Friday, March 16, 2018

An NCAA Financial Digression During March Madness

I'm an occasional part of the audience for college sports, both the big-time televised events like basketball's March Madness and college football bowl games, as well as sometimes going to baseball and women's volleyball and softball games here at the local University of Minnesota. I enjoy the athletes and the competition, but I try not to kid myself about the financial side.

 Big-time colleges and universities do receive substantial sports-related revenues. But the typical school has sports-related expenses that eat up all of that revenue and more besides. For data, a useful starting point is the annual NCAA Research report called "Revenues and Expenses, 2004-2016," prepared by Daniel Fulks. This issue was released in 2017; the 2018 version will presumably be out in a few months.

For the uninitiated, some terminology may be useful here. The focus here is on Division I athletics, which is made up of about 350 schools that tend to have large student attendance, large participation in intercollegiate athletics, and lots of scholarships. Division I is then divided into three groups. The Football Bowl Subdivision is the most prominent schools, in which the football teams participate in bowl games at the end of the season. In the FBS group, Alabama beat Georgia 26-23 for the championship in January. The Football Championship series is medium-level football programs. Last season, North Dakota State beat James Madison 17-13 in the championship game at this level. And the Division I schools without football programs include many well-known universities that have scholarship athletes and prominent programs in other sports: Gonzaga and Marquette are two examples.

Since 2014, the Football Bowl Division is further divided into two groups, the Autonomy Group and the Non-Autonomy Group. The Autonomy Group is the 65 schools that are most identified with big-time athletics. They are in the "Power Five" conferences: the Atlantic Coast Conference, Big Ten, Big 12, Pac 12 and Southeastern Conference. Under the 2014 agreement, they have autonomy to alter some rules for the group as a whole: for example, this group of schools offer scholarships that cover the "full cost" of attending the university, which pays the athletes a little more, and coaches are no longer (officially) allowed to take a scholarship away because a player isn't performing as hoped. The Non-Autonomy Schools are allowed to follow these rule changes, but are not required to do so.

With this in mind, here are some facts from the NCAA report about the big-time Football Bowl Division schools.
Net Generated Revenues. The median negative net generated revenue for the AG is $3,600,000 (i.e., the median loss for a program in the AG), which must be supplemented by the institution; for the NA is $19,900,000; and for all FBS is $14,400,000. ...
Financial Haves and Have-nots. A total of 24 programs in the AG showed positive net generated revenues (profits), with a median of $10,000,000, while the remaining 41 of the AG lost a median of $10,000,000; the 64 NA programs lost a median of $20,000,000; the total FBS loss is a median of $18,000,000. Net losses for women's programs were $14,000,000 for AG, $6,500,000 for NA, and $9,000,000 for FBS.
For the Football Bowl Championship schools, the magnitude of the losses is smaller, but the pattern remains the same:
Net Generated Revenues. The result is a median net loss for the subdivision of $12,550,000; men's programs = $5,022,000 and women's programs = $4,089,000. These medians are up only slightly from 2015. ...
Losses per Sport: Highest losses incurred were in gymnastics and basketball for women's programs and football and basketball for the men.
And for the non-football Division I schools, where the big-time revenue sport is usually basketball, the pattern of losses continues:
Median Losses. The median net loss for the 95 schools in this subdivision was $12,595,000 for the 2016 reporting year, compared with $11,764,000 in 2015, and $5,367,000 in the 2004 base year. ... 
Programmatic Results. Five men's basketball programs reported positive net generated revenues, with a median of $1,742,000, while the remaining 90 schools reported a median negative net generated revenue of $1,573,000. The median loss for women's basketball was $1,415,000. These losses are up slightly from 2015 and more than double from 2004.

There's an ongoing dispute about whether big-time colleges and universities should pay their players. When I listen to sports-talk radio, a usual comment is along these lines: "These college athletes are making millions of dollars for their institutions. They deserve to be paid, and more than just a scholarship and some meal money." I'm sympathetic. But the economist in me always rebels against the assumption that there is a Big Rock Candy Mountain made of money just waiting to be handed out.  I want to know where the money is going to come from, and how the wages will be determined.

The median school is losing money on athletics. I know of no evidence that donations from alumni are sufficient to counterbalance these losses. So if the payment for athletes is going to come from schools, there will be a tradeoff. Should costs be cut by eliminating sports that don't generate revenue (and the scholarships for those athletes)? The NCAA Report notes that salaries are about one-third of total expenses for college sports programs, and maybe some of that money could be redistributed to student-athletes. It seems implausible that the median school is going to substantially increase its subsidies to the athletics department.

What if the money for paying students came from outside sponsors? Some decades ago, top college athletes sometimes were compensated via make-work or no-show jobs. It would be interesting to observe how a single rich alum or a group of local businesses, could collaborate with a coaching staff to raise money for paying athletes--and what the athletes might need to endorse in return.

It's easy to say that student-athletes should get "more," but it's not obvious that they would or should all get the same. For example, would all student-athletes get the same pay, regardless of revenue generated by their sport? Even within a single sport, would the star players get the same play as the backups? Would the amount of pay be the same between first-years and seniors? Would the pay be adjusted year-to-year, depending on athletic performance? Would players get bonuses for championships or big wins? 

