Michael Sykuta

A(n Ethanol) Subsidy By Any Other Name?

’Tis but thy name that is my enemy; Thou art thyself though, not a Montague.
What’s Montague? it is nor hand, nor foot, nor arm, nor face, nor any other part
Belonging to a man. O! be some other name: What’s in a name? that which we call a rose
By any other name would smell as sweet; So Romeo would, were he not Romeo call’d,
Retain that dear perfection which he owes without that title.
~ Juliet, “Romeo & Juliet,” Act II, Scene II
William Shakespeare

It seems ethanol interests have a similar attitude toward the word “subsidy” as did Juliet toward Romeo.

Growth Energy, a biofuels lobbying organization, is currently holding its 2018 Executive Leadership Conference. The opening panel was titled “Up The Road: Does Ag Need Biofuels.” Not too surprisingly, the overwhelming conclusion was “Yes!”, as reported by the Iowa Renewable Fuels Association (RFA). And it’s true that biofuels are important for the corn and soy belt. According to the USDA’s Economic Research Service, 37% of corn (see Table 5) and 27% of soybeans (see Table 6) were used to make ethanol and biodiesel, respectively, in the 2016/17 marketing year. Of course, that use of biofuels is almost entirely the result of artificial demand created by government regulations that mandate use of ethanol, in particular, and biofuels more generally, in automobile fuel supplies. So when leaders in the ag industry affirm the importance of biofuels to the ag sector, they are essentially confessing the industry is dependent on an implicit subsidy in the form of consumer mandates.

That was the point I made in retweeting Iowa RFA’s tweet above.
By declaring a dependence on government mandates, these leaders in agriculture are effectively saying they cannot thrive in a competitive market and need government assistance. And these regulations do have the effect of thwarting innovation to the detriment of all fuel consumers. The rationale for incorporating ethanol in gasoline is to serve as an oxygenate to help the fuel burn cleaner, thereby reducing engine emissions. The Clean Air Act requires oxygenates be added to fuel to reduce air pollution. The Energy Policy Act of 2005 (Title XV) introduced the Renewable Fuels Standard that specifically mandates ethanol as the oxygenate that must be used, thereby discouraging research and development of alternate, potentially more cost efficient or environmentally beneficial, oxygenates.

The Iowa RFA was quick to reply, pointing out that biofuels “do not currently receive federal tax subsidies.” And that’s technically true–but it’s also disingenuous. As Juliet might say, a subsidy by any other name (like a renewable fuel standard) is no less a subsidy. It’s just a different channel of subsidy than direct tax dollar payments. But judging by the responses from other beneficiaries, it seems an important distinction. Kind of like a Capulet’s attitude about a Montague.

Some may think of subsidies as involving a direct payment to producers–like direct income payments to farmers or cost underwriting for crop insurance. But subsidies can also take the form of artificially inflating demand to increase the price and quantity demanded of the subsidized good. This is the tool the US government used to subsidize farms prior to the late 1980s; implementing commodity price supports by buying up the excess supply. It’s the same basic tool that is currently used to subsidize the electric car industry (via tax credits to car buyers; you’re welcome, Elon Musk). And, until the recent tax reform bill, it was one of the ways to help subsidize health insurance companies by mandating that individuals–particularly healthy individuals who are less costly to insure–purchase health insurance. In each case, the government subsidizes producers either directly, by giving them payments to cover costs, or indirectly, by bolstering demand (or in the case of health insurance, both).

It’s difficult when the things we love carry names, labels, or associations that are more convenient to ignore or deny than to embrace. It helps to call them something else, whether to deceive others or ourselves. But when it comes to consumer mandates, like the Renewable Fuels Standard, a subsidy by any other name is still a subsidy.

Enforcement of Non-Compete Clauses and Productivity

Non-compete clauses (or ‘covenants not to compete’, CNCs) in contracts restrict parties from working or doing business in particular industries or geographic markets for some period of time after the termination of the contract. These clauses seem to be getting more common (even for fast food restaurants). There are some economic justifications for CNCs, particularly if an employee has access to proprietary information that is central to the employee’s role or if things like client lists or industry contacts are key strategic assets. CNCs can help align the incentives of both the employee and the employer–since having those protections may increase information sharing within the firm. My colleague, Harvey James, Jr., has a nice piece (ungated version here) on employment contracts that discusses some of these incentive issues.

