Saturday, October 17, 2009

An Energetic Concern

How good are prices? How efficient? Prices exist as a universal shorthand that allow people to communicate across time, across space, and across insurmountable language barriers. Prices distill relevant information into one single signal that everyone understands without having to learn troublesome conjugation or weird syntax. Prices hit us right where we care, with all the force of a swift kick to the groin. But are they really as useful or as efficient as we might like to imagine. There's no good way for the average person to untangle the galaxy of individual effects on any given list price, just as there's no good way to trace the whole, complete, and unmolested chain of production leading to any given final product (don't believe me? Try to think of the entire set of inputs that go into making, say, a comfortable pair of shoes. Be thorough; incomplete answers will be marked down).

So how can anyone tell when and where price distortions arise? Sometimes, the answer is clear enough that there isn't much room for debate. It's pretty well clear both analytically and empirically that something like direct price controls for gasoline create artificial shortages, but when interference is milder, more diffuse, or further up the supply chain, tracing the thread of causality becomes vastly more challenging. Take the CPSC for example. The Consumer Products Safety Commission creates regulation for a really quite impressive array of consumer goods. Indeed, I never really understood how many until I just checked, just now. If you're interested in the legislation, here's the most recent version of the Consumer Products Safety Act: This agency is charged with keeping potentially harmful products out of the hands of individuals who, due to ignorance, inattention, or carelessness, are unable or unwilling to discover the hazards of products on their own. Similarly, this commission exists to help provide a buffer between consumers and producers, the latter or whom may have an incentive to hide or otherwise obscure the hidden costs of their products, including but not limited to health risks from dangerous chemicals, choking hazards, injury risks, or radiation poisoning.

Let's pick one product at random. My random product generator (scrolling down blindly) lands on isobutane, ostensibly used as cigarette lighter fuel. This chemical is regulated under the Federal Hazardous Substances Act, which gives labeling and banning authority to the CPSC (and probably other agencies too, for all I know; I'd imagine OSHA relies on this legislation as well). Anyway, here's the relevant passage from the Code of Federal Regulations:
(29) Cigarette lighters containing butane and/or isobutane fuel are
exempt from the labeling requirements of section 2(p)(1) of the act
(repeated in Sec. 1500.3(b)(14)(i)) insofar as such requirements would
otherwise be necessary because the fuel therein is extremely flammable
and under pressure, provided that:
(i) The lighters contain not more than 12 grams of fuel at the time
of sale; and
(ii) The fuel reservoir is designed to withstand a pressure of at
least 1\1/2\ times the maximum pressure which will be developed in the
container at 120 [deg]F.
Now, for a large, well-diversified lighter company, like, say, Bic, the cost of compliance per unit is pretty low. Sure, the QA division might have a few more rules to remember, but overall, it's not too tough to ensure that there aren't more than 12 grams of fuel are in the lighter and that the fuel reservoir is strong enough to contain the pressure of warmed fuel. Indeed, this seems like kind of a fluff regulation, hard to object to. Nobody wants lighters blowing up in their faces when they're about to take the small stroll to Flavor Country, right?

Right. Especially not Bic. It isn't really in their interest to have their customers maimed when using their product, so how could it be at all possible that they might develop a pocket-sized time bomb ready to detonate under a hapless smoker's schnozz at the drop of a hat? Well, to answer my own smug question, if it's possible, it's unlikely, at least as long as the costs of developing better quality control standards are outweighed by the ex ante expected costs of litigation. So what does this have to do with price distortions? Bic would probably comply anyway, so what's the fuss?

Well, the fuss is about off-brands. Large firms can eat the costs of regulation and come back for seconds. As I pointed out, the cost of compliance per unit sold is insignificant so long as you have a whole bunch of units sold. Bic has a whole bunch of units sold.

Okay, this is kind of a sidebar note, but at this point in the blog post, I'm compelled to go look up the annual report for Bic, and it turns out the SEC doesn't have a filing more recent than 1995. The company's own website lists the most recent annual report as 2005, and more interestingly, it looks like Bic moved to Europe a while back. I had no idea about this. How amazing.

Anyway, 1st Half 2004 earnings for Bic were 683 billion euros. EBIT were 90 billion euros. EPS ratio was 1.04, and they did a stock buyback. Pretty strong for 2004, particularly considering some of their more interesting expansions, including an increased presence in the kayak sector.

Kayaks, huh? How about that.

So, Bic shouldn't have much trouble keeping up with isobutane regulation. In fact, I daresay they support such regulation wholeheartedly. After all, they've always put a premium on safety and even if one of their cherished customers decides to make the decision to switch to another brand, Bic is almost certainly dedicated to their safety (this is not, as far as I've been able to find, Bic's official position, but if Bic decided to take the contrapositive stance, it would assuredly raise eyebrows). Bic can easily make a humanitarian case for supporting regulation, the same way concerned citizens and legislators can.

