negative, GDP declines, and the private sector portions of GDP must fall by more than the expansion of government purchases.

The Defense-Spending Multiplier The defense-spending multiplier is commonly assumed to be large (or significantly greater than one). If that were correct, it would mean that a reduction in defense spending will directly affect not only military contractors; it would also have major, harmful secondary effects on contractors’ clients, on services that cater to defense-sector workers, and so on.

This ripple effect argument ignores the fact that resources freed from defense or other public purposes become available to private businesses and households.
While measuring the direct effects of government programs on production and employment is comparatively easy, tracing how the private sector uses the freed-up resources to expand production and employment is impossible.
The key issue is not how government outlays can have beneficial direct and indirect effects, but whether these economy-wide spending multipliers are greater than one, positive but less than one, or negative.

Empirical Studies of Spending Multipliers

Defense spending multipliers, which in many cases assume deficit-financed spending, are generally less than one:

Barro (1984) found that defense spending multipliers were around 0.6 for spending increases associated with World War I, World War II, and the Korean War.
Hall (1986, 2009) found similar spending multipliers using US data on defense outlays for 1920–42, 1947–82, and 1930–2008, respectively.
Barro and Redlick (2011) estimated spending multipliers of 0.4 to 0.5 within a year, rising to 0.6 to 0.7 over two years, and expanding further by 0.1 to 0.2 when the public sees the changes as largely permanent.
Ramey (2011) found multipliers of around 0.6 in the short run, cumulating to a peak of about 1.2 after two to three years.

Aggregate Effects of the 2009–10 Federal Stimulus Package

Under the American Recovery and Reinvestment Act, the federal government spent roughly $300 billion (2.1 percent of GDP) extra in both 2009 and 2010. The macroeconomic effects of this deficit-financed spending could be gauged by empirical estimates of defense-spending multipliers.

Using a spending multiplier of 0.4 within the current year and 0.6 over two years, Barro and Redlick (2011) found that increased government spending would reduce private-sector portions of GDP. However, the short-term deal is quite favorable: the added government spending of $600 billion over two years comes at a cost of only $300 billion in private spending—or 50 cents on the dollar.
But to the extent this government spending does not fall, as it did not, the subsequent increase in debt will require an increase in taxes at some point.

Romer and Romer (2010) and Barro and Redlick (2011) suggest tax multipliers with a one-year lag around -1.1; that is, GDP falls the next year by $1.10 for each dollar increase in federal taxes.

Real GDP falls overall because the “balanced-budget multiplier” is negative, given that the government-spending multiplier is between 0.4 and 0.6 and the tax multiplier is -1.1. Thus, the stimulus package of 2009 was a way to get an extra $600 billion of public spending at a cost of $900 billion in private spending—not an attractive deal.

Aggregate Effects from Cutbacks in Defense Spending

Treating sequestration as a cut of five percent in defense outlays, defense spending would fall $34 billion in 2013 from its 2012 level of $677 billion. For given taxes and other federal spending, the defense-spending cut reduces the federal deficit. Hence, the public debt is lower than it would be otherwise and requires correspondingly lower taxes in the long run when compared to a benchmark path (if other federal spending does not change).

Using a defense-spending multiplier of 0.4 within a year and 0.6 over two years and assuming that taxes have a multiplier effect on GDP of -1.1 with a one-year lag, real GDP falls compared to the benchmark path by $13.6 billion in 2013 (because of the spending multiplier) but rises by $17 billion in 2014 (because the effect from the tax multiplier more than offsets the spending effect).
Private-sector portions of GDP rise by $20.4 billion in 2013 (60 cents on the dollar compared to the spending cut) and $51 billion in 2014 (because GDP is now above its benchmark).
The effect of +$17 billion on real GDP continues into the future.
Relative to the benchmark path, defense spending falls by $170 billion, taxes are cut also by $170 billion, private sector portions of GDP rise by $224 billion, and real GDP increases by $54 billion by 2017.
In other words, over five years, we get roughly $1.30 of extra private spending for each $1.00 reduction in defense spending.

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There's Nothing Fair About an Internet Sales Tax

Nita Ghei — Tue, 07 May 2013 12:01:32 -0400

Expert Commentary

Just a few years ago, retail giant Amazon primarily stood on the sidelines of the debate over federal legislation – dubbed the Main Street Fairness Act – to require online retailers to collect sales taxes. But now Amazon is front and center supporting the current iteration of the bill wending its way through Congress. Amazon's support aside, the tax revenues that states may be able to extract would be far dwarfed by the damage the legislation inflicts on growth, innovation and competition, and by further entrenching cronyism in our already troubled economy.

