Thoughts on economics and liberty

Category: Economics

Extracts from The Economic Case for Private Residential Development by Fred E.Foldvary

Folvary had an excellent chapter in is an excellent article in Private Cities ed. Glasze, Weber and Frantz (2006) from which a few key points are worth noting:

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The economic feasibility of private residential governance, empirically confirmed by the worldwide growth of private communities, turns the prevailing ‘market failure’ doctrine on its head. This doctrine posits that collective goods are subject to free-riders, making the private provision sub-optimal. But the reality of private communities demonstrates the opposite. The governmental provision of public goods such as security and recreation is often deficient, and private enterprise has responded to the demand for such by developing private residential communities.

The accusation that ‘gated’ communities create exclusive zones for the wealthy and fragment the urban community conflates cause and effect. To the extent that private communities fill needs and wants not provided by govern-ment, the fragmentation is ultimately caused by government. Gated communities are the effect, the symptom, both of the failure of government to provide adequate security, and of the desire of residents to enjoy a greater amount or better quality of club goods than provided by governments.

None of [the] … market-failure premises have any justification in logic or evidence in the context of civic goods.

The public goods typically provided by government [streets and highways, street utilities (lighting) and architecture, parks, security, fire protection, schooling, recreation and public transit such as bus services] are located in physical space. Most users are located in the vicinity of the good. Even national defence protects territory, rather than existing abstractly in ether.

To the extent that such collective goods are valued by the residents, they increase the demand to be located near them, relative to not having such goods. This added demand increases the rental that tenants (including owner-tenants) are willing to pay to be located there and the purchase price of land in that territory.

The need to pay rent, either periodically or in the purchase price or as an admission charge, in order to be located in the territory served by the public goods, prevents the resident tenants from being free-riders. Aside from occasional guests, most users are rental-payers. The rental provides the means by which private enterprise can finance the goods. If a firm or club can collect the rental, then they can finance the public good. The market does not fail.

The rentals provide the means of determining whether to provide the territorial goods, and the optimal amount. If the rental generated by the goods is greater than the cost, the good is profitably provided. The optimal amount is where the marginal or additional rental generated equals the cost of additional amounts of the goods. For example, an entrepreneur deciding on how many swimming pools to provide to a large community development would, from previous experience and data, provide pools if they add  more to site values or rentals than they cost. Since the marginal utility of swimming pools declines with increasing quantity, the profit-maximising developer provides more so long as an extra pool generates more expected rental than it costs.

Territory is inherently excludable, although in some cases the cost of complete exclusion may be higher than the benefits. Territorial clubs include private communities such as condominiums, homeowners’ associations, shopping centres, industrial estates or parks, resorts and recreational facilities, office buildings, universities and hotels.

Territory makes club goods excludable in two ways. First, the club can prevent outsiders from entering, such as with a fence and a gate. Second, club services can be de facto excludable if most of the users are paying members, so that free-riders do not materially affect the ability of the club to provide collective goods to the members. A hotel, for example, is financed by the rentals paid by the guests and other tenants, and the fact that non-payers may enter and sit in the lobby or use the elevator does not detract from the financial viability of the hotel.

When government provides the territorial public goods, users are typically double-billed for the cost. Most taxation today falls on wages and capital. A worker-tenant therefore pays taxes on his wages to finance the collective good, and also pays extra rental to a landlord to be located by the territorial goods. If he wants to be located near a metro-rail stop, he pays extra rental relative to locations further away, and he pays sales and wage taxes to the government. To the extent the worker is mobile, a tax on his wage may be passed on to the owner of the firm and to the customers, but typically there are large moving costs and few untaxed options, leaving workers rather immobile for taxes on their wages, and thus forced to bear the burden as a lower net wage.

If some are being double-billed, others must be collecting subsidies on one of those bills. With today’s typical government financing, the free-rider is not the user, who has to pay twice for the territorial goods, but the landowners, who get their land values pumped up as the goods become capitalised into higher rentals and purchase prices for real estate. The landlord of a town house near the subway stop receives higher rentals from his tenants due to the public goods paid for by others. This is an implicit redistribution of wealth, a forced transfer of income from worker-tenants to landowners in general, whether they rent out their premises or occupy them as tenant-owners.

When private communities such as homeowners’ associations, condominiums or hotels provide territorial goods, they do not enquire about the income earned by the members or tenants, or impose surcharges on the sale of goods in their territory. Hotels instead charge a room rental, and condominiums and associations have a monthly member assessment, which in effect is a site rental payment. They do not have the political power to impose arbitrary costs, so instead they must operate contractually, according to the benefit principle. The rental pays for the territorial benefits.

In private communities, tenant—users therefore pay but once for territorial public goods. They pay only the rental. The providers are thus not free-riders, because in return for the rental payment they receive, they finance the goods, rather than having them provided by some governmental third party. Aside from occasional guests having no material impact, with the private provision of territorial public goods there are neither free-riders nor forced taxpayer drivers.

