I don’t even know what this means but it is a terrible idea

Marion Nestle writing at The Atlantic continues to try and widen the food regulation Overton window. The target this time is portion sizes:

For a long time, I’ve wanted restaurant owners to give a price break for smaller portions. No luck. They say this would put them out of business. We need to make it easier for people to choose smaller portions, which means changes in public policy.

Does this mean subsidies for smaller portions? A government agency to regulate prices for relative portion sizes? A small plate mandate? Whatever Marion has is mind, it is a terrible idea.

Notice the familiar tactic of trying to sell this is more “choice”. Who doesn’t love more choice? It’s pro-freedom!

There appears to be no dimension of food that the government shouldn’t be regulating. This apparently includes a food’s color, the amount of salt or sugar, how it is advertised, what goes on the box, and now the portion size. Can’t we skip all this piecemeal regulation and just create a new government agency that must approve all foods before they can be sold? Let’s place Marion in charge, or at least put her in charge of the restaurant menu approval division.

This is becoming difficult to parody. Perhaps it would be easier to parody if I could sample more paternalist writings, but there are so many paternalists and their writings can often be too long. What we need is a government mandate for writers to provide a shorter version of every article they write. Studies have shown people are more willing to read one paragraph of regulatory overreach than several paragraphs of it. And after all, it will improve consumer choice.

Pressuring businesses for better treatment of animals versus workers

I have argued that consumer pressure for better treatment of animals in agriculture is a good thing, but that pressuring for better treatment of workers might lead to worse outcomes. Obviously, there are a lot of consequential differences between workers and animals, but I will try to explain which differences specifically matter and why. Note that in both cases I am ignoring the welfare of consumers here.

The first and fundamental difference is that animals cannot bargain and do not have choices. Humans usually have other alternatives to a given employer, and even under a local monopsony they can move. So when you observe a workers current employment situation it likely reflects the best choice among all of their alternatives. When prevent a worker from making a particular choice, say by pressuring a corporation to stop employing those workers, then you are pushing them into their next best choices which is a good indicator that you are making them worse off.

In contrast, Animals are owned outright and have no alternatives, which means that if you push corporations from using them as they currently do, their next highest use may make them better off even if it is a less profitable arrangement overall. Since they do not share in their marginal product, this need not make them worse off .

Another fundamental difference in a similar vein is that the supply of animals is much more elastic than the supply of people who might wish to work. If a given industry were to fire it’s lowest level of workers because the jobs were seen as too dangerous, or if costs are raised due to higher job perks or safety, then those workers pushed out of that job and industry will be excess labor supply in another industry. On top of the next-worst-choice problem highlighted above, this means that workers currently employed in the next worst industry will face lower wages from higher labor supply.

In contrast, when a factory farm producing pigs is pressured into ceasing operations or increasing standards so the profit maximizing quantity decreases, the supply of pigs produced can be reduced quickly in a way that is not true of workers. Since agriculture is very competitive, it’s likely that pigs across industries are being produced near long-run average cost, so that any extra supply of pigs will only decrease prices for alternative uses of pigs in the short run, and in the medium and long run less pigs will simply be raise. This is also why the next-worse-choice problem that workers face isn’t as significant for animals: for most their next worse choice is probably never being born, which very often is an improvement.

This post was inspired by an old Tyler Cowen post that I think about often but can’t seem to find. What aspects of this issue am I missing?

Why do corporations hold so much cash?

Karl has been blogging about Apple’s large cash holdings for some time now. His point is that management is taking advantage of shareholders by holding too much cash instead of paying dividends. My initial reaction when he first blogged this was “no way”. Then after the second or third post on it I had been converted to a “maybe”. Karl isn’t alone in arguing that cash holdings are too high, and Apple isn’t alone in guilt; there is a good bit of literature arguing corporations hold too much cash and trying to explain why. While the agency problem may not explain excess cash holdings overall, I do think it is at least one possible explanation, and that it may apply for some firms, especially Apple.