Amazon's volte-face on an Internet sales taxes is a reflection, ironically, of its success. It is placing warehouses in more states as part of its plan to improve shipping speeds. That means that it is required to collect sales taxes in an increasing number of states – existing Supreme Court precedent limits the obligation to collect sales taxes to retailers with a physical nexus to the state, such as a retail store or a warehouse.

There is, consequently, far less reason for Amazon to oppose the tax regime proposed by the Marketplace Fairness Act than in 2011. On the contrary, Amazon now has good reason to throw in with other big bricks-and-mortar retailers like Walmart and lobby for the change because of the burden it would impose on potential competitors.

The act would require all online retailers with gross out-of-state sales exceeding $1 million to collect sales taxes imposed by the destination taxing jurisdiction. Compliance would be extraordinarily onerous and expensive, with upwards of 9,600 taxing jurisdictions in the country among the 45 states with sales taxes. The tax rates, as well as the scope of goods taxed, also varies widely.

Under the legislation, states would have to provide software with the appropriate tax rates, but that still leaves the burden on retailers of incorporating the information and actually collecting the tax, a burden that will hit smaller retailers disproportionately hard. Resources that go toward compliance are no longer available for expansion and innovation. True, a cottage industry for tax collection would likely flourish, but compliance jobs do not increase productivity or enhance welfare as higher compliance costs are inevitably passed on, at least partially, to consumers in the form of higher prices.

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Financial Market Utilities

Hester Peirce — Mon, 06 May 2013 09:31:50 -0400

Publication

The Regulatory Studies Program of the Mercatus Center at George Mason University is dedicated to advancing knowledge about the effects of regulation on society. As part of its mission, the program conducts careful and independent analyses employing contemporary economic scholarship to assess rulemaking proposals and their effects on the economic opportunities and social well-being available to all members of American society. Thus, this response to the notice of proposed rulemaking regarding financial market utilities by the Board of Governors of the Federal Reserve System (Board) does not represent the views of any particular affected party or special interest group but is designed to assist the Board as it seeks to implement Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

The proposed rules would implement sections 806(a) and (c) of Dodd-Frank, which allow the Board to authorize Reserve Banks to establish and maintain accounts for, provide certain services to,[1] and pay interest on balances maintained by or on behalf of financial market utilities (FMUs) that are designated by the Financial Stability Oversight Council (FSOC) as systemically important or likely to become systemically important.

This public interest comment, which focuses primarily on designated FMUs that are central counterparties (CCPs), raises fundamental concerns about the new regulatory regime for FMUs, the implications of granting these entities bank-like privileges at the Reserve Banks, and the possibility that one or more FMUs will be bailed out at taxpayer expense. Before proceeding with this rulemaking— which is discretionary, yet raises serious policy issues—the Board should take a broader look at the potential risks associated with CCPs under the Dodd-Frank regulatory regime, the resultant potential exposure of the Federal Reserve and US taxpayers to losses, and the need for modifications to the Dodd-Frank framework to control those risks and avert losses.

BACKGROUND AGAINST WHICH THE PROPOSAL MUST BE ASSESSED

Under Title VIII of Dodd-Frank, the FSOC has the authority to designate FMUs that are, or are likely to become, systemically important.[2] These designated FMUs are subject to a heightened regulatory regime and—conditioned on Board authorization—are able to establish Federal Reserve accounts, obtain Federal Reserve services, earn interest on account balances, and avail themselves of discount and borrowing privileges “in unusual or exigent circumstances.”[3] The FSOC designated eight FMUs on July 18, 2012.[4] Among the designated FMUs are several that clear securities or derivatives transactions, including Chicago Mercantile Exchange, ICE Clear Credit, and the Options Clearing Corporation.

CCPs, which are commonly referred to as clearinghouses, are cornerstones of Dodd-Frank’s over-the- counter derivatives reforms. Dodd-Frank requires many over-the-counter derivatives—swaps and security-based swaps (referred to herein collectively as “swaps”)—to be centrally cleared. Proponents of this portion of Dodd-Frank point to its ability to reduce—or at least move to a purportedly safe institution—risk in the large swaps market. By stepping in after a transaction is executed and serving as the buyer to the seller and the seller to the buyer, CCPs eliminate the need for buyers and sellers to take each other’s credit and liquidity risk into account. Counterparty risk is normally an important consideration, particularly in long-dated swaps contracts. When a contract is centrally cleared, parties to the transaction need only worry about the creditworthiness of the CCP.

