2 / Regulation / Winter 2016–2017

F O R T H E R E C O R D

In his comprehensive review of my book Greening of Capitalism(Fall 2016), Art Carden picks up a somewhat casual observa-tion of mine, namely that i am so confident that commodi-

ties are going to become subject to worsening shortages as theworld industrializes that i would be prepared to bet on theirprices rising over the long term. As i put it,

there can be no expectation that the long-term trend inthe price of coal (and other minerals) will be anything butupward—and i would be prepared to bet on this with Simonif he were still alive.

Carden steps in and declares himself willing to take up the cud-gels on Julian Simon’s behalf, and challenges me to accept asimilar bet, as he details in the review. i accept his challenge.

the original wager between Simon and Paul ehrlich was madein 1980, and turned on the clash between two world views. therewas Simon’s belief that endless substitution of one commod-ity by another would, through the operation of market forces,ensure that commodity prices would decline. ehrlich’s belief wasthat population pressures would be so strong that demand forcommodities would grow and drive prices up. As we all know,Simon won the bet. But as recent commentators have noted, itall depends on where the start line is taken and over what periodthe bet is taken. Adam Smith institute senior fellow tim Worstall,for example, in a Jan. 13, 2013 column for Forbes.com, demon-strates that ehrlich would have won the bet on several alterna-tive timelines and choices of commodities baskets, particularlyin the decade 2000 to 2010. And as Financial Times writer HenrySanderson points out in his August 18, 2013 column, commodityprices overall since 1975 hardly seem to favor Simon over ehrlich.

i want to make it clear why i am accepting this bet. i am notcertain as to Carden’s world view, but it seems to be a McCloskeyanview that market forces are powerful instruments that can solvemost problems, including problems of growing shortages of com-modities as huge countries like China and india proceed with theirlong-delayed industrialization. My world view is that capitalism is apowerful human innovation that is an unparalleled wealth creator,but that for the first two centuries of industrialization it has ben-efited only a few “advanced” countries in north America, europe,and Japan. now it is the turn of the rest, so in the 21st centurywe see emerging giants like China and india claiming their share.they are likely to put enormous stresses on commodity and fossilfuel supplies if they continue to grow the traditional “business asusual” economy, or what i call the “black economy.” But becauseof geopolitical pressures and immediate environmental concerns,these countries are also growing a “green economy” that is basedon generation of power from renewable resources and recircula-

RegulationAccepting Carden’s Challenge

E D i T O R

Peter Van Doren

M a n a g i n g E D i T O R

thomas A. Firey

D E s i g n a n D L ay O u T

David Herbick Design

C i R C u L aT i O n M a n a g E R

Alan Peterson

EDiTORiaL aDvisORy BOaRD

Christopher C. DeMuthDistinguished Fellow, Hudson Institute

Susan e. DudleyResearch Professor and Director of the Regulatory Studies Center, George Washington University

William A. FischelProfessor of Economics, Dartmouth College

H.e. Frech iiiProfessor of Economics, University of California, Santa Barbara

robert W. HahnProfessor and Director of Economics, Smith School, Oxford University

Scott e. HarringtonAlan B. Miller Professor, Wharton School, University of Pennsylvania

James J. HeckmanHenry Schultz Distinguished Service Professor of Economics, University of Chicago

Andrew n. KleitMICASU Faculty Fellow, Pennsylvania State University

Michael C. MungerProfessor of Political Science, Duke University

robert H. nelsonProfessor of Public Affairs, University of Maryland

Sam PeltzmanRalph and Dorothy Keller Distinguished Service Professor Emeritus of Economics, University of Chicago

George L. PriestJohn M. Olin Professor of Law and Economics, Yale Law School

Paul H. rubinProfessor of Economics and Law, Emory University

Jane S. ShawBoard Member, John William Pope Center for Higher Education Policy

richard L. StroupProfessor Emeritus of Economics, Montana State University

W. Kip ViscusiUniversity Distinguished Professor of Law, Economics, and Management, Vanderbilt University

richard WilsonMallinckrodt Professor of Physics, Harvard University

Clifford WinstonSenior Fellow in Economic Studies, Brookings Institution

Benjamin ZycherJohn G. Searle Chair, American Enterprise Institute

PuBLisHER

Peter GoettlerPresident and CEO, Cato Institute

regulation was first published in July 1977 “because the extension of regulation is piece-meal, the sources and targets diverse, the language complex and often opaque, and the vol-ume overwhelming.” regulation is devoted to analyzing the implications of governmentregulatory policy and its effects on our public and private endeavors.

Winter 2016–2017 / Regulation / 3

tion of resources via a circular economy. Consequently i see thesecountries as driving the “next” great transformation as they switchaway from conventional fuels and commodities to products ofmanufacturing: renewable power from manufactured devices likesolar cells and wind turbines, and resource recirculation (e.g. “urbanmining”) via the innovation of a “circular economy.” (For moreon this, see my articles with Hao tan, “economics: Manufacturerenewables to Build energy Security,” Nature, Sept. 10, 2014, and“Circular economy: Lessons from China,” Nature, March 23, 2016.)So there are two kinds of economies bidding for supremacy in theseemerging giants: a black and a green economy. Which one wins willbe the outcome of a political struggle because the state plays anall-important role in these industrializing economies.

