Economics, Politics

When To Worry About Public Debt

I watch a lot of political debates with my friends. A couple of them have turned to me after watching heated arguments about public debt and (because I have a well-known habit of reading monetary policy blogs) asked me who is right. I hear questions like:

Is it true that public debt represents an unfair burden on our hypothetical grandchildren? Is all this talk about fiscal discipline and balanced budgets pointless? Is it really bad when public debt gets over 100% of a country’s GDP? How can the threat of defaulting on loans lead to inflation and ruin?

And what does all this mean for Ontario? Is Doug Ford right about the deficit?

This is my attempt to sort this all out in a public and durable form. Now when I’ve taken a political debate drinking game too far, I’ll still be able to point people towards the answers to their questions.

(Disclaimer: I’m not an economist. Despite the research I did for it and the care with which I edited, this post may contain errors, oversimplifications, or misunderstandings.)

Is Public Debt A Burden On Future Generations?

Among politicians of a certain stripe, it’s common to compare the budget of a country to the budget of a family. When a family is budgeting, any shortfall must be paid for via loans. Left unspoken is the fact that many families find themselves in a rather large amount of debt early on – because they need a mortgage to buy their dwelling. The only way a family can ever get out of debt is by maintaining a monthly surplus until their mortgage is paid off, then being careful to avoid taking on too much new debt.

Becoming debt free is desirable to individuals for two reasons. First, it makes their retirement (feel) much more secure. Given that retirement generally means switching to a fixed income or living off savings, it can be impossible to pay off the principle of a debt after someone makes the decision to retire.

Second, parents often desire to leave something behind for their children. This is only possible if their assets outweigh their debts.

Countries have to grapple with neither of these responsibilities. While it is true that the average age in many countries is steadily increasing, countries that have relatively open immigration policies and are attractive to immigrants largely avoid this problem. Look at how Canada and the United States compare to Italy and Japan in working age population percentage, for example.

Graph showing % of working age population in 4 OECD countries: Japan, Canada, USA, Italy.
After seeing this graph, I realized how hyperbolic it was to talk about Japan’s aging population. Source: OECD.

 

Even in Japan, where this is “dire”, the percentage of the population that is working age is equivalent to the percentage of the population that was working age in Canada or America in 1970. As lifespans increase, we may have to expand our definition of working age. But some combination of immigration, better support for parents, and better support for older citizens who wish to keep working will prevent us from ever getting to a point where it’s sensible to talk about a country “retiring”.

Since countries don’t “retire”, they don’t have to cope with the worry of “needing to work later to pay off that debt”. Since countries don’t have children, they don’t have to worry about having something to pass on. Countries don’t ever actually have to pay back all of their debt. They can continue to roll it over indefinitely, as long as someone is willing to continue to loan them money at a rate they’re willing to pay.

What I mean by “rolling over”, is that countries can just get a new loan for the same amount as their last one, as soon as the previous loan comes due. If interest rates have risen (either in general, or because the country is a greater risk) since their last loan, the new loan will be more expensive. If they’ve fallen, it will be cheaper. Rolling over loans changes the interest rate a country is paying, but doesn’t change the amount it owes.

Is Talk Of Discipline Pointless?

No.

Even if countries don’t really ever have to pay back the principle on their loans, they do have to make interest payments (borrowing to pay these is possible, but it isn’t a good look and can pretty quickly lead to dangerous levels of debt). The effect of these payments ranges from “it’s mildly annoying that we can’t spend that money on something better” to “we’re destroying our ecosystem growing bananas so that we have something to sell for cash to make our interest payments”. Lack of discipline and excessive debt levels can move a country closer to the second case.

In a well-integrated and otherwise successful economy with ample room in its governmental budget, interest payments are well worth the advantage of getting money early. When this money is used to create economic benefits that accrue faster than the interest payments, countries are net beneficiaries. If you take out a loan that charges 1-2% interest a year and use it to build a bridge that drives 4% economic growth for the next forty years, you’re ahead by 2-3% year on year. This is a good deal.

Unlike most talk about interest rates, where they’re entirely hypothetical, I really do mean that 1-2% figure. That’s actually higher than the average rate the US government has been paying to borrow over the last decade (Germany had it even better; they briefly paid negative interest rates). Governments – at least those with a relatively good track record around money – really have a superpower with how cheaply they can get money, so if nothing else, it’s worth keeping debt relatively low so that they don’t lose their reputation for responsibility and continue to have access to cheap money for when they really need it.

That’s the case in a moderately disciplined developed nation with adequate foreign reserves, at least. In a cash-poor or underdeveloped economy where a decent portion of any loan is lost to cronyism and waste, the case for loans being positive is much more… mixed. For these countries, discipline means “taking no loans at all”.

When discipline falls apart and debt levels rise too high, very bad things start to happen.

Is 100% of GDP The Line Beyond Which Debt Shouldn’t Rise?

There is nothing special about 100% of GDP, except that people think it is special.

Sometimes, people talk about markets like they’re these big impersonal systems that have no human input. This feels true because the scale of the global financial system is such that from the perspective of pretty much any individual person, they’re impersonal and impossible to really influence. But ultimately, other than a few high frequency trading platforms, all decisions in a market have to be made by humans.

Humans have decided that in certain cases, it’s bad when a country has more than 100% of its GDP in debt. This means that it becomes much more expensive to get new loans (and because of the constant rollover, even old loans eventually become new loans) when a country crosses this Rubicon, which in turn makes them much more likely to default. There’s some element of self-fulfilling prophecy here!

(Obviously there does have to be some point where a country really is at risk from its debt load and obviously this needs to be scaled to country size and wealth to not be useless. I think people have chosen 100% of GDP more because it’s a nice round number and it’s simple to calculate, not because it has particularly great inherent predictive power, absent the power it has as a self-fulfilling prophecy. Maybe the “objectively correct” number is in fact 132.7% of the value of all exports, or 198% of 5-year average government revenues… In either case, we’ve kind of lost our chance; any number calculated now would be heavily biased by the crisis of confidence that can happen when debt reaches 100% of GDP.)

That said, comparing a country’s debt load to its GDP without making adjustments is a recipe for confusion. While Everyone was fretting about Greece having ~125% of its GDP in debt, Japan was carrying 238% of its GDP in debt.

There are two reasons that Japan’s debt is much less worrying than Greece’s.

First, there’s the issue of who’s holding that debt. A very large portion of Japanese debt is held by its own central bank. By my calculations (based off the most recent BOJ numbers), the Bank of Japan is holding approximately 44% of the Japanese government’s debt. Given that the Bank of Japan is an organ of the Japanese Government (albeit an arm’s length one), this debt is kind of owed by the government of Japan, to the government of Japan. When 44% of every loan payment might ultimately find its way back to you, your loan payments become less scary.

Second, there’s the issue of denomination. Greek public debts are denominated in Euros, a currency that Greece doesn’t control. If Greece wants €100, it must collect €100 in taxes from its citizens. Greece cannot just create Euros.

Japanese debt is denominated in Yen. Because Japan controls the yen, it has two options for repaying ¥100 of debt. It can collect ¥100 in taxes – representing ¥100 worth of valuable work. Or it can print ¥100. There are obvious consequences to printing money, namely inflation. But given that Japan has struggled with chronic deflation and has consistently underperformed the inflation targets economists think it needs to meet, it’s clear that a bit of inflation isn’t the worst thing that could happen to it.

When evaluating whether a debt burden is a problem, you should always consider the denomination of the debt, who the debtholders are, and how much inflation a country can tolerate. It is always worse to hold debt in a denomination that you don’t control. It’s always worse to owe money to people who aren’t you (especially people more powerful than you), and it’s always easier to answer debt with inflation when your economy needs more inflation anyways.

This also suggests that government debt is much more troubling when it’s held by a sub-national institution than by a national institution (with the exception of Europe, where even nations don’t individually control the currency). In this case, monetary policy options are normally off the table and there’s normally someone who’s able to force you to pay your debt, no matter what that does to your region.

Developing countries very rarely issue debt in their own currency, mainly because no one is interested in buying it. This, combined with low foreign cash reserves puts them at a much higher risk of failing to make scheduled debt payments – i.e. experiencing an actual default.

What Happens If A Country Defaults?

No two defaults are exactly alike, so the consequences vary. That said, there do tend to be two common features: austerity and inflation.

Austerity happens for a variety of reasons. Perhaps spending levels were predicated on access to credit. Without that access, they can’t be maintained. Or perhaps a higher body mandated it; see for example Germany (well, officially, the EU) mandating austerity in Greece, or Michigan mandating austerity in Detroit.

Inflation also occurs for a variety of reasons. Perhaps the government tries to fill a budgetary shortfall and avoid austerity by printing bills. This flood of money bids up prices, ruins savings and causes real wages to decline. Perhaps it becomes hard to convince foreigners to accept the local currency in exchange for goods, so anything imported becomes very expensive. When many goods are imported, this can lead to very rapid inflation. Perhaps people in general lose faith in money (and so it becomes nearly worthless), maybe in conjunction with the debt crisis expanding to the financial sector and banks subsequently failing. Most likely, it will be some combination of these three, as well as others I haven’t thought to mention.

During a default, it’s common to see standards of living plummet, life savings disappear, currency flight into foreign denominations, promptly followed by currency controls, which prohibit sending cash outside of the country. Currency controls make leaving the country virtually impossible and make any necessary imports a bureaucratic headache. This is fine when the imports in question are water slides, but very bad when they’re chemotherapy drugs or rice.

On the kind of bright side, defaults also tend to lead to mass unemployment, which gives countries experiencing them comparative advantage in any person intensive industry. Commonly people would say “wages are low, so manufacturing moves there”, but that isn’t quite how international trade works. It’s not so much low wages that basic manufacturing jobs go in search of, but a workforce that can’t do anything more productive and less labour intensive. This looks the same, but has the correlation flipped. In either case, this influx of manufacturing jobs can contain within it the seed of later recovery.

If a country has sound economic management (like Argentina did in 2001), a default isn’t the end of the world. It can negotiate a “haircut” of its loans, giving its creditors something less than the full amount, but more than nothing. It might even be able to borrow again in a few years, although the rates that it will have to offer will start out in credit card territory and only slowly recover towards auto-loan territory.

When these trends aren’t managed by competent leadership, or when the same leaders (or leadership culture) that got a country into a mess are allowed to continue, the recovery tends to be moribund and the crises continual. See, for example, how Greece has limped along, never really recovering over the past decade.

Where Does Ontario Fit In?

My own home province of Ontario is currently in the midst of an election and one candidate, Doug Ford, has made the ballooning public debt the centrepiece of his campaign. Evaluating his claims gives us a practical example of how to evaluate claims of this sort in general.

First, Ontario doesn’t control the currency that its debt is issued in, which is an immediate risk factor for serious debt problems. Ontario also isn’t dominant enough within Canada to dictate monetary policy to the Federal Government. Inflation for the sake of saving Ontario would doom any sitting Federal government in every other province, so we can’t expect any help from the central bank.

Debt relief from the Federal government is possible, but it couldn’t come without hooks attached. We’d definitely lose some of our budgetary authority, certainly face austerity, and even then, it might be too politically unpalatable to the rest of the country.

However, the sky is not currently falling. While debt rating services have lost some confidence in our willingness, if not our ability to get spending under control and our borrowing costs have consequently risen, we’re not yet into a vicious downwards spiral. Our debt is at a not actively unhealthy 39% of the GDP and the interest rate is a non-usurious 4%.