Why do city, provincial, state and national governments not operate like private communities, financing their territorial goods from site rentals? Such has long been proposed by economists, including the French physiocrats, Adam Smith, Henry George and a number of contemporary public-finance theorists. Why does the public tolerate double billing by government, but does not put up with it in private settings?

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The horrible cost of the Mudra program for India’s future

Mudra is public sector bank micro-lending, a continuation of the failed IRDP type programs of the past. These programs were not only terrible for taxpayers since the loans were not repaid and banks had to be recapitalised, but the schemes were a major means of corruption at all levels of government and public sector banks.

Mudra’s average disbursement is Rs.45k of which I’d say that only Rs.20k reaches the actual “beneficiary”, on average. The impact of Mudra on the pubic sector banking system is going to be as disastrous as was the case with previous schemes: leading to deficit financing, money printing, inflation.

The only reason government doesn’t want to sell of public sector banks is that it won’t be able to use this hugely corrupt mechanism to cheat the taxpayers.

Private banking would restrict loans to healthy businesses, which will grow well and give real, sustainable jobs. The public sector banking model is a total disaster for India but don’t expect any party to privatise them anytime soon.

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New book project: Economics for Economists – What about roads, what about schools

I’ve started this book project.

Click HERE to read the book as it progresses.

== STARTING TEXT – BASED ON A A FEW HOURS OF WORK ===

ECONOMICS FOR PROFESSIONAL ECONOMISTS

This book aims to correct the widespread failures of economics education. Most economists jump straight from a market failure to a role for government. They have little or no economic intuition and give little or no consideration to government failure.

For example, consider recommendations from a recent competition policy report in Australia regarding town planning:

“Land can be used for a variety of purposes, including residential, industrial, commercial and conservation, which can include national parks. However, the unfettered market may not deliver an outcome across these various uses that is considered optimal for society as a whole. Hence, governments allocate land to particular uses through planning, zoning and development assessment”

The report assumes market failures (without discussing the details) and then rushes to justify the role of government in allocating land to procure uses through planning and zoning.

Such kind of thinking is rampant in policy circles and represents a massive, even catastrophic failure of economics education.

Economists have not been taught the underlying logic of economics perhaps since the time of Alfred Marshall. The discipline of economics has become a branch of geometry and calculus –  and while these mental gymnastics have a role in distinguishing elements of economic reasoning under certain limited contexts, they fail to provide the intuition regarding real life.

For instance, there is no mention of the word “infrastructure” in Mas-Colell and Whinston’s textbook of microeconomics. After waving their arms about in relation to “public goods”, and conducting considerable amounts of mental gymnastics, the authors consider their job done.

The result is that even the best economics graduates struggle with infrastructure policy. They don’t know what is infrastructure and assume, simply because it is now commonplace, that the government has a role in this area. Even in the broader economics literature there is virtually no book that analyses infrastructure from first principles. This applies to a range of issues other than infrastructure as well, such as schools, health system, town planning and public transport.

The failure to relate economics to real life has led to severe policy making problems.

Their education seems to impart to the students of economics an instinct for government intervention – when the instinct should have been quite the reverse. While the original economists like Adam Smith would have constantly questioned the role of government, economists that come out of university today have a natural proclivity to justify government intervention.

When economists who are trained only in the mathematics of the discipline and not in its logic or intuition, join government as economists, the results are often very poor. Their innate bias for government intervention combined with lazy thinking which is typical of all government departments, leads to further intervention by government in matters where it has got no business or capacity. The results can be quite disastrous.

The persistence of traffic congestion is, for instance,  a classic instance of the way governments think and operate. They simply have no capacity to understand the individual preferences of various users of roads and they refuse to even consider the possibility that they are actually creating a terrible outcome for society in this process. They have managed to create in this instance an outcome comparable with the “bread queues” of Soviet Russia – a complete and total failure of production, supply, distribution and consumption. Some extraordinarily stupid assumptions underpin government intervention in roads, and each of these assumptions leads to the denial of any role for markets or the price system.

One can barely begin to describe the extreme arrogance and stupidity of the way governments think. Virtually anywhere a government manages anything, one generally ends up with suboptimal outcomes with undersupply in some cases, oversupply in others, high prices, high costs, huge losses for taxpayers, unjustified subsidies, and an infinity of other distortions. The incentives and inevitable incompetence of governments leads in most cases to what are best characterized as socialist outcomes.

The main functions that a government is expected to perform – security and justice – are themselves so complex that governments invariably fail to deliver these functions effectively and efficiently. The idea of handing over many other functions to government – such as the supply of infrastructure and schools – surely must amount to borderline dementia.

This book aims to be the finishing school for economists so that they are able to think meaningfully about real life. This book does not compete with standard economics which is assumed to be the foundational knowledge for readers of this book.

