Author: Michael Sykuta

An Open Letter to President Trump

Eighty-eight years ago on the third of May, 1,028 economists signed an open letter to Congress to oppose the Smoot-Hawley Tariff Act, explaining that protectionist tariffs are harmful to the U.S. economy. On May 3, 2018, over 1,100 economists (including yours truly) signed an open letter to President Trump and Congress expressing concern about the President’s threatened (and enacted) trade tariffs–using substantially the exact same letter that was sent 88 years before. That is because–and to illustrate that–the basic economic principles have not changed. Protectionist tariffs harm consumers, harm a large majority of producers, and harm the economy overall .

The letter has been covered by a variety of news sites, including:

The Smoot-Hawley Act is generally viewed as having contributed to the severity of the Great Depression, despite Congress’s (misguided) intent. While the modern economic environment is not necessarily in as fragile a state as it may have been in 1930, and the extent of the implications may not be as severe, the current administration’s threats of trade restrictions nonetheless risk a dampening of economic activity and reduced social well-being.

This is the kind of thing that happens when people don’t pay attention to history.

Or even pop culture…

Why Who the Boss Is Matters (At Least for Franchises)

A few weeks ago I wrote about the Save Local Businesses Act (H.R. 3441), which has passed the U.S. House of Representatives and is currently sitting in the Senate. At the heart of that Act is defining the term “joint employer” for National Labor Relations Board purposes, an issue with tremendous potential implications for the franchising industry, among others. If passed, the Act would codify a long-standing interpretation of franchisees as being the sole employer of their local employees. For reasons I explain in the previous post, that would be a good thing for preserving and facilitating the benefits of franchising.

Franchising is an important business model in the U.S. Franchised local businesses represent the fastest growing segment for employment, and are expected to continue that trend. Franchising obviously offers benefits for both the franchisor and the franchisee.

In a forthcoming paper in Cornell Hospitality Quarterly, Matt Sveum and I find evidence for at least one of the major benefits of franchising. Namely, franchising helps to reduce agency costs and to improve performance incentives at the local establishment level. From the abstract:

A central theme in much of the franchising literature is that franchising mitigates the principle-agent problems between the owner of the franchise company and the operator of the local establishment by making the operator the owner-franchisee of the establishment. Despite the centrality of that assumption in the literature, there is little empirical evidence to support it. We use Census of Retail Trade data for essentially all full- and limited-service restaurants in the US to test whether franchisee ownership affects performance at the establishment level. We find a strong and robust franchise effect for full-service restaurants, but little effect among limited-service restaurants. We argue this difference is consistent with agency costs given differences in work processes and the importance of managerial discretion.

Full citation:
Sveum, Matthew and Sykuta, Michael E., “The Effect of Franchising on Establishment Performance in the U.S. Restaurant Industry,” forthcoming in Cornell Hospitality Quarterly; US Census Bureau Center for Economic Studies Paper No. CES-WP- 16-54. Available at SSRN: https://ssrn.com/abstract=2883267 or http://dx.doi.org/10.2139/ssrn.2883267

To “Nudge” or Not To “Nudge”

Congratulations to Alessandro Lizzeri and Leeat Yariv for receiving the American Economic Journal: Microeconomics “2018 AEJ Best Paper” award for their paper titled “Collective Self-Enforcement.” in which they model the desirability of various forms of ‘collective action’ in the form of government intervention to influence individuals’ self-control decisions. The abstract of the paper reads:

Behavioral economics presents a “paternalistic” rationale for a benevolent government’s intervention. We consider an economy where the only “distortion” is agents’ time-inconsistency. We study the desirability of various forms of collective action, ones pertaining to costly commitment and ones pertaining to the timing of consumption, when government decisions respond to voters’ preferences via the political process. Three messages emerge. First, welfare is highest under either full centralization or laissez-faire. Second, introducing collective action only on consumption decisions yields no commitment. Last, individuals’ relative preferences for commitment may reverse depending on whether future consumption decisions are centralized or not.

Lizzeri, Alessandro, and Leeat Yariv. 2017. “Collective Self-Control.” American Economic Journal: Microeconomics, 9 (3): 213-44. DOI: 10.1257/mic.20150325

Who’s the Boss? It’s not just a franchising question.

Who’s the boss?

No, I’m not referring to the hit 1980s sitcom that launched Alyssa Milano’s career and took Tony Danza from a dimwitted, cab-driving boxer (in Taxi) to lovable hunky housekeeper. It’s a more important question than that.

