Tuesday, July 29, 2014

Speaking of the drug war....

From the Washington Post. Just another mistaken identity that resulted in the beating of an innocent bystander.
"Josue Gonzalez, 27, fled from police away from Loop 410 along the Highway 151 access road before he exited at Westover Hills and ditched his car in the parking lot of a restaurant. The restaurant is a few hundred feet from where Carlos was standing.
“All three of them started beating me on the head,” said Carlos, who still showed visible signs of the beating when he spoke with KENS 5 weeks after the incident.
“It was unbelievable. I couldn’t believe it was happening to me.”
Carlos said he was struck about 50 times, even though he complied with the officers’ instructions and did not fight back.
Shortly after being handcuffed and explaining to officers that he owned the property, a fourth officer approached and said the suspect was in custody nearby."
And here is an important website from the Cato Institute that tracks police misconduct nationwide.

Discouraging drug use: prohibition or taxes?

Marijuana has been legalized in several states in the U.S. recently, including Colorado and Washington. So fare there have been no major problems with drug use and Colorado officials project to take in $30.6 million in revenue for the first fiscal year. This is not as much as previously projected, however, and one possible reason mentioned in the article is that medical marijuana is a cheaper alternative due to the insurance subsidies and thus people who should be buying retail are getting prescriptions instead. But that is a separate issue that does not change the fact that the Colorado government is making money taxing marijuana.

In my opinion the result in Colorado from legalizing marijuana would hold for harder drugs as well, and I will explain why. Let's take heroin for example. Many heroin uses are addicted to the drug or at the very least really enjoy the effects the drug has on them. If that is true, this means that their demand for the drug is price inelastic, meaning that if the price rises they will not drastically reduce their consumption of the good. Below is a diagram portraying a market for a drug like heroin. Price is on the vertical axis, quantity is on the horizontal axis.

The demand curve is relatively vertical, which portrays the inelastic demand for a drug like heroin. The point Q1*, P1*, where supply curve S1 intersects demand curve D, is the initial equilibrium quantity and price for heroin. The U.S.'s current method for decreasing drug use is largely based on attacking the supply side; the DEA goes after large drug dealers and tries to prevent drugs from crossing the border. They also raid poppy fields in places like Afghanistan to reduce the supply. This can be shown in the graph by shifting supply from S1 back to S2. When this happens the equilibrium quantity decreases from Q1* to Q2* and the price rises from P1* to P2*.

What the diagram shows is that the equilibrium price for heroin increases by more than the equilibrium quantity for heroin decreases. If that is the case, total revenue from selling heroin will actually increase when the supply is reduced from S1 to S2. This is because the increase in the price more than offsets the decrease in the quantity, and since total revenue is price times quantity the total revenue will increase. Depending on a dealers cost structure, their risk aversion, and the penalties for being caught, it is possible that the higher price makes dealing heroin even more lucrative than before the reduction in supply. A relatively high price would induce more dealers to enter the heroin market. In fact, there is evidence that drugs like heroin are more available than ever. The article also claims the drugs are cheaper too, which could happen if the government is unable to reduce supply (shift back to S2) as fast as the dealers increase it (shift S1 to the right), either by expanding existing capacity or from new dealers entering the market.

So if the war on drugs isn't working, what is an alternative? One option is to treat drugs such as heroin like cigarettes and marijuana; legalize them, tax them and regulate them. Below is a graph similar to the one above, only it portrays what an excise tax on heroin would look like.

In this scenario, instead of targeting the supply side governments would tax the demand side. An excise tax would be placed on heroin, like the tax on cigarettes or marijuana. This would shift the demand curve left from D1 to D2. Consumers would pay the high price labeled Pc* and producers of heroin would receive the low price Ps*. The gap between them, the tax, would go to the government.

This policy has some advantages over the first scenario. First, it lowers the price producers receive instead of raising it. Second, governments take in tax revenue equal to the TAX times Q2*. This revenue can be used to fund rehabilitation and education programs for heroin users. Third, the money used to fund the DEA and to care for prisoners convicted of non-violent drug offenses could be used on other things society values, such as infrastructure, education, etc.

The analysis presented here is certainly not complete; some details and dynamics were omitted. But as a first approximation I think it makes a case for legalizing, regulating, and taxing drugs instead of criminalizing them.

Thursday, July 24, 2014

The worker shortage myth leads to crony capitalism

In my inbox on July 22nd was an email from VP Joe Biden. The title is "Good for business, good for workers, good for the economy". In the email he talks about the importance of job training programs:

"During his State of the Union address, the President asked me to lead an across-the-board review of our nation's job-training programs.
It's a top priority for the President, and it is absolutely critical to our economy's success."