That said, it’s increased more quickly than the economy has grown over the past decade. Another decade going on like we currently are certainly would put us at risk of a vicious cycle of increased interest rates and crippling debt.

Doug Ford’s emotional appeals about mortgaging our grandchildren’s future are exaggerated and false. I’ve already explained how countries don’t work like families. But there is a more pragmatic concern here. If we don’t control our spending now, on our terms, someone else – be it lenders in a default or the federal government in a bailout – will do it for us.

Imagine the courts forcing Ontario to service its debt before paying for social services and schools. Imagine the debt eating up a full quarter of the budget, with costs rising every time a loan is rolled over. Imagine our public services cut to the bone and our government paralyzed without workers. Things would get bad and the people who most need a helping hand from the government would be hit the hardest.

I plan to take this threat seriously and vote for a party with a credible plan to balance our budget in the short term.

If one even exists. Contrary to his protestations, Doug Ford isn’t leading a party committed to reducing the deficit. He’s publically pledged himself to scrapping the carbon tax. Absent it, but present the rest of his platform, the deficit spending is going to continue (during a period of sustained growth, no less!). Doug Ford is either lying about what he’s going to cut, or he’s lying about ending the debt. That’s not a gamble I particularly want to play.

I do hope that someone campaigns on a fully costed plan to restore fiscal order to Ontario. Because we are currently on the path to looking a lot like Greece.

Economics, Model, Quick Fix

Not Just Zoning: Housing Prices Driven By Beauty Contests

No, this isn’t a post about very pretty houses or positional goods. It’s about the type of beauty contest described by John Maynard Keynes.

Imagine a newspaper that publishes one hundred pictures of strapping young men. It asks everyone to send in the names of the five that they think are most attractive. They offer a prize: if your selection matches the five men most often appearing in everyone else’s selections, you’ll win $500.

You could just do what the newspaper asked and send in the names of those men that you think are especially good looking. But that’s not very likely to give you the win. Everyone’s tastes are different and the people you find attractive might not be very attractive to anyone else. If you’re playing the game a bit smarter, you’ll instead pick the five people that you think have the broadest appeal.

You could go even deeper and realize that many other people will be trying to win and so will also be trying to pick the most broadly appealing people. Therefore, you should pick people that you think most people will view as broadly appealing (which differs from picking broadly appealing people if you know something about what most people find attractive that isn’t widely known). This can go on indefinitely (although Yudkowsky’s Law of Ultrafinite Recursion states that “In practice, infinite recursions are at most three levels deep“, which gives me a convenient excuse to stop before this devolves into “I know you know I know that you know that…” ad infinitum).

This thought experiment was relevant to an economist because many assets work like this. Take gold: its value cannot to be fully explained by its prettiness or industrial usefulness; some of its value comes from the belief that someone else will want it in the future and be willing to pay more for it than they would a similarly useful or pretty metal. For whatever reason, we have a collective delusion that gold is especially valuable. Because this delusion is collective enough, it almost stops being a delusion. The delusion gives gold some of its value.

When it comes to houses, beauty contests are especially relevant in Toronto and Vancouver. Faced with many years of steadily rising house prices, people are willing to pay a lot for a house because they believe that they can unload it on someone else in a few years or decades for even more.

When talking about highly speculative assets (like Bitcoin), it’s easy to point out the limited intrinsic value they hold. Bitcoin is an almost pure Keynesian Beauty Contest asset, with most of its price coming from an expectation that someone else will want it at a comparable or better price in the future. Houses are obviously fairly intrinsically valuable, especially in very desirable cities. But the fact that they hold some intrinsic value cannot by itself prove that none of their value comes from beliefs about how much they can be unloaded for in the future – see again gold, which has value both as an article of commerce and as a beauty contest asset.

There’s obviously an element of self-fulfilling prophecy here, with steadily increasing house prices needed to sustain this myth. Unfortunately, the housing market seems especially vulnerable to this sort of collective mania, because the sunk cost fallacy makes many people unwilling to sell their houses at a price below what they paid for it. Any softening of the market removes sellers, which immediately drives up prices again. Only a massive liquidation event, like we saw in 2007-2009 can push enough supply into the market to make prices truly fall.

But this isn’t just a self-fulfilling prophecy. There’s deliberateness here as well. To some extent, public policy is used to guarantee that house prices continue to rise. NIMBY residents and their allies in city councils deliberately stall projects that might affect property values. Governments provide tax credits or access to tax-advantaged savings accounts for homes. In America, mortgage payments provide a tax credit!

All of these programs ultimately make housing more expensive wherever supply cannot expand to meet the artificially increased demand – which basically describes any dense urban centre. Therefore, these home buying programs fail to accomplish their goal of making house more affordable, but do serve to guarantee that housing prices will continue to go up. Ultimately, they really just represent a transfer of wealth from taxpayers generally to those specific people who own homes.

Unfortunately, programs like this are very sticky. Once people buy into the collective delusion that home prices must always go up, they’re willing to heavily leverage themselves to buy a home. Any dip in the price of homes can wipe out the value of this asset, making it worth less than the money owed on it. Since this tends to make voters very angry (and also lead to many people with no money) governments of all stripes are very motivated to avoid it.

This might imply that the smart thing is to buy into the collective notion that home prices always go up. There are so many people invested in this belief at all levels of society (banks, governments, and citizens) that it can feel like home prices are too important to fall.

Which would be entirely convincing, except, I’m pretty sure people believed that in 2007 and we all know how that ended. Unfortunately, it looks like there’s no safe answer here. Maybe the collective mania will abate and home prices will stop being buoyed ever upwards. Or maybe they won’t and the prices we currently see in Toronto and Vancouver will be reckoned cheap in twenty years.

Better zoning laws can help make houses cheaper. But it really isn’t just zoning. The beauty contest is an important aspect of the current unaffordability.

Economics, Politics, Quick Fix

Cities Are Weird And Minimum Wages Can Help

[6-minute read]

I don’t understand why people choose to go bankrupt living the most expensive cities, but I’m increasingly viewing this as a market failure and collective action problem to be fixed with intervention, not a failure of individual judgement.

There are many cities, like Brantford, Waterloo, or even Ottawa, where everything works properly. Rent isn’t really more expensive than suburban or rural areas. There’s public transit, which means you don’t necessarily need a car, if you choose where you live with enough care. There are plenty of jobs. Stuff happens.

But cities like Toronto, Vancouver, and San Francisco confuse the hell out of me. The cost of living is through the roof, but wages don’t even come close to following (the difference in salary between Toronto and Waterloo for someone with my qualifications is $5,000, which in no way would cover the yearly difference in living expenses). This is odd when talking about well-off tech workers, but becomes heartbreaking when talking about low-wage workers.

Toronto Skyline
Not pictured: Selling your organs to afford a one-bedroom condo. Image Credit: Abi K on Flickr

If people were perfectly rational and only cared about money (the mythical homo economicus), fewer people would move to cities, which would bid up wages (to increase the supply of workers) or drive down prices (because fewer people would be competing for the same apartments), which would make cities more affordable. But people do care about things other than money and the network effects of cities are hard to beat (put simply: the bigger the city, the more options for a not-boring life you have). So, people move – in droves – to the most expensive and dynamic cities and wages don’t go up (because the supply of workers never falls) and the cost of living does (because the number of people competing for housing does) and low wage workers get ground up.

It’s not that I don’t understand the network effects. It’s that I don’t understand why people get ground up instead of moving.

But the purpose of good economics is to deal with people as they are, not as they can be most conveniently modeled. And given this, I’ve begun to think about high minimum wages in cities as an intervention that fixes a market failure and collective action problem.

That is to say: people are bad at reading the market signal that they shouldn’t move to cities that they can’t afford. It’s the signal that’s supposed to say here be scarce goods, you might get screwed, but the siren song of cities seems to overpower it. This is a market failure in the technical sense because there exists a distribution of goods that could make people (economically) better off (fewer people living in big cities) without making anyone worse off (e.g. they could move to communities that are experiencing chronic shortages of labour and be basically guaranteed jobs that would pay the bills) that the market cannot seem to fix.

(That’s not to say that this is all the fault of the market. Restrictive zoning makes housing expensive and rent control makes it scarce.)

It’s a collective action problem because if everyone could credibly threaten to move, then they wouldn’t have to; the threat would be enough to increase wages. Unfortunately, everyone knows that anyone who leaves the city will be quickly replaced. Everyone would be better off if they could coordinate and make all potential movers promise not to move in until wages increase, but there’s no benefit to being the first person to leave or the first person to avoid moving [1] and there currently seems to be no good way for everyone to coordinate in making a threat.

When faced with the steady grinding down of young people, low wage workers, and everyone “just waiting for their big break“, we have two choices. We can do tut-tut at their inability to be “rational” (aka leave their friends, family, jobs, and aspirations to move somewhere else [2]), or we can try to better their situation.

If everyone was acting “rationally”, wages would be bid up. But we can accomplish the same thing by simple fiat. Governments can set a minimum wage or offer wage subsidies, after all.

I do genuinely worry that in some places, large increases in the minimum wage will lead to unemployment (we’ll figure out whether this is true over the next decade or so). I’m certainly worried that a minimum wage pegged to inflation will lead to massive problems the next time we have a recession [3].

So, I think we should fix zoning, certainly. And I think we need to fix how Ontario’s minimum wage functions in a recession so that it doesn’t destroy our whole economy during the next one. But at the same time, I think we need to explore differential minimum wages for our largest cities and the rest of the province/country. I mean this even in a world where the current minimum $14/hour wage isn’t rolled back. Would even $15/hour cut it in Toronto and Vancouver [4]?

If we can’t make a minimum wage work without increased unemployment, then maybe we’ll have to turn to wage subsidies. This is actually the method that “conservative” economist Scott Sumner favours [5].

What’s clear to me is that what we’re currently doing isn’t working.

I do believe in a right to shelter. Like anyone who shares this belief, I understand that “shelter” is a broad word, encompassing everything from a tarp to a mansion. Where a certain housing situation falls on this spectrum is the source of many a debate. Writing this is a repudiation of my earlier view, that living in an especially desirable city was a luxury not dissimilar from a mansion.

A couple of things changed my mind. First, I paid more attention to the experiences of my friends who might be priced out of the cities they grew up in and have grown to love. Second, I read the Ecomodernist Manifesto, with its calls for densification as the solution to environmental degradation and climate change. Densification cannot happen if many people are priced out of cities, which means figuring this out is actually existentially important.

The final piece of the puzzle was the mental shift whereby I started to view wages in cities – especially for low-wage earners – as a collective action problem and a market failure. As anyone on the centre-left can tell you, it’s the government’s job to fix those – ideally in a redistributive way.