As a consequence of Dodd-Frank’s emphasis on central clearing of swaps, CCPs are rapidly assuming the difficult tasks associated with clearing swaps, including gaining an understanding of the risks of complex swaps and swap market participants, collecting appropriate margin, and making any necessary adjustments to guaranty funds. CCPs likely will be bigger, have higher concentrations of risk, and be of greater systemic importance than they were before Dodd-Frank.[5] The consequences of the mandate will become clearer as it takes effect, but it “will alter the behavior of market participants in many dimensions,” potentially including “effects on liquidity, capital structure (leverage), risk taking, and risk management decisions of financial and non-financial firms, and on their trading and financing decisions during times of market stress.”[6] CCPs’ “ability” and “incentives to self-regulate their operations and risk management procedures” are likely to suffer.[7]

In response to these changes, Dodd-Frank also places renewed emphasis on regulatory oversight of CCPs. Depending on the type of products they clear, CCPs register with the Commodity Futures Trading Commission (CFTC) as derivatives clearing organizations or with the Securities and Exchange Commission (SEC) as clearing agencies. Dodd-Frank gave the SEC and CFTC substantial authority to regulate and examine the clearinghouses within their ambit. The Board has backup authority over designated FMUs for which the SEC and CFTC serve as primary regulators.

PROPOSED RULE

The proposed rulemaking relies on permissive authority in Dodd-Frank to amend Regulation HH to allow Federal Reserve Banks to enter into agreements pursuant to which a designated FMU could have an account at and receive services and interest from the Reserve Bank. These privileges, which were previously limited to depositories, would allow FMUs to reduce their reliance on settlement banks.[8] The proposed rule conditions the authority to extend such privileges to an FMU on the Reserve Bank’s “ensur[ing] that its establishment and maintenance of an account for or provision of services to a designated financial market utility does not create undue credit, settlement, or other risk to the Reserve Bank” and requires the FMU to, in the Federal Reserve Bank’s judgment

1. be generally in sound financial condition;

2. be in compliance, based on information provided by the Supervisory Agency, with requirements imposed by its Supervisory Agency regarding financial resources, liquidity, participant default management, and other aspects of risk management;

3. be in compliance with [Board and Reserve Bank requirements regarding accounts and services]; and

4. demonstrate an ongoing ability, including during periods of market stress or a participant default, to meet all of its obligations under its agreement . . .[ 9]

With respect to swaps CCPs, these conditions will entail coordination between the Federal Reserve Banks and the CFTC or SEC, but will also allow the Reserve Banks to exercise a measure of independent discretion.

The Board’s stated objectives in the proposed rulemaking are “reducing settlement and systemic risks and strengthening the settlement processes of designated FMUs through the use of Reserve Bank accounts and services, while limiting risk to the Reserve Banks.”[10] The Board requested comment about whether additional conditions are necessary to achieve these objectives “while limiting risk to the Reserve Banks.”[11] Rather than looking only at whether and how to modify the list of conditions on account access, the Board should undertake a broader review of the potential implications of the new relationship between FMUs and the Federal Reserve, of which this proposal is one piece.

NEED FOR REGULATORY IMPACT ANALYSIS

The need for a thorough regulatory analysis in connection with this proposal stems from the marked shift it reflects in the availability of Federal Reserve resources to FMUs. Indeed, in the notice, the Board acknowledged that “the establishment of an account for a designated FMU at a Reserve Bank also may entail broader policy considerations and implications.”[12] Nevertheless, the notice made no mention of a regulatory analysis, something that the President has encouraged independent regulatory agencies to undertake[13] and something that Board policy requires.[14] Specifically, the Board’s policy requires a regulatory analysis for all nontechnical regulations that do not need to be expedited.[15] The notice did not include any indication that this is an expedited rulemaking, and, because of its discretionary nature, this is not the type of rulemaking that would be expedited under the Board’s policy statement.

Given the policy implications and potential risk to the Reserve Banks, there is good reason not to expedite this rulemaking but instead to conduct an exhaustive regulatory analysis of the sort envisioned by the Board’s policy statement. The policy statement calls specifically for the analysis to “discuss the need for and purposes of the regulation, set forth the various options available, discuss, where appropriate, their possible economic implications, evaluate their compliance, recordkeeping, and reporting burdens, and recommend the best course of action based on an evaluation of the alternatives.”[16]

An analysis of the proposed rule should include a consideration of the costs and benefits— including Federal Reserve exposure to losses[17] and competitive impacts[18]—of allowing designated FMUs to have accounts at Reserve Banks and avail themselves of services provided by Reserve Banks. In addition, it should look at the broader implications of transforming the relationship between the Federal Reserve and designated FMUs. Conducting such an analysis would help the Board, Congress, the President, and the public to understand the implications of the proposed rulemaking in the post-Dodd-Frank environment of swap clearing mandates.

