Government Intervention | Economics in Plain English

Archive for the 'Government Intervention' Category

Apr 30 2013

The winners and losers of protectionism – the US sugar industry

Episode 454: The Lollipop War : Planet Money : NPR

This episode of my favorite podcast, Planet Money provides a great overview of the effects of the US government’s long-time protectiono f the sugar industry on various stakeholders.

When teaching the effects of protectionism, I urge students to evaluate its effects on both consumers and producers. Often, however, students generalize this analysis, and make broad statements like “consumer will pay higher prices for the good”, without clarifying who, exactly, the consumers of the protected good are. In the case of agricultural commodities, the “consumer” is typically not a private individual who buys the product at a store, rather, it’s the producers of process foods that use the commodities as inputs into their products which then are sold to consumers.

This is all to say that there is more than just a loss of “consumer surplus” in the market for a protected agricultural commodity. Rather, the effects can be far more serious, as the producers of hte consumer goods that use the commodity as an input may be forced to shut down their domestic production and move overseas. This is the story told in the podcast, as the maker of the candy dum dums has moved its plants to Mexico to take advantage not of lower wages or less regulation, rather the cheaper sugar that can be acquired there.

Listen to the podcast, and respond to the discussion questions that follow:

Discussion Questions:

  1. What method does the US government use to protect domestic sugar producers?
  2. What are the main economic arguments for continued protection of the US sugar industry?
  3. What are the main arguments for the removal of protection of US sugar producers?

2 responses so far

Nov 09 2012

Economic arguments for and against a carbon tax

Reuters – Long-shot carbon tax suddenly part of fiscal cliff debate

The article above suggests that during Barack Obama’s second term as president of the United States, the country may begin to seriously consider imposing a tax on carbon dioxide emissions. The justification for such a tax, points out the article, is two-fold:

The aftermath of Superstorm Sandy, which devastated parts of the U.S. East Coast last week, has raised fresh questions about the links between climate change and extreme weather events, which also makes the idea of a carbon tax more appealing.

A carbon tax is a mechanism to charge emitters of greenhouse gases, such as power plants and oil refiners, for each ton of carbon dioxide they emit.

Prospects for such a tax as a way to address pollution and climate are probably dim in a still deeply-divided Congress, but some analysts say the measure would be more attractive if positioned as a source of new revenue.

In fact, a recent report by the Congressional Research Service, suggesting a $20 per ton tax on carbon emissions could halve the U.S. budget deficit over time.

Such a tax would generate about $88 billion in 2012, rising to $144 billion by 2020, the report said, slashing U.S. debt by between 12 and 50 percent within a decade, depending on how high the deficit climbs, the report said.

America’s government budget has been in deficit every year since 2000, meaning the government spends more than it collects in taxes. Fears over the growing national debt and the impact it will have on future economic growth potential have led many in the US government to look for new ways to earn tax revenue for the government, even some ways that have bene considered taboo until now.

In my year 1 IB Economics course this week we have been learning about and evaluating taxes and subsidies in the markets for various goods. Generally, we learn that government intervention in free markets worsens the overall allocation of resources in the market economy, imposes more costs on society than benefits, and therefore leads to a loss of total welfare. For example, a tax on American beef in Switzerland helps keep the price of imported meat high, benefiting Swiss farmers, but overall the higher price of meet and the reduced quantity and variety available to consumers harms many in society to the benefit of the few cattle farmers. Such a tax, it can be argued, creates a loss of total welfare in society, as the tax’s cost outweighs its benefit.

But not ALL indirect taxes (those placed on the production and consumption of particular goods) reduce total welfare in society. A tax on a good that is over-consumed by the free market may actually improve total welfare as the higher cost to producers leads to a reduced supply, higher price, and a reduction in the quantity demanded in the market. A cigarette tax is the classic example. Without taxes on cigarettes, more people would smoke, creating more harmful effects for society, such as the ills of second-hand smoke, higher rates of lung cancer, greater demand for health care and the higher prices that this increased demand create for all of society, even non-smokers. Cigarette taxes are so widely employed by government and accepted by society that there is no debate whatsoever about their use.

But taxes on other goods that create ills for society are highly controversial, and for good reason. Perhaps one of the most debated and divisive tax proposals of recent years has been on the emission of carbon dioxide, a greenhouse gas emitted during the burning of fossil fuels. The main emitters of CO2 in the United States are the country’s electricity generating firms, which burn coal, gas and oil more than any other industry in the country. CO2 emissions are measured in tons, and a CO2 tax would apply to each ton of the gas emitted by fossil fuel consuming firms.