I don't have a clear answer to the economic issues here, and so I will now turn off this portion of my brain and return to watching the games in peace. For those who want more, Allen R. Sanderson and John J. Siegfried wrote a thoughtful article," The Case for Paying College Athletes." which appeared in the Winter 2015 issue of the Journal of Economic Perspectives (where I work as Managing Editor).

Thursday, March 15, 2018

The Skeptical View in Favor of an Antitrust Push

Is the US economy as a whole experiencing notably less competition? Of course, pointing to a few industries where the level of competition seems to have declined (like airlines or banking) does not prove that competition as a whole has declined. In his essay, "Antitrust in a Time of Populism," Carl Shapiro offers a skeptical view on whether overall US competition has declined in a meaningful way, but combines this critique with an argument for the ways in which antitrust enforcement should be sharpened. The essay is forthcoming in the International Journal of Industrial Organization, which posted a pre-press version in late February. A non-typeset version is available at Shapiro's website

(Full disclosure: Shapiro was my boss for a time in the late 1980s and into the 1990s as a Co-editor and then Editor of the Journal of Economic Perspectives, where I have labored in the fields as Managing Editor since 1987.)

Shapiro points to a wide array of articles and reports from prominent journalistic outlets and think tanks that claim that the US is experiencing a wave of anti-competitive behavior. He writes:
"Until quite recently, few were claiming that there has been a substantial and widespread decline in competition in the United States since 1980. And even fewer were suggesting that such a decline in competition was a major cause of the increased inequality in the United States in recent decades, or the decline in productivity growth observed over the past 20 years. Yet, somehow, over the past two years, the notion that there has been a substantial and widespread decline in competition throughout the American economy has taken root in the popular press. In some circles, this is now the conventional wisdom, the starting point for policy analysis rather than a bold hypothesis that needs to be tested. ...
"I would like to state clearly and categorically that I am looking here for systematic and widespread evidence of significant increases in concentration in well-defined markets in the United States. Nothing in this section should be taken as questioning or contradicting separate claims regarding changes in concentration in specific markets or sectors, including some markets for airline service, financial services, health care, telecommunications, and information technology. In a number of these sectors, we have far more detailed evidence of increases in concentration and/or declines in competition."
Shapiro makes a number of points about competition in markets. For example, imagine that national restaurant chains are better-positioned to take advantage of information technology and economies of scale than local producers. As a result. national restaurant chains expand and locally-owned eateries decline. A national measure of aggregation will show that the big firms have a larger share of the market. But focusing purely on the competition issues, local diners may have essentially the same number of choices that they had before.

A number of the overall measures of growth of larger firms don't show much of a rise. As one example, Shapiro points to an article in the Economist magazine which divided the US economy into 893 industries, and found that the share of the four largest firms in each industry had on average risen from 26% to 32%. Set aside for a moment the issues of whether this is national or local, or whether it takes international competition into account. Most of those who study competition would say that a market where the four largest firms combine to have either 26% or 32% of the market is still pretty competitive. For example, say the top four firms all have 8% of the market. Then the remaining firms each have less than 8%, which means this market probably has at least a dozen or more competitors.

The most interesting evidence for a fall in competition, in Shapiro's view, involves corporate profits. Here's a figure showing corporate profits over time as a share of GDP.

And here's a figure showing the breakdown of corporate profits by industry.
Thus, there is evidence that profit levels have risen over time. In particular, they seem to have risen in the Finance & Insurance sector an in the Health Care & Social Assistance area. But as Shapiro emphasizes, antitrust law does not operate on a presupposition that "big is bad" or "profits are bad." The linchpin of US antitrust law is whether consumers are benefiting.

Thus, it is a distinct possibility that large national firms in some industries are providing lower-cost services to consumers and taking advantage of economies of scale. They earn high profits, because it's hard for small new firms without these economies of scale to compete. Shapiro writes:
"Simply saying that Amazon has grown like a weed, charges very low prices, and has driven many smaller retailers out of business is not sufficient. Where is the consumer harm? I presume that some large firms are engaging in questionable conduct, but I remain agnostic about the extent of such conduct among the giant firms in the tech sector or elsewhere. ... As an antitrust economist, my first question relating to exclusionary conduct is whether the dominant firm has engaged in conduct that departs from legitimate competition and maintains or enhances its dominance by excluding or weakening actual or potential rivals. In my experience, this type of inquiry is highly fact-intensive and may necessitate balancing procompetitive justifications for the conduct being investigated with possible exclusionary effects. ...
"This evidence leads quite naturally to the hypothesis that economies of scale are more important, in more markets, than they were 20 or 30 years ago. This could well be the result of technological progress in general, and the increasing role of information technology on particular. On this view, today’s large incumbent firms are the survivors who have managed to successfully obtain and exploit newly available economies of scale. And these large incumbent firms can persistently earn supra-normal profits if they are protected by entry barriers, i.e., if smaller firms and new entrants find it difficult and risky to make the investments and build the capabilities necessary to challenge them."
What should be done? Shapiro suggests that tougher merger and cartel enforcement, focused on particular practices and situations, makes a lot of sense. As one example, he writes:

