ECON 571
Public Sector Economics


Contact Information
Dr. Brian Goff/414 Grise Hall
Phone: 745-3855 / Email:
Office Hours:  M/W/F 9-11
(I am in my office or on campus most days for the bulk of the day)

Microeconomics of Public Policy Analysis (Friedman)

Reading Quizzes                          20%
Assignments 1-5                          20%
Midterm Exam                            30%
Empirical Studies                         30%                                                     

(A >= 90%; B= 80-89; C=70-79; D=60-69; F < 60

Reading Quizzes:  Brief short answer or multiple choice quizzes (probably 5 questions) to assess whether you have completed the readings
Assignments 1-5:  Short answer assignments on analytical topics

Last day to drop course with a "W" or change from credit to audit is listed on WKU's Academic Calendar.  Any students requiring special consideration under the provisions of the ADA should register with the ADA Compliance Office first and then consult with me as soon as possible.  If you are not fluent in English or are weak in your writing abilities, you should utilize a writing "consultant" to examine your written reports before turning them in.  The WKU Writing Center is one option.  Undergraduate students willing to offer tutorial services (for a fee or free) are another.

Attendance/Missed Assignments
The combination of students with job responsibilities and a course which only meets once per week can present problems. The policy below attempts to strike a balance of accommodation while maintaining legitimate standards. Under special circumstances and my approval discussed in advance, one assignment may be missed and the other assignments/final weighted more heavily contingent upon my approval of the reason. Failure to complete more than two assignments or absence from more than 2 full sessions (or equivalent) will result in a student being dropped from the course regardless of the reason.


PART I                   Analytical Emphasis

Week 1 (Jan 27)      Admistrative Matters; Basic Policy Models; Uncertainty in Public Policy Models:  The Case of Crime & Punishment (HOPE Program)
                                   Assignment 1 -- Public Policy & Hurricanes

Week 2 (Feb 3)       Impact Analysis Primer:  RIMS II Multipliers (pp. 1-14) ; Kentucky Downs Impact Study
                                  Assignment 2 -- Assessing an Impact Study 

Related:  I-O PPT

Week 3 (Feb 10)    Cost-Benefit Analysis Primer: Minn Fed Cost-Benefit Overview of Recycling
                                     Assignment 3 -- Breaking Down a Cost-Benefit Study
                                   Related Links:  OMB Guidelines ;   Seattle Monorail; Toolbox for Regional Policy);
                                                       PPT on Basics 

Week 4 (Feb 17)    Externalities + Congestion Pricing:  Auctions as a Vehicle to Reduce Airport Delays  
                                  Assignment 4 -- London Congestion Pricing

Week 5 (Feb 24)   Optimal Tax Concepts & Beyond: Econ Encyclopedia SummaryOptimal Taxation Brookings Summary;                                 
                                 Assignment 5 -- The Laffer Curve
 Week 6 (Mar 3)      Debt/Deficit Policy;   "The Needed Quantity of Government Debt" Prescott Minn Fed;
                                     Excel file with Prescott Model;
                                    CMA Sovreign Risk Report Sovreign and State Debt

Week 7 (Mar 10)     SPRING BREAK

Week 8 (Mar 17)     Industry Regulation, Market Definitions, Pricing Power-U.S. District Court Opinion in Whole Foods Case (pp. 23-67)
                                      Natural Monopoly & Industry Regulation  Electricity (Smith Article)  & Drugs (Epstein Article)   
                                      Games & Policy; Summary of Game TheoryPowerPoint on Policy Games             
Week 9 (Mar 24)     Midterm Exam

PART II                  Empirical Emphasis
Week 10 (Mar 31)    Example of Empirical Public Economics:  Role of Presidential Advisors   (forthcoming Public Choice); ADA Scores     

Week 11 (Apr 7)      Student Empirical Studies: Replicating and Improving Fair Presidential & Congressional Voting Models
                                    Replicate Fair Model; Adjust/Amend/Improve in some way(s); turn in i) replication table, ii) improved table, iii) bulleted summary of improvement(s)
                                        Fair Data Through 2008; 2008 Data and Prediction;  

Week 12 (Apr 14)   Example of Empirical Public Economics:  Goff/Tollison on Public Debt  (Selected Data)                                  
Week 13 (Apr 21)     Student Emprical Studies II: State Budget Outcomes or State Bond Ratings
                                     Select topic below; build simple empirical model; turn in i) simple empirical model results, ii) bulleted summary of model/results                                                  
                                         Why are some states in better/worse fiscal condition?       Fiscal Survey of the States    Archive of Fiscal Survey of the States   State Pension Conditions 
                                                                                                                                Budget Processes in the States  ;  Brookings-Urban Inst. Policy Data Center  
                                                                                                                                Archive of State Expenditure Reports  
                                           Why explains differences in state (or national) credit standing?   2008 State Bond Ratings  ;  CMA Sovreign Risk Report