The VP states in the email that businesses have told him they can't find workers:

"We’ve heard from businesses that many jobs in today's brightest sectors go unfilled because there simply aren't enough people with the skills to do them. " 

But as I explained in an earlier post, a shortage of workers only exists at a non-equilibrium price. If firms want more workers all they have to do is increase the wage they are willing to pay them. We don't need to use taxpayer money to subsidize worker training for firms. But that is what VP Biden wants to do:

"Some of our country's businesses, community colleges, and state and local training programs -- often supported with federal dollars -- have found ways to successfully prepare Americans for these jobs. " 

The worker shortage myth has led to taxpayers footing some of the bill to train workers for profitable firms. This is crony capitalism, or as John Stossel calls it, crapitalism. Job training programs may be good for businesses and good for the workers who get trained, but they are not good for the economy as a whole and certainly not good for the taxpayers.

Wednesday, July 23, 2014

Joe Biden on rebuilding America

Here is a video just released by the White House of VP Joe Biden trying to convince Americans that it is necessary to rebuild our crumbling infrastructure. But as I pointed out in an earlier post the Obama administration is not interested in maximizing the taxpayer's investment, so why should we trust the government with our money?

Tuesday, July 22, 2014

You can't maximize costs and profit

In the principles of microeconomics class I am currently teaching we just covered the perfect competition and monopoly models. In the beginning of the lecture I explain to them that the goal of a firm is to make a profit. Profit is defined as total revenue minus total costs i.e. Profit = TR - TC. This is pretty basic stuff. After all, a firm won't be in business for long if their total costs exceed their total revenue on a regular basis.

The idea of maximizing profit is common sense for any business owner, yet the federal government has convinced many people that the goal of a government program is to maximize costs, not profit or net benefit. For example, in February of 2014 President Obama signed an executive order mandating that federal contractors be paid no less than $10.10 per hour. This is consistent with his repeated (and misguided) call for an increase in the federal minimum wage to $10.10 per hour.

Also in February, the Obama administration announced new TIGER grants for transportation projects. This program aligns with one of his other often repeated goals of creating jobs via infrastructure spending. From whitehouse.gov:

The President explained that "one of the fastest and best ways to create good jobs is by rebuilding America’s infrastructure -- our roads, our bridges, our rails, our ports, our airports, our schools, our power grids. We’ve got a lot of work to do out there, and we’ve got to put folks to work."

These programs make it clear that Obama stands firmly behind paying government workers more and creating jobs. And this also means that Obama is not interested in maximizing the profit, or net benefit, of these government initiatives for the taxpayers who are funding them. Remember, Profit = TR - TC. Paying workers more and paying more workers are both COSTS. If you increase costs and total revenue does not change profit must be going down, not up.

One of the things I tell my students and one concept that you learn in economics training is that MAXIMIZING PROFITS and MINIMIZING COSTS for a given level of output are the SAME THING. So when Obama raises costs by creating jobs (hiring more workers) and then paying each worker more than the market rate he is necessarily lowering the net benefit of the project to the taxpayer. What would a private sector employer say if she was shown a cost benefit analysis with the labor costs on the benefits side? Hopefully she would fire that worker and hire another one who is competent. Yet somehow the national dialogue has become such that creating jobs and paying workers more is a good thing for the taxpayer i.e. it is a benefit.

One of the fundamental objectives of economics as a science is to come up with the most efficient way to allocate scarce resources. Yet many on the left, including some economists, and even some on the right have come to the absurd conclusion that using more resources than necessary to create a given level of output makes society better off. If increasing costs and wasting scarce resources can really make us better off than there is little reason for economics as a discipline to exist. It does not take specialized training to learn how to waste stuff.

Sunday, July 20, 2014

Employment in Dayton, OH and Greenville, SC

This is my third post comparing the Dayton, OH MSA to the Greenville, SC MSA. So far I have analyzed their many similarities as well as their different population trends. In this post I want to highlight the overall employment trends in each MSA over the last 24 years. Below is a graph showing the unemployment rate in both MSAs since 1990.

As shown in the graph the unemployment rates between the two MSAs are very similar since 1990. This is not too surprising since as I have pointed out the two MSAs are very similar in size and industry makeup, but I still did not expect the rates to be quite so similar. Greenville's rate has remained a tick under Dayton's but the cycles are nearly identical and there is some overlap in the mid 2000's. Both saw a spike in unemployment in the early 2000's after 9/11 and of course during the great recession that started in 2008. The unemployment rate in each MSA has been falling since 2009, though Dayton's has leveled off at around 8% while Greenville's has fallen to just above 6% and appears to be heading lower.

In order to understand the underlying causes of the unemployment rates in the two MSAs it is important to understand how the unemployment rate is calculated. The unemployment rate is the ratio of the # of people employed divided by the number of people in the workforce. In mathematical terms it is

Unemployment rate = (# of people unemployed / # of people in labor force) x 100% (to get in percentage terms).