"One promising way to tighten up on merger enforcement would be to apply tougher standards to mergers that may lessen competition in the future, even if they do not lessen competition right away. In the language of antitrust, these cases involve a loss of potential competition. One common fact pattern that can involve a loss of future competition occurs when a large incumbent firm acquires a highly capable firm operating in an adjacent space. This happens frequently in the technology sector. Prominent examples include Google’s acquisition of YouTube in 2006 and DoubleClick in 2007, Facebook’s acquisition of Instagram in 2012 and of the virtual reality firm Oculus CR in 2014, and Microsoft’s acquisition of LinkedIn in 2016.  ... Acquisitions like these can lessen future competition, even if they have no such immediate impact."
Shapiro also makes the point that a certain amount of concern about large companies mixes together a range of public concerns: worries about whether consumers are being harmed by a lack of competition is mixed together with worries about whether citizens are being harmed by big money in politics, or worries about rising inequality of incomes and wealth, or worries about how locally-owned firms may suffer from an onslaught of national chain competition. He argues that these issues should be considered separately.
"I would like to emphasize that the role of antitrust in promoting competition could well be undermined if antitrust is called upon or expected to address problems not directly relating to competition. Most notably, antitrust is poorly suited to address problems associated with the excessive political power of large corporations. Let me be clear: the corrupting power of money in politics in the United States is perhaps the gravest threat facing democracy in America. But this profound threat to democracy and to equality of opportunity is far better addressed through campaign finance reform and anti-corruption rules than by antitrust. Indeed, introducing issues of political power into antitrust enforcement decisions made by the Department of Justice could dangerously politicize antitrust enforcement. Antitrust also is poorly suited to address issues of income inequality. Many other public policies are far superior for this purpose. Tax policy, government programs such as Medicaid, disability insurance, and Social Security, and a whole range of policies relating to education and training spring immediately to mind. So, while stronger antitrust enforcement will modestly help address income inequality, explicitly bringing income distribution into antitrust analysis would be unwise."

In short, where anticompetitive behavior is a problem, by all means go after it--and go after it more aggressively than the antitrust authorities have done in recent decades. But other concerns over big business need other remedies. 

Tuesday, March 13, 2018

Interview with Jean Tirole: Competition and Regulation

"Interview: Jean Tirole" appears in the most recent issue of Econ Focus from the Federal Reserve Bank of Richmond (Fourth Quarter 2017, pp. 22-27). The interlocutor is David S. Price. Here are a few comments that jumped out at me.

How did Tirole end up in the field of industrial organization?
"It was totally fortuitous. I was once in a corridor with my classmate Drew Fudenberg, who's now a professor at MIT. And one day he said, "Oh, there's this interesting field, industrial organization; you should attend some lectures." So I did. I took an industrial organization class given by Paul Joskow and Dick Schmalensee, but not for credit, and I thought the subject was very interesting indeed.
"I had to do my Ph.D. quickly. I was a civil servant in France. I was given two years to do my Ph.D. (I was granted three at the end.) It was kind of crazy."
Why big internet firms raise competition concerns
"[N]ew platforms have natural monopoly features, in that they exhibit large network externalities. I am on Facebook because you are on Facebook. I use the Google search engine or Waze because there are many people using it, so the algorithms are built on more data and predict better. Network externalities tend to create monopolies or tight oligopolies.
"So we have to take that into account. Maybe not by breaking them up, because it's hard to break up such firms: Unlike for AT&T or power companies in the past, the technology changes very fast; besides, many of the services are built on data that are common to all services. But to keep the market contestable, we must prevent the tech giants from swallowing up their future competitors; easier said than done of course ...
Bundling practices by the tech giants are also of concern. A startup that may become an efficient competitor to such firms generally enters within a market niche; it's very hard to enter all segments at the same time. Therefore, bundling may prevent efficient entrants from entering market segments and collectively challenging the incumbent on the overall technology.
"Another issue is that most platforms offer you a best price guarantee, also called a "most favored nation" clause or a price parity clause. You as a consumer are guaranteed to get the lowest price on the platform, as required from the merchants. Sounds good, except that if all or most merchants are listed on the platform and the platform is guaranteed the lowest price, there is no incentive for you to look anywhere else; you have become a "unique" customer, and so the platform can set large fees to the merchant to get access to you. Interestingly, due to price uniformity, these fees are paid by both platform and nonplatform users — so each platform succeeds in taxing its rivals! That can sometimes be quite problematic for competition.
"Finally, there is the tricky issue of data ownership, which will be a barrier to entry in AI-driven innovation. There is a current debate between platform ownership (the current state) and the prospect of a user-centric approach. This is an underappreciated subject that economists should take up and try to make progress on."

The economics of two-sided platforms
"We get a fantastic deal from Google or credit card platforms. Their services are free to consumers. We get cashback bonuses, we get free email, Waze, YouTube, efficient search services, and so on. Of course there is a catch on the other side: the huge markups levied on merchants or advertisers. But we cannot just conclude from this observation that Google or Visa are underserving monopolies on one side and are preying against their rivals on the other side. We need to consider the market as a whole.
"We have learned also that platforms behave very differently from traditional firms. They tend to be much more protective of consumer interests, for example. Not by philanthropy, but simply because they have a relationship with the consumers and can charge more to them (or attract more of them and cash in on advertising) if they enjoy a higher consumer surplus. That's why they allow competition among applications on a platform, that's why they introduce rating systems, that's why they select out nuisance users (a merchant who wants to be on the platform usually has to satisfy various requirements that are protective of consumers). Those mechanisms — for example, asking collateral from participants to an exchange or putting the money in an escrow until the consumer is satisfied — screen the merchants. The good merchants find the cost minimal, and the bad ones are screened out.
"That's very different from what I call the "vertical model" in which, say, a patent owner just sells a license downstream to a firm and then lets the firm exercise its full monopoly power.
"I'm not saying the platform model is always a better model, but it has been growing for good reason as it's more protective of consumer interest. Incidentally, today the seven largest market caps in the world are two-sided platforms."

