Heritage: Not a Fan of the Infrastructure Bank

When doing research for my post on the infrastructure bank, I was surprised to find that the Heritage Foundation was against said bank. Conservatives generally approve of public-private partnerships. For example, former Senator Chuck Hagel co-wrote a bill trying to establish an infrastructure bank. Former Indiana Governor Mitch Daniels has been a vocal supporter of PPPs. And former Senator Kay Bailey Hutchison (I never thought that I'd miss her as much as I do) also co-wrote a bill trying to establish an infrastructure bank. So then, why is Heritage against the infrastructure bank?

Well, in their own words:

Problems abound with all of these proposals, particularly regarding transportation policy. First, they reinforce a Washington-centric view. States and regions know their transportation priorities and how to execute projects better than the federal government. Concentrating the decision making in Washington would sidestep the role of state governments and expand an already bloated federal bureaucracy.

I find this argument troubling. The infrastructure bank is not a usurpation of state and local authority by the federal government. The federal government would work in tandem with state and local governments to identify projects that have clear value but lack funding. The infrastructure bank would provide initial funding for a project, and the state or local government would affirm their support for the project by throwing in their funding. The infrastructure bank proposals make clear that the federal government will not fund the entire project - let alone a significant portion of it. Furthermore, the value of the individual projects would be affirmed by the private sector's willingness to throw in their own funding.

However, the most troubling part of the Heritage Foundation's argument against an infrastructure bank is the lack of imagine that they show with regards to the necessity of the federal-style governing structure that America enjoys. There are many infrastructure projects that span across localities and states that provide clear benefit to each locality, each state, and the entire nation. Imagine if the Interstate Highway System were to have been built by the governing framework that Heritage prefers. It's unfathomable to think that each town, city, state, and rural land owner would have been able to successfully coordinate to the degree that the construction of the Interstate Highway System required. And guess what: until the federal government stepped in, we didn't have such a system.

Taking Advantage of Identity Investing

Matt Yglesias has an interesting piece that profiles an scam investment opportunity in which fans can invest in shares of their favorite players. It works like this:

This is structured as a stock offering but it's actually more like a loan. Imagine some billionaire loaned Arian Foster $10 million and in exchange Foster promised to pay the billionaire 20 percent of his future earnings. The idea basically is to securitize that $10 million, so that tens or hundreds of thousands of small investors can each own a piece of it.

Why would fans do such a thing? For the same reason that fans buy jerseys, tickets, posters, etc.: they feel an emotional attachment to teams and players, and express this attachment in the form of purchases that solidify their identity as a fan of a team/player. The key bet that Foster and the billionaire making the loan are making is that fans are willing to pay higher-than-market value for the privilege to own stock in Foster.

Which brings me to an idea in an investment company that I've had for a while. My hometown of Austin, TX has a very strong culture of supporting local businesses. Generally, Austinites express this identity by buying tacos at Torchy's, burgers at P. Terry's, and washing 'em down with a nice cold pint of Fireman's #4. However, I imagine that Austinites would love to support their local businesses not just by consuming, but also by investing. And here enters my idea: Keep Austin Weird Bonds.

I'd bet that Austinites would be willing to loan money at below-market value for the privilege of owning a stake in the local businesses that they cherish. The support-local-business identity would be further reinforced with stickers that local businesses that received funding would have to put on their storefront; something similar to the National Recovery Administration's Blue Eagle.

Medical Device Tax: An Update

The New York Times has an article on the medical device tax, and it's truly worth a read. In my previous post about the tax, I cut the medical device industry some slack and said that they may have a case built around the concept of double taxation: that because hospitals have committed themselves to lowering their prices as a result of the ACA, the medical device industry will already feel pressure to lower their prices and a tax on top of that would be a double blow. Surprise! The industry lobbyists were being disingenuous. From the article:

The medical-device industry faces virtually no price competition. Because of confidentiality agreements that manufacturers require hospitals to sign, the prices of the devices are cloaked in secrecy. This lack of transparency impedes hospitals from sharing price information and thus knowing whether they are getting a good deal.

Even worse, manufacturers often maintain personal relationships (sometimes involving financial payments like consulting fees) with physicians who choose the medical devices that their hospitals purchase, creating a conflict of interest. Physicians often don’t even know the costs of the devices, and individual physicians often choose devices on their own, which weakens a hospital’s ability to bargain for volume discounts.

Such anticompetitive practices help generate a wide variation in the prices of medical devices — and contribute to higher prices in general.

It turns out that hospitals really don't have negotiating power when negotiating with the medical device industry. And the secretive nature of pricing may help explain why I could not find any industry estimates on the increased demand that is to be expected from 30 million possible new customers.

Here's Dean Baker with an easy mathematical example on why an industry that benefits from the ACA should help to fund the ACA:

To take a simple example, suppose a medical device company has a new screening device that it sells for $1 million. It cost $100,000 to manufacture, so it will make $900,000 from each device it sells. Before the ACA it had expected to sell 1000 copies of this screening device. That would gross it $1 billion, or $900 million in excess of its production costs.