Ultimately, however, CNCs are subject to State law and State enforcement–and not all States enforce CNCs with equal rigor. So what are the effects of State enforcement (and thereby, of CNCs themselves)?

A recent study in Human Resource Management by Smriti Anand, Iftekhar Hasan, Priyanka Sharma and Haizhi Wang explores the effect of State enforceability of CNCs on firm productivity. The results seem rather interesting. The abstract reads:

Noncompete agreements (also known as covenants not to compete [CNCs]) are frequently used by many businesses in an attempt to maintain their competitive advantage by safeguarding their human capital and the associated business secrets. Although the choice of whether to include CNCs in employment contracts is made by firms, the real extent of their restrictiveness is determined by the state laws. In this article, we explore the effect of state-level CNC enforceability on firm productivity. We assert that an increase in state level CNC enforceability is detrimental to firm productivity, and this relationship becomes stronger as comparable job opportunities become more concentrated in a firm’s home state. On the other hand, this negative relationship is weakened as employee compensation tends to become more long-term oriented. Results based on hierarchical linear modeling analysis of 21,134 firm-year observations for 3,027 unique firms supported all three hypotheses.

To LSAT, Or Not to LSAT?

An article in today’s WSJ Online reports that a growing number of law schools in the US are planning to forego the LSAT (Law School Admission Test) as their required entrance examination and to begin accepting the GRE (Graduate Record Examinations) that most (general) graduate schools accept for entry into MS and PhD programs.

Proponents argue that it will broaden the applicant pool for law schools to consider individuals who may not want–for whatever reason–to take the LSAT and the GRE as they weigh grad school options. Opponents argue it will dilute the quality and preparation of students for the rigors of law school. Well that, an cut revenues from test fees if you’re the Law School Admission Council that administers the test. Can both (or all) sides be right?

Yes, they can.

Admission to graduate school (or any academic program really) suffers from a hidden information problem. Applicants have a better idea of their ability to succeed in grad school than do admissions committees. They also have an incentive to over-represent their abilities. (They also may actually over-estimate their abilities, if you follow the behavioral economics literature, but we don’t even need that for the story to be interesting.) Likewise, admissions committees have a better idea of how rigorous their program is and what it takes to succeed than do prospective students. And they don’t want to waste time on students who are not likely to be successful in their program.

In economics we refer to this as an ‘adverse selection’ problem. It results anytime there is an information asymmetry between potential trading partners in which one party has better information than the other, and may have an incentive to hide that information (because the truth would hurt their prospects in the trade).

There are (basically) two solutions for dealing with this adverse selection information problem. First, the information-disadvantaged party (in our case, the admissions committee) can use any number of screening devices to reduce the information asymmetry and sort out the good prospects from the bad prospects. That’s exactly the purpose the LSAT (or the GRE) serves. It reveals something about the applicant’s reasoning ability (especially the LSAT) or general knowledge base (more so the GRE). So the question is, are the attributes the LSAT and the GRE screen for sufficiently similar that relying on either one would be a good screen? Obviously, some law schools–and some very good ones–appear to believe that’s the case. Or they at least believe it’s likely enough to give it a shot. Since some schools have allowed the GRE as a special case in the past, they may even have evidence to support that conclusion.

The second way of dealing with adverse selection problems is for the party with the information advantage (in our case, the law school applicants) to signal their quality by undertaking some special effort that would only make sense if they were actually good prospects. In other words, choosing to send the signal is a self-selection mechanism that makes the applicant’s information claim more credible.

Here is where critics of the GRE standard are likely correct. If schools only accept the LSAT, applicants have to go out of their way to take this “grueling test” if they want to go to law school. Only students who really want to go to law school and who believe they have the ability are willing to put themselves through that (and pay the explicit costs as well). If schools will accept the LSAT or the GRE, on the other hand, some GRE-takers may apply to law school who wouldn’t have if they had to take the LSAT. Which means, as critics point out, there may be more applicants that aren’t really dedicated to the idea of law school and therefore may be less desirable students.