Who’s the boss at a local business? Especially if that business has close relationships with another, larger company?

That’s the question at the heart of the Save Local Business Act (H.R. 3441) that is currently waiting action in the U.S. Senate. And how that question is answered could have big implications for hundreds of thousands of small business owners. For starters, and perhaps most specifically, for every locally owned franchised business in the United States. But that’s not all.

The issue stems from a 2014 National Labor Relations Board (NLRB) ruling in which the Board voted 3-2 to find that McDonald’s Corp. was a “joint employer” with all of their franchisees. In that case, labor union activists filed a complaint against McDonald’s directly rather than having to work against multiple individual franchisees, claiming that because McDonald’s Corp provides training and recommends employment standards and work policies for the local business owners that use the McDonald’s brand, the franchisor is effectively a joint-employer. And therefore, any labor violations that can be levied against one joint-employer apply to the local business as a whole. The NLRB agreed.

Prior to this ruling, the NLRB treated local franchisee owners as the sole employer of the local business. That meant that any labor complaints had to be filed against each individual franchisee. By expanding its definition of joint-employer, the NLRB made it easier for labor groups to a) file complaints against and b) potentially unionize an entire franchise network.

The NLRB doubled down on its expanded definition of joint employer in its 2015 decision in Browning-Ferris Industries, 362 NLRB No. 186, where is defined “joint employer” as:

two or more entities are joint employers of a single workforce if (1) they are both employers within the meaning of the common law; and (2) they share or codetermine those matters governing the essential terms and conditions of employment.

This is not just an issue for franchises (indeed, Browing-Ferris was not about a franchise case). In fact, the above definition could be read to mean that any company that hires another company to provide services could be considered a joint employer of the contracted company’ employees, even if only on a temporary basis as part of their otherwise full-time job. That includes anything from temp agencies to security companies to housekeeping or maintenance contractors; even to agricultural producers.

For instance, many farmers raise chickens or hogs under contract with a meat processing company. Those companies may require the farmer and any farm employees to follow certain routines or practices to ensure the health and well-being of the animals being raised. Under Browning-Ferris, one could argue the processor is a joint-employer with the farmer, making the farmer subject to a host of employment laws that typically do not apply to small businesses.

Local business owners breaking ground for their new franchised store, the first Sonic restaurant in Rhode Island.

Likewise with franchisees, whether owners of restaurants, hotels, tax preparation companies, cleaning companies, home healthcare companies, or retail outlets. Most franchisees are small, local business owners that pay the franchisor for the rights to use the franchisor’s brand name and business format, to gain access to training resources, and perhaps to access inventories and supplies. Because the franchisor provides training resources and may recommend things like staffing levels, training processes, etc., as part of their business plan (which is one of the reasons to buy the franchise in the first place), most franchisors could be deemed joint employers with their local business owner franchisees.

That creates new risks for franchisors (since they have no direct control over local store operations) and exposes small business owners to regulations that only apply to larger businesses. Moreover, it puts any franchisee at even greater risk for the behavior of other franchisees and their employees. And that is a powerful disincentive for franchising. Since franchised businesses have been the fastest growing sector of the economy, such regulations could have far-reaching implications.

Joint employer status creates new risks for franchisors (since they have no direct control over local store operations) and exposes small business owners to regulations that only apply to larger businesses. And that is a powerful disincentive for franchising.

Fortunately for now, a new presidential administration in 2017 led to a change in the composition of the National Labor Relations Board. The new NLRB board voted 3-2 to overturn Browning-Ferris and restore its previous definition of joint employer.

And therein lies part of the problem. Change presidents, change NLRB composition, change the rules. That is what the Save Local Business Act is intended to fix. The Act provides a legislative solution to the problem of agency (NLRB)) discretion in defining what constitutes a joint employer. Can laws change? Yes. But that requires more than a change of one person (as in the case of the NLRB) to change the law.

So who’s the boss? For now, it’s the local business owner. It’s up to Congress to remove the uncertainty about how that question will be answered in years to come.

The Labeling Problem, Part 2

In The Labeling Problem, I explained how the presence of a label, whether on a college course or a food item, does more than just identify the product. It actually can influence consumers’ perceptions about the attribute the label identifies. As a result, it can also influence consumers’ perceptions of similar products that don’t have the label.