As a result of the ACA more people will have access to health care and therefore demand for the screening device will increase. Suppose it were to rise by 10 percent. In this case the industry's revenue would rise to $1.1 billion and the profit over production costs will increase to $990 million.

Since the industry had not anticipated the ACA when it developed the screener, and had not expected these extra sales, this additional $90 million is pure gravy in the form of unanticipated profits. The logic of the tax is to take away this gravy to limit the windfall that device manufacturers enjoy as a result of the ACA.

Lawrence Summers Says to Focus on Growth

Lawrence Summers argues in an op-ed piece in the Washington Post that since we can't agree on the debt variable in the debt-to-GDP ratio, we should focus on the GDP variable by trying to increase growth:

Spurring growth is an area where neither side of the political spectrum has a monopoly on good ideas. We need more public infrastructure investment, but we also need to reduce regulatory barriers that hold back private infrastructure. We need more investment in education but also increases in accountability for those who provide it. We need more investment in the basic science behind renewable energy technologies, but in the medium term we need to take advantage of the remarkable natural gas resources that have recently become available to the United States. We need to ensure that government has the tools to work effectively in the information age but also to ensure that public policy promotes entrepreneurship.

So what would the details of such an agreement look like? It's tough to say for sure, and there's a lot of moving parts; so I'm going to examine the proposal piece-by-piece, starting with public infrastructure:

Remember when the president proposed $50 billion in infrastructure spending? The Treasury does! Probably because they had to do a whole analysis of it. The most game-changing part of this proposal was the National Infrastructure Bank. How would it work? The White House explains here. Essentially, Congress would create the bank. The bank would identify projects that lacked funding and provided clear benefit to taxpayers (don't worry, the bank exists outside of Congress' appropriations process and the decisions would be made by a seven-member board - no more than four of whom could be from the same political party). Loans made by the bank for the projects would be matched by local government funding or by private investors. The project would generate revenues and provide a return on investment. The White House also provides a bonus fact in their explainer (which I find hilarious [the concept of the bonus fact, that is]): the AFL-CIO and the Chamber of Commerce both support the infrastructure bank. Unions get jobs. Big Business gets money. Governments save money. Everybody* wins! *everybody does not include investment banks that deal with state and municipal bonds

The Brookings Institution also has some infrastructure bank-related suggestions: the top suggestion being to establish the bank as an independent government-owned corporation outside of any government agency (note: this is not the same as a GSE). The main advantage of existing outside of an agency would be budgetary flexibility and the ability to fund different types of projects. For example: ideally, you would want the infrastructure bank to fund improvements to highways, airports, and railways, among other things. This would touch upon the bureaucratic turf of the FHA, FAA, and FRA (all located within the Department of Transportation) - not to mention the fact that telecommunication infrastructure investments wouldn't even be in the same department (if you're looking for telecommunications infrastructure, I would suggest your neighborhood-friendly Department of Commerce).

Brookings fills in more details about the bank here, and it's definitely worth a read if you're interested in minutiae of a legislative proposal that won't pass Congress for the foreseeable future.

Of course, all of this begs the question of how an infrastructure bank would affect growth. The Treasury analysis lists a lot of positive effects: demand-side, supply-side, and everything in-between (such as an increased feeling of national community). Regarding demand, Treasury points to the obvious fact of under-utilized resources (remember those construction workers that were building houses in Arizona before the housing bubble burst? Turns out they can build roads, too!) Also, less congestion means less money spent on gas which means higher consumer demand for other things. However, demand-side issues have usually proven pretty irrelevant to winning over the votes of Republicans, so let's focus on some supply-side benefits that Treasury laid out.

First, better public infrastructure means decreased shipment time and costs. This helps make American exports more competitive. Another bonus for Republicans: this disproportionately helps Middle America since they are geographically the farthest from a port. Second, transportation agglomeration increases property values. The White House points to an example of Dallas and its experience with DART. Third, transportation agglomeration also makes businesses more efficient. The White House points to businesses taking advantage of Chicago's position in the national transportation infrastructure. A more illicit example, however, may be drug dealers taking advantage of Chicago's position in the national transportation infrastructure. Lastly, more efficient transit solutions means more efficient workers. Or, if you're a Family Values Republican in the mold of Rick Santorum, less time spent in traffic means means more time spent at home with the family.

I'm going to close out with a quote of one part from a blog post by the Treasury Department that really brings to life what infrastructure improvements would look like (the whole post is worth a read):

When the Port of Seattle improves its connection with local freight railroads, it creates construction jobs for local workers – but the project’s benefits extend far across the heartland. By making it cheaper to transport cargo, this improvement will allow cattle ranchers in rural Montana to ship their beef to new markets across the world.  Consumers who purchase imported goods and American businesses that are expanding their exports enjoy lower prices and improved access to new markets and goods.

I Refuse to Use Fitch as a Pun in this Title

Fitch put the US government's credit rating on notice, to which the collective response from just about everybody was: "meh." As far as these things go, ratings agencies really don't have any information that the rest of us don't have. Furthermore, Fitch stressed that this was not an economic problem or a problem with the government's finances, but was a political problem. Fitch's full statement can be read here.