However, it might also be the case that some prospective students have broader interests, and the GRE has a greater utility for a wider set of possible graduate programs. In a world where college students have limited dollars and time to prep for a graduate admission test, the GRE is the more economical investment. While that might make the signal value of taking the LSAT that might higher, since you really have to want to go to law school to take it, it might also be reasonable to infer that the value of the LSAT signal to admissions committees is not high enough to risk missing out on good potential students who choose to economize on their admission test choice.

So ultimately, it’s not about whether one side (or which) is right about their concern. The real question is how much difference do their concerns actually make in the outcome of law school admissions, and is the difference worth the costs associated with either policy?

Of course, there is yet another possibility–and one the American Bar Association seems to be considering. That is, that neither screening device is valuable enough to require it for admission to law school. At least not enough to make requiring a test part of the accreditation standards for law schools. Apparently the ABA believes the information asymmetry may no longer be so great that the screen/signal adds all that much value after all.

If I were in the market of selling that screening device (or either of them) and the ancillary services that go with it (e.g., test prep courses), I’d be a bit concerned about the future of our business model.

What Is A Police Officer Worth? Insights of Opportunity Cost

Zig Ziglar is purported to have said, “Show me your checkbook and your calendar and I will tell you what is most important in your life.” There is truth in that statement. Economists refer to it as “revealed preferences”; when faced with actual choices and opportunity costs, how you choose reveals what you value most.

Yesterday I had opportunity to visit with a local high school AP Econ class to discuss whatever they wanted about economics and various issues. At some point we got on the topic of the recently rejected “use tax” proposal floated by our city and county governments that I wrote about earlier. A primary argument for the use tax was that our city needs to hire more police officers, and online sales are diverting local sales tax dollars from the city coffers.

This raised the question of what priorities does the City government actually have? After all, the City has two ways of paying for more police officers: raising more revenue (in the form of more taxes) or reallocating its existing revenues from competing uses. If the City truly believed having more police was such an important use of tax dollars, the City could do what many households do: reallocate their budget to their higher priority items, then go back and buy those other things when there’s more income available.

I decided to take a peek at our City’s budget for FY2018. In particular, how much does the City spend to staff an “Office of Cultural Affairs” that basically uses tax dollars to pay city employees to subsidize and promote public art and local artists. Don’t get me wrong–art and cultural attractions are an important element of the quality of life in our community. But rarely do we fret about choosing between a good option and an undesirable option. The nature of economics is having to choose between two goods, and what that choice says about how we evaluate them.

Based on our City’s checkbook (budget), publicly supported art and culture is worth more than having six additional sworn police officers. That’s how many additional sworn police officers could be hired if the City redirected the Cultural Affairs budget to policing. That’s not a judgment of the trade-off–it’s simply the economic facts based on the opportunity cost of the City’s revealed preferences in its resource allocation decision. We could go down the line with any number of other City ‘services’ to draw similar comparisons of opportunity costs.

Would the average citizen agree that public funding for art is worth more than six additional police officers? I don’t know. I’m doubtful. But the citizens have never been asked that question. Instead, the City just continues to seek an increase in taxes to pay for more police so it can have its art and its police, too.

Of course, there’s a political economy angle to this that might be perceived as more cynical (or sinister?). Which is the average citizen more likely to be willing to be taxed for at the margin? More art? Or more police? That strikes me as pretty much a no-brainer. Which likely explains why the City refuses to reallocate the arts funding (or any other expenditures) to pay for the police now and ask taxpayers for more money to resume doing those other (lower-valued) things.

Either one of two alternatives would appear to be true: our city government values public art more than it does having another six police officers; or, City officials manipulate the decision options for taxpayers by allocating funding to lower-valued services (making the City less safe?) in order to request tax increases for the foregone higher-valued services that taxpayers are more likely to approve. The latter would seem a form of extortion, so I’m sure it must be the former.

This situation is by no means unique or limited to our fair city. It’s true in yours, too; and at the State and Federal levels as well. Every government entity has decisions in how to allocate its receipts. How those allocations are made speaks to what is truly important to those making the decisions, and to their ability to manipulate voters’ interests at the margin.

