This is the second part of my discussion of N. Gregory Mankiw’s column asserting that governmental competition is desirable for the same reason that private competition is. Mankiw was Chairman of President Bush’s Council of Economic Advisors from 2003-2005. He was one of the principal architects of the perverse incentive structures that proved so criminogenic and drove the ongoing financial crisis. He gave no useful warnings of the necessity for containing the developing crisis – even after the FBI’s September 2004 warning that mortgage fraud was become “epidemic” and would cause a financial “crisis” if it were not contained. He is now Mitt Romney’s principal economic advisor. His column favors the “competition” argument that led him to support crippling financial regulation even as private sector competition led to endemic fraud. Mankiw is a moral failure as well as a failed economist. His infamous response to Akerlof and Romer’s 1993 paper (“Looting: the Economic Underworld of Bankruptcy for Profit”) was that it would be “irrational” for CEOs not to loot “their” corporations. He ignored all of the prescient warnings we made about how accounting control fraud drove our crises and he continues to ignore those warnings and the reality of our recurrent, intensifying financial crises. He wants the U.S. to move even more rapidly downward in the “competition in regulatory laxity” that is driving those crises.
Mankiw is serving as Romney’s propagandist in chief. He is writing columns trying to defend Romney’s vulnerabilities, e.g., claiming that Romney should pay a marginal income tax rate that is lower than the marginal rate his secretary pays. In the column I am responding to, Mankiw chose this frame for his analysis: “SHOULD governments — of nations, states and towns — compete like business rivals?” (The capitalization is in the original.) He answered his question in this self-referential manner.
“[K]nowing that I have to keep up with the Paul Krugmans and the Glenn Hubbards of the world keeps me on my toes. It makes me work harder, benefiting the customers — in this case, students. The upshot is that competition among economics textbooks makes learning the dismal science a bit less dismal.
For much the same reason, competition among governments leads to better governance.”
The title of Mankiw’s article reflects his claim: “Competition Is Healthy for Governments, Too.”
It is inevitable that Mankiw thinks that competition makes his textbook superior. I leave analysis of that claim to future columns to be written with the aid of readers. I am announcing a competition among readers of our New Economic Perspectives blog at UMKC. I will provide “Mankiw Mendacity and Morality” t-shirts to the providers of the three top suggestions from readers of our blog (and Mankiw’s textbook) for the worst predictive and policy follies contained in that textbook. See details on our website.
Suffice it to say here that Mankiw’s belief that his ability to sell a textbook famous for its failed predictions and theories demonstrates the success of private markets in helping students learn actually constitutes proof of the market’s folly.
This column represents the second part of my discussion of his claim that the public and private sectors are sufficiently similar that competition in both sectors benefits the public. All three premises are overstated and frequently false. It is not true that competition in the private sector is unambiguously socially desirable. It is not true that completion in the public sector is typically desirable. (That will be the subject of the third part of my discussion of Mankiw’s ode to governmental competition.) It is not true that the public and private sectors are typically sufficiently comparable that they should be run under the same governance principles. Mankiw also ignores the destructive interaction effects of encouraging unrestrained public and private sector competition. (Those claims will be the subject of the fourth and fifth parts of my discussion.) I argue that competition in the public sector is generally a grave error and that competition in the private sector has become increasingly harmful because regulation and law enforcement has been crippled by Mankiw’s policy of encouraging “competition in laxity.”
Mankiw conflates “choices” with “competition” when he discusses government. We may benefit from the ability of a federal system to have what Justice Brandeis referred to as laboratories for experimentation. The competitive dynamic, however, is frequently harmful in government.
Government is not just like business and governmental competition is often harmful
Determining whether competition among governments is desirable as Mankiw argues requires us to examine the areas and manners in which governments compete. I start with a fundamental duty of government (as many governmental leaders have conceived the task) – national security and conquest. Some governments seek to conquer other nations or regions and seize wealth, people, and power. Each of the nations that is currently a major power, and was previously a major power over the last 300 years has engaged in conquest as a major function. Nations (and, in civil wars, rival governments) engaged in armed struggle are engaged in the ultimate form of competition. Even when wars are fought with restraints they are vicious. The explicit goal in less restrained wars is to ensure that the competition ends. The rival nation and people are destroyed. Carthago delenda est (Carthage must be destroyed) is the famous cry. (Mankiw’s version of Cato the Elder’s murderous demand would be “financial regulation must be destroyed.”) The “competitor’s” people are annihilated in a genocidal fury or their cities razed and their populations sold into slavery. Terror is a common tactic of governments, failed states such as Afghanistan under the Taliban, and would be-state actors such as the IRA “competing” with nation states. Woman and children are often targets. Rape is common and sometimes a deliberate tactic. Torture and atrocities are common. Mass deaths and maiming are expected.
