The DRC and the Data: Economic Failure is Not a Necessary Result of State Failure

There are a host of mechanisms for why state failure should result in a corresponding economic decline. These mechanisms also can be backed up by a large number of real world examples, including the Roman Empire and many contemporary African and Middle Eastern countries. However, in the course of this essay I wish to defy some of this conventional wisdom, and argue that economic collapse is not a necessary result of state failure. I will do this by presenting a rudimentary large-n regression that shows a statistically significant positive correlation of state fragility with economic growth. After expanding on this, I will explore the test case of the Democratic Republic of the Congo. Through this exploration, I will prove that a reduced state capacity may not have a negative effect on economic growth.

To bring context to this essay, I ran an exploratory large-N regression with economic growth as the dependent variable and state fragility[1] as the independent variable[2]. I controlled for resource extraction and relative wealth by including per capita GDP and percent of GDP dedicated to resource rents[3] within the regression model. I did this because more fragile states tend to have more resource wealth, and this wealth can allow brief periods of excessive growth based mainly on extraction. There are 148 countries in my analysis, with large variation over the independent variables. Using OLS, the regression coefficients are as follows:

image001

Variable Constant State Fragility Proportion of GDP from Resource Rents GDP per Capita
Coefficient in OLS 3.704*** 0.092 0.006 -0.016
Standard Error 0.7791 0.0675 0.0221 0.0191

 

R-squared: 0.0559

Main conclusion: A 1 unit rise in the State fragility index is associated with a 0.092% rise in GDP growth on average.

This is obviously a very rough model and no strong indication of any causal relationship; however it is evidence that aggregate production in a country is not necessarily negatively correlated with state fragility, as many seem to think, including Robert Rotberg. In all of the auxiliary regressions I ran, none showed a statistically significant negative coefficient of state fragility. In fact, if the GDP per capita control is left out of the regression, the State Fragility coefficient is positive and statistically significant to a 1% level of confidence. The conclusion I draw from this brief analysis is that the effect of State Fragility on production is ambiguous, even when one controls for resource rents and production level.

It is also interesting to note that auxiliary regressions reveal that state fragility is strongly positively correlated with a high level of resource rents. GDP per capita is also strongly negatively correlated with percent GDP growth. These findings are in line with the Soloh Growth model, which predicts diminishing returns for development, and the resource curse hypothesis, which predicts greater conflict and state failure as a result of natural resource wealth.

To get a better sense of process and how economic growth interacts with state fragility, I turn to the Democratic Republic of the Congo. The DRC meets the qualitative requirements of being a failed state that Robert Rotberg lays out in his article, including “weak or flawed institutions…deteriorating or destroyed infrastructures…regular food scarcities[4].” It also receives an abysmal score on the state fragility index of 23, making it the second most fragile state in the index[5]. Despite this, it is notable that it is currently experiencing its tenth year of positive GDP growth, averaging around 7% per year[6].

Now that it is established that the DRC is both improving economically and also remaining an unstable state, it is necessary to unpack the mechanisms behind such a situation. One possible driver of this growth is the natural resource wealth in the form of diamonds and minerals that the DRC contains. Yet, while these surely plays a role, analysis has shown that for Africa as a region, natural resources only account for 32% of growth[7]. So there is something deeper than resource rents at work. Another way to approach this question is to see if the DRC has overcome some of the frequently mentioned mechanisms for why state failure hurts growth. These mechanisms mainly posit that states provide stability, which allows for longer term decision making, clearer information, less transaction costs, and a greater incentive to invest instead of rent seek. While it is probably very true that the DRC, in its current state of weakness, is suffering unobservable economic losses from its instability, these losses are somehow being offset, as evidenced by the positive economic growth discussed earlier.

A key observation is that while originally resource industries drove growth, this trend has transitioned since 2006. Now, retail and agriculture lead the way in terms of economic growth. This happens despite major border control issues, which are augmented by overlapping agencies and frequent “harassment” by government officials. It also occurs despite little government investment in agriculture and large scale deterioration of infrastructure[8]. This interacts with the idea that perhaps state capacity to provide public goods is not the mechanism through which states most effectively can help economic growth. It may be that states are most effective at promoting growth by focusing on not interfering. Freedom House highlights the interference factor, when it discusses the excessive taxation in the DRC, with statutory rates as high as 40%. Such high taxation drives people into the informal sector, and it is in the informal sector that subsistence living and poverty traps develop. If this logic is extended further, it could be that at very low levels of economic development, where activity is mainly subsistence farming and mining, government becomes mainly a kleptocracy, and in that type of a situation reduced government capacity may translate into reduced government ability to rent seek.

The most important responsibilities of a state may then be those that involve providing a point of coordination, and then letting incentives play out. This may be why the DRC has recorded strong banking growth since the stabilization of monetary policy[9]. In a way, stable monetary policy provides coordination equilibrium. A medium of exchange allows people to better calculate value and translate preferences at low cost between unconnected individuals. This coordination function of government also requires low government investment, and as a result coordination activities like monetary policy can be undertaken even in fragile or low capacity states.

Beyond this speculation, it is important to realize that the DRC, while it shows signs of contradicting conventional wisdom, does still suffer endemic poverty on a massive scale, largely as a result of failed government. The GDP measure in my OLS regression is also a weak way to predict development; such a macroeconomic indicator does not measure the distributional effects of growth or whether any of that growth led to real increases in population welfare. At the end of the day, the DRC and this discussion are interesting because they bring a perspective that refines the model of state weakness leading to economic turmoil. They force an examination of what functions are truly critical to economic functionality. The success of the DRC challenges the idea that weak states would do best to try and imitate their stronger peers. When nations like the DRC are faced with a choice of possible undertakings, and they face tight budgets, they may want to focus more on coordination facilitation instead of intensive infrastructure projects, especially when they are prone to kleptocratic behavior.

 

 

Works Cited

Rotberg R., 2003, ‘The Failure and Collapse of Nation-States: Breakdown, Prevention, and Repair’, in ‘When States Fail: Causes and Consequences’, Princeton University Press, ch. 1.

Footnotes:

[1] The State Fragility Index 2013 dataset was used.

[2] Data derived from Knoema, who compiled it from “IMF World Economic Outlook.” Data is for 2014-2015, so the data used are essentially a two part time series, with the difference being used to present economic growth.

[3] The dataset for resource rents is from Index Mundi: http://www.indexmundi.com/facts/indicators/NY.GDP.TOTL.RT.ZS/rankings. The dataset for GDP per capita is from the World Bank: http://data.worldbank.org/indicator/NY.GDP.PCAP.PP.CD

[4] For evidence of this, see: http://www.voanews.com/content/millions-going-hungry-in-democratic-republic-of-congo/1928513.html.

[5] Table 3 of the State Fragility Index 2013. http://www.systemicpeace.org/vlibrary/GlobalReport2014.pdf

[6] Index Mundi. http://www.indexmundi.com/democratic_republic_of_the_congo/economy_profile.html

[7] Mckinsey & Company, “What’s driving Africa’s Growth,” http://www.mckinsey.com/insights/economic_studies/whats_driving_africas_growth, June 2010.