The labor force, the denominator, is the sum of both employed and unemployed workers. An unemployed worker is someone not employed who is actively looking for a job. Retired people do not count as unemployed since they are not looking for a job. Other potential workers who are no longer actively seeking employment also do not count as unemployed. These types of people are out of the labor force.

This formula more clearly shows how the unemployment rate could fall. Either the numerator, the number of people unemployed, could get smaller or the denominator, the # of people in the workforce, could get larger relative to the numerator.  To see how this works lets look at a hypothetical example.

Suppose there are 100 people in the labor force and 10 are unemployed. In that case the unemployment rate is 10/100 x 100% = 10%. Now suppose 5 of the unemployed people give up searching for a job; they are now out of the labor force. In this case the numerator decreases from 10 to 5 and the denominator decreases from 100 to 95. The unemployment rate is now 5/95 x 100% = 5.3%. So the unemployment rate fell from 10% to 5.3% but no one got a job. Rather some of the unemployed workers simply quit looking for a job. So the unemployment rate can fall even if unemployed workers do not get a job.

This is important. It is good when the unemployment rate falls because unemployed workers who want jobs find one. It is not so good when the unemployment rate falls because workers who want jobs simply grow tired of looking and exit the labor force. So which of these scenarios is occurring in Dayton and Greenville? The graph below shows the size of the labor force in each MSA.

The labor force has been falling in Dayton since around 2002 and has been growing fairly steadily in Greenville since 2002 and most of the prior years. This means that Greenville's unemployment rate has been falling since 2009 despite a labor force that has been slightly growing while Dayton's rate has been falling along with the size of their labor force. This is evidence that the Dayton unemployment rate is not falling because more people are getting jobs but rather because workers are getting discouraged and are giving up looking for jobs. A look at the total employment in each MSA, shown in the graph below, confirms that this is the case.

The total number of people employed in the Dayton MSA has been primarily decreasing since 2000. In the Greenville MSA the total number of people employed has been primarily increasing since 2000 except for during the worst part of the recession. Dayton still has a larger labor force and actual work force than Greenville, but if the current trends continue Greenville should be passing Dayton fairly soon.

Based on the unemployment rate alone it appears that both Dayton and Greeville have done fairly well since the worst part of the recession. However, a closer look at the actual employment numbers shows that Greenville is gaining employed workers while Dayton's decreasing unemployment rate is primarily the result of a shrinking labor force. This is another worrisome sign for the Dayton MSA.

Thursday, July 17, 2014

Why federal policies to help struggling cities are misguided

In May 2014 the Obama administration put out a press release announcing the National Resource Network a "311" resource for cities seeking guidance on economic revitalization. In the words of HUD Secretary Shaun Donovan, "The assistance and expertise provided by the National Resource Network will allow cities to maximize and better leverage their existing federal investments, and more strategically plan for their economic future and community development priorities". The federal government though HUD has committed $10 million and the plan is to raise $10 million more from the private sector.

But federal money for cities is misguided because the funds are primarily given to cities that have shown little ability to manage their resources effectively. 56 cities are eligible in the pilot program of the National Resource Network, including several large cities that have experienced sharp population declines since 1950 such as St. Louis, MO, Cleveland, OH, Buffalo, NY, Newark, NJ and Providence, RI. Many of these cities have poor management to blame for at least part of their decline and giving them even more resources is probably not the answer.

Using federal funds to help these cities means that the government is taxing and taking resources from the residents of successful cities. Just because a city like Cleveland is struggling today does not mean that a more successful city like Indianapolis, IN should be forced to help them. Cities like Cleveland and St. Louis used to be relatively large and well off while cities like Columbus, OH and Austin, TX were small and relatively poorer. Today that is flipped, but that does not mean that the federal government should attempt to put things back the way they were; no city has a right to be large and prosperous. Below are two tables showing the 15 most populated cities in 1950 and in 2013. 


The cities in bold font are the cities that are different between the two lists. As shown in the tables there have been a lot of changes between 1950 and 2013; gone are Detroit, MI, St. Louis, MO, Cleveland, OH, Pittsburgh, PA, and Boston, MA. In their places are San Antonio, TX, Phoenix, AZ, San Diego, CA, Indianapolis, IN, and Columbus, OH. 

But change is OK. There is no reason that as Americans we should say one list is better than the other. When federal funds are used to help struggling cities it's as if the government is trying to get back to the 1950's list. But cities, like countries, rise and fall all of the time for various reasons. Companies move to take advantage of cost savings, workers move to take advantage of amenities, inventions like air conditioning make some cities more hospitable than they once were, and local governments change tax structures, zoning policies, etc. 

I think that it is a good thing that cities compete for residents, but they should do so on their own dime, not the federal government's. When the federal government starts trying to pick winners and losers they distort the market, taxing some places and subsidizing others. These distortions cause the same problems in the market for cities as they do in other markets; they lead to a misallocation of resources which results in waste and inefficiency. America will be better off if the federal government does not favor some cities over others.