How is this likely to affect commodity and fuel prices? in themedium term there is likely to be a peaking in demand as China,india, et al. scale up, driving up prices. in the longer term, it islikely that the green economy will super-sede the black economy, where costs willbe falling—and the price of energy is likelyto reflect those cost falls. So i judge it likelythat there will be a rising trend in pricesfor industrial commodities over the courseof the next decade because of the contin-ued dominance of the black economy,but energy prices will fall as the greeneconomy overtakes the black economyand power generated from manufactureddevices becomes more important thanpower generated from fossil fuels. As previous industrial transi-tions demonstrate, the lower cost process or product tends to drivethe higher-priced product out of the market.

in terms of the bet itself, i see the point of replicating the origi-nal Simon–ehrlich basket of commodities over a 10-year period.i accept this aspect of Carden’s challenge. But the commoditiesconcerned—copper, chromium, nickel, tungsten, and tin—are nolonger central to industry. So i agree that we should have a fur-ther bet involving fossil fuels—particularly coal, oil, and naturalgas—because they are central to the industrializing efforts of bothChina and india. We could agree to take the nYMeX prices ofthese three commodities as benchmark, in the way proposed byCarden (but without heating oil and gasoline, which are processedversions of crude oil). We could start the twofold bet on January1, 2017 and take it up to December 31, 2026, a full decade. Wecould agree and publicly announce the procedures to govern thebet, including an amendment to Carden’s proposal to the effectthat the winner be declared by a neutral arbiter, and that the win-nings be paid to a nonprofit institution of the winner’s choice. Wecould revisit the bet each year to review how we are each traveling.And if circumstances allow, we could create a second round of thebet in the following decade, 2027 to 2036.

i am confident in taking on this bet because i am confident thatwe are moving toward a world that is greening, where energy, water,

and food will become cleaner, safer, more abundant—and cheaper.this is because i view the dominant greening trends as substitutingmanufactured products for products based on natural resourcesthat are mined, drilled, or otherwise extracted from the earth orgrown in the earth. in energy China is clearly moving to a systemthat prioritizes renewable power (clean, safe, abundant, and cheap)over fossil fuels. (See my most recent discussion, “China’s Continu-ing renewable energy revolution—Latest trends in electric PowerGeneration,” Asia-Pacific Journal, Vol. 14, issue 16, no. 6 [Sept. 1,2016].) in the case of water, desalination processes linked to solarpower make it increasingly feasible to source water from the ocean,which is analogous to sourcing electric power from renewable andabundant resources. in the case of food, we see that plants andvegetables will increasingly be grown and harvested in an enclosedenvironment, utilizing renewable energy and desalinated water (foran example, see my article “tomatoes Watered by the Sea: Sprout-

ing a new Way of Farming,” TheConversation.com, Feb. 16, 2014),while traditional animal products like meat, eggs, and milk willincreasingly be produced through tissue culture on a vast scale (likebrewing) without murdering or torturing animals.

i see China and (eventually) india as driving these greeningtrends, just as the United States was the dominant power drivingthe fossil-fueled industrial paradigm in the 20th century. this isthe context within which commodity prices will increasingly beset in a shrinking “black economy” with less and less influencebeing imposed from shortages of natural ores and mineral sources.Capital is likely to flow increasingly to these clean, green, and safeprocesses rather than traditional fossil-fueled and commodity-driven processes, making their investment costs lower. this is whati am calling the greening of capitalism and i see it as substitutingmanufactured (artificial) processes and products for “natural”products and processes. that is why i see the long-term cost trendof “natural” commodities (in the black economy) as upward asthey become subject to shortages, and the long-term cost trend ofrenewable power, renewable water, and cultured food as downwardin the emerging green economy. the forces driving these costand price dynamics are very different from those that guided thethinking of both ehrlich and Simon.

John A. MathewsMacquarie University, Sydney

There are two kinds of economies bidding for supremacyin China and India: a black one and a green one. Whichone wins will be the outcome of a political struggle be-cause of the state’s role in these industrializing economies.

4 / Regulation / Winter 2016-2017

B R I E F LY N O T E D

Do-It-Yourself andDistrusting Markets✒ By Ryan MuRphy

How many times have you heard that you can save money ifyou “do it yourself” (DiY)? At diynatural.com (“Do it Yourself… Naturally”), you can find recipes for homemade versions of

fabric refresher, mass-produced snacks, and shampoo. Other DiY web-sites and cable tV programs show people how to tile their bathrooms,build their own computers, and rewiretheir homes. And, of course, for genera-tions people have worked on their owncars and done their own landscapingrather than “outsource” the tasks.

Besides saving money, many of theseDiYers say they are motivated by the enjoy-ment they find in such work; it is a con-sumption good. they like getting underthe hood, they like running the powersaw. the work needs to be done and theyget utility from doing it, so why shouldn’tthey do it themselves?

i contend that these arguments arewrong—or, at least, incomplete. i think thatmany DiY efforts are motivated not by plea-sure or frugality, but by wrongful distrustof markets. that doesn’t mean that peopleare always wrong to attempt home proj-ects—or even cook their own meals or mowtheiryards—buttheyshouldbemindful thatthe reasons given for such efforts often areproblematic. in many cases they’d be betteroffpickinguptheYellowPagesandcontract-ing with an expert rather than buying costlytools and attempting a project that requiresconsiderable skill and experience to master.

Transaction costs / When should youundertake a home project in order to savemoney? the answer theoretically rests onwhether the project is in your compara-tive advantage. if your comparative advan-tage lies elsewhere and you operate on the

assumption that markets work as vehiclesof mutually beneficial exchange insteadof tools of exploitation, then in a perfectworld you should do it yourself only whenthose tasks are what you do professionally.Otherwise, you are better off working anextra hour and paying someone else toperform the task you aren’t as adept at.(Of course, we don’t live in this perfectworld, and we’ll consider that below.)

Suppose, on the other hand, that you’rea DiYer because you enjoy it. then whydon’t you do such projects full-time, formoney? Comparative advantage isn’tdefined solely by your ability to createx-number of widgets per hour; it is alsodetermined by how little pay you are will-ing to accept in exchange for making thosewidgets. that amount falls if you enjoyperforming the task. (think of ivy Leaguegrads working for peanuts in the offices ofMajor League Baseball teams). if you actu-ally enjoy an activity that the market remu-nerates with pay, then why work withoutpay to produce precisely the amount youwant to consume, but without performingthose tasks at all for money?

the answers to both of these questionslie in an economic fundamental: transac-tion costs. in his famed 1937 article, “thetheory of the Firm,” nobel economicslaureate ronald Coase explained how andwhy firms choose to hire workers versusoutsourcing everything. transaction costshelp explain this. it is difficult and costly tocontract out each individual task on a case-by-case basis. Firms will be more profitableif they simply hire workers on long-term

contracts to perform the tasks rather thango through this process endlessly.