Consequently, labels have the potential not just to inform consumers, but to misinform them; particularly when the label is for an attribute that consumers do not fully understand. For instance, with genetically modified (GM), or genetically engineered (GE), food products.

There is another dimension of the labeling issue that I promised to return to: what makes economic sense? Remember the Three Simple Rules? What makes economic sense comes down to this: What’s the marginal benefit of providing the additional information? What’s the marginal cost of providing that information? And because we’re talking about a diverse set of consumers with different interests, that leads to the question of “who should pay for it?”

So What’s the Marginal Benefit?

Information is economically valuable only if it will change the outcome of a decision. Consequently, a GM label would create personal (or private) benefit only if the label would change the consumer’s decision to purchase the product. A Pew Foundation study found only 1-in-6 people (16%) “care a great deal about the issue of GM foods.” Another 37% “care some.” But do they care enough that it would make them willing to change their behavior even if it cost them additional money to buy the GMO-free product? Some scholars have attempted to estimate consumers’ willingness-to-pay (WTP) for GMO-free products as a measure of the value of labels (for instance, see here and here). The results tend to show individual consumers, on average, are willing to pay at least a little more for GMO-free products, whether the label denotes the presence–or the absence–of GMOs. Of course, this is also based on the fact that a large percentage of consumers lack knowledge about what GMOs are.

From a public policy perspective, the label only has value if it would lead consumers to make decisions that improve public well-being. The consensus of the scientific community is that there is no substantive nutritional, quality. or health safety difference between food containing GM ingredients and GMO-free foods (see here, here, and here). That suggests that there is no real public benefit to having the information provided.

What’s the Marginal Cost?

A wide range of numbers have been thrown around about the potential cost of mandatory labeling. At the low end, the Consumers Union (a pro-labeling group) commissioned a study that found the cost would be only $2.30 per person (or about $740 million) per year. That estimate is based primarily on the costs of labeling itself. It does not include costs of regulatory enforcement or increased costs in sourcing inputs, keeping the inputs segregated to prevent contamination by GM inputs, and product reformulation. Other studies (funded by anti-labeling groups) have suggested costs on the order of $450 per household (or about $56.7 billion) per year. In addition to including a more systemic view of the costs, these studies also make assumptions about manufacturers shifting more of their products to being GMO-free to avoid the negative stigma of having a “contains GMOS” label.

So while the predicted cost is wide-ranging, one thing is clear: The costs are bigger than zero.

Sound economic decision making (and therefore sound policy) requires the marginal benefits of any action to be at least as big as the marginal costs of the action. From a public perspective, the benefits are arguably zero, while the costs are greater than zero. That suggests a regulation requiring labels would not make economic sense.

Does that mean there should be no labels? Not at all. It simply means it doesn’t make sense to have a law that forces all consumers (many of whom are not concerned about GMOs anyhow) to pay for a regulation that has little or no public benefit in the first place.

But the fact that there are potential private benefits to labeling suggest that voluntary labeling may be desirable. Clearly, the value of labeling information to some consumers is greater than zero. And some of those consumers would both pay for that information and change their consumption decision based on it. Manufacturers who believe they can deliver that value at a low enough cost to make a profit on it have every incentive to make that happen. And in fact, that’s exactly the situation we have now in the US with voluntary “GMO-Free” and/or “Organic” labeling.

One might still object that these voluntary labels may create a negative stigma about non-labeled products. And that’s a fair point. But that also means that industry has an incentive to more proactively educate consumers about the science behind GM-foods, so they won’t be fooled into paying more for something that may not provide the benefits they think.

Cass Sunstein, a Harvard law professor, summarizes the whole point fairly well in the abstract of a recent paper:

Many people favor labeling GM food on the ground that it poses serious risks to human health and the environment, but with certain qualifications, the prevailing scientific judgment is that it does no such thing. In the face of that judgment, some people respond that even in the absence of evidence of harm, people have “a right to know” about the contents of what they are eating. But there is a serious problem with this response: there is a good argument that the benefits of such labels would be lower than the costs.

Consumers would obtain no health benefits from which labels. To the extent that they would be willing to pay for them, the reason (for many though not all) is likely to be erroneous beliefs, which are not a sufficient justification for mandatory labels. Moreover, GMO labels might well lead people to think that the relevant foods are harmful and thus affirmatively mislead them.

