This Is Why We Can’t Have Nice Things: Healthcare Edition

Suppose I were to snap my fingers and transport us to my preferred health policy regime. Everyone pays out of pocket for most of their medical expenses, and most people carry catastrophic health insurance policies for truly bank-breaking medical episodes. I think there would be a very strong tendency in this world to push back in the direction of "insurance pays for everything." If we ever got there in the first place, preserving the "first-party pays for most medical expenses" regime requires vigilance.

The problem is that there are always marginal claims, which according to the insurance policy language might or might not be covered. Insurance companies try to nail down policy language so as to minimize this confusion, but there are always ambiguous claims. There is even a tendency for insurers to cover claims that they are clearly not on the hook for, because they like to show good faith to their customers. (I once overheard someone who was on a committee that decided how these marginal claims get paid out. She said something like, "How are we going to stay in business if we keep paying these claims that people don't have coverage for?" Presumably some insurers specialize in going the other direction, saying "No" to as many ambiguously covered claims as they can get away with.)

Everyone wants these marginal claims to be adjudicated in their favor. But at the same time, everyone wants their insurance premiums to stay affordable. It requires some discipline on the part of the insurer to say "No" to these claims and resist mission creep. And it probably requires a more mature understanding on the part of the insurance customers: with low premiums, diligent claims defense is part of the deal. The insured with the marginal claim needs to be able to say, "Low insurance premiums entail a lot of self-insurance for these kinds of claims. This is a cost I agreed to pay, and now I'm paying it."  This would probably require a massive cultural shift on the part of the American public.

I think this kind of "cover everything" mission creep in health insurance can happen even in the absence of wrong-headed legislation or foolish judicial decisions, declaring that this or that treatment must be covered by insurance.

So that's one problem. People have this, "I have health insurance, so it should pay for everything health-related" mentality, which has lead to spiraling health costs in the U.S. and elsewhere.

The other problem is that there are very high fixed costs in medicine (that's not the problem), and that they engage in price discrimination to extract more money from rich, price-inelastic customers (that's still not the problem). The people who pay high prices bitch and moan about how somebody else got the same treatment for a lower price (that is the problem). Some commentators on health policy, even conservative and free-market commentators, have called for total price transparency for all medicine. As in, the hospital lists all their prices somewhere (on a menu, on their website, whatever). Trying to charge more than the list price is fraud, in the eyes of these reformers. I'm sorry, but I don't see how you get away from price discrimination. I explain the concept here (specifically with respect to medicine) and here (more generally). By charging lower prices to price-elastic customers, hospitals and clinics can attract customers who still earn them a profit, but who are below the average price they would need to charge to keep themselves in business. Offer everyone the low price, and there isn't enough to pay support staff, keep the lights on, amortize the cost of the building, and so on. Offer everyone the high price, and the hospital/clinic misses out on these price-inelastic patients, who are still profitable. This situation is common when you have low marginal costs and high fixed costs. The price-inelastic customers, the ones who are sore about paying the higher costs, actually benefit from price discrimination, because the clinic has more customers to spread their fixed costs over (even if they don't load quite as much of the fixed costs on these low-price customers). These reformers probably imagine that under pure price transparency, everyone obtains the same amount of care but nobody gets price-gouged. This is wrong, because some people won't seek treatment except at the lower price. (I hesitate slightly to make this point, because some places have opted for total price transparency. The Surgery Center of Oklahoma and clinics offering laser eye surgery are good examples.)

As I write this, I can't help but be reminded of someone I know who complained about a surgery that cost him $20,000, in his telling for a trivial amount of time and effort on the part of the surgeon. This was someone in a very well-paid management job. I'm thinking, You're the rich patron who's keeping the lights on and subsidizing lower-income patients. Be happy to play that role. The surgeon could probably do the same surgery for 1/10th the cost for a price-elastic patient. But he couldn't stay in business and wouldn't have bothered becoming a surgeon in the first place if he had to offer that price to everyone.

I suspect a functioning market in medicine has to embrace a little bit of price discrimination, which probably means tolerating a lack of total transparency in prices. This means a culture of not bitching and moaning that someone else got a better deal than you.

Tabarrok and Cowen on the Economics of the Drug War

This is from their Modern Principles: Microeconomics text. Ellipses for omitted text, most of which is a description of a supply and demand chart.