[8] Ferf, Adriaan. Wageningen University. http://www.odi.org/sites/odi.org.uk/files/odi-assets/publications-opinion-files/7717.pdf. Page 9.

[9] http://www.heritage.org/index/country/democraticrepubliccongo.

Advertisements

Game Theoretical Discussion of Free Trade

In a previous article, I outlined how it is easy to prove mathematically that quotas reduce overall welfare, because the cost to consumers overwhelms the benefits gained by domestic firms. Given this fact, and that the benefits are more spread out, one would initially expect that free trade policies would be universal, at least in democracies. But this is hardly the case. A look at the news over the past decade is evidence of the mixed record of the world when it comes to free trade. Steel tariffs, French cheese protection, and import substitute industrialization are all examples of protectionism trumping protectionism. In this article I will argue that this empirical result can be explained by the distributional effects of free trade and their interactions with the different domestic institutions of nations. I will approach this explanation in a game theoretical context.

What was obvious from the previous article was that the total consumer welfare loss was greater than the total producer welfare gain. However, with almost every good that is produced, the number of consumers greatly outnumbers the number of producers. As a result, the per person consumer welfare loss will be far less than the per firm producer welfare gain. In other words, protectionism concentrates benefits and spreads out costs, and free trade spreads out benefits and concentrates costs.

As a result, consumers face a free rider problem. Any consumer lobbying group will then have to overcome steep cooperation problems. Because any one consumer has a strong incentive to defect, as his single deviation will not usually change the outcome of any lobbying effort. Alternatively, if a person is the only person paying the lobbying cost, even if victory is achieved, the benefits to that individual will likely not even come close to the lobbying costs.

This means that consumers face a prisoner’s dilemma. It can be modelled by:

All Other Consumers
Individual Consumer Lobby Not Lobby
Lobby T-L,N(T-L) -L,0
Not Lobby T,N(T-L) 0,0

Because this is a multiple person game, I have aggregated all consumers besides the test case being examined. As a result, this model does not appear to be a prisoner’s dilemma. However, as can be seen, for any individual consumer not lobby dominates lobby regardless of the actions of everyone else acting as a unit. It can then be reasoned that not lobbying will be the equilibrium for everyone, and the consumers are stuck in a position where they would be all better off if they could insure cooperation.

For firms, the situation is much more likely to be a stag hunt. Individual contributions to lobbying will make a difference in the end result, even if all other firms are assumed to be acting as a single unit. This is even more likely to be the case when a country has regional electoral districts that subdivide the country, like US Congressional Districts. Smaller sub-regions will have fewer competing firms in an industry, and politicians elected from these regions are more likely to care about these firms because they employ a large portion of the local population.

Empirically, there are many implications of the model I presented before. The first is that countries with many electoral districts will be more likely to undertake protectionist policies, and countries with large districts, like Israel, will be more likely to favor free trade. Additionally, politicians elected from broader bases of supporters will be more likely to support free trade. This is likely why the president of the United States has historically supported free trade more than individual congressmen.

In a future article, I will explore the implications that information access has on free trade.

The Case for Free Trade: Maximizing Total Welfare

 

One of the most contentious issues in the world today is that of free trade. For centuries, governments have undertaken efforts to protect domestic industries by erecting trade barriers. What is interesting is that a simple model shows that the gains of free trade far outweigh the gains of protection. So given that a government is acting rationally to raise the total wellbeing of the nation as a whole, it should easily decide to remove tariffs, quotas and other protections. In this article, I will prove that in a simplified example using a supply and demand model, there are high costs to protectionism and therefore net gains when a country pursues free trade.

In order to prove that the gains of free trade are greater than the cost, I will model a situation where the good in question is apples. To simplify the problem, I will aggregate the supply and demand functions. I will examine a single country, which I will call Protania, which under free trade will have an equilibrium where its’ domestic demand for apples is supplied by both domestic producers and foreign producers. Finally, I will assume that the domestic firms are inefficient with respect to foreign firms, either due climate reasons, technological lags, or some other reason. Because of this, it follows that it is safe to assume that these foreign firms supply apples to their home countries.  As a result, Protania’s producers do not export any apples. So the domestic demand of foreign countries can be left out of the following thought experiment.

Under free trade conditions, with no quotas or restrictions, here are the demand and supply curves, and the equilibrium point:

Aggregate Foreign and Domestic Supply(AS): image001

Foreign Supply[1]image003

Domestic Supply:image005

Aggregate Domestic Demand (AD): image007

Equilibrium Quantity and Price under free trade (EFT): image009

A strong measure of welfare of the different groups are consumer and producer surplus.

Consumer surplus (under free trade):  image011

Producer surplus: image013

Domestic Producers’ Surplus[2]image015

Foreign Producers’ Surplus: image020

One of the simplest protectionist policy tools is the use of quota on imported goods. In the free trade equilibrium within my example, it is easy to see that foreign producers are earning a higher surplus, and that domestic producers could benefit from a quota system that protects them from more efficient foreign competition.

Let us suppose that the government initiates a quota. In order to assume a reasonable threshold for this quota, it is important to note that a government will likely allow some level of foreign imports. In other words, the quota will not be zero. However, the government would not initiate the quota unless it hoped to have some effect on production domestically, and as a result it will set the quota on imported apples at a level that is lower than the number of apples imported in equilibrium under free trade. In simpler terms, this means that the quota must be greater than zero but less than 31.5 apples. For the sake of simplicity, I will arbitrarily pick 15 as the maximum number of apples allowed to be imported.

This quota will change the supply function of the foreign firm into a piecewise function that is defined as  image021 and q=15 when quantity is greater than 15. In order to apply this effect to the greater picture, I integrated the foreign producer’s  supply equation with the domestic producer’s, to achieve the following supply equation:

image024

image025

The demand equation remains the same, and the resulting equilibrium occurs on the second interval of the supply equation, at the point where quantity is 37.5 apples and the price is $8 an apple. As can be seen, the price has risen dramatically, and the quantity has fallen significantly. But this was expected, as any reduction in supply must result in higher prices thus less quantity. The interest part is whether consumer and producer surplus have changed.

Consumer Surplus:  image027

Producer Surplus:  image029

Domestic Producers’ Surplus[3]image031

Foreign Producers’ Surplus: image033

Total Surplus with quota=$369.63

 

Free Trade Quota System Net Change
Total Producer Surplus $81 $144.63 +$63.63
Total Foreign Producer Surplus $56.7 $87.93 +$31.23
Domestic Producer Surplus $24.3 $56.7 +$32.4
Total Consumer Surplus $324 $225 -$99
Total Surplus $405 $369.63 -$35.37

 

Given the two policy options, the above table shows that free trade maximizes total welfare. Further, if it is accepted that there are more consumers of a good than producers, than it is also true that free trade also spreads this welfare most evenly among the most people. Intuitively, the qualification of consumers being more numerous than producers is true for almost all markets. Regardless of whether a government values equality or efficiency, free trade seems to be the best route. It would appear that in almost every case, we would expect governments to pick free trade.  The paradox is that governments choose protection more often than not. This is where cooperation problems are powerful explanatory models. In a future article, I will go more in depth into the strategic interactions behind free trade lobbying.