Footnotes

[1] This is inductive up to the point where you have a critical mass; there’s no benefit until you’re the nth + 1 person, where n is the number of people necessary to create a scarcity of workers sufficient to begin bidding up wages. And all of the people who moved will see little benefit for their hassle, unless they’re willing to move back. ^

[2] For us nomadic North Americans, this can be confusing: “The gospel of ‘just pick up and leave’ is extremely foreign to your typical European — be they Serbian, French or Irish. Ditto with a Sudanese, Afghan or Japanese national. In Israel, it’s the kind of suggestion that ruins dinner parties… We non-indigenous love to move. We don’t just see it as just good economic policy, but as a virtue. We glorify the immigrant, we hug them at the airport when they arrive and we inherently mistrust anyone who dares to pine for what they left behind”. ^

[3] Basically, wages should fall in a recession, but they largely don’t, which means inflation is necessary to get wages back to a level where employment can recover; pegging the minimum wage to inflation means this can’t happen. Worse, if the rest of the country were to adopt sane monetary policy during the next bad recession, Ontario’s minimum wage could rise to the point where it would swallow large swathes of the economy. This would really confuse price signals and make some work economically unviable (to do in Ontario; it would surely still be done elsewhere). ^

[4] I think we may have to subsidize some new construction or portion of monthly rent so that all increased wages don’t get ploughed into to increased rents. If you have more money chasing the same number of rental units and everything else remains constant, you’ll see all gains in wages erased by increases in rents. Rent control is a very imperfect solution, because it changes new construction into units that can be bought outright, at market rates. This helps people who have saved up a lot of money outside of the city and what to move there, but is very bad for the people living there, grappling with rent so high that they can’t afford to save up a down payment. ^

[5] No seriously, this is what passes for conservative among economists these days; while we all stopped looking, they all became utilitarians who want to help impoverished people as much as possible. ^

Economics, Model

Against Job Lotteries

In simple economic theory, wages are supposed to act as signals. When wages increase in a sector, it should signal people that there’s lots of work to do there, incentivizing training that will be useful for that field, or causing people to change careers. On the flip side, when wages decrease, we should see a movement out of that sector.

This is all well and good. It explains why the United States has seen (over the past 45 years) little movement in the number of linguistics degrees, a precipitous falloff in library sciences degrees, some decrease in English degrees, and a large increase in engineering and business degrees [1].

This might be the engineer in me, but I find things that are working properly boring. What I’m really interested in is when wage signals break down and are replaced by a job lottery.

Job lotteries exist whenever there are two tiers to a career. On one hand, you’ll have people making poverty wages and enduring horrendous conditions. On the other, you’ll see people with cushy wages, good job security, and (comparatively) reasonable hours. Job lotteries exist in the “junior doctor” system of the United Kingdom, in the academic system of most western countries, and teaching in Ontario (up until very recently). There’s probably a much less extreme version of this going on even in STEM jobs (in that many people go in thinking they’ll work for Google or the next big unicorn and end up building websites for the local chamber of commerce or writing internal tools for the company billing department [2]). A slightly different type of job lottery exists in industries where fame plays a big role: writing, acting, music, video games, and other creative endeavours.

Job lotteries are bad for two reasons. Compassionately, it’s really hard to see idealistic, bright, talented people endure terribly conditions all in the hope of something better, something that might never materialize. Economically, it’s bad when people spend a lot of time unemployed or underemployed because they’re hopeful they might someday get their dream job. Both of these reasons argue for us to do everything we can to dismantle job lotteries.

I do want to make a distinction between the first type of job lottery (doctors in the UK, professor, teachers), which is a property of how institutions have happened to evolve, and the second, which seems much more inherent to human nature. “I’ll just go with what I enjoy” is a very common media strategy that will tend to split artists (of all sorts) into a handful of mega-stars, a small group of people making a modest living, and a vast mass of hopefuls searching for their break. To fix this would require careful consideration and the building of many new institutions – projects I think we lack the political will and the know-how for.

The problems in the job market for professors, doctors, or teachers feel different. These professions don’t rely on tastemakers and network effects. There’s also no stark difference in skills that would imply discontinuous compensation. This doesn’t imply that skills are flat – just that they exist on a steady spectrum, which should imply that pay could reasonably follow a similar smooth distribution. In short, in all of these fields, we see problems that could be solved by tweaks to existing institutions.

I think institutional change is probably necessary because these job lotteries present a perfect storm of misdirection to our primate brains. That is to say (1) People are really bad at probability and (2) the price level for the highest earners suggests that lots of people should be entering the industry. Combined, this means that people will be fixated on the highest earners, without really understanding how unlikely that is to be them.

Two heuristics drive our inability to reason about probabilities: the representativeness heuristic (ignoring base rates and information about reliability in favour of what feels “representative”) and the availability heuristic (events that are easier to imagine or recall feel more likely). The combination of these heuristics means that people are uniquely sensitive to accounts of the luckiest members of a profession (especially if this is the social image the profession projects) and unable to correctly predict their own chances of reaching that desired outcome (because they can imagine how they will successfully persevere and make everything come out well).

Right now, you’re probably laughing to yourself, convinced that you would never make a mistake like this. Well let’s try an example.

Imagine a scenario is which only ten percent of current Ph. D students will get tenure (basically true). Now Ph. D students are quite bright and are incredibly aware of their long odds. Let’s say that if a student three years into a program makes a guess as to whether or not they’ll get a tenure track job offer, they’re correct 80% of the time. If a student tells you they think they’ll get a tenure track job offer, how likely do you think it is that they will? Stop reading right now and make a guess.

Seriously, make a guess.

This won’t work if you don’t try.

Okay, you can keep reading.

It is not 80%. It’s not even 50%. It’s 31%. This is probably best illustrated visually.

Craft Design Online has inadvertently created a great probability visualization tool.

 

There are four things that can happen here (I’m going to conflate tenure track job offers with tenure out of a desire to stop typing “tenure track job offers”).

Ten students will get tenure. Of these ten, eight (0.8 x 10) will correctly believe they will get it (1/green) and two (10 – 0.8 x 10) will incorrectly believe they won’t (2/yellow). Ninety students won’t get tenure. Of these 90, 18 (90 – 0.8 x 90) will incorrectly believe they will get tenure (3/orange) and 72 (0.8 x 90) will correctly believe they won’t get tenure (4/red). Twenty-six students, those coloured green (1) and orange (3) believe they’ll get tenure. But we know that only eight of them really will – which works out to just below the 31% I gave above.

Almost no one can do this kind of reasoning, especially if they aren’t primed for a trick. The stories we build in our head about the future feel so solid that we ignore the base rate. We think that we’ll know if we’re going to make it. And even worse, we think that a feeling of “knowing” if we’ll make it provides good information. We think that relatively accurate predictors provide useful information against a small chance. They clearly don’t. When the base rate is small (here 10%), the base rate is the single greatest predictor of your chances.

But this situation doesn’t even require small chances for us to make mistakes. Imagine you had two choices: a career that leaves you feeling fulfilled 100% of the time, but is so competitive that you only have an 80% chance of getting into it (assume in the other 20%, you either starve or work a soul-crushing fast food job with negative fulfillment) or a career where you are 100% likely to get a job, but will only find it fulfilling 80% of the time.

Unless that last 20% of fulfillment is strongly super-linear [3][4], or you don’t have any value at all on eating/avoiding McDrugery, it is better to take the guaranteed career. But many people looking at this probably rounded 80% to 100% – another known flaw in human reasoning. You can very easily have a job lottery even when the majority of people in a career are in the “better” tier of the job, because many entrants to the field will view “majority” as all and stick with it when they end up shafted.

Now, you might believe that these problems aren’t very serious, or that surely people making a decision as big as a college major or career would correct for them. But these fallacies date to the 70s! Many people still haven’t heard of them. And the studies that first identified them found them to be pretty much universal. Look, the CIA couldn’t even get people to do probability right. You think the average job seeker can? You think you can? Make a bunch of predictions for the next year and then talk with me when you know how calibrated (or uncalibrated) you are.

If we could believe that people would become better at probabilities, we could assume that job lotteries would take care of automatically. But I think it is clear that we cannot rely on that, so we must try and dismantle them directly. Unfortunately, there’s a reason many are this way; many of them have come about because current workers have stacked the deck in their own favour. This is really great for them, but really bad for the next group of people entering the workforce. I can’t help but believe that some of the instability faced by millennials is a consequence of past generations entrenching their benefits at our expense [5]. Others have come about because of poorly planned policies, bad enrolment caps, etc.

These cover the two ways we can deal with a job lottery, we can limit the supply indirectly (by making the job, or the perception of the job once you’ve “made it” worse), or limit the supply directly (by changing the credentials necessary of the job, or implementing other training caps)   . In many of the examples of job lotteries I’ve found, limiting the supply directly might be a very effective way to deal with the problem.

I can make this claim because limiting supply directly has worked in the real world. Faced with a chronic 33% oversupply of teachers and soaring unemployment rates among teaching graduates, Ontario chose to cut in half the number of slots in teacher’s college and double the length of teacher’s college programs. No doubt this was annoying for the colleges, which made good money off of those largely doomed extraneous pupils, but it did lead to the end of the oversupply of teachers and a tighter job market for teachers and this was probably better for the economy compared to the counterfactual.

Why? Because having people who’ve completed four years of university do an extra year or two of schooling only to wait around and hope for a job is a real drag. They could be doing something productive with that time! The advantage of increasing gatekeeping around a job lottery and increasing it as early as possible is that you force people to go find something productive to do. It is much better for an economy to have hopeful proto-teachers who would in fact be professional resume submitters go into insurance, or real estate, or tutoring, or anything at all productive and commensurate with their education and skills.

There’s a cost here, of course. When you’re gatekeeping (for e.g. teacher’s college or medical school), you’re going to be working with lossy proxies for the thing you actually care about, which is performance in the eventual job. The lossier the proxy, the more you are needlessly depressing the quality of people who are allowed to do the job – which is a serious concern when you’re dealing with heart surgery ­– or the people providing foundational education to your next generation.

You can also find some cases where increasing selectiveness in an early stage doesn’t successfully force failed applicants to stop wasting their time and get on with their life. I was very briefly enrolled in a Ph. D program for biomedical engineering a few years back. Several professors I interviewed with while considering graduate school wanted to make sure I had no aspirations on medical school – because they were tired of their graduate students abandoning research as soon as their Ph. D was complete. For these students who didn’t make it into medical school after undergrad, a Ph. D was a ticket to another shot at getting in [6]. Anecdotally, I’ve seen people who fail to get into medical school or optometry get a master’s degree, then try again.

Banning extra education before medical school cuts against the idea that people should be able to better themselves, or persevere to get to their dreams. It would be institutionally difficult. But I think that it would, in this case, probably be a net good.

There are other fields where limiting supply is rather harmful. Graduate students are very necessary for science. If we punitively limited their number, we might find a lot of valuable scientific progress falling to a stand-still. We could try and replace graduate students with a class of professional scientific assistants, but as long as the lottery for professorship is so appealing (for those who are successful), I bet we’d see a strong preference for Ph. D programs over professional assistantships.

These costs sometimes make it worth it to go right to the source of the job lottery, the salaries and benefits of people already employed [7]. Of course, this has its own downsides. In the case of doctors, high salaries and benefits are useful for making really clever applicants choose to go into medicine rather than engineering and law. For other jobs, there’s the problems of practicality and fairness.

First, it is very hard to get people to agree to wage or benefit cuts and it almost always results in lower morale – even if you have “sound macro-economic reasons” for it. In addition, many jobs with lotteries have them because of union action, not government action. There is no czar here to change everything. Second, people who got into those careers made those decisions based on the information they had at the time. It feels weird to say “we want people to behave more rationally in the job market, so by fiat we will change the salaries and benefits of people already there.” The economy sometimes accomplishes that on its own, but I do think that one of the roles of political economics is to decrease the capriciousness of the world, not increase it.