Similarly, you should do it yourselfwhen the process of hiring someone toperform the task for you is too costly. itis not difficult, generally, to hire someoneto mow your lawn on an ongoing basis. incontrast, cutting a shrub after a suddenrealization that it has grown too long isassuredly a time to do it yourself.

One could argue that not everyone canafford to hire someone to mow his lawn.However, if we take the idea of compara-tive advantage seriously enough, does thisargument make sense? Suppose my mar-ginal revenue product is $9 an hour. Forany other employment, including mowingmy lawn, the implicit marginal productof my labor must be less than $9. in africtionless labor market (a caveat relevantonly for the short run), the argument formowing my own lawn because i cannotafford to hire someone is an argumentfor working another hour at my job. it isactually prudential to do the thing thatseems imprudent to do: “waste” money onoutsourcing my yard work.

the argument that “DiY is a consump-tion good” should also be considered inlight of transaction costs. i enjoy cooking,but i do not believe i could find someonewho would hire me to cook only when iwant to. But it’s certainly imaginable thatthere are many people out there who wouldbe better off if they took a four-hour shift onFriday nights working at a restaurant. thereason why i cannot easily contract to workfor someone is that no one i know wouldwant to hire me to make chicken parmesanfor a dozen people on a Friday night.

One other justification for you to do ityourself is that markets may be too thinfor you to purchase exactly what you want.the rationale of customization is one ofthe better arguments for DiY. if a Googlesearch for the precise good you wish topurchase does not yield the correct item,it may indeed be rational to do it yourself.

Negative-sum game? / the reasoning pre-sented above reduces the question aboutDiY to conventional microeconomic

Ryan MuRphy is a research associate in the O’neilCenter for Global Markets and Freedom at SouthernMethodist university.a formal presentation of this argument is forthcoming inthe Independent Review.

Winter 2016-2017 / Regulation / 5

issues. What are the transaction costs? Arethere labor market frictions preventingyou from finding a job with the exactlyoptimal number of hours for you to work?Are markets too thin for you to find justwhat you want? it is easy to criticize neo-classical economics for assuming homoeconomicus and leaving out the essentialsof what it means to be human, but theseare pretty basic ideas that should informwhat consumers do. Unfortunately, theseideas are generally absent from those DiYwebsites and tV shows.

the underlying logic of “saving money”is really viewing the market as a negative-sum transaction. in this view, when you buysomething from Walmart, you are somehowgetting the brunt of the negative sum. thisis why “buy it at Walmart” so rarely entersdiscussions of DiY advocates. the factthat Walmart profits from the transactionbecomes ipso facto evidence that you wouldbe better off doing it yourself, even if thatmeans that an anesthesiologist is spendingthree hours of her labor to “save” $7.

What gives rise to these intuitions is theunderlying psychology of folk economics,P

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a concept developed by emory Universityeconomist Paul rubin in an article of thesame name published in the Southern Eco-nomic Journal in 2004. Our brain is builtto think about economics in certain ways,just as it is built to think about biologyor the physical world in certain ways. Butthese ways are optimized for the periodduring which the human brain evolved.the world of positive-sum transactionsis relatively new. When confronted with amember of another tribe or an entity thatis perceived to have only its own interestsin mind (like a multinational corporation),the human mind reflexively sees zero-sumas the best outcome for the exchange.

Humanity living under capitalism is theeconomic equivalent of a world made up ofillusions. Our brains struggle to operate ineither world. these forces give rise to whatGeorge Mason University economist BryanCaplan calls anti-market bias in his 2007book, The Myth of the Rational Voter.

Irrationality or preference? / this raises aquestion: is anti-market bias a cognitivemistake or is it a simple distaste for engag-

ing in market transactions?One may argue that this biasundercuts our ability to fig-ure out how to best choosethe most efficient way ofachieving what we set out todo. But others may not see itthat way. French economistAntoine Beretti and col-leagues argue in a 2013 arti-cle in Kyklos that monetaryexchange comes with repug-nancy costs built in, mean-ing people may dislike theidea of monetary exchangejust as they may dislike theidea of eating a cat (thoughperhaps not as extreme).

the issue of interpreta-tion—are people being irra-tional or is this simply reflec-tive of preferences?—is verysimilar tothemurkyquestionof sunk costs. (Do we acceptillusions because we have a

preference for being fooled?) A sufficientlystrong statement on the subjectivity of valuewould require economists to accept the pub-lic’s annoyance at ignoring sunk costs as apreference. But since economics textbooksdo not take this position, it would be con-sistent to see repugnancy toward markets asirrationality, not a preference.

Businesses perform cost-benefit analysesto help assess complicated choices whenthe profit-maximizing path is not imme-diately obvious. i submit that DiY shouldbe approached the same way, with reason-able figures attached to the value of yourtime (i.e., your hourly wage rate). Any suchanalysis would, of course, consider the factthat many DiY activities are in part con-sumption goods. But the situations whereDiY actually makes sense pertain to theeconomic imperfections of the real world:transaction costs are greater than zero, fric-tions exist, and there are not an infinitenumber of sellers and buyers. these aresimply not the primary stated reasons of themany advocates of doing it yourself. Hence,in many cases DiY is a mistake, owing todistrust of markets. R

6 / Regulation / Winter 2016-2017

b r i e f ly n o t e d

Ike Brannon is a visiting fellow at the Cato Instituteand president of Capital Policy analytics, a consultingfirm in Washington, D.C.

When Does AntitrustActivity Stifle Innovation?✒ By Ike Brannon

When does an improved product become an entirely newand different product than what it’s improved upon, andwhen does the government consider that new product to

constitute a monopoly that needs to be broken up? the legendaryagricultural equipment maker John Deere is about to find out.

in 2014 the company came out with anew planter that featured an innovative sys-tem allowing it to plant seeds while movingas fast as 10 mph, or twice as fast as plantersnormally go these days. Besides saving farm-ers a lot of time, the big advantage of thissystem is that it allows more of a crop to beplanted at an optimal time in the growingseason, thereby boosting yields.

