Tuesday October 06 , 2015
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The Government and Economics in America

The Constitution provides the organizing principles for the social, political and economic structures of America.  The explicit clauses of the Constitution that deal with interstate commerce and fiscal policy in theory provide a nurturing environment for a vibrant capitlistic system of free enterprise.  However, the government, particularly the national government, has had a persistent appetite for power.  Throughout the history of the nation, particularly since the end of the Civil War, more and more power has migrated to the national government.  Today, every headline about a problem seems to beg a national government solution.  Unfortunately, national government solutions can be generally categorized as matching the "one size fits all" formula.  The national government, particularly over the last two decades, has demonstrated behavior that is either indifferent to, or dimissive of, the governance environment of state and local governments.  Worse, the penchant of the national government to gather power has had a deleterious impact on free enterprise.

Free markets are self correcting and need little or no interference, or support, from government.  Buyers cooperate with sellers, and information is passed between actors in the market through prices.  The more competitors there are on the supply side, the better market operations are for consumers.  However, there are circumstances when we need government help to ensure our economic system continues to operate effectively.

At the college where I am employed, Ione of the courses I teach is our principles of economics course.  I usually have 30 or so students each semester in my class and have been teaching this course every term for the past 5 years.  My economics preparation is in Public Choice economic theory so I use a textbook that expresses economics in those terms.  The approach is down to earth and fully demystifies economics for the student.  Every term, we begin our studies from a consumer perspective then transition to a study of the larger economy of the country.  We take on what happens when government begins to creep into the activities of the market.  What has been the most fascinating aspect of seeing students transition from indifferent observers to active citizens is the recognition of what government should--and should not--do in supporting capitalism in this country and around the globe.

On their own, and without fail, each class has arrived at the same five necessary activities of government needed to support capitalism.  Those actions are:

  1. Provide for the commonweal.  This means that government, based on the preferences of the citizens, will provide common public goods.  Examples of these public goods and services would be national defense, the interstate highway system, public education, public safety services, etc.  These are goods and services that are available to everyone regardless of ability to pay for or contribute to the provision of the good or service. 
  2. Mitigate negative externalities.  A negative externality is a cost assigned in an exchange that is outside the exchange.  One might call this spillover.  In the public domain, we might want government to deal with, and we are willing to pay for, such things as the reduction of pollution, the elimination of striped mussels in the Great Lakes, and influencing a neighbor that can't seem to control the volume on his or her stereo.
  3. Provide a secure and stable financial system.  As far back as 1913, with the passage of the Federal Reserve Act and the ratification of the 16th Amendment to the Constitution, the citizens of the United States have empowered the national government to establish and control currency and banking in the nation.  Further, the people that supported a national income tax allowed the national government to fund itself--a decision that certainly has led to some very negative unintended consequences.
  4. Provide for fair and free markets.  Here Congress, through the enumerated powers of the Constitution, should ensure that suppliers cannot collude to control prices or pursue unfair trade or labor practices.  Markets cannot be fair if those that want to be in the market are not allowed to compete on an even playing field.  Likewise, government action is often needed to ensure that markets remain competitive by ensuring that barriers to entry into the market are mitigated.  Pernicious regulatory regimes, often intended to make markets more "competitive" actually have exactly the opposite effect.  Regulations tend to increase costs of operations and thus force smaller, less viable competitors out of the market.
  5. Correct market failures.  In economics, market failures are defined as goods and services demanded by the public that private enterprise cannot or will not provide.  Examples might be means tested public assistance programs such as food stamps, income security, etc.