[1] As mentioned earlier, domestic supply and foreign supply equations are modified so as to be much less efficient at producing. This means that for a given price, foreign firms produce much more than domestic firms.

[2] 13.5 is found by finding the quantity that the domestic firm will produce at the given price of $5.60 in the overall market.

[3] 22.5 is the quantity produced by the domestic firms with the equilibrium price of $8.

Minimum Winning Coalitions: Why Bigger Sometimes is Better

As the final part of a course I am taking on social choice theory, I wrote the below brief essay.


In understanding the politics of parliamentary democracies with multiple parties, an interesting idea is the theory of political coalitions developed by William Riker. The logic is elegant and the assumptions are simple. Given a parliament where no single party has a majority of seats, smaller parties will build coalitions that allow them to form a majority and thus form a government. In order to maximize the spoils or benefits, there is an incentive to form minimum winning coalitions—which are the coalitions in a given situation with the minimum number of members necessary to achieve at least a simple majority. This is because the per-capita average “spoils” or α is  , where N is the number of members in the coalition. The members of the coalition have a reason to minimize N to maximize their share of the ministries. The problem with this model is that empirically this does not always happen. In fact, coalitions in most European parliaments are over-sized. In this paper I hope to explain this empirical phenomenon by exploring structural incentives that would promote deviation from the goal of a minimum winning coalition. Specifically I will address the influence location, preference similarity, and party leadership play in the game of coalition building.

The first such incentive is that created by location. One such form of the “spoils” of government membership are public works projects (or pork barrel spending). Given that these types of programs are critical components of party platforms, it is safe to say that they also factor in to the coalition formation game.  In order to illustrate the effect districts have on coalition formation incentives, let us consider the following fictional country with a 100 member unicameral parliament, with the assumption that the party with a plurality will always be in the winning coalition (this is not an unlikely assumption as rules governing government formation often give the plurality winning party agenda setting power over forming a government):

Party A Party B Party C Party D
19 members 30 members 40 members 11 members

As shown, the MWC is a union of Party C and Party D. Not only is this the MWC of this universe, it is the best possible MWC in any universe where there is no single party with a plurality because it has the very barest minimum number of members required (51). If only size mattered, there is no doubt that this coalition would form. However, consider the situation where this fictional country has four legislative districts all of equal population size and thus equal numbers of seats per district. Let us further assume that all members are elected by a system where voters vote for a party and a candidate. Within their district the seats are divided proportionally between the parties, and the seats are distributed to the party candidate with the most votes first. Below is a fictional distribution of parties divided into four districts:

District 1

Party A: 0 members

Party B: 8 members

Party C: 17 members

Party D: 0 members

District 2

Party A: 5 members

Party B: 8 members

Party C: 12 members

Party D: 0 members

District 3

Party A: 6 members

Party B:  8 members

Party C: 5 members

Party D: 6 members

District 4

Party A: 8 members

Party B:  6 members

Party C: 6 members

Party D: 5 members

Several things can be deduced. First, in this example, the plurality winner is Party C, and it is concentrated in District 1. The most likely reason for this concentration is that the party has a supporter base that is regional. Examples of a party that could exhibit a regional concentration include ethnic parties, industry based parties, and others. Having such a base makes public works programs and military bases especially attractive prizes to be won. For the sake of this thought experiment, it will be assumed that Party C advocated building a freeway system in District 1 during the recent election. Because it is a freeway, it can generally assume that if each district is sufficiently large, this freeway system is effectively useless to nonresidents.( Alternatively, a different public works product that is more excludable like a dam or an aquaduct can be used). Just at a glance, it is clear why Party C’s leadership would pursue such a goal, as half of its base lives in the district. Assuming equal taxation, a total cost that equals Ω and a total payoff that equals P, each of the parties will see the following net profit or loss based on party distribution:

Party A:    Party B: Party C: Party D:

From the above functions, it is evident that Party A and D cannot possibly benefit from the project, and they will certainly oppose it. If the freeway’s benefit is at least worth the cost, Party C makes away with a hefty profit. The interesting function is that of Party B. Party B has a sizeable group of members from District 1, and it just so happens to have just enough members so as to make the freeway a net profit for it as a party as long as the freeway is worth the total cost. With all this in mind, it is possible to see why an over-sized coalition (70 members) consisting of Party B and C might form. Such a coalition increases in likelihood as the importance of the freeway as a campaign promise increases.

The logic behind a regional principle also holds true in terms of ideology and socioeconomic similarity. Just as there is a spatial distribution of parties, there is also an ideological distribution, with parties being composed of people from similar socioeconomic backgrounds and with ties to different industries. In this distribution, it is also true that some parties will be ideologically and compositionally more similar to some parties than others. If the above map is considered again in metaphorical terms with the 2-dimensional space representing policy preference instead of location, than Party B and C could very well form an over-sized coalition around shared redistribution goals or shared tax credits for certain industries. The principles and framework in this case remain the same.

The last institution that incentivizes oversized coalitions is party leadership.  The leader of the plurality-winning party is likely to be picked as the prime minister at least in the initial round of coalition government construction.  This is because in most cases either the rules demand it, someone within his party is the formateur, or he himself is the formateur. As a result, the leader has a reason to make the first government coalition as stable as possible. The location of this equilibrium point is at the smallest Nash equilibrium, or the first point where no other party can unilaterally deviate to another coalition and change the result.

Returning to the previous example, the smallest coalition that achieves this goal is one that includes Party A, C, and D (70 members). This is clearly not a least minimum winning coalition, but it is optimal for the leader of party C in that if either Party A or D individually leaves the coalition it can still maintain a majority. Thus the status quo is “stable.” This can be proven using the following game, where both must deviate in order to form a new coalition, but if one deviates but the other does not, the deviation only results in them getting kicked out of the winning coalition, and the loyal party’s share of the ministries increases.

Party B
Party A Stay in Winning Coalition Deviate
Stay in Winning Coalition 2,2

(Nash Equilibrium)

3,-2
Deviate -2,3 3,3

(This is only a Nash with these payoffs if the other parties can somehow make a coalition without C)

Forcing this game of cooperation onto the other member parties makes the leader of Party C more secure as prime minister. Of course, this will only have a relevant effect when parties are strong and centralized. Any systems with independents and more pervasive single member districts will erode this explanation’s effectiveness as a reason for over-sized coalitions.

It is these factors, among others,that lead to the empirical result of over-sized coalitions. Incorporating party leadership, regional concentration, and demographic similarities into the model of minimum winning coalitions brings necessary nuance. My new theory then predicts that while in general parties do strive to minimize coalitions, they do so with respect to incentives.  Under certain regional distributions public works projects like freeways can pull parties to form over-sized coalitions. Demographics can similarly push parties to align with other parties that have socioeconomic overlap or that are beholden to similar industries. Finally, in countries with strong centralized parties, formateur rules can prioritize stability for the plurality-winning party. Stability can necessitate coalitions large enough to prevent unilateral deviation.

