Category Public Policy

It’s Immoral NOT to Spend Money on Infrastructure Now

Danny Vinik 2 Comments

Here’s Mitt Romney on reducing the deficit from the debate last night:

I think it’s not just an economic issue, I think it’s a moral issue. I think it’s, frankly, not moral for my generation to keep spending massively more than we take in, knowing those burdens are going to be passed on to the next generation and they’re going to be paying the interest and the principal all their lives.

And the amount of debt we’re adding, at a trillion a year, is simply not moral.

President Obama didn’t object to this at all and instead demonstrated a commitment to reducing the deficit. They’re both wrong.

We need to spend a lot of money rebuilding our infrastructure across the country – $2 trillion in total. If we put it off, the next generation will have to pay for it. If we do it now, the next generation will have to pay for it too. Our deficits aren’t going down over night and the next generation is inevitable going to either face higher taxes or reduced spending on programs. Either way, the next generation will have to pay to redo our decaying infrastructure. But, they’ll pay less if we do it now.

Here’s why:

We have to repair our infrastructure soon.

Right now, the rate on U.S. Treasuries is really low. So low, in fact, that when you account for inflation, people are actually paying us to keep their money. The current rate for a 1-year Treasury is 0.18%. That means that if you buy a 1-year Treasury at a $100 face value, the U.S. will take the $100 now and pay you $100.18 next year. But that $100.18 really is worth less than that because a year has passed and its purchasing power has decreased because of inflation. The current CPI, the most commonly used measure of inflation, from the Bureau of Labor Statistics is 1.7%. Let’s be generous and call it 1.5%. That $100.18 in 2013 is the equivalent of $98.51 in 2012.

Now, if the U.S. government took $100, held on to it and then gave you back $100.18, that would be dumb. It would lose money there. But, what if the U.S. took that $100 and bought $100 in infrastructure improvements? In a year, those improvements are still worth $100 (2012 dollars). but the government is only paying $98.51 (2012 dollars again). The government just made a profit!

Normally, when the U.S. borrows money, the interest rate is greater than inflation. Imagine if the 1-year Treasury rate was 3%. Now, the U.S. government is paying out $103 in 2013, worth $101.48 in 2012 dollars. In that case, the government loses money.

That’s how the real rate of inflation works. Right now, most U.S. Treasuries have a negative real rate of inflation. In the future, this will almost certainly not be the case. If we delay these infrastructure improvements until the next generation, they will have to pay for them with Treasuries that have a positive real rate of inflation. Instead of profiting on the infrastructure improvements, the next generation will be losing money. But they won’t have a choice. Our roads and bridges will be deteriorating so much that we will have to make those improvements and accept the losses.

By not spending money on infrastructure repairs now, we are making the next generation spend more. That’s what is really immoral. (Image via)

Misaligned Incentives in the Housing Market

Danny Vinik Leave a comment

For one of my classes this semester, I have to write a blog post by 5pm each Sunday on the readings for class. Unfortunately, the blog is private so I can’t just link over to it, but I think my last post is worth re-posting here (my first two posts weren’t as insightful). As I wrote the post, I discovered how truly messed up our system is. In a way, everyone has an incentive to create a bubble in the housing market – until it pops of course. It’s a massive tragedy of the commons. Everyone does what is best for themselves and everyone is hurt in the end. It’s a big reason why we need regulators who’s livelihoods are unrelated to housing market and thus can provide neutral, effective oversight to prevent such a bubble. It’s certainly a very difficult problem and one that we haven’t solved yet.

Here’s the full post:

This week’s articles focused on the sub-prime mortgage crisis and the rampant fraud throughout the mortgage lending industry. For me, this is the most infuriating aspect of the entire crisis – everyone is to blame from lenders to borrowers to the government.

As Binyamin Appelbaum, Lisa Hammersly Munn and Ted Mellnik document in their series “Sold a Nightmare,” and Michael Hudson reveals in his piece on Countrywide Financial Corp., mortgage lenders participated in a number of fraudulent and unethical activities that eventually lead to a huge rise in foreclosures. Borrowers themselves were not blameless either. Many took on loans they knew they could not afford.