CCP VULNERABILITY AND FEDERAL RESERVE RESCUES

There is wide agreement that the ramifications of a CCP experiencing difficulties would be felt throughout the financial system. CCPs will house a lot of risk and have relationships with a lot of significant financial institutions. The inability of a CCP to meet its obligations would be most likely to occur, and the consequences would be most devastating, during a time of systemic financial stress. Title VIII of Dodd-Frank allows the Federal Reserve to come to the aid of CCPs and other designated FMUs, but the scope and exact nature of the help that it could provide remains murky and subject to Board interpretation. Accordingly, the Board’s rulemaking regarding FMUs’ access to Federal Reserve assistance must be undertaken only after careful consideration of the consequences for markets and for taxpayers.

In a 2011 speech, Chairman Bernanke observed that “the failure of, or loss of confidence in, a major clearinghouse would create enormous uncertainty about the status of initiated transactions and, consequently, about the financial positions of clearinghouse participants and their customers.”[19] He noted that CCPs performed well during the last crisis, but cautioned that “we should not take for granted that we will be as lucky in the future.”[20] Bernanke emphasized the need for coordination among regulators and strong public and private monitoring of clearinghouse risk management.

Mr. Bernanke takes the position, however, that even with a strong regulatory structure in place, the Federal Reserve has a role to play in supporting CCPs during times of system-wide stress. Indeed, the Federal Reserve has done this in the past, albeit without the tools given to it by Dodd-Frank. As Bernanke described in an article that looked at clearing during the October 1987 stock market crash, the “Federal Reserve played a vital role in protecting the integrity of the clearing and settlement system during the crash.”[21] He explained that “conceptually, it is as if the Fed had provided ex post insurance to the clearinghouse against a shock that it seemed possible would exhaust the insurance capability of the clearinghouse itself. Thus the Fed became the ‘insurer of last resort.’”22 Rather than vainly attempting to completely armor CCPs, Bernanke suggested that “the government, especially the central bank, should be thought of as part of the system [that] protects the clearing and settlement systems, should they be in danger.”[23]

The proposed rulemaking takes a significant step towards ensuring that the Federal Reserve will be considered part of the clearing and settlement system. Opening up the opportunity for designated FMUs to establish accounts at and receive services from the Reserve Banks, privileges previously generally limited to depository institutions, would blur the line between FMUs and banks and thus make it easier for the Federal Reserve to provide support to these institutions without public notice or accountability.[24] Dodd-Frank also permits the Federal Reserve to provide “discount and borrowing privileges” in “unusual or exigent circumstances.”[25] There is no mention of a requirement that the FMU provide good collateral in connection with discount window access.[26] Moreover, the fact that access can be granted in unusual or exigent circumstances suggests that it may be available even during nonemergencies.[27] Even if the Federal Reserve’s role is limited to providing liquidity to a temporarily cash-strapped clearinghouse, as Craig Pirrong has observed, “ostensible liquidity support could be in fact a bailout of an insolvent institution.”[28] Given the highly international nature of the swaps markets and the clearinghouses that serve them, the Federal Reserve could even end up rescuing a non-US entity.[29] Together, the proposed rule and the open-ended potential for discount window access “constitute a potentially significant, explicit expansion of the federal safety net.”[30] This expansion merits public discussion.

Although some observers strongly support central bank backing of CCPs,[31] the costs and benefits of the central bank’s serving as insurer of last resort for clearinghouses deserve further consideration. Given that this proposed rulemaking would begin the transformation of the Federal Reserve’s relationship with designated FMUs, the Board should undertake that consideration in connection with this rulemaking. It should do so in light of the emerging and already troubled regulatory structure for swaps CCPs.

OBSTACLES TO EFFECTIVE REGULATION

The prospect of the Federal Reserve’s coming to the rescue at a time of trouble creates moral hazard. A CCP will take more risks, and its members will be less careful, because they understand that the CCP has the ultimate backing of the government.[32] By laying the groundwork for Federal Reserve involvement when things go wrong, Dodd-Frank thus undermines the clearinghouse’s own incentives for prudent risk management.[33] Dodd-Frank attempts to address this by providing for intense regulatory oversight, but there are numerous barriers to the success of regulatory endeavors to manage clearinghouse risk.