Why the War on Drugs Is Hard To Win 

It's hard to defeat an enemy that grows stronger the more you strike against him or her. The war on drugs is like that. We illustrate with a simple model.
The U.S. government spends over $33 billion a year arresting over 1.5 million people and deterring the supply of illegal drugs with police, prisons, and border patrols. This in turn increases the cost of smuggling and dealing drugs.
(Description of a chart accompanying the discussion follows)
The most important assumption...is that the demand curve is inelastic. It's hard to get good data on how the quantity of drugs demanded varies with price, but most studies suggest that the demand for illegal drugs is quite inelastic, approximately 0.5. Inelastic demand is also plausible from what we know intuitively about how much people are willing to pay for drugs even when the price rises. Economists have much better data for the elasticity of demand for cigarettes, which one can think of as the elasticity of demand for the drug nicotine and it too is about 0.5.
What happens to seller revenues when the demand curve is inelastic and the price rises?... When the demand curve is inelastic, an increase in price increases the seller revenues....Prohibition increases the cost of selling drugs, which raise the price, but at a higher price, revenues from drug selling are greater even if the quantity sold is somewhat smaller.
The more effective prohibition is at raising costs, the greater are drug industry revenues. So, more effective prohibition means that drug sellers have more money to buy guns, pay bribes, fund the dealers, and even research and develop new technologies in drug delivery (like crack cocaine). It's hard to beat an enemy that gets stronger the mroe times you strike against him or her.

Then follows a paragraph discussing the use of a tax to deter drug use, as opposed to outright drug prohibition. They reference a paper by Gary Becker (and Kevin Murphy and Paul Grossman) titled The Economic Theory of Illegal Goods: The Case of Drugs. I did a write-up of this excellent paper a couple of years ago. The conclusion: even if we decide it's a good idea to deter drugs (which is a dubious goal), it's better to do so with a tax than an outright ban.

This discussion in the Modern Principles text nails the economic case against drug prohibition. So I don't understand how Cowen can be such a teetotaler. Maybe Tabarrok wrote that part of the textbook, and Cowen doesn't really know the standard economic analysis of drug prohibition? Or maybe Cowen does understand the standard economic treatment in the Becker paper, but perhaps he thinks that something's missing from this analysis? (But has never, to my knowledge, explained what is missing.) Since I wrote that blog post, Cowen posted this piece with excepts from a New York Times piece. Tyler adds his own commentary, saying "I increasingly believe that decriminalization will prove a more stable solution than outright legalization." Nothing in Cowen's post or the original NYT piece supports this belief, so I guess he's just sharing his stray thoughts with us. "Decriminalization" means no penalties for users but prohibition on the supply side. But the economics of illegal goods implies that the black market grows stronger (in the "greater revenues" sense) the more you crack down on it. So I don't get it. Decriminalization keeps the high revenues for black markets intact (with all the associated black-market violence and corruption) while not discouraging the demand side (except through higher prices driven by interdiction, which price-inelastic users willingly pay). To be fair, Cowen never outright defends drug prohibition, but he's always lukewarm on the benefits of legalization and (in my reading of him) exaggerates the harms of drug use.

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In a recent assorted links post, Tyler links to Scott Alexander's post on marijuana prohibition, in which Scott references some (in my opinion, poorly done) recent studies claiming that traffic accidents rise after states legalize marijuana. (I remember reading Scott's post and thinking, "Tyler is going to post a link to this, because this drug war meta-contrarianism stuff is like catnip for him." I even e-mailed a couple of people at Cato saying that this nonsense is going to make the rounds in the news cycle again, so we might want to get ahead of it.)  My reservations about these kinds of studies are outlined here. Not to fault Scott or Tyler for referencing respectable-looking, superficially convincing research on this question. What else are they supposed to do? But there is contrary research showing the opposite conclusion. I worry that it's becoming easy to claim "studies show legalization increases traffic accidents" when in fact that's still an open question (and in my reading of the evidence to date, probably not true). Scott is careful to hedge his conclusions in conditional terms and say why the studies he cites might not be right, but the thrust of his post is about how his previous cost-benefit assessment of marijuana legalization was wrong and that this new evidence might flip the conclusion. Be careful, guys! You both have enormous influence on elite opinion. 