We can of course change the salaries and benefits only for new employees. But this somewhat confuses the signalling (for a long time, people will still have principle examples of the profession come from the earlier cohort). It also rarely alleviates a job lottery, because in practice people set this up for new employees to have reduced salaries and benefits for a time. Once they get seniority, they’ll expect to enjoy all the perks of seniority.

Adjunct professorships feel like a failed attempt to remove the job lottery for full professorships. Unfortunately, they’ve only worsened it, by giving people a toe-hold that makes them feel like they might someday claw their way up to full professorship. I feel that when it comes to professors, the only tenable thing to do is greatly reduce salaries (making them closer to the salary progression of mechanical engineers, rather than doctors), hire far more professors, cap graduate students wherever there is high under- and un- employment, and have more professional assistants who do short 2-year college courses. Of course, this is easy to say and much harder to do.

If these problems feel intractable and all the solutions feel like they have significant downsides, welcome to the pernicious world of job lotteries. When I thought of writing about them, coming up with solutions felt like by far the hardest part. There’s a complicated trade-off between proportionality, fairness, and freedom here.

Old fashioned economic theory held that the freer people were, the better off they would be. I think modern economists increasingly believe this is false. Is a world in which people are free to get very expensive training ­– despite very long odds for a job and cognitive biases that make understanding just how punishing the odds are – expensive training, in short, that they’d in expectation be better off without, a better one than a world where they can’t?

I increasingly believe that it isn’t. And I increasingly believe that having rough encounters with reality early on and having smooth salary gradients is important to prevent this world. Of course, this is easy for me to say. I’ve been very deliberate taking my skin out of job lotteries. I dropped out of graduate school. I write often and would like to someday make money off of writing, but I viscerally understand the odds of that happening, so I’ve been very careful to have a day job that I’m happy with [8].

If you’re someone who has made the opposite trade, I’m very interested in hearing from you. What experiences do you have that I’m missing that allowed you to make that leap of faith?

Footnotes:

[1] I should mention that there’s a difference between economic value, normative/moral value, and social value and I am only talking about economic value here. I wouldn’t be writing a blog post if I didn’t think writing was important. I wouldn’t be learning French if I didn’t think learning other languages is a worthwhile endeavour. And I love libraries.

And yes, I know there are many career opportunities for people holding those degrees and no I don’t think they’re useless. I simply think a long-term shift in labour market trends have made them relatively less attractive to people who view a degree as a path to prosperity. ^

[2] That’s not to knock these jobs. I found my time building internal tools for an insurance company to be actually quite enjoyable. But it isn’t the fame and fortune that some bright-eyed kids go into computer science seeking. ^

[3] That is to say, that you enjoy each additional percentage of fulfillment at a multiple (greater than one) of the previous one. ^

[4] This almost certainly isn’t true, given that the marginal happiness curve for basically everything is logarithmic (it’s certainly true for money and I would be very surprised if it wasn’t true for everything else); people may enjoy a 20% fulfilling career twice as much as a 10% fulfilling career, but they’ll probably enjoy a 90% fulfilling career very slightly more than an 80% fulfilling career. ^

[5] It’s obvious that all of this applies especially to unions, which typically fight for seniority to matter quite a bit when it comes to job security and pay and do whatever they can to bid up wages, even if that hurts hiring. This is why young Canadians end up supporting unions in theory but avoiding them in practice. ^

[6] I really hope that this doesn’t catch on. If an increasing number of applicants to medical school already have graduate degrees, it will be increasingly hard for those with “merely” an undergraduate degree to get in to medical school. Suddenly we’ll be requiring students to do 11 years of potentially useless training, just so that they can start the multi-year training to be a doctor. This sort of arms race is the epitome of wasted time.

In many European countries, you can enter medical school right out of high school and this seems like the obviously correct thing to do vis a vis minimizing wasted time. ^

[7] The behaviour of Uber drivers shows job lotteries on a small scale. As Uber driver salaries rise, more people join and all drivers spend more time waiting around, doing nothing. In the long run (here meaning eight weeks), an increase in per-trip costs leads to no change whatsoever in take home pay.

The taxi medallion system that Uber has largely supplanted prevented this. It moved the job lottery one step further back, with getting the medallion becoming the primary hurdle, forcing those who couldn’t get one to go work elsewhere, but allowing taxi drivers to largely avoid dead times.

Uber could restrict supply, but it doesn’t want to and its customers certainly don’t want it to. Uber’s chronic driver oversupply (relative to a counterfactual where drivers waited around very little) is what allows it to react quickly during peak hours and ensure there’s always an Uber relatively close to where anyone would want to be picked up. ^

[8] I do think that I would currently be a much better writer if I’d instead tried to transition immediately to writing, rather than finding a career and writing on the side. Having a substantial safety net removes almost all of the urgency that I’d imagine I’d have if I was trying to live on (my non-existent) writing income.

There’s a flip side here too. I’ve spent all of zero minutes trying to monetize this blog or worrying about SEO, because I’m not interested in that and I have no need to. I also spend zero time fretting over popularizing anything I write (again, I don’t enjoy this). Having a security net makes this something I do largely for myself, which makes it entirely fun. ^

Economics, Politics

You’re Doing Taxes Wrong: Consumptive vs. Wealth Inequality

When you worry about rising inequality, what are you thinking about?

I now know of two competing models for inequality, each of which has vastly different implications for political economy.

In the first, called consumptive inequality, inequality is embodied in differential consumption. Under this model, there is a huge gap between Oracle CEO Larry Ellison (net worth: $60 billion), with his private islands, his yacht, etc. and myself, with my cheap rented apartment, ten-year-old bike, and modest savings. In fact, under this model, there’s even a huge gap between Larry Ellison with all of his luxury goods and Berkshire Hathaway CEO Warren Buffett (net worth: $90.6 billion), with his relatively cheap house and restrained tastes.

Pictured: Warren Buffett’s house vs. Larry Ellison’s yacht. The yacht is many, many times larger than the house. Image credits: TEDizen and reivax.

Under the second model, inequality in new worth or salary is all that matters. This is the classic model that gives us the GINI coefficient and “the 1%”. Under this model, Warren Buffett is the very best off, with Larry Ellison close behind. I’m not even in contention.

I’ve been thinking a lot about inequality because of the recent increase in the minimum wage in Ontario. The reasons behind the wage hike – and similar economic justice proposals (like capping CEO pay at some double-digit multiple of worker pay) – seem to show a concern for consumptive inequality.

That is to say, the prevailing narrative around inequality is that it is bad because:

  1. Rich people are able to consume in a way that is frankly bananas and often destructive either to the environment or norms of good governance
  2. Workers cannot afford all basic necessities, or must choose between basic necessities and thinking long term (e.g. by saving for their children’s education or their own retirement)

Despite this focus on consumptive inequality in public rhetoric, our tax system seems to be focused primarily on wealth inequality.

Now, it is true that wealth inequality can often lead to consumptive inequality. Larry Ellison is able to consume to such an obscene degree only because he is so obscenely wealthy. But it is also true that wealth inequality doesn’t necessarily lead to consumptive inequality (there are upper middle-class people who have larger houses than Warren Buffett) and that it might be useful to structure our tax policy and other instruments of political economy such that there was a serious incentive for wealth inequality not to lead to consumptive inequality.

What I mean is: it’s unlikely that we’re going to reach a widely held consensus that wealth is immoral (or at what level it becomes immoral). But I think we already have a widely held consensus that given the existence of wealth, it is better to wield it like Mr. Buffett than like Mr. Ellison.

To a certain extent, we already acknowledge this. In Canada, there are substantial tax advantages to investing up 18% of your yearly earnings (below a certain point) and giving up to 75% of your income to charity. That said, we continue to bafflingly tax many productive uses of wealth (like investing), while refusing to adequately tax many frivolous or actively destructive uses of wealth (large cars, private jets, private yachts, influencing the political process, etc.).

Many people, myself included, find the idea of large amounts of wealth fundamentally immoral. Still, I’d rather tax the conspicuous and pointless use of wealth than wealth itself, because there are many people motivated to do great things (like curate all of the world’s information and put it at our fingertips) because of desire for wealth.

I’m enough of a post-modernist to worry that any attempt to create a metric of “social value” will further disenfranchise people who have already been subject to systemic discrimination and fail to reflect the tastes of anyone younger than 35 (I just can’t believe that a bunch of politicians would get together and agree that anyone creates social value or deserves compensation for e.g. cosplay, even though I know many people who find it immensely valuable and empowering).

That’s the motivation. Now for the practice. What would a tax plan optimized to punish spurious consumption while maintaining economic growth even look like? Luckily Scott Sumner has provided an outline, the cleverness of which I’d like to explain.

No income tax

When you take money from people as taxes, then give it back to them regardless of how hard they work, you discourage work. It turns out that this effect is rather large, such that the higher income taxes are, the more you discourage people from working. People working is a necessary prerequisite for economic growth and I view economic growth as largely positive (in that it is very good at engendering happiness and stability, as well as guaranteeing those of us currently working the possibility of retiring one day and generating revenues for a social safety net) and therefore think we should try and tax in a way that doesn’t discourage this.

No corporate tax

Another important component of economic growth is investment. We can imagine a hypothetical economy where absolutely everything that is produced is consumed, such that much is made, but nothing ever really changes. The products available this year will be the products available next year, at the same price and made in the same factory, with any worn-down equipment replaced, but no additional equipment purchased.

Obviously, this is a toy example. But if you’ve bought a product this year that didn’t exist last year, or noticed the cost of something you regularly buy fall, you’ve reaped the rewards of investment. We need people to deliberately set aside some of the production they’re entitled too via possession of money so that it can instead be used to improve the process of production.

Corporate taxes discourage this by making investment less attractive. In fact, they actively encourage consumptive inequality, by making consumption artificially cheaper than investment. This is the exact opposite of what we should be aiming for!

Interestingly, there have been a variety of report positive results of the recent cut in corporate tax rates in the US, from repatriation of money for US investment to bonuses for workers.

Now, I know that corporate taxes feel very satisfying. Corporations make a lot of money (although probably less than you think!) and it feels right and proper to divert some of that for public usage. But there are better ways of diverting that money (some of which I’ll talk about below) that manage to fill the public coffers without incentivizing behaviour even worse than profit seeking (like bloated executive pay; taxing corporate income makes paying the CEO a lot artificially cheap). Corporate taxes also hurt normal people in a variety of ways – like making saving for retirement harder.

No inheritance tax

This is another example of artificially making consumption more attractive. Look at it this way: you (a hypothetical you who is very wealthy) can buy a yacht now, use it for a while, loan it to your kids, them have them inherit it when it’s depreciated significantly, reducing the tax they have to pay on it. Or you can invest so that you can give your children a lot of money. Most rich people aren’t going to want to leave nothing behind for their children. Therefore, we shouldn’t penalize people who are going to use the money for non-frivolous things in the interim.

A VAT (with rebates or exemptions)

A VAT, or value added tax, is a tax on consumption; you pay it whenever you buy something from a store or online. A “value-added” tax differs from a simple sales tax in that it allows for tax paid to suppliers to be deducted from taxes owed. This is necessary so that complex, multi-step products (like computers) don’t artificially cost more than more simple products (like wood).

Scott Sumner suggests that a VAT can be easily made free for low-income folks by automatically refunding the VAT rate times the national poverty income to everyone each year. This is nice and simple and has low administrative overhead (another key concern for a taxation system; every dollar spent paying people to oversee the process of collecting taxes is a dollar that can’t be spent on social programs).

