Against Monopoly

defending the right to innovate

Monopoly corrupts. Absolute monopoly corrupts absolutely.

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The Stimulus and the Crisis

The two of us signed a statement from a number of economists urging caution about the stimulus package now before Congress. The statement was a modest one - here we want to elaborate our own views.

Amidst all the op-ed pieces and argument in Congress, the debate over stimulus spending is also a hidden fight over who gets the money. The great problem with government spending is that everybody wants a piece of the pie: each party wants make sure that its constituents benefit. So, for example, the Republicans favor cuts in tax rates because their rich constituents pay more in taxes, while the Democrats favor spending and lump sum tax rebates, because that gives money to their constituents. There is, of course, a lot of dissembling on both sides over this as the economic crisis becomes an opportunity to purchase future votes at the expenses of the public purse.

Paying off voters aside, is there a case for a stimulus package? People are worried about the future and are sensibly reducing their spending. Does this mean that the government should step in and do the spending for them? Put that way, the idea seems like a non-starter: if we are poorer, so is our government which will be able to collect fewer, not more taxes. On the other hand, government borrowing is cheap right now, and labor costs relatively low. Isn't this the right time for the government to spend? Put that way stimulus spending seems like a good idea: borrow and spend when costs are low and you get more bang for your buck. However, if we accept this logic, then we reach an interesting conclusion - the additional spending now should be offset by less spending in the future. Sadly none of the plans by either party propose anything of the sort. The plan is simply to spend more money - how that will be paid for in future tax increases or reductions in government services is not a topic of discussion.

A second key issue is whether the government should spend the money itself, or reduce taxes in hopes of inducing people to spend their money themselves. While the latter in principle seems the better approach, it does little good if the people who receive the money don't want to spend it. Giving money to people who are unemployed or otherwise struggling is likely to lead to more consumption spending than giving it to better off people who are concerned about their future and will save it. The Democratic proposal is to provide lump sum tax rebates. On the one hand this makes sure that the poor and struggling receive some money; on the other it does nothing to reduce the drag of the tax system on the private sector and on the cost of labor in particular. The Republican counterproposal is to cut the payroll tax. They rightly point out that this is a regressive tax, so cutting it will have substantial benefit for the relatively poorly paid, and that it will reduce the cost of hiring, making it easier for the private sector to get back to business. They do not point out that the payroll tax paid on the business side is not regressive, and in the short-run during the brief period of suspension - the benefit will go entirely to the business owners, who are few in number and not so likely to spend it. How about reducing just the part of the payroll tax paid by the worker? This tax is even more regressive, and will also reduce the hiring distortion. It is clear why the Republicans do not suggest this - it brings fewer benefits to their constituents. Presumably the Democrats are against it because it is expensive and interferes with their pet projects.

Should we be concerned that cutting taxes will result in less consumption than direct government spending? The essence of the question is whether we need more private savings or not. A decade of poor investments in housing and an over-valuation of assets driven by irresponsible lending has resulted in the inability of a large number of American families to cope with their debt. There are only a few ways out: default on the debt, consume less, or work and earn more. So far we have had success in defaulting on debt - with the result that financial markets have collapsed. Currently we are starting to consume less. It remains to start working more. Cutting taxes on labor income, especially for incomes in the lower brackets, cannot possibly reduce employment and it will certainly increase it. What is more important is to note that, in circumstances like these and for those households having a hard time paying their mortgages, if some of the extra income generated by a reduction in tax rate goes toward saving (keeping up with mortgage payments, paying back debt on credit cards and so on) this will be an extremely good thing for the country (including its banking system) and not a bad one. Failure to appreciate this simple point is an important conceptual mistake behind the design of the stimulus plan.

Going through the original Obama proposal of January 15, we see a random collection of proposed spending. Some are sensible. There is a proposal to spend $102 billion to extend unemployment benefits, subsidize health care for the unemployed and increase the food stamp program. The cost is modest, the benefit targeted to people who are genuinely in need, and because the proposal is so clearly tied to an economic crisis over which the beneficiaries have little control, involves little moral hazard.

Also proposed are numerous spending programs on infrastructure. Some of these, including the $146 billion proposed for transportation, improving the electrical grid, and health care infrastructure, are probably meritorious. On the other hand, the problem with these kinds of programs is that it takes time to spend money on these programs...and so by the time the work really gets under way the crisis will be over: we will have had the illusion of having done something to help, while we did not do much. Other parts of the program seem to be simple pork-barrel spending for the Democrat's constituents: 6 billion for internet access for rural areas (why do we need to subsidize rural areas?); 16 billion to repair public housing and make it more energy efficient; and 6 billion to weatherize modest homes.