However, one aspect of the sub-prime mortgage crisis that has been overlooked is the government’s involvement in it. Here is where we find an incredible number of poorly aligned incentives that significantly contributed to the crisis.

Let’s look at incentives from a general level: Politicians want to be reelected and to attain higher office, and they do so by pleasing their constituencies. What’s one way for them to please their constituencies? Make houses more affordable and available. In fact, this may be the single best way for politicians to make their constituents happy. After all, one of the most crucial aspects of the American Dream is homeownership. Politicians have a huge incentive to promote homeownership.

And across the country, we saw lower less government oversight and a rise in government-insured loans. This, in itself, is not necessarily a bad thing. The problem is once again with incentives. Government-insured loans incentivize lenders to create loans as quick as they can, ignoring borrowers’ income, credit and ability to repay their loans. When the government insures loans, lenders have no default risk on those loans.

Now, certainly, the government was not promoting fraud here. If the program had been successful, more low-income individuals would have received loans, some of whom would have defaulted. The government would have eaten the cost of those defaults but this was the acceptable tradeoff of increased homeownership amongst low-income individuals. Continue reading “Misaligned Incentives in the Housing Market” →

The Effects of Advertising

Danny Vinik Leave a comment

I’m at Logan airport, ready to head back to Duke for my senior year. I’ve been mostly MIA the past two weeks, taking a break after my internship at the Washington Monthly to reboot myself and prepare not just for the upcoming semester, but for all the political chaos surely upcoming as well.

But while I’m at it, I’ll toss in some policy as well: at some airports, I use my Verizon 3G wireless card to access the internet. Not at Logan. It offers free wifi in return for watching a short 15 second advertisement. That sounds like a great deal to me. I didn’t even watch the ad. I was getting my headphones out as it played and when I looked up again, I was connected.

Now, I’m not sure the financials behind the deal but I presume the advertising companies are paying for most of the internet and in return, Logan requires users to watch their ads. I haven’t done any research on how advertisements effect me – I like to thing I ignore them and make rational choices – but those companies have. They have loads of research on the value of advertising and would not have made the deal with Logan unless those ads work. And if they work, then they are distorting users choices. Now, this could be good or bad.

Economic theory stipulates that a rational consumer will always make the optimal, efficient purchase. They have complete knowledge of the product, the competitors’ products and prices. But most of us aren’t rational consumers in that sense. We don’t necessarily research every purchase thoroughly. We don’t check competitors’ prices for most purchases. We just don’t have the time. So maybe the advertiser is helping us out. Maybe it really does have the superior product and its ad is just saving us the research.

But the opposite can also be true: maybe the advertiser is selling the inferior product and “deceives” the consumer into purchasing it (deceives them by distorting the relevant information). Clearly, there is an economic loss here.

But is it offset by the economic benefits of ads from advertisers’ with superior products? If so, then consumers win here. Because if the net costs and benefits are zero, then all that is left is the ad revenue that often goes towards consumers (such as internet in the airport).

And beyond that, companies’ eagerness to spend money on ads does not tell us anything about the net effects of them. In an extreme example, perhaps consumers always purchase an inferior product so companies with the superior product are desperate to advertise their products everywhere. In this situation, those ads help consumers. And, those companies see great net benefit in advertising. So who are the losers here? Well, those companies’ with the inferior products. This is a situation where the more advertising, the better. The fact that the companies’ see a net benefit to advertising is meaningless

What matters is the distortion of those ads: does it lead consumers to make more efficient, economical purchases or not? What about when you include the economic benefits of the ad revenue?

These are important questions as advertisements become more and more prevalent in our day to day lives. For instance, New York City recently announced that it will sell advertisements on metro cards. At first blush, this seems like a great idea. It offers more revenue for the Metro Transit Authority to improve the train. But maybe the ads distort consumers’ choices in a negative manner. If that’s the case, then it isn’t necessarily a great idea. It depends on the benefits those consumers’ receive from the improved metro.

All of this is to say that we don’t fully know. I’m going to go through more research during the next couple of weeks and see what I can find, but it’s important to keep in mind that ads aren’t just annoying (another negative effect that I didn’t mention), they are also an important economic factor in our society.