An alternative, currently favoured in Canada, is to avoid taxing essentials (like unprepared food). This means that people who spend a large portion of their money on food are taxed at a lower overall rate than people who spend more money on non-essential products.

A steeply progressive payroll tax

If income inequality is something you want to avoid, I’d argue that a progressive payroll tax is more effective than almost any other measure. This makes companies directly pay the government if they wish to have high wage workers and makes it more politically palatable to raise taxes on upper brackets, even to the point of multiples of the paid salary.

While this may seem identical to taxing income, the psychological effect is rather different, which is important when dealing with real people, not perfectly rational economics automata. Payroll taxes also make tax avoidance via incorporating impossible (as all corporate income, including dividends after subtracting investment would be subject to the payroll tax) and makes it easy to really punish companies for out of control executive compensation. Under a payroll tax system, you can quite easily impose a 1000% tax on executive compensation over $1,000,000. It’s pretty hard to justify a CEO salary of $10,000,000 when it’s costing investors more than a hundred million dollars!

Scott Sumner also suggests wage subsidies as an option to avoid the distortionary effect of a minimum wage [1], a concept I’ve previously explored in depth and found to be probably workable.

A progressive property tax

Property taxes tend to be flat, which makes them less effective at discouraging conspicuous consumption (e.g. 4,500 square foot suburban McMansions). If property taxes sharply ramped up with house value or size, families that chose more appropriately sized homes (or could only afford appropriately sized home) would be taxed at lower rates than their profligate neighbours. Given that developments with smaller houses are either higher density (which makes urban services cheaper and cars less necessary) or have more greenspace (which is good from an environmental perspective, especially in flood prone areas), it’s especially useful to convince people to live in smaller houses.

This would be best combined with laxer zoning. For example, minimum house sizes have long been a tool used in “nice” suburbs, to deliberately price out anyone who doesn’t have a high income. Zoning houses for single family use was also seized upon as a way to keep Asian immigrants out of white neighbourhoods (as a combination of culture and finances made them more likely to have more than just a single nuclear family in a dwelling). Lax zoning would allow for flexibility in housing size and punitive taxes on large houses would drive demand for more environmentally sustainable houses and higher density living.

A carbon tax

Carbon is what economists call a negative externality. It’s a thing we produce that negatively affects other people without a mechanism for us to naturally pay the cost of this inflicted disutility. When we tax a negative externality, we stop over-consumption [2] of things that produce that externality. In the specific case of taxing carbon, we can use this tax to very quickly bring emissions in line with the emissions necessary to avoid catastrophic warming.

I’d like to generalize this to Pigovian taxes beyond carbon. Alcohol (and other intoxicants), sugary drinks, and possibly tobacco should be taxed in line with their tendency to produce costs that (in countries with public risk pooling of health costs) are not borne by the individual over-consuming. I do think it’s important to avoid taking this too far – it’s reasonable to expect people to cover their negative externality, but not reasonable to punitively tax things just because a negative externality might exist or because we think it is wrong or “unhealthy” to do it. Not everything that is considered unhealthy leads to actual diseases, let alone increased healthcare costs.

A luxury goods tax

This comes from a separate post by Scott Sumner, but I think it’s a good enough idea to mention here. It should be possible to come up with a relatively small list of items that are mostly positional – that is to say that the vast majority of their cost is for the sake of being expensive (and therefore showing how wealthy and important the possessor is), not for providing increasing quality. To illustrate: there is a significant gap in functionality between a $3,000 beater car and a $30,000 new car, less of a gap between a $30,000 car and a $300,000 car and even less of a gap between the $300,000 car and a $3,000,000 car; the $300,000 car is largely positional, the $3,000,000 car almost wholly so. To these we could add items that are almost purely for luxury, like 100+ foot yachts.

It’s necessary to keep this list small and focus on truly grotesque expenditures, lest we turn into a society of petty moralizers. There’s certainly a perspective (normally held by people rather older than the participants) in which spending money on cosplay or anime merchandise is frivolous, but if it is, it’s the sort of harmless frivolity equivalent to spending an extra dollar on coffee. I am in general in favour of letting people spend money on things I consider frivolous, because I know many of the things I spend money on (and enjoy) are in turn viewed as frivolous by others [3]. However, I think there comes a point when it’s hard to accuse anyone of petty moralizing and I think that point is probably around enough money to prevent dozens of deaths from malaria (i.e. $100,000+) [4].

Besides, there’s the fact that making positional goods more expensive via taxation just makes them more exclusive. If anything, a strong levy on luxury goods may make them more desirable to some.


As I’ve read more economics, my positions on many economics issues have shifted in a way that many people parse as “more conservative”. I reject this. There are a great many “liberal” positions that sound good on paper, but when you actually do the math, hurt the poor and benefit the rich. Free trade makes things cheaper for all of us and has created new jobs and industries. A lot of regulation allows monopolies and large companies to crush any upstart rivals, or shifts jobs from blue collar workers making things to white collar workers ensuring compliance.

It is true that I care about the economy in a way that I never cared about it before. I care that we have sustainable growth that enriches us all. I care about the stock market making gains, because I’ve realized just how much of the stock market is people’s pensions. I care about start-ups forming to meet brand new needs, even when the previous generation views them as frivolous. I care about human flourishing and I now believe that requires us to have a functioning economic system.

A lot of how we do tax policy is bad. It’s based on making us feel good, not on encouraging good behaviour and avoiding weird economic distortions. It encourages the worst excesses of wealth and it’s too easy to avoid.

What I’ve outlined here is a series of small taxes, small enough to make each not worth the effort to avoid, that together can easily collect enough revenue to ensure a redistributive state. They have the advantage of cutting particularly hard against conspicuous consumption and protecting the planet from unchecked global warming. I sincerely believe that if more people gave them honest consideration, they would advocate for them too and together we could build a fairer, more effective taxation system.

Footnotes:

[1] A minimum wage can make it impossible to have Pareto optimal distributions – distributions where you cannot make anyone better off without making someone else worse off. Here’s a trivial example: imagine a company with two overworked employees, each of whom make $15/hour. The employees are working more than they particularly want to, because there’s too much work for the two of them to complete. Unfortunately, the company can only afford to pay an additional $7/hour and the minimum wage is $14/hour. If the company could hire someone without much work experience for $7/hour everyone would be better off.

The existing employees would be less overworked and happier. The new employee would be making money. The company could probably do slightly more business.

Wage subsidies would allow for the Pareto optimal distribution to exist while also paying the third worker a living wage. ^

[2] Over-consumption here means: “using more of it than you would if you have to properly compensate people for their disutility”, not the more commonly used definition that merely means “consuming more than is sustainable”.

An illustration of the difference: In a world with very expensive carbon capture systems that mitigate global warming and are paid for via flat taxes, it would be possible to be over-consuming gasoline in the economics sense, in that if you were paying a share of the carbon capture costs commensurate with your use, you’d use less carbon, while not consuming an amount of gasoline liable to lead to environmental catastrophe, even if everyone consumed a similar amount. ^

[3] For example, I spent six times as much as the median Canadian on books last year, despite the fact that there’s a perfectly good library less than five minutes from my house. I’m not particularly proud of this, but it made me happy. ^

[4] I am aware of the common rejoinder to this sort of thinking, which is basically summed up as “sure, a sports car doesn’t directly feed anyone, but it does feed the workers who made it”. It is certainly true that heavily taxing luxury items will probably put some people out of work in the industries that make them. But as Scott Sumner points out, it is impossible to meaningfully fix consumptive inequality without hurting jobs that produce things for rich people. If you aren’t hurting these industries, you have not meaningfully changed consumptive inequality!

Note also that if we’re properly redistributing money from taxes that affect rich people, we’re not going to destroy jobs, just shift them to sectors that don’t primarily serve rich people. ^

Economics, Falsifiable, Politics

Franchise Economics: Why Tim Hortons Has Become A Flashpoint In The Minimum Wage Fight

Since the minimum wage increase took effect on January 1st, Tim Hortons has been in the news. Many local franchisees have been clawing back benefits, removing paid breaks, or otherwise taking measures to reduce the costs associated with an increased minimum wage.

TVO just put out a piece about this ongoing saga by the Christian socialist Michael Coren. It loudly declares that “Tim Hortons doesn’t deserve your sympathy“. Unfortunately, Mr. Coren is incorrect. Everyone involved here (Tim Hortons the corporation, Tim Hortons franchisees, and Tim Hortons workers) is caught between a rock and a hard place. They all deserve your sympathy.

This Tim Hortons could be literally anywhere in suburban or rural Canada. Image Credit: Marek Ślusarczyk via Wikipedia Commons

It is a truism that a minimum wage increase must result in either declining profits, cuts to other costs, or rising prices. While supporters of the minimum wage increase would love to see it all come out of profits, that isn’t reasonable.

Basic economics tell us that as we approach a perfect market, profits should fall to zero. The key assumptions underpinning this are global perfect information (so no one can have any innovations that allow them to do better than anyone else) and zero start-up costs (so anyone can enter any market at any time). Obviously, these assumptions aren’t true in reality, but when it comes to fast food, they’re fairly close to true.

It is relatively cheap to start a fast-food restaurant (compared to say opening a factory). The start-up costs for a McDonalds, KFC, or Wendy’s are $1,000,000 to $2.3 million, while a Subway costs about $100,000 to $250,000 to start. This means that whenever someone sees fast-food restaurants making large profits in an area, they can open their own and take a fraction of the business, driving everyone’s profits down.

They’re probably driven down much lower than you think. If you had to guess, what would you say the profit margins for a fast-food restaurant are? If you’re anything like people in this study, you probably think something like 35%. The actual answer is 6% [1].

In addition to telling me that the average fast food restaurant has a 6% profit margin, that link helpfully told me that 29% of operating expenses in a fast-food restaurant come from labour costs. Raising those labour costs by 20% by increasing wages 20% increases total costs by 6% [2]. The minimum wage isn’t making fast-food restaurant owners make do with a little less in the way of profits. It’s entirely wiping out profits.

Now maybe your response to that is “well my heart doesn’t really bleed for that big multinational losing its profits”. But that’s not how Tim Hortons works. Tim Hortons, like almost all fast-food restaurants is a franchise. Tim Hortons the corporation makes money by collecting fees and providing services to Tim Hortons the restaurants, which are owned by the mythical small business owners™ that everyone (even the proponents of the minimum wage increase) claim to care so much about.

Most of these owners aren’t scions of wealthy families, but are instead ordinary members of their communities who saw opening a Tim Hortons as an investment, a vocation, or as a way to give back. They need to eat as much as their workers.

Faced with rising labour costs and no real profit buffer to absorb them, these owners can only cut costs or raise prices.

Except they can’t raise prices.

That’s the rub of a franchise system. The corporate office wants everything to be the exact same at every store. They set prices and every store must follow them. But there’s divergent incentives here. Tim Hortons the corporation makes a profit by selling supplies to its franchises; critically, they make a profit on supplies whether those franchisees turn a profit or not. They really don’t want to raise prices, because raising prices will hurt their bottom line.