First, regulators are driven by considerations other than safety and soundness in their regulation
of CCPs. There is intense pressure on regulators to move more derivatives into CCPs, and correspondingly less emphasis on safety and soundness of CCPs.[34] Regulators are also less likely to ensure that CCPs carefully assess the risks associated with the new products and the dynamic correlations among different products that CCPs clear. In addition, regulators are under pressure to make CCPs broadly accessible,[35] which could increase CCPs’ exposure to risky clearing members.

Second, the CFTC and SEC do not have strong histories of CCP oversight and may be continuing that tradition. Recently, for example, CFTC Chairman Gary Gensler told the Senate Agriculture Committee that “we’re also not doing the examinations that we really should be doing of the clearinghouses . . . we do not have staff examining clearinghouses annually for their risk management and we’re pushing— statutorily pushing—all sorts of additional transactions into clearinghouses.”[36]

Finally, there are significant barriers to effective regulatory coordination. Dodd-Frank includes a provision that prohibits the CFTC from sharing information about CCPs with another regulator without an indemnification agreement from the other regulator.[37] Ongoing disputes with international regulators about the proper reach of US regulatory authority have further complicated regulatory coordination.[38]

The discretionary element in the proposed rule enables the Reserve Banks to supplement risk management requirements imposed by the relevant supervisory agency. In this sense, the proposed rule may represent something of an end-run around Dodd-Frank’s allocation of primary regulatory responsibility over CCPs to the CFTC and the SEC.[39] The authority to make this type of change in the regulatory oversight of CCPs rests with Congress. A thorough regulatory analysis in connection with the proposed rule would look at whether obstacles to sound regulation of CCPs increases the risk that the Federal Reserve would incur losses in connection with exercising its authority to grant bank-like privileges to CCPs.

CONCLUSION

In the midst of the debate about whether Dodd-Frank has solved the too-big-to-fail problem, little attention has been paid to Title VIII’s role in establishing a set of too-important-to-fail entities with a government backstop.[40] The notice of proposed rulemaking raises the issue of what kind of Federal Reserve support is appropriate for CCPs that the FSOC has deemed to be systemically important. It does so without asking—or allowing the public to comment on—basic questions about the particular proposal, let alone more fundamental questions about the costs and benefits of installing the Federal Reserve as ex ante insurer of last resort to CCPs. Before proceeding, the Board should look at these questions. It should consider what the problem is that it is trying to solve and whether making Federal Reserve accounts and services available to designated FMUs solves that problem more effectively than alternatives would. One alternative is revisiting the regulatory structure put in place by Dodd-Frank, a structure that is causing CCPs to take on—without time for adequate deliberation—extensive and perilously complicated risks, risks that could ultimately be borne by taxpayers.

See Footnotes as a PDF

Labor Participation Remains Low Despite Job Gains

Keith Hall — Fri, 03 May 2013 11:14:28 -0400

Expert Commentary

This year the economy is adding more jobs per month than it did in 2012, according to new data from the Bureau of Labor Statistics. However, Mercatus Center senior research fellow Keith Hall—a former BLS commissioner—said that the labor participation rate is still quite low and the economy is not yet adding enough jobs to stimulate a robust recovery.

“For 2013 so far, we’ve averaged a gain of 196,000 jobs per month, a faster pace than the 183,000 rate in 2012. However, the labor force held constant as the participation rate remained at 63.3 percent, the lowest level since 1979. While the unemployment rate has dropped by 0.4 percentage points since January, this was primarily due to declining labor force participation, as the employment rate held constant over this period.”

Although the unemployment rate has dropped to 7.5 percent from a peak of 10 percent in October 2009, the current employment rate of 58.6 percent is nearly the same as the October 2009 rate (58.5 percent), according to Hall.

“Average monthly job gains since the end of the recession have only been enough to keep up with population growth. So most all of the decline in the unemployment rate is the result of people dropping out of the labor force.”

Veronique de Rugy and Will Ruger Discuss Freedom in the 50 States on Stossel

Veronique de Rugy, William Ruger — Tue, 07 May 2013 08:50:03 -0400

Video

Get Uncle Sam Out of the Green Startup Loan Business

Veronique de Rugy — Fri, 03 May 2013 09:58:42 -0400

Expert Commentary

Meet the Solyndra of the electric car industry: Fisker Automotive. In 2009, the company was awarded a $529 million loan through the Advanced Technology Vehicles Manufacturing program. It is in bankruptcy, and has now fired 75 percent of its workforce.