Certification, Teacher Quality, and Click-bait Academic Publishing

Today’s email brought a content alert from Economic Inquiry on a newly accepted paper titled “New Evidence on National Board Certification as a Signal of Teacher Quality”. The abstract of the paper reads:

“Using longitudinal data from North Carolina that contains detailed identifiers, we estimate the effect of having a National Board for Professional Teaching Standards (NBPTS) teacher on academic achievement. We identify the effects of an NBPTS teacher exploiting multiple sources of variation including traditional-lagged achievement models, twin- and sibling-fixed effects, and aggregate grade-level variation. Our preferred estimates show that students taught by National Board certified teachers have higher math and reading scores by 0.04 and 0.01 of a standard deviation. We find that an NBPTS math teacher increases the present value of students’ lifetime income by $48,000.” (emphasis added)

Based on the abstract, one might infer that having NBPTS certification makes for a better teacher and that having NBPTS certification allows math teachers to have a meaningful lifetime income effect on students. If you read just a bit further, you might feel comfortable that you made the right inference when you read:

With aggregation and school-by-year fixed effects only variation between cohorts is used to identify the effect of NBPTS on test scores.

Unfortunately, if you concluded that being NBPTS certified has a meaningful relevance to student performance, you’d be completely wrong–as the paper itself explains.

Reading the abstract, the first question one should ask is “How does one become NBPTS certified, and what does that have to do with teacher quality?” In statistical terms, there’s a significant question of endogeneity and causation. Namely, does getting certified make one a better teacher, or do only better teachers get certified? If the latter, then whether or not one is certified has nothing to do with academic outcomes. It might provide a signal that the teacher is already a good teacher, but having the certification would have no meaningful effect on academic outcomes or lifetime earnings.

And indeed, that is exactly the case, as the authors themselves explain if you read just a little further than the statement about their method “to identify the effect of NBPTS on test scores.” What matters is the teacher and the teacher’s skills and practices. The certification itself is superfluous to the academic achievement result.

“Comparisons of teacher performance before and after certification suggest that greater average effectiveness of certified teachers reflects fixed quality differences identified by the certification as opposed to human capital effects. Implementing policies with a primary goal to modify the effectiveness of teachers should place little weight on the NBPTS certification as a potential facilitator. Rather the certification can be used to reward more effective teachers where use of direct evidence on performance in the districts is not feasible.” (emphasis added)

In other words, it’s the teacher-effect, not the NBPTS effect, that matters–to the point that the authors specifically say that little weight should be place on NBPTS certification as a potential facilitator (i.e., a policy tool) for improving student outcomes.

What the authors really purport to show, as the paper title alludes, is that being NBPTS certified is a pretty good indicator that a teacher is a good teacher. The NBPTS standards appear to be well-aligned with effective teaching practices. But if that’s the actual research objective, then the authors should also have looked at the causation from the other direction and tried to sort out the selection bias in who wants to get certified and why.

It’s unfortunate that the abstract of the paper is so misleading, because many people economize on their time by only reading the abstracts of articles to get a sense of the paper’s results. After all, that’s the purpose of an abstract. In this case, however, the abstract is written so poorly that it buries the actual results beneath a misleading presentation and might be perceived as a serious case of ‘bait and switch’. While the title of the paper is still correct–having national board certification is a signal of teacher quality–the abstract’s wording risks painting a false picture of the relevance of certification for student achievement. And that false picture is perpetuated by their description of their methods.

The editors of Economic Inquiry should be a bit ashamed for allowing such a bait and switch. The authors should as well. At best, it’s carelessly poor writing. At worst, it’s the academic equivalent of click-bait. Unfortunately, some people may look no further than the abstract as the basis for what would ultimately be a misguided potential education policy.

Corporate Tax Policy and Productivity Growth

An article by Colin Davis and Ken-ichi Hashimoto in the latest Economic Inquiry seems relevant to the current GOP tax reform proposals. The paper, titled “Corporate Tax Policy and Industry Location with Fully Endogenous Productivity Growth,” purports to show the effects of differential corporate tax policy on business location choice, productivity and innovation. The abstract follows:

This paper considers how national corporate tax policy affects productivity growth through adjustments in geographic patterns of industry in a two-country model of trade. With trade costs and imperfect knowledge spillovers between countries, production concentrates partially and innovation concentrates fully in the country with the lowest tax rate. A rise in the international corporate tax differential accelerates productivity growth through an increase in the production share of the low-tax country that improves knowledge spillovers from industry to innovation. The paper also investigates the relationship between the corporate tax differential and the level of market entry, and analytically characterizes the effects of changes in tax policy on national welfare.