Competition in the run-up to war, or the effort to deter war, is also typically destructive from an overall societal standpoint. We engage in arms races and battleship races that lead to a waste of resources whether or not the war occurs. The opportunity costs of taking many of our brightest thinkers and skilled engineers out of inventing, developing, and manufacturing useful goods and services and diverting them to figuring out clever means to maim and kill is severe.
Some nations and proto-national movements engage in warfare by non-traditional means. They launch cyber attacks, counterfeit other nation’s currencies, and kidnap foreign nationals to trade them for cash and weapons. They sell illegal drugs or counterfeit goods to fund their efforts.
Governmental military competition is a leading cause of death and misery. This competition can be seen as essential from the standpoint of individual nations, but it is, net, a social catastrophe. It threatens our survival as a species given weapons of mass destruction. It is not “healthy.”
Some nations compete economically by theft. One form is the theft of intellectual property by conventional means, but nations also use their intelligence services to steal trade secrets and learn about other nations’ secret international trade bargaining positions. They suborn foreign nationals as secret assets who will betray their nation’s interests. Another form of economic warfare is factory fishing. This can produce over-fishing and habitat destruction that can permanently destroy other nations’ traditional fishing industries. Nations and their businesses compete with other nations and their businesses (an example of the interaction of public and private competition) for exports by bribing foreign nationals (particularly government officials).
International tax competition
All nations are affected by international tax competition and some nations engage in it as their defining function that shapes the entire nation. Tax havens are the ultimate in tax competition. They typically exist to shelter wealth from taxation in the nations where the wealth was generated in order to evade taxation, launder the proceeds of illegal sales, and allow secret transfers of funds to commit crimes such as the 9/11 attacks. Banks, accountants, and attorneys help corporations engage in complex frauds to evade taxes including schemes that use “transfer pricing” to make it appear that the profits were earned in the tax haven. Tax havens benefit principally the exceptionally wealthy and criminals. They typically become corrupted. The OECD attempted to eliminate tax havens. The incoming Bush administration blocked the proposed OECD initiative, arguing that tax havens caused desirable tax competition that led to reduced corporate taxation. The Bush administration claimed that reduced corporate taxation was desirable. After the 9/11 attacks, funded through tax havens, the Bush administration reduced its opposition of the OECD effort, allowing a weaker version of the initiative to be adopted. Tax havens reward criminals and terrorists. They distort competition by allowing some corporations that evade taxation a great economic advantage over other corporations. They increase wealth inequality. The competition is unhealthy.
That perverse competition has helped to make Romney wealthy. His recent, minimal disclosures of tax information demonstrate that he has long had money hidden in the Cayman Islands. That nation exists to serve as a tax haven to those seeking to evade taxation and launder funds. We do not know why Romney has accounts there or how much money he has in the accounts because he has refused to make that information public. Mankiw’s ode to governmental competition is designed to protect Romney from criticism, but it demonstrates the opposite.
Mankiw’s column asserts that it is “it is noteworthy that [Obama and Romney] agree on the direction [the corporate income tax] should head.” It is “noteworthy” that both Obama and Romney are proposing reductions in the U.S. corporate income tax rate. But one must focus on the word “should” and how Mankiw uses that word. He does not prove that the U.S. “should” further reduce its U.S. corporate income tax rate because such a rate is actually excessive in any real economic sense. He simply shows the effect of international competition for corporations – it leads unambiguously to lower corporate income tax rates. He assumes that the reduction is desirable – he assumes his own desired policy. When Obama proposes to cave to international competition to reduce corporate income tax rates he does not prove that it is socially or economically desirable to have a lower statutory corporate income tax rate (the effective U.S. corporate income tax is already quite low). Mankiw’s example actually proves the harm of governmental competition to benefit corporations. Government leaders, regardless of party or policy views, are coerced by the competition to give ever greater tax breaks to corporations. Mankiw, and Romney, want to lower corporate taxes and intend to cut them more than Obama. Who will they tax instead? They do not say. Again, Mankiw’s effort to justify Romney’s eagerness to reduce Romney’s already exceptionally low tax payments actually demonstrates how harmful governmental competition is.
Anti-environmental and anti-labor competition
Corporations place nations in competition to harm their workers, environments, animals and plants, and citizenry. In 2006, a Netherlands company delivered toxic waste to contractors in the Ivory Coast who dumped it in and near the capital (Abidjan). Corporations engage in illegal coal mining in China. They, seek local governments that are weak in enforcing the laws against illegal mining. The illegal coal mines are often death traps for the workers and dispose of mine materials and contaminants in unsafe manners. Businesses seek out the governments with the weakest regulation and criminal justice systems to harvest trees illegally. U.S. and European businesses contract for suppliers in nations that do not enforce their labor laws. Apple’s own “audits” show that its suppliers routinely and recurrently violate the labor laws – year after year despite purported promises to stop their unlawful actions. U.S. corporations seek to end union representation by locating in states hostile to unions. By placing the states in competition, U.S. corporations have created an increasing number of states hostile to unions.