Arguments against a carbon tax

The primary argument against a tax on CO2 emissions is that it would drive up the costs of energy production, leading to higher energy costs for the nation’s households and firms. This boost in prices would increase costs to producers of all other goods and services in the economy, effectively reducing the supply in several key sectors of the US economy, leading to falling national output, more inflation and greater unemployment. American industry would become less competitive with other nation’s producers, leading to more factories closing down and moving overseas, taking American jobs with them.

Such a conclusion requires that a CO2 tax would, in fact, lead to significant decreases in the amount of energy demanded by the nation’s households and firms. In other words, it assumes a relatively elastic demand for electricity. It also assumes that as the price of fossil fuel generated electricity rises, there will be few alternative forms of electricity for firms to switch to. This leads us to the arguments for a carbon tax.

Arguments for a carbon tax

Energy is an essential good that consumers (whether they be households or firms) demand in large quantities regardless of the price. A carbon tax, which increases the cost and decreases the supply of fossil fuel energy, will not significantly reduce the amount of fossil fuel energy consumed in the United States; at least not in the short run, during which there will be very few substitutes for fossil fuel energy available to consumers.

However, one outcome that proponents of the tax hope for is an increase in the demand for alternative energies, such as wind and solar, which do not require the burning of fossil fuels. Such alternatives are not currently price-competitive with fossil fuels, but a carbon tax would make them more competitive, increasing demand for alternative energies and leading to a greater percentage of America’s total energy production coming from wind and solar.

The graphs below show the desired outcome of a CO2 tax on the markets for fossil fuel energy and renewable energies.

Notice that the tax does not lead to a significant decrease in the quantity of fossil fuel energy consumed in the short run. Businesses in the US will face higher costs, but energy costs are a relatively small proportion of most US industries’ total costs. (The biggest cost faced by US firms, not surprisingly, is labor costs). But the highly inelastic demand assures that fossil fuel energy prices will rise, leading to greater interest from consumers in alternative energies. In the graph on the right, we see an increase in the demand for renewables, leading to a greater quantity being produced.

But what might the long-run impact of a carbon tax be on the US energy sector? As we can see in the graph on the right above, greater demand for renewables will drive their prices up, which over time will increase the appeal of renewable energies to the country’s electricity producing giants. Slowly, the number of renewable energy producers will grow, as old coal or gas burning electricity plants are decommissioned and new wind or solar plants are installed. The supply of renewable energies should rise while the supply of fossil fuel energy should decrease. The result is an ever growing percentage of America’s total energy production generated using wind, solar, or other renewable sources of power. The graphs below show the possible long run impact of a carbon tax in the fossil fuel and renewable energy sectors.

Here we can see that in the long-run, the prices of renewable energies and fossil fuel energies will become closer as the supply of energy produced using wind and solar grows, making it more price-competitive and therefore reducing the demand for fossil fuel energies.Presumably, if the outcomes described above come to pass, the proposed carbon tax could lead to meaningful reductions in America’s greenhouse gas emissions over the long run, as the composition of the nation’s energy production slowly transitions away from non-renewable fossil fuels to renewable, non-polluting energy sources.

But what about the other reason the government is considering a carbon tax now? Remember those fears over the national debt and deficit? How effective would a carbon tax be at raising revenue to help the government balance its budget? To determine this, we must look again at the first graph we drew, only examine the impact of the tax on government, not just the market for fossil fuel energy.

In the graph above, we see that the tax creates a large chunk of tax revenue for the government, “about $88 billion in 2012, rising to $144 billion by 2020”. These figures seem optimistic, especially if the previous outcome in which the demand for fossil fuel energies falls in the long run comes to pass. But for now, at least from this Economics teacher’s perspective, a tax on carbon is a good first step towards both reducing American’s dependence on fossil fuels and generating desperately needed government revenues.

26 responses so far

Nov 01 2012

Has the Baby Market Failed?

The tools of economics can be applied to almost any social institution, even the decision of individuals in society whether or not to have children. All over the rich world today, potential parents have decided against having babies, the result being lower fertility rates across much of Europe and the richer countries in Asia, including Japan, South Korea and Singapore. Lower fertility rates have some advantages, such as less pressure on the country’s natural resources, but the disadvantages generally outweigh the benefits.

The story below, from NPR, explains in detail some of the consequences of declining fertility rates in the rich world, and identifies some of the ways governments have begun to try to increase the fertility rates.