Temp Agencies and Employer Learning

Paging Bryan Caplan.

In this episode of Econtalk featuring Noah Smith, Russ Roberts brings up the topic of temp agencies. Why, Roberts asks, do temp agencies command such a high premium? They take a large fraction of their workers' hourly wages. Why should temporary workers be willing to pay such a premium to someone to find them work? (This is particularly baffling when you consider that these are people with already-low wages.) Both Noah and Russ seem confused and don't have an easy answer, but some commenters present plausible explanations.

From a listener called MF:

Towards the end of the conversation, Russ and Noah talk about the role of temp agencies in employment.

My company (A small manufacturer, just under $10M in rev and ~30 employees) uses the temp agency as a long-term screening tool.  Basically, we have found that people are generally good at getting through an interview and a month or two of employment while “holding it together” but people tend to be who they are by say 90 days of being part of the team.
 When you hire someone as a regular full-time employee and then after 90 days or so they start acting out, slacking off, being overly confrontational, etc it is really hard to get rid of them and even if you properly document all the behavior/performance issues they often still end up on unemployment benefits which drives up the premium for the companies unemployment insurance.
 For us, (I can’t say why other companies use temp labor) it is well worth the premium paid to the temp agency to help manage this process.  Especially when considering that bad behavior or animosity towards co-workers can bring about horrible results on a production line, in a busy warehouse, etc…basically anywhere that heavy equipment is running.
 If a temp employee does start acting out, behaving dangerously on the line, etc there is NO paperwork and all we need to do is call the temp agency and say “person X is no longer needed” and that’s it.  The agency may send a replacement for that person the next day if needed.
 However, it is much better value in the long run for the company to hire them, and indeed at my company, those who are eager to learn, want to work as part of the team, be safe, etc are most often offered full employment and benefits with the company in the long term.

I think this fits well with Bryan Caplan's discussion of "employer learning" in his book The Case Against Education, which I wrote about previously. Employers who use temp agencies are in effect laundering the firing process. You're not "fired." You're simply "no longer needed."

I think this is very sad. It means our labor markets are inflexible, and that inflexibility is particularly harmful to low-skilled laborers. I wish the labor market was more fluid. I wish these low-wage laborers could float in and out of jobs more easily. It would be nice if they could work directly for the employers at the normal wage, rather than having to fork over huge sums to the temp agencies. Yes, that might mean some of them get fired more often. However, knowing that they can fire at will, employers would be more willing to actually take a chance on these low-skilled workers. That would be a much more forgiving labor market. It would create opportunities for low-skilled workers, who perhaps have had behavioral issues and a spotty work history.

Why is our labor market so inflexible? It's hard to escape the notion that labor regulations make the problem worse than it needs to be. Mandatory benefits make wages inflexible, because if I have to give you $X worth of benefits, I have to reduce your wages by $X (in an on average and all else equal sense). If I have to pay you a huge severance when I fire  you, it means firing you will be costly, which means I'm less willing to take a chance by hiring you in the first place. There might be good reasons for offering severance packages that have nothing to do with labor regulations. Preserving morale of the existing workers, convincing them the process is fair, etc. But this might make less sense for low-wage workers, who earn their employers pretty slim margins. Common "wisdom" says that labor regulations protect workers from exploitation. I think the shape of the labor market, particularly for low-skilled laborers, implies that there is a huge cost to these regulations. 

Some of the commenters on the Econtalk episode give plausible explanations for the temp agency phenomenon, and some of this is coming from employers who actually make hiring and firing decisions. They are explaining their actual reasons for being inflexible in hiring/firing decisions. If you're usually dismissive of arguments about regulations having counter-productive effects, I implore you to not dismiss so easily. This excellent essay in Regulation Magazine by Warren Meyer seems appropriate to this discussion.