The broadband access spending proposal highlights the key deficiency of having the government involved in "innovation." As a give-a-way to a few politically well connected internet service providers who have been slow to build up their wireless networks, Congress and the Executive are trying to delay the requirement that over-the-air TV switch to HD. This, of course, will slow the introduction of wireless infrastructure by those providers who have innovated and are building out their networks. More to the point - why do we still have over-the-air TV at all? This benefits a handful of people while tying up massive amounts of bandwidth that would be far more useful for internet service or other wireless communication. The fact that the same bandwidth used by a TV station is worth ten times as much if used for a cell phone network shows the enormous distortion involved. Rather than spending billions building what will no doubt turn out to be relatively useless internet access, why not free the bandwidth and let the innovators provide us with really high speed internet access? This would have the additional benefit that there would be widespread competition over the "last mile" putting to rest once and for all any need for "internet neutrality" laws.

This latter point perhaps needs elaboration. If we are to get out of the current crisis we must come up with new ideas and ways of doing things. The stimulus bill is full of rhetoric about innovation. Predicting the next big thing is no easier for us than for Congress - but it is at least possible to make some sensible conjectures. The last big thing was the wired internet. It looks like the next big thing may well be the wireless internet. We already see people browsing the web on their cell phones in restaurants. The next generation of wireless technology promises us the mobile always on personal high bandwidth internet. All the information in the world at the tip of our fingers everywhere all the time. Who knows what great new businesses and entertainment will be built on the back of such an infrastructure? What is blocking this dream? Is it the fact that the government hasn't dumped $6 billion dollars into rural internet access? No. The government is itself the obstacle standing in the way. From foolishly allowing obsolete television stations to cling to over-the-air bandwidth; by regulating the use of radio devices on airplanes; by delaying new technologies such as HDTV (since when do we promote innovation by delaying it?); by over-regulating the spectrum - as in the recent set of roadblocks created over the use of "white-space," to the fact that so many technologies are tied up in obscure patents that should never have been issued...The government here is the problem, not the solution.

Turning back to the stimulus proposals, the big joker is the 91 billion in aid to the states. This is a good way to get money spent right away on useful things. Unfortunately the states have been less than provident in budgeting, and if we do this we will wind up like Argentina or Brazil where the states spend money, but the Federal government picks up the tab. Needless to say this makes it impossible to balance a budget in those countries and has led to enormous long term economic problems. If we believe that the states are "too big to fail," then at the very least the Federal government needs to behave like the old bad IMF - tying any aid to reforms that will get their fiscal house in order.

One of the most dangerous, and revealing, aspects of the proposed bill is the provision to "buy American." This is sold as a "patriotic" measure, but it is quite the opposite: buying only from each other makes us all worse off not better off. Tragically, if we start becoming protectionist the rest of the world will happily follow us - and we may truly have a decade long depression. The "buy American" provision also reveals the stimulus bill for what it is: we are not spending the $800 billion because we need to make needed investments in infrastructure but because we want to give away public money to politically favored businesses. If the projects are there because we need these investments and want to take advantage of low borrowing rates and low labor costs, then the government should be looking to get good value for its money - which doesn't mean buying from American firms if they do not offer the best value. Bailing out badly run steel firms by borrowing against future taxes is not going to move us forward.

Finally - how can we discuss innovating our way out of trouble without speaking of patents? A long collection of articles in Sunday's NYTs speaks of the need for innovation. Not one of these articles mentions patent reform. We now live in a world in which patents do not serve to encourage innovation. Rather rent-seekers look around to see who has the most successful new businesses and then use patents to blackmail them. The software industry - and the internet - have been one of the great engines of recent growth. Yes Bill Gates said: "If people had understood how patents would be granted when most of today's ideas were invented, and had taken out patents, the industry would be at a complete standstill today." He was right - industry is now at a standstill and there can be no new direction for American innovation without a radical patent reform. Let us roll back patent protection in software; enforce the existing standard of non-obviousness for inventions; and eliminate the kidnapping of ideas for ransom by providing a proper independent invention defense. These reforms - that would not cost a penny of public money - would do far more to build the foundation for sustained economic growth than the random assortment of stimulus spending currently being proposed in Congress.

Ultimately the current crisis is driven by a failure of confidence in institutions. Bankers have absconded with peoples' life savings; investment brokers have perhaps accomplished the same thing legally. Sadly, while trust is quickly broken it takes time to restore. One of the few institutions in which people still have confidence is the Federal government - so now is not the right time to talk about reducing its role in the economy. Unfortunately, the current stimulus package appears to be a compendium of the worst form of government misbehavior: pork barrel spending and a large increase in our future debt, without almost any tax relief for working families. While this may generate some popular enthusiasm in the short run, it may have dire consequences shortly after: not in the famous long run when we are no longer around, but a year or two from now. If the Federal government is the only remaining institution that draws public confidence, it needs to behave well enough that this confidence is sustained in the long run.


Only a note about "internet neutrality": I'm not sure we need laws for that, but seeing it as a "last mile" issue completely misses the point. The main concern is for big "backbone" providers, which are few and own big and fairly expensive communication networks.
Turning back to the stimulus proposals, the big joker is the 91 billion in aid to the states. This is a good way to get money spent right away on useful things. Unfortunately the states have been less than provident in budgeting, and if we do this we will wind up like Argentina or Brazil where the states spend money, but the Federal government picks up the tab. Needless to say this makes it impossible to balance a budget in those countries and has led to enormous long term economic problems. If we believe that the states are "too big to fail," then at the very least the Federal government needs to behave like the old bad IMF - tying any aid to reforms that will get their fiscal house in order.