It’s well known that (in general) the more expensive something is, the less people want it. Raising prices will hurt the sales volume of Tim Hortons franchises, which will decrease the profits at corporate Tim Hortons. The minimum wage hike affects Tim Hortons the corporation very little. They might see slightly increased shipping costs, but their costs are far less dependent on Canadian minimum wage labour. Honestly, the minimum wage increase probably is a net good for Tim Hortons the corporation. More money in people’s pockets means more money spent on fast-food.

Tim Hortons the corporation probably won’t say it, because they don’t want to antagonize their franchisees, but this minimum wage hike is great for them.

So, Tim Hortons franchisees have to cut costs or run charities. Given that they are running restaurants and not charities, we can probably assume that they’re going to cut costs. Why does it have to be labour costs that get cut? Can’t they just get their supplies for cheaper?

Here the franchise system bites them again. If they were independent restaurateurs, they might be able to source cheaper ingredients, reduce the ply of the toilet paper in their bathrooms, etc. and get their profits back this way.

But they’re franchisees. Tim Hortons the corporation has a big list of everything you need to run a Tim Hortons and you are only allowed to buy it from them. They get to set the prices however they want. And what they want is to keep them steady.

The only cost that Tim Hortons the corporation doesn’t control is labour costs. So, this is what franchisees have to cut.

There are two ways to decrease your labour costs. You can “increase productivity”, or you can cut wages and benefits. “Increase productivity” is the clinical and uninformative way of saying “fire 20% of your workers and verbally abuse the others until they work faster” or “fire 20% of your workers and replace them with machines”. While increased productivity is generally desirable from an economics point of view, it is often more ambiguous from a moral point of view.

Given that the minimum wage was just raised and it is illegal to pay any less than it, Tim Hortons franchisees cannot cut wages. So, if they’re against firing their employees and want to keep making literally any money, they have to cut benefits.

This might make it seem like corporate Tim Hortons is the bad guy here. They aren’t. The executives at Tim Hortons labour under what is called a fiduciary duty. They have a legal obligation to protect shareholder interests from harm and to act for the good of the corporation, not their own private good or for their private moral beliefs. They are responding to the minimum wage hike the way the government has told them to respond [3].

Minimum wage jobs suck. For all that economists claim there is no moral judgement implied in a wage, that it merely shows the intersection of the amount of supply of a certain type of labour and the demand for that labour, it can be hard to believe that there is no moral dimension to this when people making one wage struggle to make ends meet, while those earning another can buy fancy cars they don’t even need.

It is popular to blame business owners and capitalists for the wages their workers make and to say that it shows how little they value their workers. I don’t think that’s merited here. Corporate Tim Hortons has crunched the numbers and decided that if they raise prices, fewer people will buy coffee, their profits will decrease, and they might be personally liable for breach of fiduciary duty. In the face of rising prices, franchisees try and do whatever they can to stay afloat. We can say that caring about profits more than the wages their workers make shows immense selfishness on the part of these franchisees, but it’s little different than the banal selfishness anyone shows when they care more about making money for themselves than making money and giving it away – or the selfishness we show when we want our coffee to be cheaper than it can be when made by someone earning a wage that can comfortably support a family.

Footnotes

[1] As long as there are other available investments approximately as risky as opening a fast-food restaurant that return at least 6%, profits shouldn’t drop any lower than that. In this way, inefficiencies in other sectors could stop fast food restaurants from behaving like they were in a perfectly free market even if they were. ^

[2] This calculation is flawed, in that there are probably other costs making up total labour costs (like benefits) beyond simple wage income. On the other hand, it isn’t just wages that are going up. Other increased costs probably balance out any inaccuracies, making the conclusions essentially correct. This is to say nothing for corporate taxes, which further reduce profits. ^

[3] We can’t blame fiduciary duty, because fiduciary duty is how investing at all can happen. You might not like investing, but without investing, saving for retirement or having a national pension plan is impossible. If your response to this is to say “well let’s just tear down capitalism and start over”, I’d like to remind you that people tried that and it led to a) famine, b) gulags, c) death squads, d) more famine, and e) persistent shortages of every consumer good imaginable, including food ^

Economics, Model, Quick Fix

Regulation Revisited

Previously I described regulation as a regressive tax. It may not kill jobs per se, but it certainly shifts them towards people with university degrees, largely at the expense of those without. I’m beginning to rethink that position; I’m increasingly worried that many types of regulation are actually leading to a net loss of jobs. There remains a paucity of empirical evidence on this subject. Today I’m going to present a (I believe convincing) model of how regulations could kill jobs, but I’d like to remind everyone that models are less important than evidence and should only be the focus of discussion in situations like this, where the evidence is genuinely sparse.

Let’s assume that regulation has no first order effect on jobs. All jobs lost through regulation (and make no mistake, there will be lost jobs) are offset by different jobs in regulatory compliance or the jobs created when the compliance people spend the money they make, etc., on to infinity. So far, this is all fine and dandy.

Talking to members of the local start-up community, I reckon that many small sized hardware start-ups spend the equivalent of an engineer’s salary on regulatory compliance yearly. Instead of a hypothetical engineer (or marketer, or salesperson, etc.), they’re providing a salary to a lawyer, or a technician at the FCC, or some other mid-level bureaucrat.

No matter how well this person does their job, they aren’t creating anything of value. There’s no chance that they’ll come up with or contribute to a revolutionary new product that drives a lot of economic growth and ends up creating dozens, hundreds, or (in very rare cases) thousands of jobs. An engineer could.

There’s obviously many ways that even successful start-ups with all the engineers they need can fail to create jobs on net. They could disrupt an established industry in a way that causes layoffs at the existing participants (although it’s probably fallacious to believe that this will cause net job losses either, given the lump of labour fallacy). Also, something like 60% of start-ups fail. In the case of failure, money from wealthy investors is transferred to other people and I doubt most people care if the beneficiaries are engineers or in compliance.

But discounting all that, I think what this boils down to is: when you’re paying an engineer, there’s a chance that the engineer will invent something that increases productivity and drives productivity growth (leading to cheaper prices and maybe even new industries previously thought impossible). When you pay someone in sales or marketing, you get a chance to get your product in front of customers and see it really take off. When you’re paying for regulatory compliance, you get an often-useless stamp of approval, or have to make expensive changes because some rent-seeking corporation got spurious requirements written into the regulation.

Go on, tell me all million pages of this are necessary to protect consumers – I dare you. Image Credit: Coolcaesar on Wikimedia Commons

Or the regulatory agency catches a fatal flaw and averts a catastrophe. I’m not saying that never happens. Just that I think it’s much rarer than many people might believe. Seeing the grinding wheels of regulation firsthand has cured me of all my youthful idealistic approval for it. Sometimes consumers need to be protected from out of control profit-seeking, sure. But once you’ve been forced to actually do some regulatory compliance, you start to understand just how much regulation exists to prevent established companies from having to compete against new entrants. This makes everything more expensive and everyone but a few well-connected shareholders worse off.

Regulations has real trade-offs; there are definite goods, but also definite downsides. And now I think the downsides are even worse than I first predicted.

Economics, Politics

Why Don’t we Subsidize Higher Wages? Or: Public Policy is Expensive

[7 Minute Read]

Epistemic Status: Started as a reduction ad absurdum.

It used to be a common progressive grumbling point that the social safety net subsidized the low wages of McDonald’s and Walmart (and many less famous and less oft grumbled about enterprises). The logic went that employees at those companies just weren’t paid enough; they wouldn’t be able to survive – a necessary prerequisite to showing up at work – without government assistance. The obvious fix for this would be forcing these companies to pay their employees more – raising the minimum wage.

In my last piece on the minimum wage, I said the existing evidence pointed towards minimum wage hikes having few negative consequences. Recent evidence from Seattle suggests this may not be the case (although there are dueling studies, further complicated by accusations of academic misconduct against the scientists who found the hike had no effect). If my earlier prediction proves false, it will be because $15/hour is much higher – and a much larger percentage increase, then any of the past studies looked at.

If a $15/hour minimum wage “fails” [1] then we will face a choice. Do we give up on higher minimum wages? Do we accept higher unemployment (and all of its associated disconnection, wrenching poverty, and mental health costs)? Do we try something radically different?

Certainly, there exist other potential programs that we can use to accomplish some of the goals of a minimum wage increase if an increase itself proves untenable. A guaranteed basic income (GBI) [2], while expensive, would accomplish many of the same economic security goals as a higher minimum wage, but it wouldn’t fix the fact that some people see their wage as a reflection on their moral value, instead of a commentary on the supply and demand of various skills. This could become quite the sticking point; one reason that libertarians get behind a GBI is that it would allow us to abolish minimum wage laws.

Eliezer Yudkowsky (don’t groan, this really is relevant) has an interesting theory about the left. He thinks that the left doesn’t hate capitalism – they just hold it to the same ethical standards they hold people to. It might be people on the right who claim that corporations are people, but it’s the left who treat corporations like people.

If we accept Yudkowsky’s theory, there are a lot of people for whom paying someone $8/hour is an unacceptable slur on that person’s value as a human being [3]. This seems to match what I see from time to time on Facebook or in editorials. Here’s one out of Seattle; it ends with: “Finally, let’s be mindful that a minimum wage is about more than keeping the poor from starving. It’s also about attaching dignity to a person’s labor”.

Dignity being on the line changes the minimum wage debate. People can squabble over the economic pie endlessly. But make it about dignity and workers can’t back down. Even if a higher minimum wage leads to price increases or lost jobs.

And the Seattle Times article I linked is far too sanguine about price increases [4]. It is correct when it points out that well-off people can eat price increases with nary a change in behaviour, but I don’t know how it can so calmly ignore how much of a struggle it is for low-income families to deal with price increases.

Of course, raising the minimum wage might give people some breathing room. But that breathing room is wasted if prices immediately increase to match the new incomes. Have you ever watched someone on a treadmill?

The real effect of increased prices will be felt by people living on fixed incomes. Price increases are especially rough on seniors, who often can’t work even if they wanted to. Although I suppose we could use inflation to deal with the truly scary unfunded pension liabilities that many governments now have to deal with.

Raising the minimum wage will have to result in higher prices if it doesn’t lead to improved productivity (and therefore laying off the least productive workers). Retailers can absorb wages up to about $11/hour and still turn a profit. Beyond that, they can only raise prices, raise productivity, or run a charity. They won’t do the third.

But look, steadily rising wages are nice. They’re an excellent anesthetic for discontent. They alleviate poverty. If it was worth the cost, the government could make the complaints of subsidization true by literally subsidizing wages.

For the government to carry out this subsidization in Ontario, the cost would be something like $9 billion dollars [5]. This is equivalent to about 6% of the current budget – a bit less than the amount Ontario pays to service its debt. It wouldn’t be impossible to raise revenue for this – a progressive 1-5% tax increase would cover it handily [6], with the median Ontario worker seeing about $10.00 come off each paycheque with the new taxes.

There would obviously need to be some pretty strict rules in place here. What company would chip in $13 or $14 when their worker would be paid the same if they instead chipped in $11.60 (the current minimum wage)? We might get around this by making subsidization depend on the number of workers you employ (although this will tend towards monopolization and give the big retail giants quite an advantage) or their low productivity (but this has terrible incentives).

We still don’t know if the minimum wage hike will result in lost jobs. It’s also an open question how much we should (at a policy level) be aiming for full employment. But raising the minimum wage is a massive, $9 billion undertaking. Who pays for it (and if it happens at all) is deeply tied into questions about fairness, dignity, good governance and regressiveness. The least regressive way to do it is probably via subsidies; unfortunately, subsidies are the most corruptible of all options.