Monday, March 12, 2018

The Distressingly Weak Lessons of Research on Gun Control

If you want to know what actual research on the effects of various gun control policies have to say, the RAND Corporation has your back. It has published a lengthy reports: "The Science of Gun Policy:  A Critical Synthesis of Research Evidence on the Effects of Gun Policies in the United States," by a team of 17 researchers led by Andrew R. Morral. A smaller group led by Morral also published  "The Magnitude and Sources of Disagreement Among Gun Policy Experts."  And there's also a nice accessible website with a summary of results and links to these more detailed studies. They write: 
The 13 classes of gun policies considered in this research are as follows:

1. background checks
2. bans on the sale of assault weapons and high-capacity magazines
3. stand-your-ground laws
4. prohibitions associated with mental illness
5. lost or stolen firearm reporting requirements
6. licensing and permitting requirements
7. firearm sales reporting and recording requirements
8. child-access prevention laws
9. surrender of firearms by prohibited possessors
10. minimum age requirements
11. concealed-carry laws
12. waiting periods
13. gun-free zones.

The eight outcomes considered in this research are

1. suicide
2. violent crime
3. unintentional injuries and deaths
4. mass shootings
5. officer-involved shootings
6. defensive gun use
7. hunting and recreation
8. gun industry.
They focus on high-quality studies published since 2003. They write:
"[W]e produced research syntheses that describe the quality and findings of the best available scientific evidence. Each synthesis defines the class of policies being considered; presents and rates the available evidence; and describes what conclusions, if any, can be drawn about the policy’s effects on outcomes. In many cases, we were unable to identify any research that met our criteria for considering a study as providing minimally persuasive evidence for a policy’s effects. Studies were excluded from this review if they offered only correlational evidence for a possible causal effect of the law, such as showing that states with a specific law had lower firearm suicides at a single point in time than states without the law. Correlations like these can occur for many reasons other than the effects of a single law, so this kind of  evidence provides little information about the effects attributable to specific laws. We did not exclude studies on the basis of their findings, only on the basis of their methods for isolating causal effects. For studies that met our inclusion criteria, we summarize key findings and methodological weaknesses, when present, and provide our consensus judgment on the overall strength of the available scientific evidence."
One main result is that the actual evidence is pretty thin. "Of more than 100 combinations of policies and outcomes, we found that surprisingly few were the subject of methodologically rigorous investigation." For example, evidence on four of the eight outcomes was "essentially unavailable," including defensive gun use, officer-involved shootings, hunting and recreation, and effects on the gun industry. None of the studies of waiting periods and licencing and permitting requirements have reached more than inconclusive results. There are no methodologically sound studies at all on the effects of gun-free zones or requirements for reporting of lost or stolen firearms. I'll just list the study's overall conclusions here:
Conclusion 1. Available evidence supports the conclusion that child-access prevention laws, or safe storage laws, reduce self-inflicted fatal or nonfatal firearm injuries among youth. There is moderate evidence that these laws reduce firearm suicides among youth and limited evidence that the laws reduce total (i.e., firearm and nonfirearm) suicides among youth.
Conclusion 2. Available evidence supports the conclusion that child-access prevention laws, or safe storage laws, reduce unintentional firearm injuries or unintentional firearm deaths among children. In addition, there is limited evidence that these laws may reduce unintentional firearm injuries among adults. ...
Conclusion 3. There is moderate evidence that background checks reduce firearm suicides and firearm homicides, as well as limited evidence that these policies can reduce overall suicide and violent crime rates.
Conclusion 4. There is moderate evidence that stand-your-ground laws may increase state homicide rates and limited evidence that the laws increase firearm homicides in particular.

Conclusion 5. There is moderate evidence that laws prohibiting the purchase or possession of guns by individuals with some forms of mental illness reduce violent crime, and there is limited evidence that such laws reduce homicides in particular. There is also limited evidence these laws may reduce total suicides and firearm suicides. ...

Conclusion 6. There is limited evidence that before implementation of a ban on the sale of assault weapons and high-capacity magazines, there is an increase in the sales and prices of the products that the ban will prohibit.

Conclusion 7. There is limited evidence that a minimum age of 21 for purchasing firearms may reduce firearm suicides among youth.

Conclusion 8. No studies meeting our inclusion criteria have examined required reporting of lost or stolen firearms, required reporting and recording of firearm sales, or gun-free zones. ...

Conclusion 9. The modest growth in knowledge about the effects of gun policy over the past dozen years reflects, in part, the reluctance of the U.S. government to sponsor work in this area at levels comparable to its investment in other areas of public safety and health, such as transportation safety. ...

Conclusion 10. Research examining the effects of gun policies on officer-involved shootings, defensive gun use, hunting and recreation, and the gun industry is virtually nonexistent.

Conclusion 11. The lack of data on gun ownership and availability and on guns in legal and illegal markets severely limits the quality of existing research. ...