The students also come to one other conclusion--government should be limited in its ability to interfere in markets, because government interference skews market outcomes, distorts information available in the market and leads to increased costs and less competion, thus raising the prices consumers (citizens) must pay for goods and services.  Here are some examples of government interference in the market:

  1. Price ceilings.  Let's say that the going rate for a two bedroom apartment in your city is $600 dollars a month, plus utilities.  The city has suffered a series of financial set-backs such as losing several large employers.  Similarly, the economy has gone into recession so there are a lot of people out of work or with reduced incomes.  The city council, in order to alleviate some of the financial stresses being felt by people in the city, pass an ordinance that places a price ceiling on apartment rents.  A two bedroom apartment can now be rented for no more than $450 a month, utilities included.  What is likely to be the outcome of this action?  The quantity of two bedroom apartments demanded will go up while the number of two bedroom apartments made available in the market will go down.  This action of placing a price ceiling will lead to a shortage of available two bedroom apartments.  Landlords will not likely be able to afford to keep two bedroom apartments on the market or will make up the lost revenues in other ways, such as reducing maintenance, limiting management availability, eliminating amenities, etc.  With the intention of making apartments more affordable, the outcome is to actually make apartments less available and those that are available, less maintained.
  2. Price floors.  Let's say that a gallon of milk in your favorite supermarket sells for $3.  The Department of Agriculture gets the Congress, in order to support dairy markets, to pass price controls that dictates that supermarkets cannot charge less than $4 a gallon.  This price floor is above the market clearing price.  The quantity of milk demanded will go down because the price of a gallon of mild is above the price at equilibrium.  However, because dairy farmers now see that they can sell every gallon of milk they bring to market at $4, they will oversupply milk.  Thus, the action of government has led to a surplus of milk that no one will buy.
  3. Regulation or tax on production.  Let's say that electrical energy plants that burn coal must reduce particulate output by 50%.  In order to that, suppliers have to buy electronic scrubbers and install them on all exhaust stacks.  The cost of those scrubbers is passed directly on to consumers, because any cost, whether imposed by regulatory compliance or through a tax, is passed on to consumers.  Thus, consumers are being taxed through increased prices for goods and services. 
  4. Minimum wage.  When the government decides to increase the minimum wage, a number of negative outcomes occur.  Let's say that the minimum wage is $5.15 an hour and you have 10 employees working for you at that wage.  That means you have a labor budget of $51.50 an hour.  When the government raises the minimum wage to $7.25 an hour, most businesses are going to be put into a difficult situation.  The $51.50 will now pay for only 7 employees, not 10, so three people lose their jobs.  If the employer needs the 10 employees to keep things going, the employer can either take less profit or figure out a way to keep the 10 employees.  The most likely approach will be to reduce the number of full-time workers and then hire part time workers or worse, hire those that will work for below market wages (those in the country illegally).  This action that makes legislators feel better will lead to increased unemployment and will incentivize illegal behavior.  Certainly not the intended consequences.

All of these actions interfere with market operations.  All of these actions are forms of indirect taxation on citizens.  All of these actions lead to negative, unintended consequences.

When we see government moving toward interfering in market processes, we have to ask if the actions are required based on the five things we want government to do to support market operations.  Let's take a look at the current healthcare reform legislation pending in the House of Representatives.  We have to ask under what condition we might want Congress to allow the national government to take over 1/6th of the national economy.

Does the healthcare industry represent a market failure?  The answer is "no," because more than 260 million residents of the country have healthcare insurance coverage provided through the private sector or through entitlement programs.  Is healthcare insurance coverage part of the commonweal?  Again, the answer is "no," because the private sector provides opportunities for purchasing insurance.  However, the pending legislation will eventually force all residents to a single payer system.  This action on the part of Congress is a major interference in the market.  Further, there are no negative externalities involved so again, no government action is needed.  If government is supposed to support fair and free markets, why is interstate purchase of health insurance not on the table for consideration.  Congress, under their enumerated powers, should be obliged to ensure such activity.  The legislation, and the healthcare industry, have little or no impact on banking or currency, so there does not appear to be any reason for Congress to interfere from an economic perspective.

Why, then, is government so bent on taking control of the healthcare industry?  I will address the possible reasons in subsequent blog entries.  There is plenty here to think about already.