 

 

 

The Labeling Problem

(Part 1 of 2)

“Labeling” is a big thing these days. After all, as I hope you have concluded if you’ve read many (any?) of my previous posts, information (or lack thereof) is one of the biggest challenges for an effective market-based economy. But does that mean “labeling” is necessarily a good thing?

I bet you thought I was going to talk about food, didn’t you? A little bit, but first…

The university where I work has a “Writing Intensive” requirement for which students must take at least two courses that are designated as “writing intensive” or WI. WI courses have to be approved as satisfying certain criteria, including a minimum number of pages of revisions and a significant portion of the overall grade being based on students’ writing. It’s largely up to the instructor as to whether to apply for the WI designation in any particular course.

Naturally, not all students are thrilled about taking WI courses that actually require them to write, in real English, with some evidence of proper grammar and structure and all those nasty, time-consuming details. (Like OMG uv got 2 b kidding!)

Some students complained about unwittingly enrolling in courses that were WI. You know, because heaven forbid they end up in a class that requires writing they could have avoided. Professional advisors and administrators concurred, and contrived a labeling scheme to make it clear that a course is approved as WI–because the language in the course description itself was apparently insufficient. (Perhaps the dislike for writing stems from a dislike for reading as well.) Now courses have to be reviewed and approved in time to be listed in the course catalogue for registration the following semester so the course number can be affixed with a W on the end (e.g., ABM 4971W vs ABM 4971).

But this course designator has created a different kind of problem: Students are now upset anytime a course without a W on the number includes any substantive amount of writing.

The presence of a WI label changes students’ expectations and perceptions
about all courses, not just WI courses.

And this is part of the problem in the larger ‘labeling’ debates we face as a society. When we add information on labels, it doesn’t just provide information; it shapes consumers’ perceptions not just of the labeled product, but of all similar products. This is especially true for mandatory labels for attributes that consumers do not fully understand and for which consumers’ personal valuations are more subjective and varied.

Take foods containing genetically modified (GM), or genetically engineered (GE), organisms, for instance. Survey results suggest that a majority of US consumers has little knowledge or understanding about what GM foods are (for instance, see here and here), never mind the fact that a consensus report from the National Academy of Sciences, Engineering and Medicine (p. 2) “found no substantiated evidence that foods from GE crops were less safe than foods from non-GE crops.”

Notwithstanding that lack of knowledge, a large majority of consumers, if asked, will agree with the idea that consumers have a right to know what’s in their food and that GM content should be labeled. Kind of like college kids who object simply to the idea of writing. That said, only a small percentage of consumers (1 in 6) actually care deeply about having that information themselves.

Despite the value of more information, GM labeling runs a couple different risks. First, if food products containing GMOs are required to be labeled as such, most all food would carry the label because most prepared foods contain products derived from soybeans and corn, which are predominantly grown using GM biotechnologies. If everything in a store carries the same ‘warning’ label, the label doesn’t convey any relative information. That is, it doesn’t help distinguish between products. In fact, it would be harder to find the products without the label. Imagine students scrolling through the 90%+ of courses marked “Not WI” in order to find the 10% that are WI. A “GMO-Free” label, on the other hand, would communicate more effectively by standing out relative to other products.

Second, even with a (voluntary) “GMO-Free” label, the label itself implies that GMOs are bad by comparison, just like having WI courses marked “W” seemingly implies courses without “W” don’t involve much writing. In that case, the label actually misinforms consumers, or at least misleads them, relative to the science of GM foods and their safety (or to instructors’ pedagogy, as the case may be).

The presence of a GM label changes consumers’ expectations and perceptions
about all food products, not just the ones labeled.

Having labels that misinform or mislead consumers, whether explicitly or implicitly, defeats the purpose of labeling to begin with, and is therefore an ineffective policy tool. There is also the issue of what is an economically sensible policy for providing information in the market place, even if labeling were to be effective. Stay tuned for a follow-up post on that.

Legalized Price-Fixing in Public Construction?

Imagine you wanted to have your house painted, remodeled, or even have a new house built, but all the contractors had agreed to charge the same prices. What if your local government passed a law requiring you to pay the same price no matter which contractor you chose? Sound like a good idea?

