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March 2009 Archive for Economic Sense

RSS By: Matt Bogard, AgWeb.com

Matt's primary interest is in the biotech industry and ag policy.

The Future of Trucks and SUVs in Rural America

Mar 30, 2009

I’ve written about this before, but after today’s news, and because so many of us in rural America depend on our trucks and SUVs I wanted to cover it again. Today it was announced that the CEO of GM would be thrown out and replaced. It was made clear by our president that this was not punitive, but I fear that many people (especially some of our legislators) still want to blame all of this on automakers not producing the kinds of cars that Americans want to drive. This is ridiculous. Americans love their trucks and SUVs and the Big Three have made them well. I fear that certain interested parties want to use this crisis as an opportunity to punish America for all of the 4x4s, suburbans and hummers that we have been driving these past few years, and set up a regulatory apparatus that will limit their production in the future.  Already, short-sighted government interventions have lead to major problems in the auto industry.

Issue #1 Short Sighted Fuel Economy Standards

As I have said before (harmful and deadly – see this link from the American Enterprise Institute) fuel economy standards have forced automakers to make a lot of small fuel efficient cars that no one wants to buy. Resources that could have went into the costly engineering problem of developing more fuel efficient TRUCKS and SUV’s over time have hastily been funneled to meet immediate regulatory demands. Further, automakers not only had to waste resources building these low quality cars that no one wants to drive, but they had to absorb heavy losses because they don’t sell. Were it not for the regulatory requirements imposed ‘yesterday’ it is likely that we would have more fuel efficient options in TRUCKS & SUVs for the higher gas prices ‘today.’

Issue #2 Short Sighted Regulatory Requirements in Energy Production

From 1988-1992 environmental compliance costs went from an annual 560 million to 2.69 billion (400% increase).Return on investment dropped 42% per year between 1996 and 2001. With reduced ROI, refining capacity is severely limited, and the profitability of expansion is greatly reduced.  Due to these low returns and stringent environmental restrictions we have not built a refinery since 1976, and we have to refine nearly 20 different types of gasoline to meet these standards.( which lead to ‘regional’ price spikes like never before experienced) The cost to oil companies of complying with these types of regulations is nearly $10 billion per year.

We got by with this for a few years, but as the world economy grew and along with it demand, we have not been able to keep up. In a normal market economy, scarce resources lead to increased prices which provide incentives for bringing more supply to the market or alternatives via substitution or technological change.  The artificial restrictions on supply have led to upward pressures on prices that we have not been able to compensate for through technological change.

Issue # 3 Short Sighted Interventions in Financial Markets

Making matters worse, government interventions in the financial markets ( through the federal reserve and public private partnerships like Freddie and Fannie) lead to a housing boom and bust. Once real estate and financial markets started taking a downturn, speculators fled to commodities driving up the cost of already scarce fuel. This lead to the massive price spikes which killed SUV sales. The job losses and financial losses in the economy as a whole due to the financial collapse delivered a final blow to the auto industry.  

The car companies will not have a viable business model again until they can get back to producing and selling the cars that most Americans want,( Trucks and SUVs)   and Americans can afford the fuel required to drive them. Due to numerous short sighted governemnt interventions, Americans no longer find it viable to purchase the cars they have revealed such a strong preference for over the last few decades and automakers no longer find it profitable.  These government interventions have certainly upset the business model for the Big Three, and more interventions will not likely be successful.

So maybe the government bears a huge part of the blame, and should be responsible for more bailouts. No matter what they do, lets hope they seriously consider changing the short sighted regulatory policies that led to these problems, instead of trying to change the auto industry that has served its consumers so well in the past.

 Matt Bogard, Economic Sense

Do Business/AgBusiness Schools Need a New Curriculum?

Mar 19, 2009
At least from these comments from a recent New York Times article  ( Is it Time to Retrain B-Schools 3/17/09) I get the impression that there are some people that think that one of the problems with the financial crisis might have something to do with business  students being taught to give profit maximization too much emphasis.

"Critics of business education have many complaints. Some say the schools have become too scientific, too detached from real-world issues. Others say students are taught to come up with hasty solutions to complicated problems. Another group contends that schools give students a limited and distorted view of their role — that they graduate with a focus on maximizing shareholder value and only a limitedunderstanding of ethical and social considerations essential to business leadership."

First, I think it is important that students be properly informed about what profit maximization implies: Profits represent the net contribution a firm makes to society. That is, when a firm produces a product or service, it imposes costs on society ( through the resources it uses, the leisure and time given up by laborers, and the use of scarce funding etc. ) but with a free market system that firm has to pay a price for those costs. People only buy a product or service from  a business if it benefits them as members of society in some way. The difference between a firm’s costs and the benefits it contributes to society represents that firm’s ‘net contribution to society.’  This is ‘profit.’

It follows then that  the ethical and socially responsible thing to do is to maximize the firm's net contribution to society, or in other words maximize profits, or as a close approximation, maximize shareholder value.