An Analysis of Approval Voting as Compared to Plurality Voting

When searching for the optimal voting system, two presented options are plurality rule and the approval voting rule. For the purposes stated here, I will define plurality voting as a system where all alternatives are voted on at once, and the alternative that gets the most votes, regardless of a majority, is selected. I will assume no runoffs are held. I will define approval voting as a system where voters can approve or not approve all candidates, and they can approve or disapprove as many people as they want. I will operate under the assumption that people must either approve or disapprove. They cannot refuse to answer for an individual person. In the process of this brief paper, I will evaluate both systems in regards to Condorcet winners. Then, I will proceed to evaluate them in terms “reverse relevance” and polarization management.

A Condorcet winner is one that can beat any other option when put in a two alternative contest with that other option. Although such a winner does not always exist, when it does, it is usually socially desirable for it to be chosen. As such, it is a valid criterion to begin evaluating the two methods of voting. I start with plurality voting. In plurality voting under my assumption, the Condorcet winner can lose. In order to prove this, it is only necessary to show one counter example that is feasible. Such a counter example is the following voter profile chart:

VOTERS
Preferences P1 P2 P3 P4 P5  P6  P7
B B A A D C B
C C C C C B C
A A D D B D A
D D B B A A D

In the chart, C is clearly the Condorcet winner, because C would beat every other candidate, even B, in a one-on-one matchup. However, in the plurality system under sincere voting, B would be chosen. This is because we assume all candidates are admitted and that all people vote for their most preferred candidate. However, let us also consider a realistic situation of strategic voting. Let us assume that the voting block composed of {P1, P2,P7} who all most prefer B, are very vocal about their support, so much so that everyone is aware that they will all certainly vote for B. If everyone has this information, is it clear that enough people will strategically vote for C? In this case it is: B is the least preferred outcome of voting block {P3,P4} and the second to last preferred outcome for P5. The only other feasible strategic vote block would be for A, but as the non-B coalition is polarized on that choice, such a coalition seems not to be likely. Therefore under strategic voting assumptions there do appear to be instances where plurality voting can overcome the elimination of the Condorcet winner.

In the same way, I now move on to approval voting. In the case of approval voting, if I take the Condorcet winner to be the person that has the most number of “yes” or “approve” votes, then by definition the Condorcet winner will always win. However, given that people rarely ever have binary opinions of anything, it is almost certainly the case that the approval voting system is really a simplification of the underlying preference listings of each voter for the purpose of public choice. With this in mind, it is quite obvious that depending on which arbitrary point a voter places their standard of approval, the Condorcet winner can either always be selected or sometimes be selected. So a Condorcet analysis of the approval voting system is actually paradoxically illogical, because it is difficult to say whether people have some absolute threshold for competence or approval (ie, whether someone would mark No for everyone if they did not meet the criterion, or yes for everyone if they all did) or whether they only approve or disapprove relative to other candidates. It is my general belief that they likely have a mixture of both systems, but will always approve someone and likely never approve no-one, for the simple reason that doing so makes a vote worthless.

So the Condorcet analysis is inconclusive on both fronts. However, there are other ways to compare the two methods. One is to examine whether each method allows certain bad outcomes to occur. Returning to approval voting, it can be shown that approval voting can allow someone who would receive no support in a non-strategic plurality system to win:

Preference P1 P2 P3 P4 P5
A A B B C
D D D D D
B B C C B
C C C C C

If it is assumed that in the above example all voters approve their top two alternatives and disapprove all the others, then the Condorcet winner, D, will win. However, D would win no votes in a nonstrategic plurality vote. This property, which I will name “reverse relevance”, places value on plurality voting over approval voting, as plurality voting has reverse relevance with approval voting, as the winner of plurality voting in a nonstrategic framework must by definition be approved by at least one voter. (If my assumption that no one will vote for everyone or no one holds true).

Now on to polarization management, which I define as the ability to recognize polarized preferences as well as manage or reduce polarized results. Let us consider this example of a polarized electorate:

Preference P1 P2 P3 P4 P5
A A B B B
C C C C C
D D A A D
B B D D A

In this group of voters, the Condorcet winner is B, and the plurality system would pick B the winner. However, it is also true that B is tied for the least preferred candidate. The plurality system even under strategic voting allows no ability to express extreme support or extreme dislike for a candidate, and it has no likelihood of selecting a moderate candidate under nonstrategic conditions. In a less obvious way the approval system does allow voters to express degrees of support, and it also allows for a moderate winner. If in the above example at least 4 of the players approve C along with their top choice, then C , the moderate choice, will be chosen.  As for expressing degree of preference, take, for example, voter P1 and P2. Those voters can express extreme dislike for B by choosing to approve every candidate except B. If they do so, it does not change the vote outcome, but it does in a way express relative degree of dislike, in that the person was only not satisfied with B. Alternatively, the voter can choose to convert his vote into essentially a plurality system vote. In doing so, he can fail to approve all but his top choice.

This analysis forgoes any empirical evidence, and as a result is mainly just a thought exercise. It mainly reveals the well-hashed out conclusion that even with the most innovative of voting systems, there are always drawbacks. This is a sad result of democratic choice, and it even applies to systems that choose the Condorcet winner every time. However, I believe that a crude evaluation would conclude that approval voting is preferable to plurality voting, just due to voter flexibility and polarization management.

UCLA “Cultural Crisis” and the Malicious Outing of Professors

I recently wrote an article detailing the questionable tactics being used by some supporters of the “diversity” graduation requirement at UCLA. It is key to distinguish between honest debate and shameful tactics that border on those used by McCarthy during the Red Scare.

You can read the full article here.

I think it is additionally important to point out that being opposed to the diversity graduation requirement in no one means one is opposed to diversity. In fact, I would argue that opposing the requirement is the only way to support freedom, which is the true root of pluralism and intellectual diversity.

 

The 1953 Iranian Coup

I recently wrote a term paper on the motivations, impacts, and relevance of US involvement in the 1953 Iranian Coup that overthrew the government of Mossadeq. Foreign policy is a little beyond the scope of what I usually write about here, but I was very excited to write this paper and pleased with how it turned out.

A “NEW LOOK” AT THE 1953 COUP IN IRAN: THE COLD WAR MOTIVATION AND THE LESSONS OF COVERT INTERVENTION

Abstract

The United States’ overthrow of the democratically elected Iranian government in 1953 is directly linked to the 1979 Iranian Revolution. The regime that came to power in 1979, and the strained relations it has with the United States, is of great foreign policy concern. In order to help understand the complicated relationship, and to make wise intervention choices in the future, it is necessary to understand the 1953 coup and the American role. In the course of this paper, I will prove that oil drove British involvement and subsequently opened the opportunity for US involvement, but the United States’ central rationale for intervention was its “New Look” containment strategy. I will then establish that the impact of the coup was the discrediting of Iranian secular political parties in the long run, and little tangible impact on events in the short term. Finally, I will explore the lessons to be gleaned from the Iranian 1953 coup through the lens of public opinion theory, bargaining theory, and the bureaucratic politics model. With all of this in mind, I will support the conclusion that the United States should never forget the importance of the appearance of state sovereignty, even in the face of large geopolitical conflicts.