I previously mentioned the guaranteed basic income. My crude calculations give a (no doubt slightly high) estimate of $37 billion [7] for a GBI in Ontario, much higher than I’ve seen in the estimates from proponents. I’m personally worried that a GBI would be absorbed into raised rents [8], another example of a treadmill effect.

Economics policy is difficult enough as a scientific discipline. But tied up in ancillary questions (like “what is fair?”) as it is, it is uniquely susceptible to corruption by what people wish, rather than what is true [9]. When it can’t be corrupted, it is often ignored. Public policy has a cost. Resources are still limited. For every dollar spent, there must be a dollar raised (if not now, then eventually).

When we focus only on what we feel is fair or justified and not on what is achievable, we aren’t doing anyone any favours. Raising the minimum wage to $15/hour might cause job losses or spiralling inflation, or it might require subsidies and tax raises. These aren’t the consequences of greedy corporations. They’re the predictable results of people making reasonable decisions in a massively complicated system.

Disturb it at your own peril.

Footnotes:

[1] Failure (to me) means increased unemployment. A decrease in labour force participation would probably represent a return to single income families, unless preceded by high unemployment of the sort that drives people to give up looking for work. There’s also the failure mode of “causes spiralling inflation”, but that seems more likely to end the whole experiment prematurely. ^

[2] Unanswered questions I still have about a guaranteed minimum income include: “how can we pay for?”, “are you sure it won’t cause massive inflation in rents?”, and “no seriously, just saying it was fine when the Fed did QE isn’t good enough! Why won’t all that money chasing the same desirable housing cause the housing to become more expensive?” ^

[3] It’s weird to see the left capitulating here and more or less agreeing that a person’s value is at all tied to their wage. I think it’s important to strongly reject all attempts to link the intrinsic human value of a person with their economic value. Economic value maps to supply and demand, not intrinsic worthiness, so it’s an inherently fragile thing to base any moral worth on. ^

[4] It also makes a horrendous false equivalence between worker pay and CEO pay. Walmart’s CEO makes $21.8 million. Walmart has 2.3 million “associates”. Let’s say they average 20 hours per week, 50 weeks per year, for 2.3 billion employee hours per year. Removing the CEO’s salary would free up enough cash to pay the workers one extra cent per hour ($10/year). CEO salaries are a very tiny drop in the bucket compared to total compensation for companies with huge workforces. ^

[5] 1.7 million people make less than $15/hour. Assume they all make $11.60/hour, that they all work 40 hour weeks, 50 weeks a year and we end up with $11.6 billion. Since all of these are overestimates, this gives us an upper bound. $9 billion is my guess at a more realistic number. ^

[6] Here’s my calculations, based on the really excellent Statistics Canada data available here. I’ve made some simplifying assumptions (e.g. that everyone in each bracket makes the exact centre value of the bracket, that higher taxes won’t make people look for more ways to avoid them), but this should be broadly accurate. If you want to play around with the workbook, leave a comment with your email address and I’ll send it your way.

Note that “Total Revenue”, “Total Tax”, and “Tax as percent of income” are calculated by adding the “Tax at Midpoint” value to the “Taxes For Entire Bracket” values for all previous brackets. This is how the taxman does it. ^

[7] Calculations:

Not pictured: any adjustment for the percent of people who are married. The simplest approach (50% of Ontarians are married and couples receive 30% less, so the cost should be 15% lower) brings the cost down to a “mere” $37 billion. This is the cost I quote above. ^

[8] Rent control is the only possible solution, but it might be worse than what it seeks to cure. The economist Assar Lindbeck claimed that “In many cases rent control appears to be the most efficient technique presently known to destroy a city—except for bombing.” This was falsified by communist Vietnam, according to a speech by its onetime foreign minister: “The Americans couldn’t destroy Hanoi, but we have destroyed our city by very low rents. We realized it was stupid and that we must change policy”. ^

[9] On all sides. For every Bernie bro convinced we need socialism right now, there’s someone who believes in the explicitly anti-empirical assertions of the Austrian School. ^

Economics, Model, Politics

Meditations on Regulation, or the Case of the $10,000 Staircase

[10-minute read]

Breaking news: a retired mechanic spent one afternoon and $550 building a staircase. This is news because the City of Toronto said it would cost $65,000 for them to do it. They’ve since walked back that estimate, claiming it won’t be that expensive (instead, the final cost looks to be a mere $10,000).

Part of this is materials and labour. The city will probably go for something a bit more permeant than wood – probably concrete or metal – and will probably have higher labour costs (the mechanic hired a random guy off the street to help out, which is probably against city procurement policy). But a decent part (perhaps even the majority) of the increased costs will be driven by regulation.

First there’s the obvious compliance activities: site assessment, community consultation, engineering approval, insurance approval. Each of these will take the highly expensive time of highly skilled professionals. There’s also the less obvious (but still expensive and onerous) hoops to jump through. If the city doesn’t have a public works crew who can install the stairs, they’ll have to find a contractor. The search for a contractor would probably be governed by a host of conflict of interest and due diligence regulations; these are the sorts of thing a well-paid city worker would need to sink a significant amount of time into managing. Based on the salary information I could find, half a week of a city bureaucrat’s time already puts us over the $550 price tag.

And when the person in charge of compliance is highly skilled, the loss is worse than simple monetary terms might imply. Not only are we paying someone to waste her time, we are also paying the opportunity cost of her wasting her time. Whenever some bright young lawyer or planner is stuck reading regulatory tomes instead of creating something, we are deprived of the benefits of what they could have created.

When it comes to the stairs, regulations don’t stop with our hypothetical city worker. The construction firm they hire is also governed by regulations. They have to track how much everyone works, make sure the appropriate taxes go to the appropriate parties, ensure compliance with workplace health and safety standards and probably take care of a dozen minor annoyances that I don’t know about. When you aren’t the person doing these things, they just blend into the background and you forget that someone has to spend a decent part of their time filling out incredibly boring government forms – forms that demand accuracy under pain of perjury.

No source needed, because I stole this from a US government form and no documents produced by the US government can be copyrighted
What, you never noticed how fond government documents were of waving the p-word around? This basically says “fill this out right, or one of the state’s armed enforcers will use violence to bring you to a small room that you won’t be allowed to leave for a very long time”.

Hell, the very act of soliciting bids can inflate the cost, because each bid will require a bunch of supporting paperwork (you can’t submit these things on a sticky note). As is becoming the common refrain, this takes time, which costs money. You better bet that whichever firm eventually gets hired will roll the cost of all its failed past bids (either directly or indirectly) into the cost the city ends up paying.

It’s not just government regulations that drive up the price of stairs either. If the city has liability insurance, it will have to comply with a bunch of rules given to it by its insurer (or face higher premiums). If it chooses to self-insure, the city actuaries will come up with all sorts of internal policies designed to lessen the city’s chance of liability – or at least lessen the necessary payout when the city is inevitably sued by some drunk asshole who forgets how to do stairs and breaks a bone.

With all of this regulation (none of which seems unreasonable when taken in isolation!) you can see how the city was expecting to shell out $65,000 (at a minimum) for a simple set of stairs. That they managed to get the cost down to $10,000 in this case ­(to avoid the negative media attention of over-estimating the cost of stairs more than one hundred times over?) is probably indicative of city workers doing unpaid overtime, or other clever cost hiding measures [1].

The point here is that regulation is expensive. It’s expensive everywhere it exists. The United States has over 1,000,000 pages of federal regulation. Canada makes its federal regulation available as a compressed XML dump(!) with a current uncompressed size of 559MB. Considering XML overhead, the sum total of Canadian federal regulation is probably approximately equivalent to that of the United States.

The only thing that hates federal regulation more than libertarians is the bookshelf that has to hold it all. Image Credit: Coolcaesar on Wikimedia Commons

This isn’t it for either country; after federal regulation, there’s provincial/state and local regulations. Then there are the interactions between all three, with things becoming even worse when you want to do anything between different jurisdictions within a country or (and it’s a miracle this can even happen at all) between countries.

People who can hold a significant subset of these regulations in their head and successfully navigate them (without going mad from boredom) are a limited resource. Worse, they’re a limited resource who can be useful in a variety of fields (i.e. there has to be some overlap between the people who’d make good programmers, doctors, or administrators and the people who can parse and memorize reams of regulation). Limited supply and consistent (or increasing) demand drives the excessive cost of buying their time that I mentioned earlier.

This is the part where I’m supposed to talk about how regulation destroys jobs and how we should repeal it all if we care about the economic health of our society. But I’m not going to do that. The idea that regulation kills jobs is based on economic fallacies [2] and not borne out by evidence (although it is surprisingly poorly studied and new evidence could change my mind here).

As best we can currently tell, regulation doesn’t destroy jobs; it shifts them. In a minimally regulated environment, there will be fewer jobs requiring highly educated compliance wizards and more jobs for everyone else. As the amount of regulation increases, we should see more and more labour shift from productive tasks to compliance tasks. Really regulation is one of the best ways that elites can guarantee jobs for other elites.

Viewed through this lens, regulation is similar to a very regressive tax. It might be buying us social goods that we really want, but it does so in a way that transfers wealth from already disadvantaged workers to already advantaged workers. I think (absent offloading regulatory compliance onto specialized AI expert systems) that this might be an inherent feature of regulation.

When I see progressives talking about regulation, the tone is often that companies should whine about it less. I think it’s totally true that many companies push back against regulation that is (on the face of it at least) in the public good – and that companies aren’t pushing back primarily out of concern for their workers. However, rejecting the libertarian position doesn’t mean we should automatically support all regulation. After reading this, I hope you look at regulation as a problematically regressive tax that can have certain other benefits.

Because even taking into account its regressive effects, regulation is often a net good. Emissions standards around nitrous oxide emissions have saved thousands of lives – and Volkswagen cheating on them will lead to the “pre-mature deaths” of over one thousand people.

Corporations have no social duty beyond giving returns to their shareholders. It’s only through regulation that we can channel them away from anti-social behaviour [3]. Individuals are a bit better, motivated as they are by several things beyond money, but regulation is still sometimes needed to help us avoid the tragedy of the commons.

That said, even the best-intentioned regulation can have ruinous second order effects. Take the new French law that requires supermarkets to donate unsold, expiring produce to food banks. The law includes a provision indemnifying supermarkets against any legal action for food poisoning or other problems caused by the donated food. Without that provision, companies would be caught in a terrible bind. They’d face fines if they didn’t donate, but face the risk of huge lawsuits if they did [4][5].

Regulation isn’t just the purview of the government. If all government regulation disappeared overnight, private regulation – overseen primarily by insurance companies – would take its place. The ubiquity of liability insurance in this litigious age has already turned many insurers into surrogate regulators [6].

Insurance companies really hate paying out money. They can only make money if they make more in premiums than they pay out for losses. The loss prevention divisions of major insurers work with their clients, making sure they toe the line of the insurer’s policies and raising their premiums when they don’t.

This task has become especially important for the insurers who provide liability insurance to police departments. Many local governments lack the political will to rein in their police force when they engage in misconduct, but insurance companies have no such compunctions. Insurers have written use of force policies, provided expensive training, furnished use of force simulators, and ordered the firing of chiefs and ordinary officers alike.