One uncontroversial fact is that cash holdings have been going up over time for firms. There are several explanations for why, and Karl’s agency problem is just one. For instance, one theory is that taxes provide firms with incentives to hold cash, and another is that there are frictions in access to capital markets so firms should hold more cash when shocks become more likely.  A 2006 NBER working paper from Bates, Kahle, and Stulz provides a good overview and some interesting empirical insights. Here is how they summarize the literature on Karl’s agency problem theory of cash holdings:

As argued by Jensen (1986), entrenched managers would rather hold on to cash when the firm has poor investment opportunities than increase payouts to shareholders. Dittmar, Mahrt-Smith, and Servaes (2003) find cross-country evidence suggesting that firms hold more cash in countries with greater agency problems. Dittmar and  Mahrt-Smith (2006) and Pinkowitz, Stulz, and Williamson (2006) show that cash is worth less when agency problems between insiders and outside shareholders are greater. Dittmar  and Mahrt-Smith (2006) and Harford, Mansi, and Maxwell (2006) provide evidence  suggesting that entrenched management actually spends excess cash quickly.

The paper provides some empirical tests of the agency problem explanation and do not find the evidence in support of it:

Agency theory predicts that cash holdings will increase for firms with high free cash flow. Our evidence on the changes in cash holdings for subsamples of firms is largely inconsistent with the agency explanation. In particular, we find that cash holdings increase more in firms that are financially constrained, as proxied by negative net income, than for other firms. Further, larger, more established firms are more likely to have agency problems of free cash flow that could lead to an increase in cash  holdings. However, the increase in cash holdings is much more significant for smaller and recently listed  firms.

I don’t know the literature well enough to say whether or not these results are consistent with most of the research in this area, but they should at least make us somewhat skeptical of the agency explanation. However, while agency problems might not explain the increase in cash holdings overall, Karl could still very well be correct in the case of Apple.

An important and related issue here is that as firms have held more cash they have also decreased net debt, which has implications for the question of whether the corporate income tax is causing firms to have too much leverage. Mihir Desai, for example, has argued:

While excessive leverage is sometimes associated with the tax code because of a presumed debt bias for corporations, concerns over the role of tax policy in fostering the financial crisis appear unfounded…. For the non-financial corporate sector where the presumed debt bias is thought to exist, the startling fact is how unlevered that sector was prior to the crisis.  In particular, the rise of cash balances and the decline of net debt is the  dominant corporate finance trend of the last decade.

He provides the following graph showing that leverage for non-financial corporations is not high by historical standards:

Reading the literature on leverage and the corporate income tax I have moved recently from thinking this is obviously a big problem to thinking that perhaps this isn’t as big of a problem as we commonly think, or perhaps it is not a problem at all. Points to Karl and Tyler Cowen who have both been arguing this.

For his part, Desai argues that there are three main explanations for the excess cash holdings issue:

 1. Weak product market demand

2. Regulatory and macroeconomic uncertainty

3. A coordination problem leading managers to be frozen into not spending

Desai proposes a tax that could fix the coordination problem if in fact that is the cause. Karl’s explanation of an agency problem implies some possible solutions relating to changing shareholder rights, and a tax might help here too. But the relationship between excess cash and low corporate leverage raises the question of whether it is in fact a problem at all. Desai argues:

“…the remarkable underleverage of the  non-financial sector prior to the financial crisis was a saving grace in ensuring that the financial crisis was not nearly as severe as it could have been.”

The overleveraging of banks is a persistent problem that regulators seem unwilling or unable to fix, and this creates serious macroeconomic risks. Perhaps we should just be glad for the corporate sector’s opposing bias against leverage and not worry about taxing it away. Excess cash may be a problem at the firm level, but it could be a boon at the macro level.

This also raises the question of whether we should be reconsidering the wall between commerce and finance. If non-financial firms have a bias against leverage, than allowing them to take banking business from financial firms is one way to eat away at leverage in the financial system. Letting Walmart get into retail banking would be one obvious way to do this.

On the other hand, perhaps allowing non-financial firms into the banking business will just remove their bias against leverage and infect that currently safer sector with the leverage problem. It’s an issue worth discussing more.

Regulation and industrial change in a recession

I want to reply to this Paul Krugman post on mercury regulations, but let me start with some important caveats. First, I have no idea if the new regulations are desirable, but if he’s correct that “it will save tens of thousands of lives every year and prevent birth defects, learning disabilities, and respiratory diseases” then I have a hard time imagining the costs exceeding these benefits. Also, Krugman is correct that there have been big successful environmental regulations in the past where the benefits clearly and largely exceed the costs. So to be clear: this post isn’t really about the mercury regulations at hand. What I really want to discuss is his more abstract and general point about when the best time to make these sorts of large regulatory changes is.

Krugman argues:

…if we’re going to have to scrap some power plants and replace them, it’s hard to think of a better time to do it than now, when the workers and resources needed to do the replacing would largely have been unemployed otherwise.