Shortly after Deere unveiled this inno-vation, a company called Precision Plant-ing, a division of Monsanto, came out withits own high-speed planting system thatcould be attached to existing planters toachieve the same precision and speed asthe Deere planter. Deere responded thenext season by coming up with its ownhigh-speed planter attachment for exist-ing planters. Soon afterward, PrecisionPlanting partnered with two of Deere’smajor competitors—Case–internationalHarvester and AGCO (whose brandsinclude Massey Ferguson)—to allow themto offer Precision Planting’s technology asan option on their new planters.

At the end of 2015—about 18 monthsafter the appearance of high-speed plant-ers—this flurry of activity culminated inDeere making an offer to buy PrecisionPlanting, which was accepted. Last month,the Justice Department’s antitrust divisionannounced it would sue to stop the merger,claiming that the combined entity wouldhave a virtual monopoly over the high-speed planter market and would thus beanticompetitive.

Distinct market? / Of course, whether thereis a separate “high-speed planter market”or just one broad market for planters fastor slow is the relevant question to ask.After all, scarcely two years ago there wasno such thing as a high-speed planter, andthe majority of planters being used in thefield today are not high-speed planters.the two are interchangeable and it’s stillnot completely clear just how much thenew version improves field output. no oneseems to think that every farmer will havea high-speed planter in the near future.

these days most economists tend to beleery of claims that a merger will produce aharmful monopoly. As long as competingfirms have the ability to enter the market, it

stands to reason that new firms will appearif Deere sets the price on its planter toohigh. However, the Justice Department pro-duced a memo from one of Deere’s employ-ees stating that the merger would “lock up”the market for high-speed planters, owingto the patents and intellectual property thatthe combined entity would hold.

Maybe that would be true in the short-run, but there’s no reason to think thatcompeting companies couldn’t figure outa way to come up with their own originalinnovations and boost market share. ifDeere charges too high a price, its com-petitors will have a very lucrative incen-tive to do precisely that. in fact, two com-petitors—Kinze and Horsch—have alreadyentered and together comprise nearly 15%of high-speed planter sales. the JusticeDepartment’s complaint describes Kinze’sand Horsch’s products as inferior and sug-gests they would never be as efficient asthe Precision Planting or Deere products,but that implies a degree of foresight thatwould be unusual for a bureaucrat.

the government isn’t very prescientwhen it comes to determining a market—Microsoft’s domination of the market forinternet browsers in the late 1990s didn’tlast terribly long or inflict too much lastingdamage, despite the government’s con- p

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Winter 2016-2017 / Regulation / 7

cerns about that market concentration.the Justice Department’s lawsuit isn’t

the last word, of course; normally it nego-tiates with the parties involved in merg-ers it doesn’t like in order to reach somesort of settlement that the bureaucratsdeem acceptable. But in the case of JohnDeere and Precision Planting, such talksapparently came to naught—predictably,perhaps, since there does not seem to bemuch that could be spun off to lessen thecombined entity’s market share. Besides,it’s quite likely that the DOJ and Deerehave completely conflicting viewpointsabout what the market share actually is.And it is hard to conceive of the com-pany licensing its intellectual property toa competitor at some “reasonable” pricenegotiated by Justice.

Conclusion / it’s hard not to conclude thatthe government’s attempt to call high-speed planters a new market, distinct from

Suggestions for PresidentTrump’s FirstDeregulatory Push✒ By SaM BatkInS

President-elect trump has promised that he will repeal many ofthe regulations issued by his predecessor and that this will helpfoster higher economic growth. the reality is more complex:

without new legislation, he will find it difficult to roll back much ofPresident Obama’s regulatory handiwork. even with the necessary

SaM BatkInS is director of regulatory policy at theamerican action Forum.

legislation, there may be relatively little sav-ings from such a roll-back. What trumpshould be able to do is stop the imple-mentation of rules issued in the waningmonths of Obama’s term and work withCongress to identify and fix other problem-atic regulations.

The process / the Congressional reviewAct (CrA) allows Congress, with the sig-nature of the president (the important

part), to repeal a regulation under expe-dited procedure in the House and Senate.the CrA has only been used successfullyonce, however, largely because instancesof one party owning large congressionalmajorities and the White House are rare.(See “Do Presidents rush rules to Avoidthe Congressional review Act?” Fall 2016.)

the only successful CrA vote was in2001, with the Department of Labor’sergonomics rule. A rare confluence ofcircumstances generated this successfulrepeal: an incoming republican president

who (like trump) had promised to cut reg-ulations, a republican House and Senatemajority (albeit narrow), and a regulationthat was well-known, controversial, andissued in the waning days of the previousadministration.

that rare combination returns in Janu-ary 2017 with trump, who pledged torepeal up to 70% of previous regulations,and a republican majority in both cham-bers, many of whom also promised votersthat they would do something about oner-ous regulations that are costing U.S. jobs.republicans have spent the last few yearslaying the groundwork for comprehensiveregulatory reform, from how courts grantdeference to agencies to the role of con-gressional oversight and the practice ofcost-benefit analysis.

Using the CrA might make sense,but if Congress has a large list of rules itwants to repeal then even using expeditedprocedures could consume valuable floorand committee time. enter H.r. 5982,the Midnight rule relief Act, proposedlegislation that would amend the CrA toallow joint resolutions of disapproval enbloc. this would permit the new Congressto review every rule finalized in the last60 legislative or session days of the 2016term, which would cover roughly the lastsix months of 2016. if the bill passes, thenthese rules would be generally strickenuntil Congress in essence redelegates therulemaking power to agencies.