The reality, however failed to meet this goal. It did produce -- at least until last year -- the Karma sedan, a $104,000 plug-in electric hybrid car. But the car wasn't just exclusive and expensive, it didn't even work. According to a recent New York Times article, a Consumer Reports test drive ended with the Karma breaking down and having "to be hauled away on a flatbed truck."

Adding insult to injury, the company used batteries from A123 Systems, another company that went belly-up after receiving government help -- $249 million in 2009 stimulus money, a $9 million grant from the state of Michigan, and another $100 million in tax credits as well as $41 million in tax breaks and subsidies.

In fact, by some accounts, the Fisker loan was meant to ensure a market for A123's batteries. A123 was ultimately purchased by Chinese investors, but there is no evident interest from anyone in buying Fisker today.

This is bad news for taxpayers who will foot that bill, minus the $21 million that the government managed to seize from the company's cash reserves. The silver lining, if we must find one, is that the company was actually doing so poorly and missed so many deadlines that the Department of Energy suspended its support after having guaranteed $192 million of the $529 million loan.

But it gets worse, if you ask me. While the failures of these green-energy loan programs like Fisker or Solyndra are widely publicized, the public and lawmakers pay very little attention to the fact that most of the DOE loans are actually going to well-connected companies that would have been able to get capital without the government's help or are not startups at all.

Under the 1705 loan program, under which Solyndra was funded, the money went to companies like Goldman Sachs and energy giants like NRG Energy. Under the ATVM program, most of the money went to Ford and Nissan (87 percent of the $8.4 billion guaranteed under the program).

Unfortunately, the fact that these companies don't go under after getting a DOE loan is often cited by advocates of these loan programs as evidence of their success. It's nonsense. In fact, the large amount of taxpayer money being funneled to these companies simply highlights the rampant corporate welfare in Washington.

Of course, any recipient company loves the handout because it gives them a significant advantage over the competition. For one thing, it helps attract private investors who now see the projects as safe regardless of their merits.

The Washington Post's Chuck Lane reported earlier this week that, according to public records, "A green-energy loan was the only hope, Fisker executive Bernhard Koehler explained in an e-mail to the Department of Energy -- because it would help bring in private money."

Lane cites Koehler pleading that the company was "oversubscribed in this equity round with the DOE support -- and nowhere without it." And in fact, that's another benefit of these government loans. They allow the recipient company to borrow more money at lower interest rates.

Unfortunately, this favoritism introduces some serious distortions and unintended consequences to the market. Loan guarantees are privileges granted to special interests -- in other words, cronyism -- whether the companies that benefit from the loans go under or stay afloat.

The government shouldn't be in the business of lending money to private companies or providing particular incentives for banks to do so. Besides, as Lane reminded us, former Obama administration chief economic adviser Larry Summers rightfully noted in 2011 that "government is a crappy V[enture] C[apitalist]."

It is time to abolish all government loan guarantee programs. All of them.

Uncreative Destruction: The Misguided War on Vertical Integration in the Information Economy

Adam Thierer, Brent Skorup — Tue, 30 Apr 2013 14:30:17 -0400

Publication

Are information sectors sufficiently different from other sectors of the economy such that more stringent antitrust standards should be applied to them preemptively? Columbia Law School professor Tim Wu responds in the affirmative in his book The Master Switch: The Rise and Fall of Information Empires. Wu proposes preventing vertical mergers in the information economy and the mandatory divestiture of vertically integrated companies. To implement this, Wu proposes a Separations Principle for the information economy, which would segregate information providers into three buckets, which we have labeled information creators, information distributors, and hardware makers.

This article outlines Wu’s separations proposal, explains why his fears regarding vertical relationships should be rejected by regulatory and antitrust policymakers, and illustrates the legal and practical problems his Separations Principle poses. Wu justifies his Separations Principle by citing monopolies and market power in the information economy. He also advocates using U.S. antitrust authorities to enforce his Principle.

We argue that the antitrust harms he fears are not present, and we highlight scholarship on the accepted benefits of vertically integrated firms. We show that Wu’s remedies are policy preferences wrapped in the language of competition law. In fact, the information economy is largely competitive and does not warrant interventionist regulatory enforcement. Since much of American economic vitality flows from the information economy and technology, policymakers should reject a radical antitrust remedy like Wu’s preemptive Separations Principle.