When insurers make these demands, they expect to be obeyed. Cross an insurer and they’ll withdraw insurance or make the premiums prohibitively high. It isn’t unheard of for police departments to be disbanded if insurers refuse to cover them. Absent liability insurance, a single lawsuit can literally bankrupt a small municipality, a risk most councillors won’t take.

As the Colombia Law School article linked above suggested, it may be possible to significantly affect the behaviour of insurance purchasers with regulation that is targeted at insurers. I also suspect that you can abstract things even further and affect the behaviour of insurers (and therefore their clients) by making arcane changes to how liability works. This has the dubious advantage of making it possible to achieve political goals without obviously working towards them. It seems likely that it’s harder to get together a big protest when the aim you’re protesting against is hidden behind several layers of abstraction [7].

Regulation isn’t inherently good or bad. It should be able to stand on its own merits and survive a cost-benefit analysis. This will inevitably become a tricky political question, because different people weight costs and benefits differently, but it isn’t an intractable political problem.

(I know that’s what I always say. But it’s a testament to the current political climate that saying “policy should be based on cost-benefit analyses, not ideology” can feel radical [8].)

I would suggest that if you’re the type of person whose knee-jerk response to regulation is to support it, you should look at how it will displace labour from blue-collar to white-collar industries or raise prices and ponder if this is worth its benefits. If instead you oppose regulation by default, I’d suggest looking at its goals and remembering that the cost of reaching them isn’t infinite. You might be surprised at what a true cost benefit analysis returns.

Also, it probably seems true that some things are a touch over-regulated if $65,000 (or even $10,000) is an unsurprising estimate for a set of stairs.

Epistemic Status:  Model

Footnotes:

[1] Of course, even unpaid overtime has a cost. After a lot of it, you might feel justified to a rather longer paid vacation than you might otherwise take. Not to mention that long hours with inadequate breaks can harm productivity in the long run.  ^

[2] It seems to rest on the belief that regulation makes things more expensive, therefore fewer people buy them, therefore fewer people are needed to produce them. What this simple analysis misses (and what’s pointed out in the Pro Publica article I linked) is that regulatory compliance is a job. Jobs lost directly producing things are more or less offset by jobs dealing with regulations, such that increased regulation has an imperceptible effect on employment. This seems related to the lump of labour fallacy, although I’ve yet to figure out how to clearly articulate the connection. ^

[3] In Filthy Lucre, Professor Joseph Heath talks about the failures of state-run companies to create “socially inclusive growth”. Basically, managers in companies care far more about their power within the company than the company being successful (the iron law of institutions). If you give them a single goal, you can align their incentives with yours and get good results. Give them two goals and they’ll focus on building up their own little fief within the company and explaining away any failures (from your perspective) as the necessary results of balancing their dual tasks (“yes, I posted no profits, I was trying to be very socially inclusive this quarter”).

Regulation, if set up so that it seriously affects profits (or if set up so that it has high personal consequences for managers) forces the manager to avoid acting in a ruinously anti-social way without leaving them with the sort of divided loyalties that can cause companies to become semi-feudal. 

[4] The end game would quite possibly involve supermarkets setting up legally separate (with significant board overlap) charitable organizations that would handle the distribution, and compelling these shells (who would carry almost no cash so as to be judgement proof) to sign contracts indemnifying the source supermarket against all lawsuits. This would require lots and lots of lawyer time and money, which means consumers would see higher food prices. ^

[5] Actually, higher food prices are pretty much inevitable, because there’s still a bunch of new logistics that have to be worked out as a result of this law. If the logistics turn out to be more expensive then the fines, supermarkets will continue to throw out food (while passing the costs of the fines on to the consumer). If the fines are more expensive, then food will be donated (but price of donating it will still inevitably be passed on to consumers). Any government program that makes food more expensive is incredibly regressive – it’s this realization that underlies the tax-free status of unprepared food in Canada.

Supplemental nutrition programs (AKA “food stamps”) have the benefit of subsidizing food for those who need it from the general tax pool, which can be based on progressive taxation and mainly paid for by the wealthy.

It’s really easy to see a bunch of food sitting around and realize it could be better used. It’s really hard (and expensive) to actually handle the transport and preparation of that food. ^

[6] Meaning that a government that really wanted to reduce regulation would have to make it rather hard to sue anyone. This seems like an unlikely use of political capital and also probably in conflict with many notions of fundamental justice.

Anyway, you should look at changes to liability the same way you look at regulation. Ultimately, they may amount to the same thing. ^

[7] This is dubious because it’s inherently anti-democratic (the government is taking actions designed to be opaque to the governed) and also incredibly baroque. I’m not talking about simple changes to liability that will be intuitively understood. I’m talking about provisos written in solid legalese that tweak liability in ways that I wouldn’t expect anyone without a law degree and expertise in liability law to understand. If a government was currently doing this, I would expect that I wouldn’t know it and wouldn’t understand it even if it was pointed out to me. ^

[8] Note, crucially, that it feels radical, but isn’t. Most people who read my blog already agree with me here, so I’m not actually risking any consequences by being all liberal/centrist/neo-liberal/whatever we’re calling people who don’t toe the party line this week. ^

Economics, Model, Politics

Minimum Standards or Broad Access?

[5-minute read]

There are two sides to every story. Zoning and maximum occupancy regulations are exclusionary and drive up the price of housing. They are also necessary to prevent exploitative landlords from leaving their tenants in squalor. Catastrophic health insurance plans leave patients uncovered for many of the services they might need. They’re also often the only plans that are rational for younger people to buy.

Where you come down on either of these – or any similar cases where there’s a clear trade-off between maximum access and minimum standards – is probably heavily dependent on your situation. If you’re an American millennial without an employer-provided or parental health care plan, you’re probably quite incensed about the lack of catastrophic health care insurance. For healthy young adults, those plans were an excellent deal.

Similarly, workaholics in the Bay Area sometimes want to be able to stuff a house full to the bursting to save on rent. If you’re never going to be home, regulations around the number of square feet per bed feel incredibly onerous.

I like to point out that regulation is a trade-off. Unfortunately (or perhaps fortunately), it’s a trade-off made at the middle. People in the long probability tails – those who are far from the median when it comes to income or risk-tolerance often feel left out by any of the trade-offs made by the majority. This is an almost inevitable side-effect of trade-offs that I rarely see mentioned.

If you have health problems for which Obamacare didn’t mandate coverage, then you might find yourself wishing that the coverage requirements were even more expansive. If you find yourself really hating the illegal AirBnB you’re living in with twelve other programmers, you might wish that the city’s rental enforcement unit was a bit more on their game.

Most articles about people on the extremes leave out the context and leave out the satisfied middle. They don’t say “this is the best trade-off we could get, but it’s still imperfect and it still hurts people”. They say breathlessly “look at this one person hurt by a policy, the policy hurts people and is bad; the people who advocate for it are evil.”

It’s understandable to leave out the middle in the search of a better story. The problem arises when you leave out the middle and then claim all advocates are evil for failing to care about the fringes. Because most of the time, no one is being evil.

The young people skipping out on coverage because it’s not worth it for them aren’t shirking a duty. They’re making the best of their limited finances, ravaged by a tough entry-level job market and expensive university education. The NIMBYs who fight against any change to local building codes that might make housing more affordable are over-leveraged on their houses and might end up underwater if prices fall at all.

Even appeals to principles don’t do much good in situations like this. You can say “no one should live in squalor”, but that might run right up against “everyone should be able to afford a place to live”. It can be that there simply isn’t enough housing supply in desirable cities to comfortably accommodate everyone who wants to live there – and the only way to change that involves higher direct or indirect taxes (here an indirect tax might be something like requiring 15% of new rental stock to be “affordable”, which raises the price of other rental stock to compensate), taxes that will exclude yet another group of people.

When it comes to healthcare in America, you can say “young people shouldn’t be priced out of the market”, but this really does compete with “old people shouldn’t be priced out of the market” or “pre-existing conditions shouldn’t be grounds for coverage to be denied”.

The non-American way of doing healthcare comes with its own country specific trade-offs. In Germany, if you switch from the public plan to a private plan it is very hard to get back on the public plan. This prevents people from gaming the system – holding cheaper private insurance while they’re young, healthy and earning money, then trying to switch back during their retirement, but it also can leave people out in the cold with no insurance.

In Canada, each province has a single, government-run insurance provider that charges non-actuarial premiums (premiums based on how much you make, not how likely you are to use healthcare services). This guarantees universal coverage, but also results in some services (especially those without empirical backing, or where the cost-benefit is too low) remaining uncovered. Canada also prohibits mixing of public and private funds, making private healthcare much more expensive.

Canadians aren’t spared hard choices, we just have to make different trade-offs than Americans. Here we must pick (and did pick) between “the government shouldn’t decide who lives and who dies” and “care should be universal”. This choice was no less wrenching then any of those faced by Obamacare’s drafters.

Municipalities face similar challenges around housing policy. San Francisco is trying to retain the character of the city and protect existing residents with rent control and strict zoning regulations. The Region of Waterloo, where I live, has gone the other way. Despite a much lower population and much less density, it has almost as much construction as San Francisco (16 cranes for Waterloo vs. 22 for SF).

This comes at a cost. Waterloo mandated that houses converted into rental properties cannot hold more than three unrelated tenants per unit, thereby producing guaranteed renters for all the new construction (and alleviating concerns about students living in squalid conditions). The region hopes that affordability will come through densification, but this cuts down on the options student renters have (and can make it more expensive for them to rent).

Toronto is going all out building (it has about as many cranes on its skyline as Seattle, Los Angeles, New York, San Francisco, Boston, Chicago, and Phoenix combined), at the cost of displacing residents in rooming houses. There’s the hope that eventually supply will bring down Toronto’s soaring house costs, but it might be that more formal monthly arrangements are out of the reach of current rooming house residents (especially given that rent control rules have resulted in a 35-year drought on new purpose-built rental units).

In all of these cases, it’s possible to carve out a sacred principle and defend it. But you’re going to run into two problems with your advocacy. First, there’s going to be resistance from the middle of society, who have probably settled on the current trade-off because it’s the least offensive to them. Second, you’re going to find people on the other underserved extreme, convinced all the problems they have with the trade-off can be alleviated by the exact opposite of what you’re advocating.

Obamacare looked like it would be impossible to defend without Democrats controlling at least one lever of government. Republicans voted more than 50 times to repeal Obamacare. Now that they control everything, there is serious doubt that they’ll be able to change it at all. Republicans got drunk on the complaints of people on the long tails, the people worst served by Obamacare. They didn’t realize it really was the best compromise that could be obtained under the circumstances, or just how unpopular any attempt to change that compromise would be.

(To be entirely fair to Republicans, it seems like many Americans, including many of those who opposed Obamacare up until Obama left office, also just realized it was the best possible compromise.)

This is going to be another one of those posts where I don’t have a clear prescription for fixing anything (except perhaps axing rent control aka “the best way to destroy a city’s rental stock short of bombing it”). I don’t actually want to convince people – especially people left out of major compromises – not to advocate for something different. It’s only through broad input that we get workable compromises at all. Pluralistic society is built on many legitimate competing interests. People are motivated by different terminal values and different moral foundations.

Somehow, despite it all, we manage to mostly not kill each other. Maybe my prescription is simply that we should keep trying to find workable compromises and keep trying not to kill each other. Perhaps we could stand to put more effort into understanding why people ask for what they do. And we could try and be kind to each other. I feel comfortable recommending that.

Epistemic Status: Model