Conclusion 12. Crime and victimization monitoring systems are incomplete and not yet fulfilling their promise of supporting high-quality gun policy research in the areas we investigated. ...

Conclusion 13. The methodological quality of research on firearms can be significantly improved.
Of course, absence of evidence is not evidence of absence--that is, just because there is a lack of evidence on certain policies or outcomes doesn't prove that those policies don't work. But it does suggest that a degree of humility might be appropriate on all sides. As a hopelessly out-of-touch academic, perhaps there could be bipartisan consensus on building up the data and evidence so that better studies can be done, but maybe this is a situation where neither side wishes to take the risk tha their presuppositions might be rebutted. Or at least when gun control laws are passed, the law could include a specific provision for exactly how those laws will be meaningfully evaluated a few years down the road.

Follow-up on 3/13/18: Faithful reader DK reminds me that Congress blocked the public health authorities from doing research into gun control issues back in the 1990s, as the New York Times just reported.  I'm pretty much always in favor of additional research, and I don't like research being limited  That said, it seems pretty clear to me as someone who has never fired a gun and tends to favor additional gun controls that most public health researchers then and now have been so  stridently anti-gun that their research was not trustworthy. I also tend to view gun policy as a social science issue, which is best tackled with the social science research methods like those considered in the RAND report. It's not clear to me that public  health researchers have the tools or expertise to address it appropriately.

Saturday, March 10, 2018

About those Tariff Exemptions for Canada and Mexico ...

I wrote a few days ago with some skepticism about the claim of a "national security" justification for President Trump's steel and aluminium tariffs. When the tariffs were actually imposed, Trump decided to exempt Canada and Mexico.

At a political level, the exemptions for Canada and Mexico make sense. As I mentioned in the earlier post, the US has treaty commitments with Canada going back to the 1950s to integrate their defense-related industrial bases, and there is even a North American Technology and Industrial Base Organization (NATIBO). This is part of the reason why Canada is by far the largest source of US aluminum imports (aluminum imports from Canada are about the same as the combined imports from the next 10-largest exporters to the US, combined). Canada is also the largest source of US steel imports, while Mexico is fourth. And of course, the US is part of the North American Free Trade Agreement with Canada and Mexico, too. Even if Trump wants to renegotiate that agreement, it doesn't make sense to do it haphazardly.

So now we are imposing import tariffs on steel and aluminum on the basis that they are vital to US national security, but the tariffs don't actually affect the main source of steel and aluminum imports, which is Canada.

Moreover, the exemptions for Canada and Mexico make it even less likely that the tariffs can benefit the US economy. Here's why:

The entire purpose of import tariffs is to reduce the extent of foreign competition so that domestic producers can charge more and earn higher profits. (Otherwise, there would be no point to enacting them.) Of course, domestic users of steel and aluminum will pay those higher prices. But at least with a tariff imposed against all trading partners, the higher prices paid by US consumers of steel and aluminum go to two places: either higher revenues for US steel and aluminum producers or higher revenue for the US Treasury. Foreign producers don't benefit.

With Canada and Mexico now exempted from the tariffs, the higher prices paid by US consumers of steel and aluminum now go three places: 1) higher revenues for US steel and aluminum producers, 2) higher revenues for Canadian and Mexican steel and aluminum producers, who will also benefit from the higher price; and 3) higher revenues for the US Treasury.

To understand how strange this is, imagine that someone in Congress proposed this policy to "help" the US steel and aluminum industries. Start by imposing a tax on US domestic users of steel and aluminum, based on how much they used. Then some of the revenues from that tax would be be rebated to US producers of steel and aluminum, some would be sent to Canadian and Mexican producers of steel and aluminum, and the rest would be kept by the federal government.

As I have commented before in the context of tire tariffs imposed by the Obama administration some years ago, this way of trying to assist the US steel and aluminium industry seems literally insane once you spell it out in this way.  It's hard to imagine that even the steel and aluminum industries would favor it. But it accurately describes the economic effect of steel and aluminum tariffs with a Canada and Mexico exemption.

Friday, March 9, 2018

Some Economics of Place-Based Policies

When it comes to public policies for helping the poor, economists have tended to favor a focus on individuals who are poor, rather than on places that had a higher share of poor people. This seemed like a better way to target scarce public resources. There was some fear that if the focus shifted to places, much of the benefit would flow to homeowners who lived in those places--and thus saw an improvement in property values-- or to local building contractors, rather than helping the poor directly. Also, a healthy economy will see a flow of people moving toward destinations that are more attractive, while place-based support of locations that aren't doing well would tend to hinder such migration.

But some economists are rethinking the mertics of place-based policies. Benjamin Austin, Edward Glaeser, and Lawrence H. Summers have written "Saving the heartland: Place-based policies in 21st century America ," for the Spring 2018 issue of the Brookings Papers on Economic Activity. As they argue, we seem to have entered a time when geographic mobility is down and when regional convergence of incomes has dropped off.  They write:
"America’s western frontier may have closed at the end of the 19th century, but there was still a metropolitan frontier where workers from depressed areas could find a more prosperous future. Five facts collectively suggest that this geographic escape valve has tightened: declining geographic mobility, increasingly inelastic housing supplies in high income areas, declining income convergence, increased sorting by skill across space, and persistent pockets of non-employment. Together these facts suggest that even if income differences across space have declined, the remaining economic differences may be a greater source of concern. Consequently, it may be time to target pro-employment policies towards our most distressed areas. ...