There’s certainly a valid point here. Spending like this, or any spending, in non-recessionary times has a crowding out cost, in that the resources being used to make new power plants would have gone to some other use and must be diverted. Labor and capital that had some other use must be bid away from those uses.

In a recession this is not necessarily true, as lots of capital and labor lays unused. Thus you are bringing unused inputs into use rather than diverting inputs from another use. Or at least you might, if you use the right inputs.

And here is one problem with big regulatory changes in a recession that Krugman ignores: the workers who are displaced from dirty factories may not be the same ones hired to build the new, cleaner factories. Are the skills necessary to build a new power plant the same as those necessary to run it? For that matter will clean power output replace dirty power output one-for-one, or will higher costs shift the supply curve leftward and increase prices? Both of these are possible reasons why workers at the dirty plant could become unemployed as a result of this policy.

And for these disemployed workers the costs are much higher if the regulatory change happens in a recession than if it happens out of a recession. I have voiced this concern about simplifying taxes right now: if you’re going to undertake large structural change that will require capital and labor to shift to different firms, and especially if it is to different industries, then those adjustment costs will be higher for the unemployed if the changes happen during a recession.

I am a big fan of creative destruction, and that’s kind of what we’re talking about when we talk about better policies causing industrial shifts. And even given the added costs of doing this in a recession, there are many policies where the benefits of doing it now outweigh the costs. This mercury regulation may very well be one of them. So too might tax simplification. Also the benefits of lower opportunity costs might outweigh the higher adjustment costs for workers.  But we shouldn’t pretend that making big changes like this is better along every dimension during a recession than during times of healthy economic growth.

A Sympathetic Account of Geithnerism

You are a centrist New Keynesian Technocrat who is set to become Treasury Secretary during what looks like a replay of the Great Depression and the Japanese Depression.

However, Ben Bernanke is the Chairmen of your Central Bank. You are used to an environment where the Chairman exercises his full moral authority and moves the entire Federal Reserve. Ben Bernanke is personally an expert on the Great Depression and was highly critical of the Bank of Japan’s failure to act during its crisis.

You also see your Chairman swiftly moving to create  innovative facilities to prevent contagion from spreading in financial markets.

What are you likely to conclude?

1. Your primary role is to enable the Fed. You have to create an environment where the Fed can enact the type of policy your Chairman advised Japan to enact two decades ago. This means in large part bringing down risk spreads in the financial markets. You don’t believe you can do this if banks are afraid of overly aggressive action by the Central Government. Your role is then to stonewall such action.
2. You are aware that the Fed may need to engage in Quantitative Easing. The Fed will likely receive criticism that it is “Monetizing the Debt” and that the US is becoming a Banana Republic. You need to remove such criticism by staking out a serious position on the US’s long term fiscal situation.
3. You believe that populist anger is likely to rise up from the Left. This is your sense of the history of these types of situations. The danger of this could take many forms but the most obvious is the empowerment of activists and Congressmen who want to rapidly increase regulation. You need to stand in the way of this.

In short, your mission seems simple. Hold together the centrist neoliberal vision of the relationship between the State and the Economy while the Federal Reserve hits the gas and revives the economy.

You know its only a matter of time before Bernanke makes a credible commitment to be irresponsible, the dollar falls, US manufacturing revives and middle America experiences a mini-boom.

You just have to hold back the lions until that time arrives.

Unfortunately it never arrives and you are left having cut the legs out from underneath fiscal policy that could have revived the economy. You put deficit reduction on the table at exactly the wrong time and you hobbled the only effective counterweight to a massive populist uprising on the Right.

Hindsight is 20/20.

Unsurprising economics lessons

There are some unfortunately unsurprising economics lessons to be seen in what is starting to result from interchange regulations. First, is that there when the government sets prices there are often unintended consequences:

…McDonald’s and other U.S. retailers that rely on a high volume of small dollar transactions could see an increase in their debit card processing costs, because prior debit costs for smaller purchases had lower fees….

…Richard Peck, 7-Eleven’s senior director for corporate finance, said the company’s gas stations and convenience stores will likely see a mixed impact from the capped fees… But for smaller, everyday purchases, executives said those costs will likely lead to price increases for consumers.

Oops, I don’t think that was supposed to happen. Another lesson is that regulation is often a slippery slope. Walmart seems to think that is the case anyway:

Michael Cook, treasurer for Wal-Mart, said the discounter viewed the debit fee overhaul as a precursor to overhauling credit card processing fees.