The rules / if Congress does pass the Mid-night rule relief Act and it is signed intolaw, what rules would Congress considerrepealing? the first one many conserva-tives want to target is the Clean PowerPlan, President Obama’s signature climatechange rule. But because it was finalizedin 2015, it is ineligible for review underCrA procedure. thus, to undo the rulewould require either a series of appropria-tions riders or the new administration fol-lowing the Administrative Procedure Actto formally repeal the regulation.

there are a host of other notable andcontroversial regulations that many inCongress would like to address. Because

other planters, amounts to moving thegoalposts in the middle of a game. there’sno evidence that not having high-speedplanters will put any farmers out of busi-ness, or that every farmer (or even mostfarmers) will feel compelled to buy one evenif his current planter is fully depreciated.

two companies made sizeable invest-ments in research and development andcame up with a nearly identical innova-tion at precisely the same time that radi-cally improved productivity for an existingproduct. the tight competition this engen-dered meant that neither manufacturermade nearly the profits it expected. So theymerged. Condemning this as somethinggovernment should stop is a difficult argu-ment to make.

One thing is certain: if the JusticeDepartment’s decision to stop the mergeris upheld, it will make some companiesthink twice about what sorts of innova-tions they pursue. R

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the eligible period under the CrAstretches from sometime in May to theend of President Obama’s term, the totaluniverse of rules is close to 200. Here aresome of the largest rules issued since Maythat could be repealed, along with theirtotal estimated costs:

■ Phase 2 Greenhouse Gas Standardsfor trucks, $29.3 billion

■ Overtime rule, $2.9 billion■ Aviation Drone rules, $2.5 billion■ Drilling in the Outer Continental

Shelf, $2 billion■ Disclosure of Payments by resource

extraction issuers, $1.2 billion■ Fracking emissions Standards, $890

million■ Fair Pay and Safe Workplaces, $872

million■ treatment of Certain interests in

Corporations, $280 million

Combined, these rules will impose morethan $5 billion in annual economic costsand 8.5 million paperwork burden hours.that $5 billion figure wouldn’t get trumpanywhere near his 70% goal (depending onhis denominator), but it would representa rolling-back of regulatory activity andwould doubtless please many of his sup-porters in the transportation, energy, andlabor sectors. in addition to those rules,Congress could scrutinize new efficiencystandards for refrigerators, which promiseto raise prices for consumers.

Just out of the CrA’s grasp is theDepartment of Labor’s Fiduciary rule,

which will impose more than $31 billionin cumulative costs. the administrationwas wise to transmit that rule to Congressas soon as it was published in the FederalRegister. it did the same with the Overtimerule, which may not be eligible for repealdepending on how many days Congressmeets in December. Sometimes the delayin publication and transmission can takemonths.

there are at least five final rules await-ing formal publication that PresidentObama is planning to release before leav-ing office, all of which are related to energyand the environment and likely to piquethe interest of Congress. For example, finalrules governing natural gas production onpublic lands could cost more than $1.4 bil-lion. the newest version of the renewableFuels Standard and the “Stream Protec-tion” rule for the coal industry are alsopending. Combined, these rules are esti-mated to cost $2.2 billion and generate2.5 million new paperwork burden hours.

there are other rules not subject toCrA that Congress and the next admin-istration may want to review separately. ifthey decide to go after the Affordable CareAct’s most significant regulations, therewill be plenty of targets: subsidies andregulations establishing federal exchanges,the de facto banning of Health SavingsAccounts, and the essential Health Ben-efits rules would likely be altered, forinstance, and the regulations leading tostandardized health plans—which repub-licans have complained limit choice and

drive up insurance costs—will also beripe for review in any Affordable Care Actreform.

Limits to benefits from repeal / Whilerepublicans may lament that the CrAonly applies to the last few months of anadministration, that may be for the best.While reaching further back might scoresome political points, repealing rules thathave already been implemented for sometime will have a negligible economic effectand may not pass a cost-benefit analysis.For example, the environmental Protec-tion Agency implemented the Mercuryand Air toxics Standards in 2012, anddespite some legal setbacks in the courts,it has largely resulted in coal power plantsshutting down or switching to natural gas.the seismic changes in the energy world—especially the shift to natural gas–firedgeneration—mean that these power plantswill likely never operate again. Similarly,the Volcker rule might be a credible can-didate for repeal, but many financial insti-tutions began winding down their propri-etary trading desks as soon as Dodd-Frankpassed and would not be reconstitutedsoon regardless of the applicable rules.

it is important to realize that repeal-ing a few past rules won’t affect economicgrowth or boost employment. Generally,a piecemeal deregulatory approach ishardly ideal, considering how little onerule affects the national economy andhow easily future administrations can re-propose measures. it would be far better P

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in a bit of a shift, Frank has shone abright light on general circulation models(GCMs)—models used to predict long-term changes in climate—and illuminatedsome fatal flaws. His bottom line is thatthese models, as they stand today, are use-less for helping us understand the relation-ship between greenhouse gas emissionsand global temperatures. this means thatall the predictions of dramatic impendingwarming and ancillary calls for strong gov-ernment action are based on conjecture.

Modeling climate / the atmosphere is about0.8˚ Celsius warmer than it was 100 yearsago. Given that the atmospheric concentra-tion of carbon dioxide has risen 40% since1750 and that CO2 is a greenhouse gas,we have the antecedents for a compellinghypothesis: the increase in CO2 has caused,and is causing, global warming.

But a hypothesis is just that. For obvi-ous reasons we can’t test this hypothesis byrunning a controlled experiment where weincrease and lower CO2 levels around theglobe and measure the resulting changein temperatures. instead, scientists buildsophisticated GCMs based on known andassumed physical properties and run themon supercomputers. they then comparethe forecasted results for various scenariosto each other and to reality.

GCM forecasts for the years 1998–2014predicted much greater warming thanwhat actually happened. if the modelswere doing a good job, their predictionswould cluster symmetrically around theactual measured temperatures. that is notthe case here; a mere 2.4% of the predic-tions undershot actual temperatures and97.6% overshot, according to Cato instituteresearchers Patrick Michaels, richard Lin-dzen, and Chip Knappenberger. Climatemodels as a group have been “runninghot,” predicting about 2.2 times as muchwarming as what actually occurred over1998–2014. Of course, this doesn’t mean

that no warming is occurring, but ratherthat the models’ dire forecasts have beenwrong—at least so far.