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By the way, Noah Smith makes the absurd argument that big companies can keep wages down because they wield "market power." That would imply that big companies earn enormous returns on their low-wage workers. Given the temp agency phenomenon discussed above, given that low-wage workers are the first to lose their jobs during an economic down-turn, and given that these workers experience the highest rates of unemployment, I find these arguments kind of ridiculous. Maybe I'm being dense, and the high unemployment is actually part of the "monopsony/ market power" story: "Large employers employ fewer people than they would if they were forced to offer the market wage. That's how they keep wages down, by keeping people unemployed. Fewer workers means you're lower on the supply curve for labor, which means you can pay lower wages. D'uh!" But that doesn't make sense to me. Someone who is turned down by Wal-Mart can go work for McDonalds or KFC or Walgreens. At least one of these companies will hire this worker, whom they could supposedly exploit for a huge return on investment. The monopsony story implies more than one big employer wielding market power. It implies that all big employers are conspiring together to keep labor costs down, and they are all resolutely resisting the urge to earn huge profits by "cheating" on the deal. This is a "secret cabal of evil businessmen" level conspiracy theory.

A second aside. Caplan has a long section in his book about "IQ laundering." As in, explicit IQ testing is illegal if it leads to racial bias (which it often does), so educational credentials launder the IQ test. Universities effectively do the IQ testing for the employer, via years of coursework and student selection. Employers can then merely impose a degree requirement for a job and escape the threat of lawsuits they would incur if they used explicit IQ tests. Caplan does some back-of-the-envelope math to show that the effective penalty for IQ testing is a pittance compared to overall labor costs. If it were beneficial to do so, most employers would gladly flout the law and do IQ testing.

If someone did a similar back-of-the-envelope calculation for "wrongful termination" lawsuits, I'm curious how that would turn out. Maybe employer fear of wrongful termination lawsuits is vastly exaggerated, but they still are averse to firing. But if this were the case it would undercut Caplan's story about IQ laundering, because it would demonstrate that employers sometimes have irrational fear of small costs. Caplan's estimate of the "IQ testing penalty" is based on legal defense costs and settlement amounts, but maybe the threat of bad press about being a racist employer is more salient in the minds of HR professionals than the explicit dollar costs.

You Need a Reason to Refuse an Immigrant Entry

I'm an advocate for open borders. I think it is the only moral immigration policy. It's the only policy that actually respects everyone's fundamental rights. Immigration restrictions violate the rights of citizens in the country that imposes restrictions. If I can't rent out an apartment to whomever I choose or hire whomever I choose to work at my business, my country has violated my property rights and my right to freedom of association. The would-be immigrant's rights are also violated, and to add injury to insult they are relegated to dire poverty (or horrifying civil war or corrupt institutions or political persecution).

But the term "open borders" freaks people out. I think some advocates brandish the term in a way that's deliberately provocative, like "Watch me bite this bullet!" It's like calling yourself an "atheist" just because the term sounds harsher than "agnostic", even when the second term gets the point across. If I were trying to make the case for open borders to someone who is very skeptical to the idea, I would frame it differently. I would try to frame it as: You need a reason to say "No" to this person. "Immigrants" aren't an undifferentiated mass of humanity. This is a person you're talking about. A migrant worker who wants to earn first-world wages and send remittances back to his family at home, or a mother who wants a better life for her children. If they want to come here, and someone who already lives here wants to host them and hire them (perhaps marry them, or be their colleague), then you need a reason to say "No" to this specific person. If you can't look that person in the eye and explain to them why your personal uneasiness with immigrants trumps their right to move here, you don't really have the right to tell them "No."

Folks in the anti-immigration crowd often point to crimes committed by immigrants as if that's a legitimate reason to restrict immigration (even though, by all accounts, immigrants commit fewer crimes than natives). Okay, if that's your reason, that's fine. Would you tell someone, to their face, "I'm sorry, but the social statistics imply that the probability that you will commit a crime is X%. I'm not willing to take that risk. Please return home to live in dire poverty." That's the policy decision we're making with immigration restrictions, so let's just be upfront and honest about it. We're effectively doing this millions of times over, but without the moral courage to actually say what we're doing.

Some anti-immigration folks are worried about, how should I say this, the "cultural makeup" of America (or whatever their home-country is). I don't particularly like it when people fling around loose accusations of racism, but in this case I can't help it. At least some people who are anti-immigration are worried that America will become "less Anglo" and become more Hispanic, Chinese, and Indian. (Scott Sumner has written insightfully on this point; restrictionists aren't worried about being swarmed by Canadians and Britons and Aussies, or even by Europeans. If you comment to tell me that you're in favor of immigration restrictions but you're not racist and the racial makeup thing doesn't bother you at all, that's fine, I believe you. I'm just pointing out that these people exist. I've literally heard them voice their concerns.) I still think you need a reason to tell someone "No." When faced with someone who would like to immigrate here, to work for a willing employer and rent from a willing land lord, you need to be able to say, "Your presence here pollutes a cultural ideal that I would like to preserve. I'm not willing to endure that cost."