Now, what if there are cases where in the process, people in society are harmed as a result of the firm’s pollution or something of that nature? We learned from economists Ronald Coase and Howard Demsetz that most cases of these ‘externalities’ can be handled quite easily by the market as long as the government assigns and enforces property rights. With property rights and markets, all parties are forced to take the well being of others into account, and over time as new problems arise, new institutions and forms of property and markets evolve to deal with them. ( like selling carbon offsets or trading water quality permits)

One thing that may need more emphasis in business school however, is how to run a profit maximizing business in an environment of government intervention. With the current financial crisis we have seen what happens when the government manipulates interest rates ( see this piece from the Wall Street  Journal) and the risky incentive structure created by public-private partnerships and government sponsored enterprises ( see this piece from the Wall Street Journal).

 How many times have you heard it said that the current crisis is the result of failed market philosophies and deregulation?  Perhaps it is our political leaders and media that should be retrained . With an understanding of markets, profits, and incentives their stories may not end up so far off base.

OTHER REFERENCES:

'The Myth of Social Cost' Stephen S. Cheung
Coase. 'The Problem of Social Cost (1960) Journal of Law and Economics
Demsetz. 1967. Toward a theory of property rights. American Economic Review 57 (
May): 347-359

Matt Bogard, Economic Sense

Laying Out The Facts

Mar 14, 2009

From a recent issue of Nature Biotechnology:

"Obama is clearly a science buff, and is really, honestly, into knowing the facts, having them laid out, and then making the best choices that can be mustered," says a policy watcher who was close to the transition team but is outside the federal government. "It is a whole different approach compared to the 'How can we spin this information?' approach of the [Bush administration]. Back to 'honest-to-goodness' curiosity, which is, yes, incredibly refreshing."

There has certainly been a problem in the past with closed mindedness and fact spinning with regard to  the environmental and health benefits of biotechnology ( although I would say that this was likely due more to environmental hypochondriacs and those that are averse to capitalism and technology on the left , as opposed to the Bush administration’s policies)  However, if the current administration is open minded and curious about the science of agriculture and willing to embrace the evidence and communicate that to others, that will be a great thing. As stated later in the article:

"The EU approach has helped keep African countries from adopting GM [genetically modified] crops," agrees De Greef of EuropaBio. "We hope if the EU and US become less adversarial, it could remove pressure from Africa, which feels forced to choose between US or EU regulations."

The current administration may warm up much better to the Europeans, and as a result win some influence that could be beneficial to the biotech industry. That would be refreshing, as long as we are not selling them on our policies in exchange for some of their more troubling ideas regarding healthcare , taxes, and unemployment.

Source: Nature Biotechnology 27   237-244 (2009)

 

Matt Bogard, Economic Sense


 

Taxing our Farms and Businesses

Mar 08, 2009
What meets the criteria for being a small business? See this link from the Small Business Administration.

The link above provides a table for size standards regarding annual receipts.

'For the most part, size standards are the average annual receipts or the average
employment of a firm.'

'A size standard is the largest that a concern can be and still qualify as a small business for Federal Government programs.'

This is what our government considers to be classified as a small business. Firms can be earning millions per year, but still be classified as a small business.

Examples:
Corn,Wheat, Soybean production — $750,000
Cattle Ranching — $750,000
Cattle feedlots $2.5M
New Single-Family Housing Construction — $33.5M
Concrete, framing, roofing, masonry, plumbing and other contractors— $14M

These numbers represent maximum incomes. Many small businesses may not earn this amount. A good question is, what percent of these small businesses actually earn over $250K per year. And, secondly how many are taxed as 'sole prorprietorships' and are subject to income tax increases for those earning over $250K per year?

Even if it turns out to be a small percentage, it is important to note that a small percentage of a large number is still a large number.

For example, in California ( see link  to a CA state government web page) only .8% of all sole proprietorships earned between $200K and $299K in 2005, but there are 2.6 million sole proprietorships in California. That's a total of around 20,000. In addition there were about 15,000 businesses in California earning over  $299K.

That means that there are at least if not more than 20,000 sole proprietorships ( small businesses) in California that will see their taxes raised during the worst economic crisis at least since the late 70'searly 80's.

That is just California. In the U.S. in 2006, there were approximately 22.1 million individual income tax returns that reported nonfarm sole proprietorship status. See IRS data here.  According another  IRS  table there were 1.6 million Farm Sole Proprietorship or Schedule F filers in 2008.

Even if a very small percentage of these earn >$250K per year, we are still talking about 1000's of small businesses and farms across the country that will be subject to higher taxes as a result of the proposed tax increases for those earning over $250K/year.

This isn't legal or accoounting advice by any means,and none of my posts should ever be construed that way. They are just theoretical pontifications. But it does imply we should take a second look at the policies coming down the pipeline.

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