Clouds / Another way to assess models isto look at internal errors and systematicflaws. Here’s where Frank comes in.

to build a successful climate model,researchers need to include all the fac-tors that can affect atmospheric tempera-tures. One factor to include is CO2 levels.Another is clouds. Clouds both reflectincoming and trap outgoing radiation.A world entirely encompassed by cloudswould have dramatically different atmo-spheric temperatures than one devoid ofclouds. But modeling clouds and theireffects has proven very difficult. the inter-governmental Panel on Climate Change(iPCC), the established global authorityon climate change, acknowledges this inits most recent Assessment report:

the simulation of clouds in climatemodels remains challenging. thereis very high confidence that uncertaintiesin cloud processes explain much of thespread in modelled climate sensitivity.[bold and italics in original]

What is the net effect of cloudiness? Acooler atmosphere. Some 342 watts persquare meter (Wm–2) reach the earth’satmosphere, on average, keeping it warmenough for us to thrive. Clouds both reflectincoming solar ultraviolet radiation, pro-viding a cooling effect, and prevent theescape of infrared energy back into space,supplying a warming effect. the net effectof clouds is to cool the atmosphere byabout 25 Wm–2. this means that with-out clouds, more energy would reach theground and our atmosphere would bemuch warmer. there’s the rub.

Clouds are hard to measure and pre-dict, and climate models have an uncer-tainty of ±4.0 Wm–2 that is due purely toclouds. this error is 114 times as large asthe estimated extra energy from excessCO2 (±4.0 Wm–2 versus 0.035 Wm–2). intotality, the combined errors in climatemodels produce an uncertainty of about±150 Wm–2, which is equal to 44% of all

ChaRleS l. hOOpeR is president of ObjectiveInsights, a consulting firm for pharmaceutical and bio-tech companies. DavID R. henDeRSOn is a researchfellow with the hoover Institution and an economicsprofessor at the naval postgraduate School. they areco-authors of Making Great Decisions in Business and Life(Chicago park press, 2006).

A Fatal Flaw withClimate Models✒ By ChaRleS l. hOOpeR anD DavID R. henDeRSOn

Patrick Frank is a scientist at the Stanford Synchrotron radiationLightsource (SSrL), part of the SLAC (formerly Stanford LinearAccelerator Center) national Accelerator Laboratory at Stanford

University. the SSrL produces extremely bright x-rays as a way forresearchers to study our world at the atomic and molecular level.

for the new administration to contemplatebroader procedural reform to provide fora lasting solution to regulatory accumula-tion. However, the Midnight rule reliefAct would allow Congress to bundle doz-ens of major regulations, with billions ofdollars in annual costs, and undo the finalgasps of a presidency.

Few would dispute that the regulatorystate imposes compliance burdens on U.S.businesses that total somewhere near $1trillion, but significantly reducing that

burden is a difficult task. While President-elect trump promised to repeal 70% of allregulations, the near-term reality is that thebest he could do would be to repeal a merehandful of recent regulations and save theeconomy $5 billion in annual compliancecosts. However, such a step could prove tobe the first big leap in a series of reformsthat conservatives and libertarians havesought for decades that would change howour government issues and implementsfederal regulations. R

10 / Regulation / Winter 2016-2017

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incoming energy and is over 4,000 timesas large as the estimated extra energy fromhigher CO2 concentrations. the underly-ing question that Frank raises needs to beaddressed by climate scientists: How canthe faint CO2 signal possibly be detectedby climate models hampered with suchgigantic errors?

Frank points out that systematic clouderrors are the same across climate models,and shows that this could occur only iftwo conditions hold: (1) all the climatemodels employ the same theory, and (2)that theory is flawed. Further, Frank haspublished papers that explain how theerrors in temperatures recorded by weatherstations have been incorrectly handled andhow temperature readings have an error of±0.46˚C, not the ±0.2˚C claimed by others.in a 2011 article in the journal Energy &Environment, he states:

the 1856–2004 global surface air tem-perature anomaly with its 95% confi-dence interval is 0.8˚C ± 0.98˚C. thus,the global average surface air tempera-ture trend is statistically indistinguish-able from 0˚C.

For our purposes, we will focus on thefact that the CO2 “signal” that climatescientists say is responsible for increasingtemperatures is overwhelmed by the errorin their own models.

it’s really a signal versus instrumentresolution issue. if you are timing a highschool track athlete running 400 meters atthe beginning of the school year, and youmeasure 56 seconds with your stopwatchthat reads to ±0.01 seconds and your reac-tion time is ±0.2 second, then with yourequipment you can clearly measure animprovement to 53 seconds by the end ofthe year. the difference in the two timesis far larger than the resolution of thestopwatch combined with your imperfectreaction time, allowing you to concludethat the runner is indeed now faster.

What if this runner then dons somehigh-tech running shoes designed toknock 0.05 off the 53-second time? Yourhypothesis is that the runner would befaster because of the fancy shoes, but can

you actually measure such a small differ-ence with the instrumentation at hand?no. there is no point in even running theexperiment because you will have no wayof knowing if the runner is slightly faster,is running at the same speed, or is slightlyslower. that’s the case with climate mod-els and CO2.

that’s our way of putting it. in a 2008article in the journal Skeptic, Frank putsit this way:

it’s as though a stronger and strongerdistorting lens was placed in front ofyour eyes every time you turned around.First the flowers disappear, then thepeople, then the cars, the houses, andfinally the large skyscrapers. everythingfuzzes out leaving indistinct blobs,and even large-scale motions can’t beresolved. Claiming GCMs yield a reliablepicture of future climate is like insistingthat an indefinable blurry blob is reallya house with a cat in the window.

the iPCC has looked at a number ofdifferent cases and it reports that tem-peratures could be, in the worst case, upto 4˚C higher by 2100. However, basedon Frank’s work, when considering theerrors in clouds and CO2 levels only, theerror bars around that prediction are±15˚C. this does not mean—thankfully—that it could be 19˚ warmer in 2100.rather, it means the models are look-ing for a signal of a few degrees whenthey can’t differentiate within 15˚ ineither direction; their internal errors anduncertainties are too large. this meansthat the models are unable to validateeven the existence of a CO2 fingerprintbecause of their poor resolution, just asyou wouldn’t claim to see DnA with ahousehold magnifying glass.

in a recent podcast for the Center forindustrial Progress, Frank concludes thus:

Large systematic errors make projec-tions of future earth temperaturesentirely unreliable. What do climatemodels reveal about a human [green-house gas] fingerprint on the terrestrialclimate? nothing.