Too often, immigration debates deal in aggregates. We need to do a better job of reminding people what the proposition is at the individual level. (Many open borders folks have actually been great on this point.) The crime and "cultural makeup" objections to immigration seem to be weighing insignificant costs against tremendous benefits. I don't see how these could yield a "No" answer for a typical immigrant in a fair process. (Saying "No" to a known criminal, on the other hand, might make sense, depending on the severity of the crime and recidivism risk.)

If "You need a reason to say 'No'" yields "We almost never actually say 'No'", and if "We never actually say 'No'" implies "Basically open borders", so be it. We followed a fair process to it's logical conclusion, even if the resulting policy is surprising to many people. Moral inquiry often leads to surprising conclusions. But I wouldn't start the conversation at "Open borders, or else you're an awful person."

With all that said, there are often more sensible solutions than just saying "No" and outright denying someone entry. "You can come here if you put up a bond, which you forfeit if you commit a crime." Or "You can come here if you secure employment and housing first." Or "You can come here if you forfeit your right to certain provisions of the welfare state." All of these conditions seem a little unfair and demeaning, but they are far better than an outright and unconditional "No!"

This Econtalk interview with Bryan Caplan made me an instant convert to open borders, without my having previously given the topic much thought. Caplan rests much of his argument on the unfairness of immigration restrictions to the individual.

When Libertarians Start Achieving Electoral and Policy Success...

I hope that libertarians start to influence policy soon, and I see signs that they are beginning to affect some elections. But I have this nagging feeling that the recent election cycle really brought home to me. Attack ads against Republicans often feature some minor piece of legislation that slightly altered how our massive welfare state functions. Maybe a slight reduction in transfer payments or Medicaid. This gets tagged as "casting thousands of families into dire poverty" or causing "millions to lose their health-care," often without any substantive empirics on any actual harm done.

Uh oh. I favor cuts to the welfare state far deeper than anything any Republican has proposed. I think these programs tend to be counter-productive, or they tend to enrich the government employees who administer them without actually helping poor people very much. But nuts to my "sophisticated" argument to this effect. Any such proposal to cut government is going to be demagogued as "Heartless libertarians want to cast millions into Dickensian poverty!"

My nagging gut feeling is that shitty, simple-minded populism is going to kill libertarian chances of policy success. Unless we can really change the conversation, unless we can institute some sort of social sanction for this kind of overheated rhetoric, these cheap tricks are going to keep winning. (Someone apparently thinks so, according to the numerous campaign fliers that came to my house in recent weeks.)

I wrote about this a while ago. I'm trying (along with many other libertarians who write about policy) to preempt this kind of nasty partisan bickering. The case has been laid out on the table. It's there now for all to see. If there are any objections, raise them now while tempers are cool. Fat chance of that, though. Critics will ignore these arguments until they are within striking distance of an actual policy change, and then react with feigned surprise and outrage.

Ugh. Sorry to be such a downer. What is there to do about this? Learn your topics really, really well. Be prepared to confront this kind of rhetoric, and calmly, and without any bullet-biting. ("No, I did not just advocate murdering all children. Let's try this one more time...") If nothing else, you'll come off looking polished and the insult-slinging demagogue will come off looking foolish.