Now, it may be that Bic honestly and truly believes that they are helping to make the world a better place, and it's just coincidence that their weaker competition is unable to meet the testing requirements to ensure that fuel reservoirs for isobutane lighters are sufficiently rugged to meet standards, but Bic benefits nonetheless through regulatory protection. Bic can charge monopolistic prices (or, at least, prices closer to those a monopolist might charge) on this variety of lighter by letting the sickle of government harvest the weak, nascent firms who might have otherwise been able to compete on an unregulated field. Voila, distorted prices from well-intentioned, otherwise sensible regulation. Meanwhile, consumers pay double for this, both in the higher prices paid for the lighters and in government expenditures needed to provide monitoring and enforcement of the isobutane regulation (see how charitable I am? I'm not even mentioning deadweight bureaucratic waste).

I don't want it to seem like I'm picking on Bic specifically (though the CPSC regulates both ink cartridges and razors as well), since my selection of isobutane really was random. Because of this, it should be clear that regulation favors incumbents, and we (by we, I mean frazzled, shocked first year economics PhD. students) should refrain from thinking that prices contain the sort of utility-maximizing, cost-reducing calculus we embrace in the classroom. Hell, I didn't even talk about the demand side of inefficient prices, so maybe I'll get to that in another post. I wanted to spend the remainder of our time together talking about James Buchanan's 90th birthday party.

James Buchanan turned 90 last Wednesday, or at least had his party for his 90th birthday last Wednesday. Both Dan Houser, the new department chair and Don Boudreaux, the former department chair, made some stirring remarks. Don's can be found here. After Don spoke, the wizened Dr. Buchanan made some rather... I think compelling is the right word here... yes, compelling remarks. Well, compelling in the sense that they generated a small flurry of discussion about just what he meant and what the implications might be. The first comment that caught my attention was the the 2007- crisis was sparked by a constitutional failure. At least, I heard it as a small "c" constitutional. I think others heard it as a big "C" Constitutional failure, especially once he started talking about one of the enumerated powers of Congress: to coin money. The way I heard "constitutional" was in the medical sense, that the body of law (I use the word law to represent something other than legislation, as I normally do) had become sick though repeated insults to its character and integrity. In this sense, I think the cherished old man had it right. The body in this case is not just the perverse regulatory environment that rewards vasty financial enterprises, but the odd set of incentives in place for lenders, as well as the thinned green blood pumping around the shambling beast (if that metaphor is too abstruse, I mean the tidal increase in the money supply). Various promises abounded from this quarter and that, not the least of which was the implicit guarantee of good ol' Unk Sam, coal shovel in hand, ready to stoke the furnaces of crony capitalism every time the engine threatened to falter. Oof. Now I'm really starting to mix my metaphors. I better quit while the quittin's good. I think you get the picture anyway. There was no one specific failure you can point to. The elephant in the room is that there's a fucking elephant in the room, not a snake or a trash can or a rope or whate'er. As far as the mahout astride the beast, he wears many faces, but one hat: interference. I'd like to say that it's misguided interference, but in the case of central planning, all interference is misguided interference. That is to say, there is no pure signal, free from interference, that can possibly tell any central authority how best to direct resources other than the wisdom of a well-ordered crowd.

Anyway, that's my inner Austrian grumbling. I better feed him or he'll be liable to pillage a coastal fishing village. Dr. Buchanan's other controversial comment was that if money is a natural monopoly, then it makes sense to auction off its production to the highest bidder. That was, rents will be captured by the public. Well, the conclusion makes sense, but it seemed like the audience had a hard time swallowing the premises. The audience, including me. My friend Garrett even asked how, under this system, exchange rates would be managed (a sensible question for which he received no answer), but the next question appeared to be the one on the tips of almost everyone else's tongue: under what circumstances could money be considered a natural monopoly? I still find myself puzzling over this one. With purely fiat money, the case for a single issuer might be slightly stronger for a monopolist, but not by much. Under any commodity standard, especially one with a 100% reserve requirement (which I still don't support, no matter the arguments I hear), it shouldn't matter one fig, jot, or tittle whence the script. You could have competing currencies even within a town of 1,000 citizens. As far as a fractional reserve system with fiat money, a private, independent currency rating firm would mop up the slobbery mess of uncertainty. I have a hard time imagining a case for a monopoly in money apart from perhaps interbank exchange rates, but again, this is a problem supremely easy to overcome, especially with today's communication efficiencies.

At any rate, he did mention the big-C Constitution, as I noted earlier, with respect to Congress' charge to utter currency. I'd like to hear what he would have had to say about a competing world currency, and idea I suspect might have some merit. Well, that and I would have like him to sign my copy of Cost and Choice, but he was being so thronged by faculty (understandable) that I would have needed a forklift to get anywhere near him.

Anyway, happy birthday sir. Here's to hoping for another decade of your uncommon wisdom.

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