The problem of declining fertility rates can be analyzed using simple supply and demand analysis. In the graph below, we see that the marginal private cost of having children in rich countries is very high. The costs of having children include not only the monetary costs of raising the child, but the opportunity costs of forgone income of the parent who has to quit his or her job to raise the child or the explicit costs of child care, which in some countries can cost thousands of dollars per month. Marginal private cost corresponds with the supply of babies, since private individuals will only choose to have children if the perceived benefit of having a baby exceeds the explicit and implicit costs of child-rearing.

The marginal private benefit of having babies is downward sloping. This reflects the fact that if parents have just one or two children, the benefit of these children is relatively high, due to the emotional and economic contributions a first and second child will  bring to parents’ lives. But the more babies a couple has, the less additional benefit each successive child provides the parents. This helps explain why in an era of increased gender equality, families with three or more children are incredibly rare. The diminishing marginal benefit experienced by individual couples applies to society as a whole as well, therefore the market above could represent either the costs and benefits of individual parents or of society at large.

Notice, however, that that the marginal social benefit of having babies is greater than the marginal private benefit. In economics terminology, there are positive externalities of having babies; in other words, additional children provide benefits to society beyond those emotional and economic benefits enjoyed by the parents. The podcast explained some of these external, social benefits of having children: a larger workforce for firms to employ in the future, more people paying taxes, allowing the government to provide more public goods, more workers supporting the non-working retirees of a nation, and more competitive wages in the global market for goods and services. Higher fertility rates, in short, result in more economic growth and higher incomes for a nation.

When individuals decide how many children to have, they make this decision based solely on their private costs and benefits, since the external benefits of having more babies are enjoyed by society, but not necessarily by the parents themselves. Therefore, left entirely alone, the “free market” will produce fewer babies (Qe) than is socially optimal (Qso).

So what are Western governments doing about low fertility rates? The podcast identifies several strategies being employed to narrow the gap between Qe and Qso. In Australia households receive a $1000 subsidy for each baby born. In Germany mothers receive a year of paid leave from work. Here in Switzerland mothers get three months of government paid leave and $200 a month subsidy to help pay for child care after that. Each of these government policies represents a “baby subsidy”. In the graph above, we can see the intended effect of these policies. By making it more affordable to have children, governments are hoping to reduce the marginal private cost to parents, encouraging them to have more children, which on a societal level should increase the number of babies born so that it is closer to the socially optimal level (Qso).

Unfortunately, as the podcast explains, it appears that parents are relatively unresponsive to the monetary incentives governments are providing. This can be explained by the fact that the private demand (MPB) for babies is highly inelastic. Even if the “cost” of having a baby falls due to government subsidies, parents across the Western world are reluctant to increase the number of babies they have.

As we can see in the graph above, a subsidy for babies reduces the marginal private cost of child-rearing to parents. But the MPB curve, representing the private demand for babies, is highly inelastic, meaning the large subsidy has minimal effect on the quantity of babies produced. Without the subsidy, Qe babies would be born, while with the subsidy only Qs are born, which is closer to the socially optimal number of births at Qso, but still short of the number of births society truly needs.

The “market for babies” in rich countries is failing. Because of the positive externalities of having children, parents are currently under-producing this “merit good”. One of two things must happen to resolve this market failure. Either the marginal private costs of having babies must fall by much more than the government subsidies for babies have allowed, or the marginal private benefit must increase. Either larger subsidies are needed, or some moral revival aimed at encouraging potential parents to consider both the private and social benefits of having children when making their decisions.

Don’t you love economics? We make everything seem so logical! And like they say, it all comes down to supply and demand!

Discussion Questions:

  1. What makes low fertility rates among parents in the rich world an example of a “market failure”?
  2. What are the primary reasons fertility rates are lower in the rich world than they are in the developing world?
  3.  What are the economic consequences of lower birth rates? What are the environmental consequences of lower birth rates? Should government be trying to increase the number of babies born?
  4. Why have government incentives for parents to have more babies failed to achieve the fertility rates that government wish they would achieve?
  5. Do you believe that government can create strong enough incentives for parents to have more babies? If not, what will become of the populations of Western Europe and the rich countries of Asia given today’s low fertility rates? Should we be worried?

75 responses so far

Jan 29 2012

A History of Public Goods

One question that often comes up in my class discussions of market failure and public goods is “Why can’t we just have a global government that intervenes to correct those market failures with global impacts?” The global market failures my students get so worked up about are those arising from common access resources, such as deforestation, over-fishing and global warming, those resulting from information asymmetry, such the global financial crisis of 2008-2009, and the global inequality in the distribution of income and economic opportunity.

What I haven’t ever really considered or explained to my students (until now) is the history of public goods. In the column below, Martin Wolf of the Financial Times’,  tells the history of public goods, which as it turns out, is intimately tied to the history of the modern state as we know it. This column should become a must read for all economic students studying market failure.