One part of Fitch's outlook, though, did jump out at me (the bold is mine):

Fitch's medium-term fiscal projections imply federal and general government (which includes states and local governments) gross debt stabilising next year and over the remainder of the decade at around 72% and 104% of GDP, respectively. This is below the 80% and 110% thresholds that Fitch previously identified as being inconsistent with the U.S. retaining its 'AAA' status.

Not only does Fitch have a threshold for government debt, they have a threshold that is 10 percentage points less than the much maligned Rogoff-Reinhart tipping point. I don't have access to Fitch's rationale for this, and would be very curious to see why they picked 80%. I did a cursory search on the 80% threshold and could only find mention of a correlation between 80% debt-to-GDP and debt crises. And I don't think I'm alone in being completely flummoxed on the use of this number. When European Commissioner Olli Rehn cited 80% as a debt threshold, Brad Delong could not find any reason for why that number was used.

It's a bit disconcerting that ratings agencies are using numbers that were seemingly pulled out of thin air. Even if Fitch used the now-debunked 90% threshold, at least the rationale would have been clear.

The Medical Device Tax Makes Sense

Ezra Klein seems to be against the medical device tax - a 2.3% excise tax on medical devices that's supposed to help pay for the ACA. And sure, he's right about the fact that if you were designing optimal tax policy, the medical device tax would never enter the discussion. But, as the debt ceiling debate illustrates, we don't live in an optimal world. So, instead of comparing tax policy to the optimal, let's compare tax policy to the actual.

When writing the ACA, the House really wanted this to be a bill financed by taxes on the wealthy. However, the Senate wanted this to be a bill financed within the industry. This meant that a bill that aimed to expand health care coverage would be partially financed by the health care industry's stakeholders. The health insurance industry, hospitals, and others, would help partially pay for their increased business via taxes and fees. This included the medical device industry. And that makes sense; if you want to both expand coverage and contain costs, taxing and charging health care stakeholders for increased coverage achieves both of these goals while avoiding the economically strange outcome of redistributing resources from the wealthy to the health care industry. And thus was born the medical device tax.

Klein cites job losses and off-shoring as negative effects of the tax. In addition to these, the industry cites reduced R&D expenditures. However, the CBPP is not so convinced. Since the tax applies to both domestically-produced and imported devices, this tax will not increase the incentive to move production overseas. Additionally, cost-containment measures in the ACA may actually spur R&D spending for medical devices. Furthermore, the study that most people cite about increased job losses used economic models and demand elasticities that don't apply to the medical device industry. In other words, they were bogus.

The only plausible argument against the tax that I've seen is the argument of double taxation: that because hospitals agreed to cut costs and because Medicare is decreasing payments, both of which to help pay for the ACA, and because these cut costs and decreased payments will fall on the medical device industry, then the medical device industry will paying twice for increased business. But until the medical device industry releases a credible study on the effects of the ACA on the demand for their products as well as cuts in spending on their profit-margin, we simply won't know whether or not their argument has merit. My suspicion is that they did do a study and found that the ACA, including the taxes, was a net positive. But why release that study when you already stand a good chance of repealing a tax that negative affects you?

The Cost of House Republicans

We know that recent budget cuts have depressed economic growth. Paul Krugman talks about the Macroeconomic Advisers' estimate on the costs that the House Republicans have inflicted on the US economy via fiscal policy: $700 billion of wasted economic output and an unemployment rate that is 1.4 percentage points higher than it otherwise would have been. But the cost of House Republicans is even higher than that.

Felix Salmon notes the damage that they have done to the financial markets:

Rather, the harm done would be a function of the way in which the Treasury market is the risk-free vaseline which greases the entire financial system. If Treasury payments can’t be trusted entirely, then not only do all risk instruments need to be repriced, but so does the most basic counterparty risk of all. The US government, in one form or another, is a counterparty to every single financial player in the world. Its payments have to be certain, or else the whole house of cards risks collapsing — starting with the multi-trillion-dollar interest-rate derivatives market, and moving rapidly from there.

I think that this is a subtle point that has been missed in the entire debt-ceiling/budget debate but deserves some echo: even in the unlikely event that Republicans recant all of their demands and agree to a clean debt ceiling hike, the mere fact that they even attempted to govern as a minority party via threat of default could increase borrowing costs forever for everybody.

Essentially, Republicans introduced risk into the one risk-free investment. And this one risk-free investment is used as a baseline to price all risky investments. And so, while we may not see it now (because of being up against the zero lower bound), it's entirely possible that in the future we could see a slight risk premium being charged to the US government that will increase the costs of borrowing for everybody else. In other words: priced into all investments is the assumption that Treasury payments are 100% certain; as long as this assumption is questioned in the minds of investors, then borrowing (for everybody) will cost more than it otherwise would have. So congratulations, Republicans! Not only have you stunted economic growth for the past couple of years, you have permanently stunted all future economic growth!