A review of declassified documents, both in 2013 and the early 2000s, reveals indisputably that the Central Intelligence Agency in cooperation with the British government supported the overthrow of the democratically elected government of Iran in 1953. [1] In the course of this paper, I will prove that oil drove British involvement and subsequently opened the opportunity for US involvement, but the United States’ central rationale for intervention was its “New Look” containment strategy. I will then establish that the impact of the coup was the discrediting of Iranian secular political parties in the long run, and little tangible impact on events in the short term. Finally, I will explore the lessons to be gleaned from the Iranian 1953 coup through the lens of public opinion theory, bargaining theory, and the bureaucratic politics model. With all of this in mind, I will support the conclusion that the United States should never forget the importance of the appearance of state sovereignty, even in the face of large geopolitical conflicts.

The British were the spark that encouraged American involvement, and their motivation was primarily oil extraction rights. Prior to the 1953 overthrow, Iran was in heated negotiations with the Anglo-Iranian Oil Company, a British company that operated the world’s largest oil refinery in Iran. The company supplied an enormous share of the oil needs of Britain, and around 75% of its profits came from its Iranian operation[2]. The British government also held a 51% share in the company, meaning that any conflict involving the AIOC was essentially a conflict with the British government.[3] The disagreement was over the terms of a supplement that would change the profit sharing ratios. When bargaining over the Supplement collapsed in 1951, Mosaddeq capitalized on “British intransigence” to nationalize the oil industry, effectively forcing many British employees to leave while at the same time propelling himself to power. [4]

Mosaddeq argued adamantly that the Supplement negotiations were about something much deeper than profit sharing—he made control of Iranian oil an issue of national sovereignty. At the same time, the British Foreign Office secretly came to the conclusion that “control” of the oil reservoirs, not profit sharing, was the problem. One official even went as far as admitting that the British government would allow a 60/40 agreement, if it meant that AIOC retained operational control. Given that it is not possible to reconcile or bargain between control or no control, and Mosaddeq was the politician responsible for framing the debate in this way, many officials throughout the British administration realized that Mosaddeq had to be removed for negotiations to continue. When their initial efforts on this front proved unsuccessful, they moved to lobby for American support[5]. Thus, the British created the opportunity for the Eisenhower administration, and the British targeted Mosaddeq because he created a situation with no bargaining range.

Although oil motivated the British, Eisenhower and his administration were motivated by the calculus of their soon to be unveiled Cold War Strategy, the New Look. This claim is controversial, because it implies that the Cold War concerns must have been greater than oil concerns for Eisenhower, which is not an easy claim to make, especially from the perspective of the current Middle East situation. However, evidence points to this Cold War interest. NSC-162/2, released in 1953 just weeks after the coup, supports covert action as a new component of the Eisenhower strategy in “uncommitted areas” where “forces of unrest and of resentment against the West are strong.”[6] The coup follows the theme of NSC-162/2, in that it represents a cheap, covert response in an “uncommitted area.”  In this same vein, it is key to note that although the Eisenhower administration supported the coup, the Truman administration was against interventionism in Iran, especially covert government overthrow that would align them with oil companies[7].  Truman’s cabinet, including Dean Acheson, even went as far as stopping British military action[8]. Eisenhower and his administration had few problems with covert overthrow as long as it was discreet and affordable.  This suggests, since little changed between the administrations, that the American involvement in the coup was part of the larger change in US containment strategy that came with the New Look.

What solidifies the primacy of a Cold War strategy motive is evidence that the British intelligence community was aware that oil interests alone would not galvanize American participation. In order to push the narrative of communism, the British secretly implemented staged communist demonstrations. This implies that the British new that oil alone would not pull Eisenhower into the conflict. At this point I want to point out that I am again attempting to prove that Cold War considerations were the primary motivator. I am not trying to prove that the threat of communism was realistic. On the contrary, this example highlights that there was not enough credible evidence of communism arising, and that despite this the British knew Eisenhower and his administration would be more willing to intervene if there was.

It is also true that later on even American agents formented or staged communist Tudeh rallies. This indicates that at the lower levels of administration there was a clearer idea that communism was not a threat. The understanding of this fact either was purposefully distorted to gain upper level support or higher level officials suffered from confirmation biases. Whatever the case, primary sources indicate that Eisenhower was fully aware of the situation and authorized it. A journal entry from him in October of 1953, several months after the coup, reveals that if things proceeded as planned, “[the United States] may really give a serious defeat to Russian intentions and plans in that area.”[9] The journal further makes clear that Eisenhower wanted the situation to be secret so that the United States could continue to do things “of like nature in the future.” It is clear that Eisenhower not only imagined the Iran coup as a proxy within his New Look strategy, but he imagined it as a model for future interventions.

Before accessing the short run impact, it is necessary to fully explain how the coup unfolded. Oil talks fully collapsed between Mosaddeq and Britain near the end of 1952, and at that time Mosaddeq broke off relations with Britain. The CIA and MI6 came fully together to design the coup plan, named Oepration TPAJAX, in March of 1953. The plan was allocated only $285,000, and it intended to use existing political forces ignited by a crisis around Mosaddeq. It appointed General Zahedi the leader, and the planners tried to get the Shah to support their plan. During the days leading up to the coup, the situation crystalized into the Shah issuing royal decrees to replace Mosaddeq, and Zahedi and other officers arresting him if he refused[10] . In the time leading up to the event, the coup planners actively lobbied the Shah for support, while also using agents to ferment unrest. The unrest and negative propaganda was meant to depict Mosaddeq as unable to maintain order and as in league with the Communists. This was helpful for co-opting the clerics.[11]

The difference between the plan and what occurred is telling of the short-run impact. Four days before the coup, Tudeh (the communist party of Iran) agents planted in the military informed Mosaddeq of the coup plot. He promptly arrested many officers, and issued a warrant for Zahedi’s arrest on August 16th. The Shah subsequently fled the country[12]. Thus, both prongs of the coup as originally planned never occurred. In fact, Under Secretary of State Walter Smith reported to Eisenhower that the coup had failed. Review of CIA documents also reveal that there was no contingency plan in case of complete failure[13]. When Mosaddeq did fall, it occurred mostly organically, by a spur of the moment plan organized by General Zadehi that took advantage of pro-Shah riots and band-wagoning military personnel to surround and force Mosaddeq to capitulate. Mosaddeq aided in his own demise by dissolving Parliament, thus removing any barriers that protected him from royal decrees by the Shah, and opening him to more legitimate attacks by the military-Shah alliance. Although Kermit Roosevelt, the CIA chief in Iran, was still leading an operation alongside the events, most riots, formations, and other actions seem to have either been the idea of Zahedi or the result of already snowballing events[14].  The CIA/MI6 impact is clearly, as a result of failed aims and mostly organic events, limited. Additionally, documentation reveals that two Tehran agents were hired for the purposes of TPAJAX. Both these agents were tasked according to CIA reports with creating fake Tudeh crowds that supposedly united with real Tudeh crowds and helped improve the atmosphere of chaos and Tudeh violence. But interviews with Tudeh leaders reveal that most of the rioting was ordered by Tudeh leaders[15]. Thus, not only were the direct events of the plot beyond CIA control, but so were the influencing and background events.