"We divide the U.S. into three regions: the prosperous coasts, the western heartland and the eastern heartland, The coasts have high incomes, but the western heartland also benefits from natural resources and high levels of historical education. America’s social problems, including non-employment, disability, opioid-related deaths and rising mortality, are concentrated in America’s eastern heartland, states from Mississippi to
Michigan, generally east of the Mississippi and not on the Atlantic coast. The income and employment gaps between three regions are not converging, but instead seem to be hardening ..."
The paper has a bunch of figures showing differences across these three regions. Here are figures  on economic growth, the share of prime-age men not working, and mortality rates for men across these three regions.

What would place-based policies look like? As the authors point out, such policies can be explicit or implicit. For example, an infrastructure policy like the Tennessee Valley Authority is explicitly aimed at a certain geographic region. However, an infrastructure project like the federal  highway system, or a program like flood insurance, will clearly have specific geographic effects for those closer to highways or at higher risk of floods, without actually naming a certain geographic area. After mulling the options, they suggest that targeted employment subsidies may be the best bet. They write:
"The best case for geographic targeting of policies is that a dollar spent fighting non-employment in a high not working rate area will do more to reduce non-employment than a dollar spent fighting non-employment in a low not working rate area. The empirical evidence for heterogeneous labor supply responses to demand shocks or public interventions is limited, but broadly supportive of the view that reducing the not working rate in some parts of the country is easier than in other parts of the country. ...  While infrastructure remains an important investment for America, targeting infrastructure spending towards distressed areas risks producing projects with limited value for users. By contrast, enhanced spending on employment subsidies in high not working rate areas, and perhaps the U.S. as a whole, seems like a more plausible means of reducing not working rates."
For those interested in this approach, here's an earlier discussion of "What Do We Know about Subsidized Employment Programs?" (April 25, 2016).

Wednesday, March 7, 2018

The National Security Argument for Steel and Aluminum Tariffs

The reason behind the tariffs that President Trump has announced for steel and aluminum is an unusual one. The legal justification for the tariffs is based Section 232 of the Trade Expansion Act of 1962, which gives the President the power to impose tariffs if "national security" is at stake.

As Chad Bown of the Peterson Institute for International Economics has pointed out, this specific justification for import tariffs has led to a total of 28 investigations in the 56 years since the law was enacted. The most recent investigation as to whether national security should lead to import tariffs was in 17 years ago in 2001; the most recent time in which national security actually led to imports being limited was 32 years ago, when President Reagan used this argument to limit imports of certain machine tools.

However, the argument that it might sometimes be necessary to limit imports because of national security has a venerable history. Adam Smith, the intellectual godfather of free trade arguments, listed national defense as an exception in  Book IV of the The Wealth of Nations.. Smith wrote:
"There seem, however, to be two cases in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry. The first is, when some particular sort of industry is necessary for the defence of the country. The defence of Great Britain, for example, depends very much upon the number of its sailors and shipping. The act of navigation, therefore, very properly endeavours to give the sailors and shipping of Great Britain the monopoly of the trade of their own country in some cases by absolute prohibitions and in others by heavy burdens upon the shipping of foreign countries."
By all means, the national security argument deserves serious consideration. And seriously, are the steel and aluminum tariffs actually about national security in the sense of military strength? Or is it "national security" in a more generic and rhetorical sense, really meaning that if it's good for steel industry profits, then it's good for "national security."

(Side note: Of course, this second argument is essentially similar to the line attributed long-ago to to Charles Wilson, a former head of General Motors who was nominated to be Secretary of Defense in 1953. Wilson was widely mocked for saying, "What's good for General Motors is good for the country." That's not actually what he said, as I explain in "What's Good for General Motors ..." (October 23, 2012). But the sentiment that if corporate profits for favored industries are vital to national security was certainly common enough, then and now.)

The US Department of Commerce has put forward the "national security" justification for the steel and aluminum tariffs in two January 2018 reports: "The Effect of Imports of Steel on the National Security" (January 11, 2018) and "The Effect of Imports of Aluminum on the National Security" (January 17, 2018).

As the reports point out, Section 232 allows for a broad definition of "national security." It quotes from a report back in 2001, the last time the national security justification for tariffs was considered (although not ultimately used), to note that“in addition to the satisfaction of national defense requirements, the term “national security” can be interpreted more broadly to include the general security and welfare of certain industries, beyond those necessary to satisfy national defense requirements that are critical to the minimum operations of the economy and government.” These reports have a lot of detail on levels of steel and aluminum imports and the difficulties of US steel and aluminum companies. But the details about just how national security is being affected are harder to find and to pin down. Here, I'll first give some details on the steel industry from the US Department of Commerce report, and then turn to the aluminum industry report.

Background on the US Steel Industry

The report sums up its case in this sentence: "It is these three factors – displacement of domestic steel by excessive imports and the consequent adverse impact on the economic welfare of the domestic steel industry, along with global excess capacity in steel – that the Secretary has concluded create a persistent threat of further plant closures that could leave the United States unable in a national emergency to produce sufficient steel to meet national defense and critical industry needs."