Terrible Arguments That (Apparently) Only Apply To Healthcare

Imagine someone were to say, "Homes are very expensive to purchase. That's why we need insurance to make the purchase of a home affordable." It would be a remarkably silly statement, because there are plenty of non-insurance ways to finance very expensive things. In fact most listeners would probably immediately think about how the average  home buyer does some combination of saving for the down payment and borrowing to cover the remainder. Insurance is great if your house burns to the ground or otherwise is in need of expensive repairs that would break the bank. The unexpected house fire is a good case for insurance. But "paying for my first house" is emphatically not an "insurable risk." It is something that is perfectly predictable from the point of view of the home buyer. (Traditionally, insurable risks have to be "fortuitous from the point of view of the insured", which means they don't decide when the "risk" is coming.) Most of medicine is predictable in the same sense as buying a home is predictable. Routine check-ups, the occasional illness, and the more intense utilization of medicine in old age are predictable costs, even if these things are expensive. Insurance doesn't make these things any more affordable. Whatever you think your insurer is "paying for" is in effect making your premiums more expensive. So at best it's a wash. (In reality, it's expensive to have someone handle your money and then go through a claims adjustment process when you need some of it back. Financing via insurance makes routine, expected medicine, the kind that the average person can expect to consume over the course of a typical life, less affordable.) Insurance is great if you have a (temporarily) debilitating but treatable disease or injury. That would be roughly analogous to the house fire mentioned above. But expected medicine (say, the amount of medicine consumed by the median individual) would be better financed through savings and perhaps even borrowing. (I'd love to have the option of saving on my insurance premiums if I could purchase a "medical line of credit", rather than making the insurer promise to pay outright for my treatment.) The "insurance makes healthcare more affordable for typical patients" argument is silly on its face. It seems like we recognize the silliness in any other context.

Or suppose someone said, "Information technology keeps improving rapidly. That's why computers keep getting more and more expensive." This would be another silly statement, because a unit of computing power has been getting cheaper at an exponential rate. Even if someone takes "a computer" to mean "the unit that a consumer purchases, as in a single laptop or desktop", the purchase price has fallen (or at least has not been rising). Improvements in technology bring costs down, not up. On the other hand, if Dell came out with the fastest possible laptop it could build and everyone wanted one as soon as it came to market, you might see an "increasing cost". Unconstrained demand for the very top of the line would tend to drive costs up. I think that's more analogous to what we're seeing in medicine. The new drug comes out that it slightly better than the next best alternative. Since the patient generally isn't the one paying, and since almost no one in the chain of decision making is sensitive to costs, almost everyone gets the new drug. In one sense, the cost of "achieving the cancer-fighting effectiveness of Latest Generation Chemo Drug " has come down. It used to be infinity, because there was nothing on the market that was as good. In another sense, patients (or insurers or governments) are spending exorbitant sums and society at large is sinking tremendous resources to eke out a tiny gain in medical outcomes. The casual observation that "medicine is getting more expensive because of advancing technology" is a half-truth. The cost of buying "the medicine we would have bought taking last year's technology as a given" is going down. The cost of buying "top of the line medicine for all ailments without any constraints on demand" is probably going up. It seems like there is a useful way of phrasing this and a misleading way of phrasing this, and I usually hear the latter. Maybe when people say this, there is an implicit "...and of course once new technology comes out, it is obligatory that everyone has access to it." My usual response to this is to say that of course cybernetic organs are a basic human right. Of course, a trip to the lunar health spa, which has been shown to improve life expectancy by an average of ten weeks, is a basic human right. It's fine to be soft-hearted and think we have an obligation to help people who have trouble affording healthcare. But when it leads to logical absurdities or spiraling costs, it's time to rethink how we're doing it.

Given That X Exists, Where Should You Put It?

I try to resist reaching for the cynical explanation for something when there’s a more reasonable one handy. It’s terribly tempting to see cynical motives everywhere, even though basic economics and a little common sense reasoning offer a far more plausible explanation.

Those “impulse purchases” at the check-out counter are a prime example. Supposedly these are placed so as to tempt shoppers with poor impulse control waiting to ring up their shopping cart. I think it’s far more reasonable to ask, “Suppose the store wants to offer the service of selling loose candy bars. Where should you place them?” Do they belong in the candy aisle with the packaged/bulk candy? So you’d throw it in your shopping cart and hope that you’ll keep track of it when all your groceries are bagged up? Probably not. If you’re buying a single candy bar, most likely it’s for immediate consumption. You don’t want to have it bagged up and have to search all your groceries for it. It probably makes sense to place those items at the check-out counter, so you have it in hand after you buy it. Also, look at the other “impulse buys”. Nail clippers and files. Lighters. Batteries. Mints and gum. Are these impulse items? As in people just can’t help themselves and chomp down an entire tin of mints? Or are they conveniently placed for 1) items you’d like to carry on your person and 2) items you need but always forget about? It seems “convenience” is the better explanation for where these items are located.