He adds:

One cannot say that CO2 has definitelycaused the mild warming in the climate.We have absolutely no idea what isgoing on. the climate has warmed andcooled in the past without any changesat all from us or from changes in carbondioxide or apparently in greenhousegases, and the changes that we’ve seenare well within natural variability, andso as far as we can tell, nothing impor-tant is going on.

He argues that, given this, there’s no sci-entific merit to predictions of dramaticfuture warming, there’s no reliability ofthe iPCC’s warnings, and there’s no evi-dence of a looming climate disaster fromCO2 emissions. the most rational thingto do right now about the “problem” ofCO2 emissions? Have the courage to donothing.

For all the drumbeat of “the scienceis settled,” the relationship between CO2

emissions and climate change is a topicwhere our ignorance is far greater than ourunderstanding. it would be wiser to waituntil we have a more complete understand-ing of the atmosphere before committingto expensive policies. to do otherwise is toact based on conjecture.

Readings

■ “A Climate of Belief,” by Patrick Frank. Skeptic, Vol.14, no. 1, 2008.

■ “Dr. Patrick Frank on the Accuracy of ClimateModels,” podcast hosted by Alex epstein. Power Hour,Center for industrial Progress, Sept. 8, 2016.

■ “evaluation of Climate Models,” Chapter 9. inFifth Assessment Report, international Panel on ClimateChange, 2014.

■ “imposed and neglected Uncertainty in theGlobal Average Surface Air temperature index,” byPatrick Frank. Energy & Environment, Vol. 22, no. 4(2011).

■ “is there no ‘Hiatus’ in Global Warming AfterAll?” by Patrick J. Michaels, richard Lindzen, andPaul C. “Chip” Knappenberger. Cato@Liberty (blog),Cato institute, June 5, 2015.

■ “no Certain Doom: On Physical Accuracy inProjected Global Air temperatures,” speech by PatrickFrank to Doctors for Disaster Preparedness, Omaha,neb., July 10, 2016.

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Winter 2016-2017 / Regulation / 11

Defending the IndefensibleMortgage Interest Deduction✒ By Ike BRannOn

Ihatethemortgageinterestdeduction(MiD)andinevertireoftellingpeoplewhy.itsflawsaretwofold:First,sinceitisadeduction,itmeansthat a homeowner can benefit from it only if he has a big enough

mortgage (combined with his other deductions) to bother with item-izing deductions rather than take the standard deduction. According

Ike BRannOn is a visiting fellow at the Cato Instituteand president of Capital policy analytics, a consultingfirm in Washington, D.C.

to the tax Foundation, only about 30% ofall taxpayers currently do this—the rich-est third. Since the homeownership rateis around 62%, this means that less thanhalf of all homeowners avail themselves ofthe MiD. the ones left out would be themiddle-class homeowners—the ones whocould actually use some sort of housingassistance.

the second problem is the MiD’s ben-efits scale up with income, as homeown-ers move up into a higher tax bracket orbuy more expensive houses. A guy mak-ing $75,000 a year with a $200,000 homein Peoria, ill. gets a deduction of $1,500from his mortgage interest—but only ifhe has enough deductions elsewhere toitemize, which he probably doesn’t. theMiD would save him less than $400 givenhis tax rate.

Meanwhile, a San Francisco tech entre-preneur making $500,000 a year and livingin a $1 million home might deduct asmuch as $40,000, saving over $20,000—oralmost 40 times the middle-class guy inthe Midwest. the MiD’s benefit growsdisproportionately with income, whichis simply indefensible, and does little toboost homeownership.

And i’m setting aside the fact that feweconomists who study housing issues con-sider homeownership an unalloyed goodworth subsidizing at all. the oft-repeatednotions that homeowners are more civic-minded, more likely to be employed, andhave more stable home lives may be true,

but they confuse cause and effect and thusdon’t justify policymakers’ attempts to cre-ate more homeowners.

Most people in the real estate worldunderstand these truths and behave accord-ingly when called on to defend the MiD.A few months ago i was on a dais with aneconomist employed by a major player inthe industry. After i vivisected the mortgageinterest deduction, the microphone passedto him and he completely ignored myremarks, instead talking about somethingelse. After the event concluded i asked himwhy he didn’t respond to my comments.He explained that he and other industryreps realized long ago that a public-spirited

defense of the MiD simply does not exist,and that their practice, when put in a spotto defend it, is to simply change the subject.they know it’s a fight they can’t win.

Keynesian stimulus? / A few people nevergot that memo, however. As Congress hasbegun to explore tax reform more seriously,a couple of economists and institutionshave given a full-throaed defense of theMiD and its supposedly beneficial effectson homeownership and the economy.

One such effort is a 2014 paper fromthe Heritage Foundation,written by Curtis Dubay.He reasons that while theMiD may do little to boosthomeownership (acknowl-edging that its savings isfully offset in current homeprices, which is yet anotherreason to dispense with thededuction), it is nonethe-less good policy because itincentivizes the 30% of thepopulation that do availthemselves of it into spend-ing more money on housing.And, this reasoning contin-ues, since housing representsan “investment” for thesepeople, and investment is akey ingredient in economicgrowth, it therefore standsto reason that the deductionboosts growth.

it’s an impressive sleight of hand:the trick employed here is to conflatethe meaning of the word “investment.”economists reserve the word to meanmoney spent by firms on plant, equip-ment, technology, or other things thatwill boost productivity and future output.But people do not invest, they save. Whilesavings creates funds available for firms tomake investments, not all of what we saveis used that way.