THE MISSING ECONOMIC INTUITION AND UNDERSTANDING OF GOVERNMENT FAILURE

Economic intuition

Most economists have never learnt to think like economists. Economics is all about incentives and about understanding the logic of why people do certain things. What this book aims is to build an intuition for economics, an intuition that incorporates incentives and a rich understanding of the price system and markets, an intuition that prevents economists from supporting any government intervention – including existing interventions – without extremely deep questioning. A crucial aspect involves the understanding that only markets are able to deal with complex information. The geometries or calculus of economics do not reflect the infinite richness of real-life tatonnement or catallaxy.

Very soon, no matter how intense the course they have attended, graduates of economics forget their geometry and mathematics. There is virtually no professional economist I’m aware of who can recall all this mathematics. It is only the academics who teach on a daily basis who continue with their understanding of the technical aspects of economics. What should remain behind once all the maths is forgotten are the core ideas of economics. But unfortunately, since students are not taught the core ideas of economics nor how these apply to real life, there develops an arrogance in their minds that economists can somehow resolve policy problems.

They forget that the key message of economics is humility and that even governments do not have –  and cannot have – the instruments to understand, leave alone resolve, complex information. Information that is diffused across the world in numerous forms cannot be obtained by government under any circumstances, leave alone processed optimally.

The economist should therefore study how markets resolve the market failures and humbly figure out ways to support markets in their endeavour to fix the problem. Economists need to learn that there is no method available to mankind apart from the market to identify, understand and resolve the myriads of differences of preferences and affordability.

Government failure

Every single sensible policy should involve analysing any associated government failures and only after both the market and government failures have been understood, and it is made clear why the government can improve at low cost the so-called imperfections of the market, only then should economists even consider any government option. Otherwise any government option simply cannot exist.

Once a market failure has been identified it is critical to also look and examine at great length the actual situation on the ground, including historically. For example, there are invariably a large number of market mechanisms to deal with market failures or challenges. In the case of occupational licensing there is an infinite variety of mechanisms used in the marketplace to resolve issues of information asymmetry.

In my over 35 years of experience in government departments in India and Australia I have not come across anyone with the ability to understand complexity. Indeed, it is the first principle of communication within government to simplify matters so that the executives and ministers are able to form of a view. These people are time poor and do not have the headspace to read, leave alone understand complexity. Some of them might well have been capable of advanced mathematics in their younger days but the nature of their job makes it impossible for them to act in a logical and coherent manner. They invariably resort to shortcuts and in almost all cases these shortcuts lead to the wrong results.

Markets, on the other hand, have no choice but to specialise and to remain at the cutting edge frontier of logic and reason. Their entire existence depends upon making the right decision under the market circumstances. They cannot afford mistakes. That is why it is markets and not governments that create iPhones or computer chips. Markets have no choice but to sue the best possible knowledge available to humanity.

As a general rule, policy in government is made  largely to justify someone’s whim. There is no reward for deep and sophisticated thinking that considers – for instance – how markets can be supported to create optimal outcomes for society. The inability of government decision makers to understand complexity – or rather the impossibility of their understanding complexity – does not lead to humility and a desire to revert to the market. Instead, it leads to arrogance and the delusion that they are somehow able to solve complex problems.

ROADS

The first example I discuss in this book is of roads. Government policy makers assume that the coordination problem is so significant in this case that the private sector cannot manage it. But most economists are not aware that even today tens of thousands of kilometers of roads in France are in private hands. Second they are ignorant about the methods and options by which roads can be charged. They assume that only tolling is possible but there is the “McDonald method”.

SCHOOLS

Or consider the case of schools. Most economist are not aware – in fact are completely ignorant –  about the fact that schools have been managed in the private sector since times immemorial and that only after Macaulay did the idea of government schools come in, and it led to the immediate decline in the number of private schools as well as quality of schooling in general in the West (and in India where it was first started). James Tooley explains this well. Basically, a range of perverse incentives set in when governments manage schools.

HEALTH

And then consider health care. When everyone is responsible for their own health then incentives are fully aligned. It’s only when incentives are not well aligned and other people get involved in managing our health that health system incentives get perverse and we get seriously bad results.

TOWN PLANNING

Then we can consider the field field of urban planning which allegedly has significant failures so the government has to get involved. Once again, this is a classic example of government failure and not sufficient market failure.

PUBLIC TRANSPORT

Then we have the field of public transport in which the government has got directly involved.

REGULATORS FAIL BECAUSE THEY DON’T HAVE SKIN IN THE GAME

For instance, it is extremely harmful to create situations in which regulators do not have skin in the game, such as independent panels for town planning. In such cases we can expect freaks and lunatics including academic “geniuses” to come in with their “big” ideas and tell us how we should behave. It is a futile exercise to ask a third person who has no interest in our well being or understanding of our priorities to tell us how we shall live.

In each of these cases we see massive government failure.

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Memes against socialism

I’m compiling a few that I have readily found on the internet. This is a placeholder post with more material to be added when I find it. I’ll also embed any short videos that I find.

MEMES CREATED BY ME

MEMES I’VE FOUND ON THE INTERNET

 

 

KEYWORDS

#socialism

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