How much steel is actually used by the US Department of Defense? The answer is 3% of domestic US production. The report says: "The U.S. Department of Defense (DoD) has a large and ongoing need for a range of steel products that are used in fabricating weapons and related systems for the nation’s defense. DoD requirements – which currently require about three percent of U.S. steel production – are met by steel companies that also support the requirements for critical infrastructure and commercial industries."

What about the "critical industries" more broadly? The answer is about half of domestic production. The report says: '"[T]here are 16 designated critical infrastructure sectors in the United States, many of which use high volumes of steel (see Appendix I). The 16 sectors include chemical production, communications, dams, energy, food production, nuclear reactors, transportation systems, water, and waste water systems. ... The updated analysis in Appendix I shows that 49.1 percent of domestic steel consumption in 2007 was used in critical industries."

The report has a LOT to say about steel production in China. But when you look at US imports of steel, this table taken from the report shows that Canada is at the top and China is 11th. US steel imports from 2011 to 2017 are up considerably overall, especially from Brazil, South Korea, Mexico, Russia, Turkey, Germany, and Taiwan. But over that time, US steel imports from China are down by about one-third.

How much is US production capacity dropping off? Here's the figure from the report. There's a rise before the Great Recession and a fall after, but current steel capacity is about the same as it was in the early 2000s.  
Logically speaking, the number of jobs in the US steel industry shouldn't be part of the national security argument. After all, steel like pretty much every other industry is continually making more use of automation and robots. But here's what the report shows about steel industry jobs: a big drop from about 2000-2003, but not much change since then. 

For me, it's hard to look at these kinds of figures and see a national security crisis in the making in the military strength category. The report even notes that while steel prices are low all around the world, "Notwithstanding these effects, prices for steel in the U.S. remained substantially higher than in any other area. However, relative to prices between 2010 and 2013, prices are still relatively depressed."

The report does give a few examples of specific types of steel products that are important for defense production and where there are few domestic suppliers. The report notes:
"This is not a hypothetical situation. The Department of Defense already finds itself without domestic suppliers for some particular types of steel used in defense products, including tire rod steel used in military vehicles and trucks. ... In the case of critical infrastructure, the United States is down to only one remaining producer of electrical steel in the United States (AK Steel – which is highly leveraged). Electrical steel is necessary for power distribution transformers for all types of energy – including solar, nuclear, wind, coal, and natural gas – across the country. If domestic electrical steel production, as well as transformer and generator production, is not maintained in the U.S., the U.S. will become entirely dependent on foreign producers to supply these critical materials and products."
The report also notes that steel producers have reduced their capability to ramp up production in a national emergency:
"[D]omestic steel producers have a shrinking ability to meet national security production requirements in a national emergency. The U.S. Department of Commerce, Census Bureau regularly surveys plant capacity, and has found that steel producers are quickly shedding production capacity that could be used in a national emergency. The Census Bureau defines national emergency production as the “greatest level of production an establishment can expect to sustain for one year or more under national emergency conditions.” From 2011 to 2017, steel producers increased the utilization of the surge capacity they would have during a national emergency from 54.2 percent to 68.2 percent ...  As steel producers use more of this emergency capacity, there is an increasingly limited ability to ramp up steel production to meet national security needs during a national emergency."
As the report notes, ramping up steel production in the patterns that occurred during the Vietnam War or World War II would take time and effort. Of course, the notion that the US steel industry should be continually prepared to ramp up at high speed for the equivalent of World War II is a questionable one. Let's pause there for a moment, and turn to the aluminum report.

Background on the US Aluminum Industry

As the aluminium report explains: "Aluminum originates from bauxite, an ore typically found in the topsoil of various tropical and subtropical regions; the United States is not a significant source of bauxite as it cannot be economically extracted here. Once mined, aluminum within the bauxite ore is chemically extracted in a refinery into alumina, an aluminum oxide compound. In a second step, the alumina is smelted to produce pure aluminum metal."

One of the ironies here is that the US is worried about the national security importance of an industry that depends entirely on imported raw materials. However, as the report notes: "The U.S. Government does not maintain any strategic stockpile of bauxite, alumina, aluminum ingots, billets or any semi-finished aluminum products such aluminum plate."

How much aluminum is used by the US Department of Defense? The report blacks out this information. It reads: "The U.S. Department of Defense (DoD) and its contractors use a small percentage of U.S. aluminum production. The DoD “Top Down” estimate of average annual demand for aluminum during peacetime is XXXXX, or XXXXX percent of total U.S. demand." However, later in the discussion in the specific category of high-purity aluminum, the report reads: "The U.S. manufacturers of products based on aluminum require 250,000 metric tons of high-purity aluminum a year. Approximately 90 percent of this is for commercial aerospace and other applications. Ten percent is used to support the manufacture of defense-related products."