Housing is most emphatically not aninvestment; it amounts to one way forpeople to hold their wealth. When peoplespend more money on housing, it does notimprove the productive capacity of the econ-P

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12 / Regulation / Winter 2016-2017

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omy one iota; indeed, the more wealth peo-ple have wrapped up in their home meansthey have less money available to put intostocks or bonds or their bank, where thatmoney could be used to invest in expandingthe capacity of the economy. in fact, someeconomists have blamed a portion of theslowdown in productivity growth in theearly 2000s on the massive uptick in spend-ing on constructing new homes.

Dubay implicitly acknowledges thisuncomfortable fact and tries to zigzagaround it by arguing that the increase inspending on housing stimulates the economy,and that the spending creates more jobsbuilding houses, manufacturing homeproducts, and the like. For a Heritage Foun-dation paper, this is a remarkably Keynesianargument. But it’s Dubay’s only optionif he wants to defend the mortgage inter-est deduction. Without this situationalembrace of a left-wing economic perspec-tive, he would be caught in an utterly unjus-tifiable position—which, of course, he couldavoid by simply choosing not to defend thededuction in the first place.

Main Street Republicans? / Jeffrey Ander-son of the Hudson institute offers a differ-ent defense of the deduction. He recentlytook issue with the tax plan released byHouse republicans this summer for itseffective, surreptitious gutting of theMiD. the republicans would nominallypreserve the deduction, but they wouldcreate an environment in which few peo-ple take it.

their plan would do this by boostingthe standard deduction, lowering and flat-tening tax rates, and eliminating mostother deductions. that means that fewerpeople would find it worth their while toitemize. if high-income earners are onlysaving 30 cents of each dollar of mortgageinterest paid instead of 39.6¢, they wouldhave to pay much more interest to make itworth itemizing. And if there are few otherdeductions a taxpayer can take, it meansthat the interest paid has to be higher stillto make it worth itemizing and forgoingthe standard deduction.

in particular, the deduction for state

and local taxes tends to go arm-in-arm withthe MiD because most people with a mort-gage will also deduct their property taxes,which can be anywhere from 40% to 100%or more of the amount of the mortgageinterest deduction. eliminating that deduc-tion—which the House republicans’ planwould do—drastically reduces the size of ahomeowner’s tax deductions and makes itmuch less likely that she will itemize and,thus, deduct her mortgage interest.

As a result, enacting the republicanHouse tax plan would reduce the propor-tion of people itemizing from 30% today toless than 5%, according to estimates fromthe Joint Committee on taxation. this,Anderson avers, would hurt “Main Street”republicans, which is apparently his moni-ker for those in the 6th–30th percentile ofthe income distribution.

in essence, he appears to be arguing fora code with higher tax rates, more deduc-tions, credits, and exclusions, and more taxbrackets because—what? it would help thewealthy to afford their houses? it’s sheernonsense. it is not a secret that the hous-ing and real estate industry would prefer tokeep the present jury-rigged contraption ofa tax code because of the outsized impactit gives to the MiD, but it is not somethingthey would ever admit. Bully for Andersonfor clearly articulating that completely cor-poratist logic and then trying to spin it asgood for the overall economy.

the sad reality is that the MiD isn’tgoing anywhere, simply because its patronsare too powerful. there are over one mil-lion realtors in the United States, many ofwhom are exceedingly wealthy, and theirpolitical arm, the national Organizationof realtors, takes in nearly $300 milliona year. if the deduction ever came underattack, it’s easy to conceive of them raisinganother $300 million to finance a defense.the various state-level realtor organiza-tions collect hundreds of millions of dol-lars a year as well, not to mention the tradeassociations for the homebuilders, mort-gage bankers, roofers, drywallers, plumbers,tile installers, title insurers, and the like.

the realtors and their allies know howto push all the levers of politics, as i’ve

seen firsthand. A decade ago i wrote aspeech for a politician i worked for thattook an indirect swipe at the MiD. Whenwe traveled back to his home state thenext month, he met with a group of localrealtors. their leader told him they weredisappointed in his comments on theMiD and they wanted to show their dis-pleasure. Upon his command the 100 orso in attendance stood on their chairs andbegan yelling loudly. My boss profuselyapologized and blamed it (correctly) onhis economist. He instructed me to nevertouch the topic again.

the realtors and their allies are aggres-sive about heading off all assaults on thededuction. A few years ago i wrote a piecein my hometown paper in Peoria suggest-ing that a proposal that was then beingfloated to cap the mortgage interest deduc-tion at $500,000 would be a good thingfor the residents of the city. A six-figuread campaign financed by Peoria’s home-builders, realtors, and mortgage bankersdefending the deduction quickly ensued.

Shortly thereafter i called a realtorfriend who pulled the listing of sales ofhouses over $600,000 in the area for thatyear—that is, homes that would be affectedby such a cap. there were less than a dozenhouses above that threshold. in essence,the ad campaign cost more than such acap would have cost central illinois home-owners.

there is no honest public policy ratio-nale for the MiD. it is a tax break that willcost the U.S. government nearly $1 trillionin the next decade while accomplishingnothing save for boosting the prices forthe homes of upper-middle-class families.it also does nothing to make housingmore affordable for the middle class andbelow. those who attempt to argue other-wise do so via half-truths, semantic games,or obfuscation.

Readings

■ “House GOP tax Plan: Great for Growth, Badfor Homeowners,” by Jeffrey H. Anderson. WeeklyStandard, Aug. 22, 2016.

■ “the Proper tax treatment of interest,” by CurtisS. Dubay. Backgrounder #2868, Heritage Foundation,Feb. 19, 2014.

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