In assessing the short term impact of the coup, it is sufficient to say that it had little effect. Most historical evidence I mentioned before shows that the outside organizations did little more than piggyback on already occurring movements and events. Mosaddeq made critical mistakes in dissolving Parliament, repressing dissent and allowing the British economic sanctions to continue. His coalition was fractured, unrest fed into the narrative of his inability to maintain order, and powerful interests within the country were united in ousting him.  In a sense, the coup was a perfect failure: all the goals were met despite the failure of all the actions proposed to achieve them.

The long term effect is by and large a negative one for the United States. Because Eisenhower and his administration viewed the conflict mainly on the balance sheet of the Cold War, it at first seemed to be successful: communist Tudeh elements were suppressed by the Shah regime, the oil resources were kept within the Western sphere, and the United States had a staunch ally in the Shah and the Iranian military. But the 1979 Revolution is evidence of the much deeper effects American and British intervention through the coup had on politics in Iran. The coup, and the implication of the United States, took legitimacy away from the military by showing its willingness to cooperate with foreign powers. In the same way, it further reduced Iranian confidence in the Shah as a national figure independent of foreign powers. It also discredited nonreligious parties, especially the National Front and the Tudeh. The only elements left mostly unscathed were the Islamist factions[16]. After they successfully overcame the Shah’s regime in 1979, they filled the power vacuum nicely.  As a consequence, the defeat of communism and populist nationalism through the overthrow only served to make way for a militant Islamic state.

Examining the coup yields important lessons for future policy. In reading the primary source documents, including Eisenhower’s journal and “A Secret History”, and the aggregations of these documents in the forms of several different journal articles, it is clear that almost no one agrees on the story. In order to account for these differences, it is helpful to consider the bureaucratic politics approach. By analyzing interests of the organizations and individuals involved from the United States’s side, it is possible to evaluate for why there are such disparities between the stories.  The largest sources of information currently are the memoires of CIA officers involved, and a commissioned history by the CIA. The commissioned history written specifically by Dr. Wilber blatantly omits many details, especially those that involve many unsavory actions that likely occurred. It also focuses only on the CIA’s role, and leaves out other agencies. Memoires of Kermit Roosevelt, which serve as another main source for many documents, and for Eisenhower’s perception of the coup, are also filtered. Roosevelt had a vested interest in attributing causality for Mosaddeq’s downfall to CIA action. This would increase his own prestige and elevate the CIA above other competing agencies. The 1953 Iran coup can be viewed as a test of Eisenhower’s new Containment policy under NSC 162/2. It came right after the issuing of the document and near the beginning of Eisenhower’s term. Roosevelt and other contemporaries had a vested interest in telling the President that the New Look Policy, which encouraged covert overthrows, worked.

Eisenhower confirms in his journal he had some suspicions about the claims made regarding the casual link between CIA action and Mosaddeq’s fall. Specifically, he says the report sounded more like a “dime novel” than “historical fact.[17] Further, reports from Tudeh leaders and General Zadehi are contrary to much of the CIA’s reporting. Local interviews and a comprehensive overview of the situation makes author Bayandor conclude that the CIA actions did not make any intentional difference in Mosaddeq’s fall.[18] The lack of a non-CIA American perspective is troubling, given that the TPAJAX coup was used to model other potential and actual coups by the United States government throughout the Cold War.[19] In order to fix this problem with objectivity, the Eisenhower administration should have taken active steps to assure that some non-CIA oversight was enforced. The administration should also have pressed for more detail regarding how an orchestrated coup could go from abject failure to sudden success in a few days. In covert operations, policymakers should always realize that bureaucrats have the inherent advantage in their ability to filter information and claim the need for secrecy.

Secondly, the Iranian coup holds a lesson in foreign public opinion. In the course of this paper, I have so far established that the American intervention had little practical effect: Mosaddeq had many weaknesses that occurred organically, and many of the situations leading to his demise occurred outside the CIA’s control. But the coup still has massive public opinion effects on the reception of the US to the Iranian public. A Rand Poll found that nearly 52% of Iranians still believe that the 1953 coup influences their feelings toward the US. And of the Iranian’s polled, over 70% view the US negatively.[20] This has large implications, especially because the poll also found that a large majority of Iranians learned of the coup from state-run media sources.[21]I can then infer that the Iranian coup of 1953 is at the very least a very effective propaganda tool for the Iranian regime. I imagine that US involvement in something that appears to violate legitimate government, and national sovereignty, resonates with Iranians, as it would with many peoples. The coup is also effective as public opinion mechanism because it allows the current regime to build a narrative of Western oppression. It allows the regime to divert the anger from painful economic sanctions back on to the West[22]. It is for this reason that future interventions would do well to avoid violating what is perceived as legitimate government.

The final relevant lesson from Iran, is not to miss situations with flexible bargaining ranges. As it stood in 1950 under the past oil agreements, Iran received 17% of the profit, and it wanted 50%. The terms of the Supplement the AIOC provided offered a 24% share, no deadlines on promoting Iranians to managerial positions, and no concessions on domestic oil discounts for Iran. It also did not address many other transgressions brought forward by the Parliament. As a result, and with advisement from an outside consultant, the Parliament rejected the Supplement, and Mosaddeq was able to redirect effort to nationalization[23]. The overconfident bargaining offers of the AIOC directly resulted in the destruction of a bargaining range. It is much easier to bargain over a divisible situation, like profit sharing rates, as opposed to binary choices, like to nationalize or not. Future negotiators should be wary of the possibility that an issue can be reframed in a less negotiable manner.

Aggregating all these lessons, motivations, and impact analyses, I have come away with my own evaluation of such an intervention. Before concluding, I think it is important to mention that further research must be conducted when the rest of the CIA documents are released. A large number of correspondences, especially involving outside organizations in the American government, still needs to be evaluated. With this caveat in mind, I will continue.

My conclusion is that the United States should only undertake covert regime changing operations if it can assure that there is at least an appearance of state sovereignty and legitimacy, otherwise only coercive assistance from the United States will keep the regime in place. In other words, there needs to be solid evidence that the new regime was driven into power by the proper vehicles. From how the United States viewed Iran in 1953, it is easy to see how sovereignty and legitimacy considerations were left out. The Cold War dominate political thought, either for real security reasons or just as a convenient explanation for less ideal real reasons. In the Iran case, it is my opinion that the larger geopolitical conflict of the Cold War overshadowed these considerations of legitimacy and sovereignty, with disastrous long-term results. The US would do well to not make this mistake again.

[1] Bryne, http://www2.gwu.edu/~nsarchiv/NSAEBB/NSAEBB435/#_ftn1

[2] Abrahamian, “The 1953 Iran Coup,” 185.