For over 100 years, US antitrust law has prohibited sellers from conspiring to fix prices. According to the US Federal Trade Commission’s “Guide to Antitrust Laws” price fixing is defined as:

“…an agreement (written, verbal, or inferred from conduct) among competitors that raises, lowers, or stabilizes prices or competitive terms. Generally, the antitrust laws require that each company establish prices and other terms on its own, without agreeing with a competitor. When consumers make choices about what products and services to buy, they expect that the price has been determined freely on the basis of supply and demand, not by an agreement among competitors. When competitors agree to restrict competition, the result is often higher prices. Accordingly, price fixing is a major concern of government antitrust enforcement.”

Compare that first line to the following language:

“…a wage of no less than the … wages for work of a similar character in the locality in which the work is performed shall be paid to all workmen employed…”

One might think that sounds like an agreement to “stabilize prices or competitive terms” for labor services. But in fact, it’s an excerpt from Missouri Revised Statutes Section 290.220, otherwise known as the Prevailing Wage Law, which reads:

“It is hereby declared to be the policy of the state of Missouri that a wage of no less than the prevailing hourly rate of wages for work of a similar character in the locality in which the work is performed shall be paid to all workmen employed by or on behalf of any public body engaged in public works exclusive of maintenance work.”

The effect of the prevailing wage law is to require all public construction projects, from State to local school districts, from new building construction to repainting existing buildings, to pay workers a wage determined by the Missouri Department of Labor as being the ‘prevailing wage’ for the specific type of work in that local area. From a practical perspective, the prevailing wage law amounts to little more than a legalized form of price fixing, facilitated by the State.

Proponents of the law–particularly labor unions and contractors that hire union workers–argue the law helps ensure higher quality work because it eliminates contractors’ incentive to hire lower skilled labor. Critics argue that the law does nothing but protect union interests by eliminating competition in the labor market, and increases the cost to tax payers of all public construction projects. (Some critics would add that the law infringes on individuals’ freedom to contract).

Empirical research on the effect of prevailing wage laws is mixed. Some researchers find that prevailing wage laws increase the cost of public works projects by anywhere from 9 to 30%. Other researchers have found that even though the cost of public projects is significantly higher in prevailing wage states, those differences are negligible when other factors are controlled for.

However, what does not seem to get much attention in the empirical literature is how the prevailing wage is determined, and how that process itself may affect the cost of construction projects in both the private and public sectors due to the incentives the process creates.

At least in Missouri, the Annual Wage Order is based on wage information voluntarily reported by contractors. Contractors are “heavily encouraged” to submit wage reports for any commercial construction projects. Only contractors that participate in public contract bidding have incentive to submit wage reports since they are the only ones with an interest in the established wage. This incentive to report may inflate the prevailing wage calculation because companies that specialize in private commercial construction may pay lower wages in attempt to be more competitive.

Because accepting a public contract would require paying (higher) “prevailing wages”, contractors whose business is primarily private commercial construction may have even less incentive to participate in public project bidding. Contractors may find it difficult to pay their workers more for some projects than for others. Accepting public contracts may put the contractor in a position of being less competitive in the private construction market, since it would not be able to lower wages for those projects. The end result? Only higher wage contractors participate in public bidding and report their wages to the Department of Labor, further skewing the “prevailing wage”.

To the extent contractors participate in both public and private construction projects and do manage to pay different wage rates, contractors still can be selective in which wages they report to the Department of Labor. Contractors can submit wages for their public contracts and their more generous private commercial contracts and withhold information about any lower-wage contracts.

This endogenous wage-setting problem is even more likely in the case of construction projects that are uniquely public in nature. Almost all road construction in the US is done by public entities. Companies that specialize in road construction are the only firms submitting wage reports that determine the prevailing wage for road construction work. As a result, there is absolutely no competitive check on the potential escalation of wages for such projects.

There are some testable hypotheses implied by the arguments above. One would be the degree of specialization in public versus private construction projects by contractors. Another would involve the trend or serial correlation of prevailing wages for construction projects that are uniquely public in nature versus construction projects that have a mix of public and private buyers. And if one were able to get the data, a third would be to test whether the types of projects for which wages are reported to the Department of Labor are systematically biased in a way that would result in biased estimates of the ‘prevailing wage’.

Private firms that engage in price fixing, even by tacit collusion (that is, by informally following one another’s lead) are subject to fairly strict antitrust prohibitions. State prevailing wage laws, especially ones that are based on selective, voluntary reporting, amount to little more than a legalized form of State-sponsored price fixing. It’s worth thinking about why price fixing should be illegal when individuals pay for things themselves, but not when politicians and bureaucrats use taxpayers’ money to buy things for them.