Given the U.S. has one of the highest corporate tax rates among developed nations, the results of this study would seem to support efforts to lower that tax rate to be more in line with international peers. And lest the result seem too politically convenient, an ungated copy of an earlier draft of the paper (from 2015) is available here.

“Net Neutrality” Isn’t So Neutral–Nor So Good

The Federal Communications Commission lit up social media by formally announcing plans to roll back regulations imposed by the Obama administration that treat internet service providers (ISPs)–companies such as Comcast, AT&T, Verizon, or my beloved-be-damned Mediacom–like traditional utilities. Part of this roll back includes rules about net neutrality, which forbid ISPs from treating packets of data differently depending on who sent them or what they contain.

If you believe critics of this decision (such as here and here), the Internet is about to fall apart and all the things you love, from cute cat videos to online shopping to the latest streaming series sensation, will no longer be delivered to your desktop or mobile device. Instead, ISPs would control everything you’re allowed to say, do and view on the Internet, and they would thwart all innovation and potential disruptive technologies.

Never mind that the Obama-era regulation wiped out consumer protections that the Federal Trade Commission had developed, leaving Internet consumers in a privacy protection wasteland. And never mind that the regulation traded a vague threat of control by private companies for a very tangible control by government. The reality is that “net neutrality” itself threatens innovation and the development of disruptive technologies.

The concept of net neutrality is nothing new and isn’t unique to the Internet. Consider your local road system. The roads are the “pipes” of the Internet. Packets of data (cars and trucks) use the pipes to go here and there. Different packets carry different kinds of data–semis full of food, semis full of hazardous materials, city buses, and lots of personal vehicles whether with single passengers or multiple. Some of these packets are very big, take up a lot of space, and tend to bog things down in traffic. And especially at peak times of day, when there are thousands of different ‘packets’trying to get here and there, the system gets very congested and everything slooowwsss dddoooowwwwnnnn. Don’t you just hate that?

In order to alleviate congestion, many transportation authorities (the ISPs of the highways) restrict use of certain lanes to certain kinds of vehicles: “No Trucks in the Left Lane”, high-occupancy vehicle (HOV) lanes, and even toll roads that charge different fees for different size vehicles reflecting the different costs they impose on the system.

Why do we allow transportation authorities to discriminate on who gets to drive where and how much they have to pay to use the road? Simple. We understand the congestion problem. We understand that having lots of individual cars with only one passenger contributes more to the congestion than a car (or bus) with many passengers, so we reward HOVs by giving them a lane with less congestion so they can get to their destination more quickly. We understand that bigger vehicles impose higher costs on the system. We also know they value using the roads more than smaller, especially personal, vehicles, because they typically are carrying products to market that consumers value. Not surprisingly, trucking companies tend to dislike higher toll fees because it increases their cost of business. They’d much rather have other vehicles–and even people who don’t drive on the roads–pay for the infrastructure instead.

Proponents of net neutrality on the Internet–particularly streaming companies like Netflix, Hulu, or Sling–are basically like truck companies. These companies stream huge packets of data, taking up tons of bandwidth. If you have a cap on your data plan, you know how quickly you can reach your limit if you stream a lot of television through one of these services. Likewise, you know how frustrating it is when the pipes are so full of packets of all sorts that you get a lot of buffering or reduced image quality or the interminable little whirling circle that your download is still in progress.

With net neutrality, ISPs cannot charge more for “big trucks” and they can’t set up dedicated lanes for high-value traffic. They’re forced to make everyone stay on the same road, at the same speed, and deal with the congestion. Not only do they have less incentive to invest in the infrastructure since they can’t charge more for it, they also have fewer resources to do it since they can’t collect more money from the higher-value users.

As consumers of the Internet, the problems of net neutrality are less immediately obvious than our experiences with traffic on the highway. However, the nature of the problem is the same. We understand why ‘net neutrality’ on the highway is not the best policy. And the same applies to the Internet.