Here’s a very different example. Suppose there is someone who moderates disputes in drug markets. They tell rival drug dealers where their territory lies, settle “differences of opinion” between rival gangs, and reallocate territory when one dealer can’t maintain a drug supply in their currently assigned neighborhood. Fighting is costly, so dealers would likely want such a service, even knowing it will sometimes rule contrary to their interests. (The occasional adverse ruling is probably cheaper than constant gang warfare.) But who is going to provide it? Being such a moderator would make you an accomplice to a “crime” that has severe mandatory minimum sentences. If you go so far as to charge a fee for your service, it will be even easier to convict you.

Enter David Skarbek’s excellent book on prison gangs, The Social Order of the Underworld. Prison gangs (necessarily comprised of people already in prison) often mediate these disputes and in fact charge a “tax” on the proceeds of drug sales. Gangs that attempt to sell without paying their “taxes” are “green-lighted”, meaning they are open game for other drug dealers. Skarbek tells the story of one gang that refused to pay its taxes to the prison gangs, proudly calling itself The Greenlight Gang. Violent conflicts with other gangs eventually made their business unprofitable (despite their savings on “taxes”), and the gang disbanded.

To an outsider, or even to a drug dealer, this arrangement looks totally crooked, perhaps even nonsensical. Prison gangs are shaking down drug dealers to pay them “taxes”? Why would drug dealers, who are not yet imprisoned, bother to comply? The people making demands of them are safely tucked away in prison. One answer is that drug dealers who are currently outside of prison recon on the high probability that they will one day be inside prison, where they will be vulnerable to prison gangs. Prison gangs have very good intelligence on new prisoners. They know about associates and prior crimes, so they'll probably know you were a "tax dodger". Your life in prison will be miserable, and probably short. 

Another perfectly serviceable explanation presents itself when you ask: If there is going to be an underworld government that regulates and taxes the drug trade, where would you put it? And: Wouldn’t drug dealers want such a government, so as to minimize conflict? (Or should I say “optimize conflict”?)

What else? Are there other behaviors or institutions that look absurd or cynical or crooked at first, but look more reasonable when you ask, "Assuming there was such a thing, where would it be located?"

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Here is an Econtalk with David Skarbek on his book. Recommended listening. 

Pindyck on Two Kinds of Discount Rates

I recently finished Tyler Cowen's new book Stubborn Attachments. I enjoyed it and I appreciated the message. The book is mostly about how important economic growth is. As societies get wealthier, other problems tend to solve themselves. Richer populations tend to demand cleaner environments, lower rates of crime, and solutions to other social problems. Expanded wealth gives these populations the means to tackle these problems. So, the thinking goes, if we can keep our eye on the growth ball, other problems simply dissolve. Given the logic of compounding growth, it becomes extremely important over long timelines to maximize the rate of growth. Adding a mere 1% to the rate of economic growth means the economy will be 2.5x larger in 100 years. If we care about future generations, it seems like this should be a serious consideration.

It reminded me of a topic that was discussed in this episode of Econtalk with Robert Pindyck. About 10 minutes in, there is a discussion of what interest rate should be used to discount the future. A thousand dollars today is worth more than a thousand dollars a year from now, or ten years from now, or 100 years from now. So if we're talking about solving problems today versus passing those problems on to our children or grandchildren, we need to think about how we compare costs today versus costs in the future.

In a distinction I have never heard made anywhere else (and I've read quite a lot on economics), Pindyck makes a distinction between two kinds of interest rates: a utility discount and a financial discount. The "utility" discount is the "I'd rather have it now" effect. Given pleasure today or pleasure 100 years from now, I'd rather have it now. If you want someone to forego pleasure they could have today and instead take it decades from now, you'll have to compensate them (even assuming it's the same quantity of "pleasure", however you'd measure that, and even assuming there is a 100% guarantee they'll get it later). Some people argue, I think reasonably enough, that this discount rate should be zero. There's no moral reason that we should prefer ourselves to other people, whether they live in another country or another century. As Russ Roberts puts it in the podcast, their blood is just as red as mine.