[3] Cavendish, “Iranian Oil Fields”

[4] Gheissari and Nasr, Democracy in Iran, 53

[5] Abrahamian, “The 1953 Iran Coup,” 191.

[6] NSC 162/2

[7] Abrahamian, “The 1953 Iran Coup,” 197.

[8] Bayandor, Iran and the CIA, 34.

[9] Eisenhower, Journal Entry, 11.

[10] Bayandor, Iran and the CIA, 94.

[11] Gheissari and Nasr, Democracy in Iran, 53.

[12] Bayandor, Iran and the CIA, 95.

[13] Bayandor, Iran and the CIA, 97.

[14] Ibid., 111.

[15] Ibid., 129.

[16] Abrahamian, “The 1953 Iran Coup,” 213.

[17] Eisenhower, Personal Journal Entry, 10.

[18] Bayandor, Iran and the CIA, 175.

[19] Abrahamian, “The 1953 Iran Coup,” 183.

[20] Sarah Beth Elson and Alireza Nader, What Do Iranians Think? 22.

[21] Ibid.

[22] Parsi, Trita and Marashi, Reza. “Why Sanctions on Iran are Not Working.”

[23] Cavendish. “Iranian Oil Fields.”

BIBLIOGRAPHY

Abrahamian, Ervand. “The 1953 Coup in Iran.” Science & Society Volume 65. No. 2

(Summer. 2001):182-215. Accessed October 29. 2014. http://www.jstor.org/stable/40403895.

Bayandor, Darioush. Iran and the CIA: The Fall of Mosaddeq Revisisted

(Palgrave McMillan 2010).

Byrne, Malcolm. “CIA Confirms Role in 1953 Iran Coup.” The National Security Archives.

Last modified August 19. 2013. http://www2.gwu.edu/~nsarchiv/NSAEBB/NSAEBB435/#_ftn1

Cavendish, Richard. “The Iranian Oil Fields are Nationalised.” History Today.

Last modified 2001. http://www.historytoday.com/richard-cavendish/iranian-oil-fields-are-nationalised.

Eisenhower, Dwight. Excerpt from typed journal, October 8, 1953. Eisenhower Archives.

http://www.eisenhower.archives.gov/research/online_documents/declassified/fy_2010/1953_10_08.pdf

Elson, Sarah Beth and Nader Alireza. What Do Iranians Think? Santa Monica: RAND

Corporation: 2011. November 2014. http://www.rand.org/content/dam/rand/pubs/technical_reports/2011/RAND_TR910.pdf

Gheissari, Ali and Nasr, Vali. Democracy in Iran (Oxford University Press. 2006). 50-153.

NSC 162/2. (paper presented to the National Security Council by the Executive Secretary on

October 30. 1953. Washington, DC).

Parsi, Trita and Marashi, Reza. “Why Sanctions on Iran are Not Working.” Al Jazeera.

May 15, 2013. http://www.aljazeera.com/indepth/opinion/2013/05/2013515121958344336.html

UC System Tuition Hikes: Avoidable through better Fiscal Management

Daily Signal

From: Daily Signal

As a student at UCLA, I have witnessed the recent protests over the possible implementation of tuition hikes. And while I agree wholeheartedly with the sentiment of the protesters, I think that the anger needs to be reinforced with tangible alternatives for the UC and the state government to consider. And so, I would like to present a brief overview of some policies the UC and state government could implement to avoid tuition hikes.

The Regents’ Policy Announcement

On November 19th, the Regents of the University of California voted to phase in tuition hikes up to 5% per year for the next 5 years. The tuition hikes could technically be reduced or even eliminated if more state funding is allocated. The Regents have framed the issue as placing them in a bind, where they have to choose between tuition hikes or compromising the universities core mission.

With the added money, the Regents propose to keep class sizes low and to use half of the money for financial aid. So while I sympathize with the accessibility argument pushed by many protesters, the rise in financial aid and the already existing aid for those making under a certain threshold means that those who will be hard pressed by such a tuition increase are middle income students.

Savings and Fiscal Analysis

The UC has estimated that the fee increase will raise about $459 million in additional funds over the five years. This averages out to about $92 million per year.

This averages out to about $92 million per year.

This is an immense amount of money, and it is worthwhile to examine what it is going to fund. Like any service based industry, education costs are largely driven by employment costs. The largest growth in employment at the UC has been within the administration, not faculty. And the growth is immense. Since 1991, the number of management jobs has exploded by 220%, compared to only 47% job growth on average. According to Charles Schwarz, a professor at UC Berkeley, this equates to 4,647 jobs in excess of growth of other employees. And the 4,647 are excess, because management jobs should not grow at a higher rate than the jobs which are managed. The cost of this excess when the $120,000 management salary average is used, is $560 million annually.

The cost of management excess is $560 million.

On top of this ballooning of management at all levels, the UC also has many overpaid top executives. President Napolitano proceeded with a plan to raise Chancellor salaries just a few months ago. These increases were ostensibly enacted to fix the awkward payscales, where some newer chancellors were making more than senior counterparts. This is in light of the fact that the highest paid Chancellor,UCSF’s Sam Hawgood makes nearly $750,000 a year. Protestors are right to question why a UC Chancellor earns almost double the salary of the President of the United States.

In addition, UCLA specifically has begun using the hiring of top executives as a way to address campus issues. Last year, Chancellor Block announced the creation of a “Vice Chancellor for Equity, Diversity, and Inclusion” in order to advance the schools “full commitments” to diversity. Not only is this a foolhardy way to handle situations, it is also an expensive, taxpayer funded way to fix problems. Such Vice Chancellors quite often make over $200,000 in salary. They also can have offices with operating expenses ranging up to a $1 million per year. Given that such offices will eventually exist across most campuses, Californians are left with up to $10 million annual bill.

Finally, there is the general cost explosion of the UC’s pension obligations. Cited explicitly by President Napolitano as a reason for the hikes, there is no doubt that they are the single largest statewide and university wide solvency issue. As it stands, the UC will pays out $1.2 billion to the pension fund this year alone.  This payout dwarfs all the numbers formerly mentioned, and for good reason. The necessary large payouts come from gross mismanagement of the fund and a complete lack of contributions for over two decades.

The UC currently pays out $1.2 billion to service its pension liabilities.

The sticking point here, is that the pension system could be fixed with a simple switch from a defined benefit to a defined contribution system, similar to the systems over 80% of private sector employees use. Such a system would require employees to accept some of the investment risks of their pension, and would move away from the university guaranteeing a pension payout that the economic situation cannot support.

If the Governor, in cooperation with the University and legislature undertook meaningful pension reform, it would decrease university costs and increase the state debt rating.

There is finally the stipulation that extra funding could be covered by reallocation of state funds. Protesters are again right to be angry that the state has declined in contributing to the operation of the University. But their anger should be directed towards what California has instead used its money for. Projects like the High Speed Rail Line, mismanaged prison systems, and other costs all suck up resources that could otherwise go towards the UC. Additionally, failing tax and regulatory policy pushes tax receipts out of the state, netting the state less tax revenue.