The “Competition in Laxity” in financial regulation
My prior column emphasized this area. I add my spouse’s (Professor June Carbone, UMKC Law School) comment on the fact that Mankiw and the Bush administration’s financial anti-regulators were extreme opponents of financial regulation by the states and sought to prevent any competition in vigor by the states by preempting state financial regulation wherever possible. June remarked that his support for preemption demonstrated that Mankiw supported the “competition in laxity” in regulation not because it produced competition, but because it produced laxity.
Government competition in international and interstate trade
I explained in my first column that the Framers drafted the Constitution, particularly the interstate commerce and supremacy clauses, to restrain the competition among the states that was one of the principal causes of the failure of the Articles of Confederation. The states competed to provide their domestic businesses with advantages over businesses located in other states. This competition crippled interstate commerce and harmed economic development. Similarly, the General Agreement on Trade and Tariffs (GATT) and the World Trade Organization (WTO) are designed primarily to restrain competition among the nations. Member nations are generally forbidden to compete by providing special benefits to domestic firms or imposing special burdens on foreign firms.
Competition in State and Local Public Finance
Consider three examples of harmful competition among U.S. states and localities. Where taxation is local, competition creates a powerful incentive among the rich to cluster in wealthy communities. Elementary and secondary education is largely paid for by local school districts through property tax revenues. Cities compete to exclude the poor and working class by mandating minimum lot sizes, blocking multi-family housing generally, and public housing in particular. The inevitable result is that poorer communities have to charge dramatically higher property tax rates to obtain far less per capita school funding than wealthy cities can obtain with low property tax rates. Education is the route to entry into the upper classes, so the competition among cities for wealthy citizens leads to inadequate school financing in poorer school districts, exacerbates inequality, and reduces social mobility out of the lower classes. We could easily avoid these harmful effects by funding education at the state or national level, which would greatly reduce this form of local governmental competition. The wealthy, however, are eager to perpetuate these advantages for their families and have blocked state and federal funding of elementary and secondary education. Localities with poorer citizens cannot “win” this “competition” for the wealthy. The deck is stacked in the favor of the wealthy.
Some States compete for businesses by charging lower corporate income tax rates. This competitive dynamic works in only one direction, reducing corporate income tax revenues. The competition leads to greater State funding by sales taxes, which are highly regressive or moderately regressive if food is excluded from the sales tax.
States and localities compete for businesses by offering enormous tax breaks. This is particularly true when a business threatens to move or close a facility to another state or nation. Romney became wealthy largely through exploiting this perverse competitive dynamic. Private equity firms like Bain Capital do not make profits through brilliance. They make money largely by threatening desperate states and localities that are in financial distress. The threat is that unless the business Bain has acquired is granted enormous new tax concessions Bain will close or relocate the business in another state or nation.
Mankiw does not explicitly address the competition among states and localities to provide tax subsidies to businesses. At best, the competition is zero sum – states and localities that win the competition do so at the expense of other states and localities. It is far more likely, however, that the competition is negative sum. It distorts competition by giving some companies a competitive advantage over their rivals and its functions to reduce overall state and local governmental revenue. This leads to greater reliance on regressive sales taxes and property taxes on un-favored owners – people like us. Mankiw’s ode to governmental competition again fails to cover Romney’s flanks from criticism for becoming wealthy largely by extorting desperate state and local governments to give Bain Capital’s corporate holding special tax breaks or suffer plant closures.
President George W. Bush was made wealthy because the owners of the Texas Rangers over-compensated him – well beyond what he should have earned for the percentage of stock he owned – for convincing the local government to provide the baseball club with valuable land concessions and other governmental subsidies. Bush was an oft-failed oil businessman whose expertise was finding dry holes. He used his political connections to get governmental subsidies and the owners decided that making the Governor of Texas and prospective Republican candidate for the presidency wealthy by over-paying him was an excellent business move. Crony capitalists simultaneously pervert private and public “competition” to make the governmental and private leaders wealthy. Governmental competition to attract and retain professional sports teams is another example of a negative sum transaction.
In future installments I will discuss why private sector competition, making private sector governance the model for the public sector, and the interaction effects of crony capitalism competition can all cause catastrophic harm.
Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.
Follow him on Twitter: @WilliamKBlack