The other component of the interest rate is the financial discount rate. This rate should not be set to zero, even if we care for future generations just as much as we care for ourselves. The reason isn't too hard to understand. A future generation values $1,000 in cash the same as $1,000 worth of climate abatement (by definition). We should pass to them whichever option is cheaper. Resources we spend today on climate abatement (or environmental cleanup or violence reduction) are resources we can't pass on to our grandchildren. A meager-sounding 3% interest rate causes savings to grow by a factor of 19 in 100 years. At 4% it's a factor of 50. At 5% it's a factor of 130. This is a big deal. Trying to solve a future generation's problem incurs a serious opportunity cost.

(I'm not sure whether to use the market rate of return here or the rate of economic growth. I can stow away money today in financial assets today and it might grow at a stellar 7%, which means growing by a factor of 870 in 100 years. But maybe social investments are different from financial investments. The social rate of return might be smaller than the private rate of return. Foregone consumption today may only compound at 2% or 3%, something more like the rate of economic growth. These are very different propositions: "Society as a whole foregoes consumption on $1,000 worth of economic resources so that future generations can use those resources." versus "I personally set aside $1,000 in an investment account to make my great-great-grandchildren filthy rich." Society's investment in the future probably grows more slowly than my personal investment. But if future generations have better technology and better institutions, the resources we bequeath to them will be used more efficiently. So the foregone $1,000 of consumption today compounds at something like the economic growth rate.)

Pindyck claims that when economists say that "the rate of discounting should be zero" they are only talking about the utility discount rate, not the financial discount rate. I think he may be giving a little too much credit to his fellow policy analysts, some of whom aren't quite so nuanced, some of whom fail to communicate this point clearly. But I take his point.

I kept expecting Stubborn Attachments to make this point explicitly. The book spends a lot of time discussing the "utility discount" (though not using Pindyck's terminology). It basically lands on: we shouldn't discount the future at all. We should treat the interests of future generations as equivalent to the interests of people living today. Maybe I missed it, or maybe it's so implicit to the books message that it didn't need to be said, but I had this expectation that Cowen would spell out the two kinds of discount rates and explain why only one is relevant for calculating costs or benefits to future generations. This comes out clearly in the Pindyck and Roberts discussion. They say that if we can grow the economy in a way such that future generations enjoy the fruits of that growth, those future generations would like us to do that. Anything else we'd like to give them has to be traded off against the economic growth we could otherwise bequeath to them.

There's another reason not to use a discount rate of zero, even if we care dearly about future generations. Existential risk. To take an extreme example, if there were a 1% chance each year of a civilization-ending asteroid strike or nuclear war or super-volcano, then it would make very little sense to care much about climate-related harms that take 100 years to manifest. Giving next century's generation, say, $1 trillion worth of climate change abatement isn't very useful if they only have a 37% chance of enjoying it (0.99 raised to the power 100). Even supposing that climate change itself is an existential risk, it may need to be traded off against other existential risks. Maybe shutting down fossil fuels slows the economic rate of growth such that future societies aren't prosperous enough to build an asteroid defense system or space travel. Maybe the wrong emissions reduction policy costs us a century of economic growth, which is the margin between being able to solve some other existential risk and not being able to do so. Like any other set of costs, existential risks need to be traded off against each other. There's no simple answer here, and there's everything at stake. It's a hard problem. But I think Cowen's "maximize growth" principle in Stubborn Attachments is a good place to start.

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Listen to the Econtalk episode, all the way to the end. It's kind of funny. Russ Roberts is something of a luke-warmer, and Pindyck is the "warmist" in this discussion (that's not to say an alarmist). Roberts brings up the worst-case-scenario for global warming, and Pindyck has to cool him back down. Roberts discusses the possibility of civilization ending and human extinction. Pindyck responds with:

I think you are going a little overboard. There's the worst case scenario; and there's the worst worst-case scenario. And I think you're on the worst, worst, worst case scenario. I don't think that--when we talked about a 5% chance or even a 1% chance, I don't think it's that bad. I think we're looking at something catastrophic, but not that terrible. It would be something that would impose pretty big costs on the world economy, maybe reduce the effective capital stock by 10% or even 20%. That's pretty bad.

A 10-20% reduction in the capital stock would be pretty terrible. It's a bland way of stating things; maybe "reduction in the capital stock" is a euphemism for building falling down or random cities falling into the ocean. But it makes me think some of the worst scare-stories over global warming are oversold.