Before I end this article, I would like to put some perspective behind this fee increase. Here is a chart showing all the possible savings that could be used not only to stop a tuition increase, but create tuition roll back:

UNIVERSITY OF CALIFORNIA: SAVINGS FROM WASTE
Source of Savings Fix: Annual Savings Estimates Savings as a Percent of Tuition Increase Revenue Generation Possible tuition Rollback Amount**
Unfunded Pension Liability Payouts Defined Contribution, increased retirement age 600,000,000* 652.17% Not included, but potentially hundreds of millions
Unnecessary Management Growth Management Cuts, Hiring Freezes $560,000,000 608.70% $3,111.11
Diversity Vice Chancellor Positions Remove the Diversity Vice Chancellor Offices $10,000,000 10.87% $55.56
Luxurious Chancellor Pay $100,000 Paycut $1,000,000 1.09% $5.56
Total: $1,171,000,000 1272.83% $2,660.89
*This is a very rough estimate based on the assumption of completely switching plans, even for current employees. It is half current pension payouts.
**Rollback estimate based on current undergraduate population of 180,000. An annual revenue generation of $92 million from the tuition rise of 5% annually is subtracted from the total.

As I have shown, even if I do not include pension savings in the analysis, management changes alone could save enough money to prevent the tuition increase six times over. The takeaway from this data is that not only can the Regents mitigate the tuition hikes, they can also rollback tuition with necessary reform. Students should understand the full fiscal situation, so they can present meaningful solutions. Regents should understand that their are other options.

Browsing through an Internet Sales Tax: Policy Analysis

https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&uact=8&ved=0CAcQjRw&url=%2Furl%3Fsa%3Di%26rct%3Dj%26q%3D%26esrc%3Ds%26source%3Dimages%26cd%3D%26cad%3Drja%26uact%3D8%26ved%3D0CAcQjRw%26url%3Dhttp%253A%252F%252Fwww.activistpost.com%252F2014%252F07%252Finternet-sales-tax-quietly-moving.html%26ei%3DdudiVMjXFNL3oAT8voGQBA%26bvm%3Dbv.79189006%2Cd.cGU%26psig%3DAFQjCNGTK148qYrBoVv9038NAr9RHOaTIg%26ust%3D1415854309644541&ei=dudiVMjXFNL3oAT8voGQBA&bvm=bv.79189006,d.cGU&psig=AFQjCNGTK148qYrBoVv9038NAr9RHOaTIg&ust=1415854309644541

Washington has been abuzz lately over discussion of an internet sales tax law, called the Market Place Fairness Act, which specifically gives states the ability to force out of state online retailers to collect sales tax from instate consumers. Because online sales are technically interstate commerce, the federal government must pass such a law to abdicate its enumerated power over interstate commerce over to state governments. The issue is especially relevant for political and policy reasons, because it is not a clear cut issue. Although Speaker Boehner and House Republican Leadership has decided to halt the progress of the bill, which has made it through the Senate, there are many Republicans that support the idea. The division in the Republican Party’s ranks parallels my own division over the issue, and it shows that there are deeper arguments for and against the policy. In the end, I believe a careful cost benefit analysis reveals that an internet sales tax only is a bad idea, but comprehensive tax reform is not.

Before delving further, I think it is essential to point out that the law gives power to the states to enforce online sales tax collection, but does not establish any new taxes. It also identifies the location of the transaction as first the address for delivery, then the customer’s known address, then the billing address, in that order. Due to varying state laws and state taxes, the effects of the law will be different on each state government individually, ranging from no effect for those states that have no sales tax, to a large effect for those states with high sales taxes.

The surface argument against an internet sales tax is composed mainly of the following statement: paying more taxes are bad because it means we have less money, an internet sales tax represents more taxation, therefore an internet sales tax is bad. Likewise, the surface argument for the internet sales tax is simplistic: sales taxes make prices artificially higher, only brick and mortar shops are forced to levy sales taxes, therefore online retailers receive an unfair price advantage over brick and mortar shops.

These two points are important when considering any policy, because tax neutrality is important, as is limiting the amount that residents are taxed. But they are just the tip of the iceberg. Perhaps the biggest missed line of argument is in regards to compliance and privacy. Because the law allows interstate enforcement of sales tax obligations, it means online businesses will need to stay compliant with a complex system of 50 separate state tax codes, and nearly 9000 other local codes. If they are forced to collect, they will need to send owed taxes through the collection systems of dozens of states, which means becoming familiar with several dozen times more forms and regulations than a brick and mortar store would possibly have to deal with. These transaction costs are essentially deadweight losses: resources spent on things that do not make anyone better off.

In order to carry out this law, there is also the implication that governments will need to set up databases to track out of state transactions. Such databases are yet another vulnerability point for identity theft and further government privacy invasion. Given the government track record with the NSA and the management of the Affordable Care Act Exchange websites, this is no small concern.

In addition, the fact that out of state internet sales are effectively tax free serves to restrain state officials from enacting punitive state tax rates. State officials cannot make brick and mortar stores collect ridiculous sales tax rates if they do not want residents to flock to online out of state retailers for their goods. Further, state legislatures are forced to compete with other states when it comes to income tax, as an out of state online retailer in a lower income tax state will have a competitive advantage over in state businesses, if instate income tax rates are high. The fact that current internet sales tax policy has positive externalities for taxpayers in other parts of the code is an excellent reason to further oppose the bill.

To end off this analysis, I think it is only fair to address several of the very legitimate concerns that this tax debate has brought up. One such concern is that tax codes should be fair. In that sense, I agree with many people who support the Marketplace Fairness Act: tax policy should attempt to be as fair as possible. But this should also take into account if the entity bearing the tax is using state services, like road systems, local police enforcement, etc. In the case of out of state online businesses, the answer is by and large a resounding no. Even if this is left aside, there is also an inherent problem with advocating only for internet sales tax changes.

If it is to be argued that  the playing field should be leveled between internet and brick and mortar stores, it must also be achieved in all realms of sales taxation. In most states with sales taxes, services, foods, and many other types of items are exempted, for one reason or another, and this is done purposefully. How can policymakers cry out for fairness, if service industries, like hair salons, nail parlors, car repair shops, and others do not get taxed? Many of these services compete with physical goods for people’s money, especially when it comes to leisure. And in all these cases, the government is effectively giving unfair advantage to one type of good over another.

This all goes back to my opinion that it is easier and less transparent to put exemptions into sales taxation than income taxation. It is one of the reasons why I think that an ideal code for any state would use a flat income tax system. Income tax systems, according to some simple microeconomic models, maximize the welfare of the individual the most for the same amount of revenue vis-à-vis a sales tax, because they allow the individual to fully choose how to change consumption to meet the lost income. But that is a story for a different time.

The bottom line is that the Marketplace Fairness Act destroys interstate tax competition, presents a privacy problem, and will result in large dead weight losses. All of these reasons present a more nuanced argument as to why the internet sales tax is misguided fiscal policy.