“Starve the Beast” has become a libertarian policy mantra. The beast they mean is government. But the more wasteful beast is positional spending. (More)

The Darwin Economy, Part II – Starve Which Beast?

This week Morning Feature looks at Cornell professor Robert Frank’s new book, The Darwin Economy: Liberty, Competition, and the Common Good. Yesterday we considered why libertarian arguments for efficient markets misread Adam Smith and ignore Charles Darwin. Today we examine why “starve the beast” is good public policy, if you starve the right beasts. Saturday we’ll conclude with why taxes are the most efficient and least intrusive ways to starve those beasts.

Note: Please welcome Dr. Robert Frank to Blogistan Polytechnic Institute. Dr. Frank is the H. J. Louis Professor of Management and Professor of Economics at the Johnson Graduate School of Management at Cornell University. He has authored or co-authored 11 books, and writes the “Economic View” column for the New York Times. Dr. Frank will join our discussion this week, as his teaching schedule permits. Please check back throughout the day for his comments.

Once upon a coffee machine….

Most of us remember or have heard of the $7,600 coffee maker. It was one of several “government boondoggles” revealed in the 1980s by what is now the Project on Government Oversight. Citizens were outraged, especially as most of us didn’t hear the entire story. Dr. Frank decided to dig a little deeper into the $7,600 coffee maker story, as one of his college classmate works for the company who built it.

Astonishingly, Dr. Frank’s old classmate not only worked there but also helped test the infamous coffee maker. It was built for the Lockheed C-5, a huge troop transport aircraft, and had to be specially designed. The coffee maker had to run on the aircraft’s electrical system, which uses 400Hz alternating current rather than the 60Hz in American homes. The faster cycle allows the electrical components aboard an aircraft to be smaller and lighter, and size and weight are dominant design criteria for aircraft parts. The coffee maker also had to pass military operating conditions testing, which included hard landings, vibration, extreme cabin temperatures, cabin pressure loss, and the like. And the military only bought 120 C-5s, so the design, testing, and production costs had to be recouped in a tiny production run.

In short, it wasn’t a “boondoggle” after all. In fact, much of the so-called “waste” in government spending is a function of similar economic dynamics. Private business snaps at the chance to do a profitable activity, but we citizens need other goods and services where exceptional operating standards and/or the lack of mass production make cost comparisons misleading.

Yes, there is some actual waste in government, but not as much as anti-government activists would have you believe. For decades, candidates have campaigned on promises to cut government waste, and many tried to follow through on those promises. They usually discover there isn’t as much waste as they imagined, and that no system involving human beings will ever be completely waste-free.

Not even private markets.

Twice upon a party….

Your daughter only has one bat mitzvah, and you want it to be special. So of course you book two floors of the Rainbow Room at the top of New York’s Rockefeller Center. Just a small gathering, for her and 150 or so of her closest friends. Music would be nice, so you make arrangements for 50 Cent, Don Henley, Aerosmith, Stevie Nicks, and some other headline musicians. And everyone likes party favors, so the swag bags should have the latest video iPod. You want your daughter and the world to know how much you love her, after all. So $10 million sounds about right for a coming of age party.

Well, okay, maybe you do that if you’re David H. Brooks, the CEO of a major defense contractor. And maybe federal prosecutors charge you with multiple counts of securities fraud, insider training, and other financial crimes that looted the company to sustain your lavish lifestyle.

But you’re not. You’re just a suburban mom whose daughter and her friends have watched MTV’s My Super Sweet 16, and you don’t want your daughter to feel left out. So you spend $12,000 for her birthday party, including invitations, a big tent in the backyard, linen-clothed tables, a dance floor, a band, an ice cream sundae bar, and of course DVDs of the shindig for all the guests. You know it’s hype and peer pressure, but “you do what you do for your kids, even if it means biting your tongue and spending the money.”

Spending cascades

Okay, so you can’t afford that. But you do want your daughter’s Sweet Sixteen Party to be special, so you look around and find a local theme park that offers a deal for birthday parties. Just $25 per person. She wants to invite a dozen or so of her best friends, so that’s about $400, plus gifts. Say, $500 total. You can swing that if you scrimp a little here and put off a bill there.

Congratulations. You’ve just been caught up in a spending cascade. You can’t keep up with high-rolling CEOs. You don’t even know any. But upper management types know CEOs, and the upper managers compete with each other to show who’s nearest the top. Middle managers know the upper managers, and do the same, if on a smaller level. By the time positional spending gets down to your social circle, you’re not looking for $10 million or even $12,000 for that party. You’re just looking for $500. But you still have to scrimp a little here and put off a bill there.

Ahh, you’re wiser than that. You parents warned you about “keeping up with the Joneses,” even if looking back you can see they were keeping up with the Smiths. You won’t repeat that mistake – and you can’t afford to – so you try to teach your daughter to resist peer pressure. Her Sweet Sixteen Party was homemade pizza and a sleepover with DVDs, and she and her six friends had a great time. They even raved about your pizza. Don’t you feel wonderful?

Still, that was a year ago. This year she needs to take her SATs. She’s an honor roll student, but SATs measure test-taking skills as much as they do knowledge. The National Association for College Admission Counseling says test preparation courses only add an average 30 points to a student’s SAT score, but that 30 points may matter. And all of her classmates are taking SAT prep courses. You don’t want her to be 30 points behind just because you were stingy. Those courses cost about $500, but you can swing that if you scrimp a little here and put off a bill there.

Positional spending and waste

But what are you getting for that $500? With all of your daughter’s classmates and students across the country taking SAT prep courses, average SAT scores are going up. And colleges can’t increase enrollment to admit every qualified student. Some college admissions offices are raising their SAT standards, while others are reducing the weight of SATs and focusing more on applicants’ grades in difficult high school courses. So you and hundreds of thousands of other parents spent $500 each on SAT prep courses … to change colleges’ admission policies.

You spent $500 and gained your daughter nothing. But as we saw yesterday, individuals can’t opt out of positional spending. If you hadn’t spent that $500 on the SAT prep course, your daughter would have scored an average 30 points lower. Those 30 points might not have mattered. Or they might have been critical. Are you willing to take that risk?

And that’s why the test preparation industry is booming, taking in an estimated $4 billion a year in 2009. Despite the Great Recession, entrepreneurs are vying to challenge the major test prep firms. All to change colleges admissions’ policies … and make a lot of money for themselves. Call it a “private market boondoggle.”

Once upon a broken window….

“But wait!” a libertarian might argue. “Those test prep firms provide jobs! And they provide social value. If parents don’t buy test prep courses, their children may fall behind and miss out on college!”

Welcome to the broken window fallacy, based on a parable by Frédéric Bastiat. In the parable, a vandal breaks a shopkeeper’s window. The shopkeeper obviously has to replace the window. That’s a paycheck for the town glazier, who now has money to spend, boosting other businesses. Is the vandal really a town hero? Of course not. The money the shopkeeper spent to replace that broken window was money he could have spent on something else. Maybe he’d been saving to expand his shop, which would have meant hiring a new employee. Maybe he was going to take the family out to dinner, which would have been income for the people who work at the restaurant. Instead, the shopkeeper spent the money to repair an unnecessary loss.

In economic terms, there is no difference between spending money to repair an unnecessary loss (a broken window) and positional spending that gains no advantage except to avoid falling behind (an SAT prep course). Both displace spending that would have offered better individual and social benefit.

We need to “starve the beast,” but the beast we need to starve is positional spending. And tomorrow we’ll discuss Dr. Frank’s proposals to do that.

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Happy Friday!