Category: regulation

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.

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.

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.

 

Board Independence Gone Too Far?

The corporate governance literature has long argued that corporate boards should be comprised of a majority of independent directors. This is the result of a simple agency theory argument: Boards comprised of insiders (i.e., firm employees) will put their own interests ahead of the shareholders’. Moreover, any insider other than the CEO may have incentive to accommodate, rather than challenge, the CEO in the boardroom. Independent directors are assumed not to have such conflicts of interest and therefore to be better monitors of management on behalf of shareholders.

This argument, combined with corporate scandals in the early 2000s, has led to both regulatory requirements and shareholder activist pressure for increased board independence–to the point that many firms now have only one insider on the board, the CEO. That’s well beyond the theoretical justification for increased independence. But is it actually a good thing for the CEO to be “home alone” as the sole insider on the board? Has the push for board independence gone too far?

A forthcoming paper in the Strategic Management Journal by Michelle Zorn, Christine Shropshire, John Martin, James Combs and David Ketchen, titled “Home Alone: The Effect of Lone-Insider Boards on CEO Pay, Financial Misconduct, and Firm Performance,” suggests that such extreme independence is actually a bad thing. The abstract follows:

ABSTRACT

Research summary

Corporate scandals of the previous decade have heightened attention on board independence. Indeed, boards at many large firms are now so independent that the CEO is ‘home alone’ as the lone inside member. We build upon ‘pro-insider’ research within agency theory to explain how the growing trend toward lone-insider boards affects key outcomes and how external governance forces constrain their impact. We find evidence among S&P 1500 firms that having a lone-insider board is associated with (1) excess CEO pay and a larger CEO-top management team pay gap, (2) increased likelihood of financial misconduct, and (3) decreased firm performance, but that stock analysts and institutional investors reduce these negative effects. The findings raise important questions about the efficacy of leaving the CEO ‘home alone.’

Managerial summary

Following concerns that insider-dominated boards failed to protect shareholders, there has been a push for greater board independence. This push has been so successful that the CEO is now the only insider on the boards of more than half of S&P 1500 firms. We examine whether lone-insider boards do in fact offer strong governance or whether they enable CEOs to benefit personally. We find that lone-insider boards pay CEOs excessively, pay CEOs a disproportionately large amount relative to other top managers, have more instances of financial misconduct, and have lower performance than boards with more than one insider. Thus, it appears that lone-insider boards do not function as intended and firms should reconsider whether the push towards lone-insider boards is actually in shareholders’ best interests.