While this is true, there is a rationale for aiding the states, given by the fact that (most, I think) states have balanced-budget rules that require them to balance their budgets every year. Some states have rainy day funds, but these are not funded nearly enough to make up for the shortfall in revenues caused by the recession. It makes sense for the states to be able to smooth things over time, without having to, e.g., fire 15,000 teachers and then try to hire them back in a couple of years (NY State).

Having said that, fiscal discipline is key especially for the states, who tend to "waste" a lot of money in various ingenious ways. One solution would be for the Federal govt to lend the money to the states, instead of simply giving it away, so that states can pay it back in good times and have an incentive to minimize waste and pork-barrel.

In general, I agree with the comments made by Boldrin & Levine. Government spending rarely accomplishes what it was intended to accomplish. They also make an extremely valid point that by the time the dollars hit the economy, the economy is usually already recovering. We must also remember that sooner or later someone must pay the piper. At this point, it is likely that our grandchildren will still be paying for the profligate spending of the last 40 years.

What surprises me is that Boldrin and Levine throw in patents out of the blue. On a scale of 1 to 10, with 10 being irresponsible government spending, people living beyond their means, and Sarbanes-Oxley (which, using a similar technique for estimating that others have estimated for the cost of patents (I disagree with the methodology, but since the methodologies were consistent between estimating the market affect of patents and the market affect of SOX, seems appropriate for comparison purposes), is more than $1 TRILLION), patents are relatively negligible, perhaps a 2, maybe a 3 if you throw in every possible effect, real and imaginary. Is it not better to focus on things that have hundreds of billions of dollars in affect rather than something that affects a few billion dollars, and for which there are some positive benefits?

Most economists think there is adequate competition over the backbone; in addition the the fiber network was heavily overbuilt, so it isn't that difficult to enter the industry - Google constantly threatens to do so. You can find some information about backbone providers here
In addition to the rent seeking angle, David and Michele make a good point that is too often ignored, namely the necessity of firms and individuals repairing their broken balance sheets by saving more. If the government taxes something (like labor), less of it is supplied, and if it lowers the tax on something (like labor), more of it will be supplied. (The devil is in the empirical details, but the larger theoretical point remains.) Reducing the tax on labor should be done posthaste.

Another point too often overlooked is the Austrian point made by Mises and stressed again and again by Hayek, namely that the business cycle is caused by government intervention in capital markets. When the State over issued Treasuries (like it did in the 19th century before the central bank era, at least in the U.S.), or expanded the monetary base (when central banks had a monopoly of supplying money), this caused the loan rate of interest charged by banks (and shadow banks, which until a year ago accounted for 70-80% of loan volume in the U.S.) to fall below the natural rate of interest (the rate that clears the market for investible resources). This induced entrepreneurs to ramp up their demand for loans, which led them to overinvest in projects that were later revealed to be malinvestments. Sub-market interest rates also caused the real estate and mortgage booms, and caused consumers to save too little and consume too much. They used their home equity as ATM machines, maxed out their credit cards, and lined up for student loans. The private equity guys and LBO artists also got into the act thanks to interest rates that were too low, and their chickens have been coming home to rest.

The latest boom and bust cycle, like its predecessors, was caused by the government forcing interest rates below their free market level. This prevented the rate of interest from performing both its microeconomic function of clearing the various capital markets, and, crucially, its macroeconomic coordinating role.

In a few years, if the New York Times hasn't gone bankrupt, look for Paul Krugman to write a column arguing either that the stimulis didn't work because it was too small and therefore wasn't actually tried (reprising E. Cary Brown's line regarding fiscal policy in the Great Depression); or that it did work (assuming the economy recovers, which it will some day as the malinvestments are washed out), and was therefore just what Dr. Keynes would have ordered (even though the economy could have recovered anyway and might have recovered more quickly without the stimulis--he won't mention this possibility).

Yesterday he hit a new all time low for hypocrisy (even by his standards) in his article "Bailouts for Bunglars". He was the first person calling for the banks to be bailed out, only he wanted it done by capitalizing them the way Gordon Brown was trying to do in the U.K., instead of the government buying their bad assets. Bailouts, just for Mr. Krugman's information, by definition go to bunglars (like with Chrysler's first bailout in 1980). They don't normally go to successful industries and profitable firms (okay, some of the bailout money is going to profitable banks that shouldn't be getting it, but most of it is going to shore up the capital base at other banks that lost money).

So when he gets all worked up over the fact that bunglars got bailed out, what's his point? He was always for the bailout, so therefore he was for bunglars getting bailed out from the getgo.

The only way to solve the problem is laissez faire. Get rid of the Fed, the worst monopolist of all, and allow freedom in the supply of money and banking. This means a real gold standard (not the phony gold exchange standard) and free banking. Freedom of bank entry, and freedom of supplying demand deposits and note issue--these are what we need to prevent future boom and bust cycles. And bye bye bailouts.

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