From The World’s Hunger for Pulbic GoodsJanuary 24, 2012, Financial Times

What… is a public good? In the jargon, a public good is “non-excludable” and “non-rivalrous”. Non-excludable means that one cannot prevent non-payers from enjoying benefits. Non-rivalrous means that one person’s enjoyment is not at another person’s expense. National defence is a classic public good. If a country is made safe from attack everybody benefits, including residents who make no contribution. Again, enjoyment of the benefits does not reduce that of others. Similarly, if an economy is stable, everybody has the benefit and nobody can be deprived of it.

Public goods are an example of what economists call “market failure”. The point is generalised in the language of “externalities” – consequences, either good or bad, not taken into account by decision-makers. In such cases, Adam Smith’s invisible hand does not work as one might like. Some way needs to be found to shift behaviour; public goods usually involve some state provision; externalities usually involve a tax, a subsidy or some change in property rights…

The history of civilisation is a history of public goods. The more complex the civilisation the greater the number of public goods that needed to be provided. Ours is far and away the most complex civilisation humanity has ever developed. So its need for public goods – and goods with public goods aspects, such as education and health – is extraordinarily large. The institutions that have historically provided public goods are states. But it is unclear whether today’s states can – or will be allowed to – provide the goods we now demand.

The story of public goods goes back to the very beginning of states, which were the result of the agricultural revolution. The latter made populations vulnerable to… “roving bandits”. The answer was the “stationary bandit” – the state. It was not a perfect answer – answers almost never are. But it worked well enough to permit substantial increases in population. The state provided defence in return for taxation. The empires – Rome or China – enjoyed economies of scale in providing security. When Rome collapsed, security was privatised by local gangsters, at huge social cost: this we now call feudalism.

The industrial revolution expanded the activities of the state in innumerable ways. This was fundamentally because of the needs of the economy itself. Markets could not, on their own, provide an educated population or large-scale infrastructure, defend intellectual property, protect the environment and public health, and so on. Governments felt obliged – or delighted – to intervene, as suppliers and regulators, or subsidisers and taxers. In addition to this, the arrival of democracy increased the demand for redistribution, partly in response to the insecurity of workers. For all these reasons, the modern state, vastly more potent than any that existed before, has exploded in the range and scale of its activities. Will this be reversed? No. Does it work well? That is a good question.

Yet consider where we are now. The impact of humanity is, like the economy, increasingly global. Economic stability is a global public good. So, in the era of nuclear weapons, is security. So, in important respects, are control of organised crime, counterfeiting, piracy and, above all, pollution. So, even, is the supply of education or health. What happens anywhere affects everybody – and increasingly so. Unless there is a global economic collapse, an increasing number of the public goods demanded by our civilisation will be global or have global aspects.

Our states cannot supply them on their own. They need to co-operate. Traditionally, the least bad way of securing such co-operation is through some sort of leadership. The leader acts despite free riders. As a result, some global public goods have been adequately – if imperfectly – supplied. But as we move again into a multipolar era, the ability of any country to supply such leadership will be limited. Even in the unipolar days, it only worked where the hegemon wanted to provide the particular public good in question.

I started with economic stability, because the big surprise of the past few years is just how difficult it has proved to provide even this. The point I finish with is far broader. Ours is an ever more global civilisation that demands the provision of a wide range of public goods. The states on which humanity depends to provide these goods, from security to management of climate, are unpopular, overstretched and at odds. We need to think about how to manage such a world. It is going to take extraordinary creativity.

 

7 responses so far

Nov 29 2011

Market failure versus Government failure – what should we be more concerned about?

One of the most prominent economists of the 20th century was the late Milton Friedman, an ardent free market supporter who remained skeptical of government’s ability to correct market failures through interventionist policies.

I found the talk below interesting. Friedman offers several examples of market failures that have been pointed to as a justification for government intervention, and argues that in fact, government often does not truly know what the right outcome is in most cases. He believes that government failure should be just as much a concern as market failure; and that therefore societal welfare would be best met by finding market-based solutions to the misallocation of resources that sometimes arises under conditions in which externalities exist.

As you watch the video, consider Friedman’s claims regarding the role of government, then post your response to one of the discussion questions below.

Discussion Questions:

  1. Is government better able to know the “optimal” quantity of output of different goods and services than private individuals are?
  2. Under what conditions would the free market be best able to achieve solutions to market failures such as those described by Friedman?
  3. What do you think should be of greater to concern to society, market failure or government failure?

 

8 responses so far

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