As with steel, the main source of US aluminum imports is Canada. In fact, this outcome is the result of long-standing polices. The report notes: 
"The U.S. in 2016 relied on imports for 89 percent of its primary aluminum requirements, up from 64 percent in 2012. Canada, which is highly integrated with the U.S. defense industrial base and considered a reliable supplier, is the leading source of imports. With Canadian smelters operating at near full capacity and with the vast majority of their production already going to customers in the United States, there is limited ability for Canada to replace other suppliers. ... 
"The U.S. and Canadian defense industrial bases are integrated. This cooperative relationship has existed since 1956 and is codified in a number of bilateral defense agreements. For example in 1987, DoD (all Services), the Defense Logistics Agency (DLA), the Office of the Secretary of Defense (OSD), and the Canadian Department of National Defence (DND) joined together to form a North American Technology and Industrial Base Organization (NATIBO). NATIBO is chartered to promote a cost effective, healthy technology and industrial base that is responsive to the national and economic security needs of the United States and Canada." 
How low is the price of aluminum? Here's a graph from the report showing aluminum prices since 1998. Prices peaked during the commodity boom in the lead-up to the Great Recession, then crashed, but presently are above where they were in the late 1990s and early 2000s. In other words, it's hard to make the case that prices have fallen below their usual historical range, rather than being pretty much in the middle of that range. 

Where is the world's aluminum produced? The report says: "Because aluminum production is highly energy intensive, the world’s leading producers are generally the countries with the lowest energy costs (including Canada, Russia, the United Arab Emirates (UAE), and Bahrain). The exception is China, where electricity costs are actually higher than those of the United States ($614 per metric ton of aluminum produced in China versus $532 per metric ton in the United States); China’ overall production costs were equal to that of U.S. producers." 

What jumps out at me from the previous table is the US capacity utilization rate in aluminum production is so very low. 

The report does note two particular issues that seem to me potentially relevant to national security in the military sense. One is the particular area of "high-purity aluminum:
"The U.S. currently has five [aluminum] smelters remaining, only two smelters that are operating at full capacity. Only one of these five smelters produces high-purity aluminum required for critical infrastructure and defense aerospace applications, including types of high performance armor plate and aircraft-grade aluminum products used in upgrading F-18, F-35, and C-17 aircraft. Should this one U.S. smelter close, the U.S. would be left without an adequate domestic supplier for key national security needs. The only other high-volume producers of high-purity aluminum are located in the UAE and China (internal use only)."
A somewhat related issue is that many of the high-tech uses of aluminum involve research into new alloys and their properties. But aluminum industry R&D seems to have died off:
"At this time most aluminum companies cannot afford to fund research. The importance of research in this industry is clear, however. More than 90 percent of all alloys currently used in the aerospace industry were developed through Alcoa’s research. ... Of the three remaining companies with U.S. smelting operations in 2016, Alcoa is the only company to report spending on Research and Development over the past five years in its financial statements; Century Aluminum and Noranda reported zero spending on R&D since 2012."
Some Thoughts about the National Security Argument for Protection

Imagine for a moment that you were firmly convinced that the US faced a national security problem with steel and aluminum--and I mean in the specific sense of being related to military and critical industry needs, not in the generic sense of just thinking some industries should have bigger profits. What would you propose? Here are some ideas: 
  • Focus on the specific areas where the dependence on imports of steel and aluminum is most concerning, like the areas of steel tire rods, electrical steel, and high-purity aluminum mentioned in the reports. 
  • Undertake a crash R&D program to find ways of substituting for steel and aluminum in various applications, and also to reuse and recycle existing steel and aluminum where possi le 
  • Stockpile bauxite and other raw materials, so as not to be vulnerable to import disruptions. 
  • Take all the subsidies that are proposed or enacted for favored noncarbon energy sources like solar and wind, and adapt them to apply to steel and aluminum: maybe tax cuts for these industries; or government guarantees that these companies could borrow large sums at subsidized or zero interest rates; or the  Department of Defense and other government purchasers would buy purchase steel and aluminum from US producers at above-market prices; or government could pay steel companies to keep unused excess capacity that could be ramped  up quickly. 
  • Make  contingency plans that would redirect steel and aluminum from noncritical uses to national security uses, if needed. 
  • Avoid undercutting Canada, which is both a key US ally and the largest outside supplier of steel and aluminum.
Just to be clear, I'm not advocating everything on this list of ideas. I'm saying that someone who is seriously concerned that the domestic production of steel and aluminum raises national security concerns should be considering all of these ideas, and advocating for at least some of them.

If the response to national security concerns over steel and aluminum is just "slap on tariffs, help domestic industry earn higher profits, and just kinda sorta hope that domestic industry uses those profits to build up capacity and specialized products and R&D"--well, that response doesn't actually seem like a serious concern over national security to me.  If the national security concerns are legitimate, seems like a remarkably sloppy and unserious way to address them.  

Speaking of being serious, one frustration for any economist reading these reports is that at no point do they acknowledge that imports tariffs or quotas have any costs to consumers and other industrial users of these products. After all, the key mechanism by which import restrictions benefit domestic firms is by allowing them to charge higher prices to buyers.  

I care a considerable amount about national security. But waving the words "national security" should not exempt anyone from an actual consideration of actual costs, benefits, and alternative strategies. 
There is zero question in the mind of any economist that import tariffs will offer short-run benefits to  the domestic steel and aluminum industries. Whether it benefits the country overall--either in the military or the economic sense of "national security"-- is considerably more dubious. The inevitable trade retaliation from other countries will only worsen these tradeoffs.

Finally, one sometimes hears the argument that these steel and aluminum tariffs are just an opening bid in the renegotiation of trade agreements. In this telling, the steel and aluminum tariffs could be bartered away for concessions in other parts of trade agreements. Maybe this is true. But if the tariffs are now bargained away or discarded so, I would conclude that the national security justification for their existence was not made sincerely in the first place.