Week 14 (Apr 28)    Example of Empirical Public Economics:  KTRS and Defined Benefit Plan Issues;  Anecdotes on Pension Problem Source
                                     KTRS PublicationsFinancial ReportActuarial Report;   Statistical Report    

Week 15 (May 5)    Student Empirical Studies in Public Policy III;  KTRS Simulation Worksheet 
                                 i)   Examine possible changes in key variables (retirement age, retirement pop, ...) and then present values of of policy changes (retirement eligibility rules, contribution rates, benefit rates)
                                  ii) Examine handling shortfalls through increasing public transfers (sizes of these implied transfers; difference in timing/size of transfers) on state tax burdens
                                     iii) Examine economic environmental variables (wage growth, longer lives, ...) on present values;  can we "grow out" of the problem?

  Miscellaneous Topics
                                 Natural Monopoly & Industry Regulation  Electricity (Smith Article)  & Drugs (Epstein Article)    
                                 Games & Policy; Summary of Game Theory;  PowerPoint on Policy Games
                                 Estimating Regressivity of Consumption Taxes (Ricmond Fed, Winter 2009)
                                 Measuring Output, Cost, & Productivity in Not-for-Profit Settings                               
                                 Rand Study on Higher Ed Productivity  ;    StlFed-HigherEd  Productivity      


Written Assignment 1:  Public Policy for Things Difficult to Insure

Read “Are Hurricanes Uninsurable?” and answer following questions (1-2 pages; use equations, graphics where appropriate and useful)

1.  List the key variables in a simple economic model (equation) of hurricane insurance pricing.


2.  Relate the items in the simple insurance model to the discussion by Jenkins – that is, briefly explain how government policies and actions have distorted key elements of the insurance pricing model. 


2. What aspects do terrorism made and hurricanes share in common that may cause people to question whether they are insurable? 


4. If governmental subsidy is a given, as assumed by Robert Litan, how does Litan suggest to establish the government subsidy to better match the insurance market? 

Written Assignment 2: Impact Study Assessment

Read the Impact Study for a proposed Pittsburgh Casino,  Station Square Casino Study, and answer the following questions (1-2 pp.)

1.  What is the basis of the revenue estimates used in this study, and what are the intial impacts from which multipliers are applied?

2.  What are potential leakages that might impact the size of the initial impacts?  Are these clearly identified in the paper?

3.  What are the basis of the multipliers used in the study and what strengths/weaknesses might they have versus other possible sources?

4.  What additional questions/issues arise regarding this study, particularly with respect to changes over time that may occur?


Written Assignment 3: Breaking Down a Cost-Benefit Analysis

San Marcos C-B Study

1.  Identify and describe the main sources of benefit measured by the author.


2. Identify and describe the main sources of cost measured by the author.


3. From the standpoint of economic theory/practice, what are some weaknesses of the author’s methods?

Written Assignment 4:  Pricing & Policy in London

Victoria Transport Institute
(Also, additional information  Jonathan Leape  full Leape article at   Journal of Economic Perspectives, Fall 2006, pp. 157-176;)

1.  List the key factual features of the London congestion pricing system.


2. Draw a diagram(s) providing economic basis behind the London pricing system.


3. What economic (non-political) complications may arise from implementing a congestion pricing system like this (refer to the airport congestion article for ideas):

4. How was London able to overcome these obstacles and related political objections?


5. What difficulties might arise appear in trying to apply such an idea in Los Angeles or other major American cities that may be different or greater than in the London case?

Written Assignment 5: Laffer Curve Topics

Read  The (Shifty) Laffer Curve   (Govt Spending influenced LC) (Atlanta Fed, 3rd QTR 2000) and answer the following questions

1.  Draw and give and briefly sketch (using equations Prescott's model or simplifications of it) an explanation of the logic behind the Laffer Curve's shape.

2.  What is the key variable(s) influencing the shape of the Laffer discussed in this article.  What equations might this work through in a Prescott-type model?  ?

3.  How might differences in wealth over time or across countries influence the shape of the curve?  (show a graphic and explain your reasoning through parameters in the Prescott model)

4. Searching economic literature, locate up to date estimates of the Laffer curve peak/shape (indicate specifically the sample used to generate these estimates)

Why Do Americans Work more Than Europeans - MinnFed

(Note: this reading includes extensive mathematical expressions; these expressions really just involve algebra.  My intent is not for you to be able to replicate the mathematics but for you to be able to uncover key arguments and logical links within the presentation.)

1.  Which of Prescott’s equation’s pertain to:

a) consumer behavior

b) producer behavior

c)  market equilibria


2. What are the key “parameter” values used by Prescott?


3.  Attempt to give a simple explanation for each of these parameter values.


4. Attempt to make a flowchart type diagram of the ways that an increase in income tax rates work themselves into the choice of labor hours in Prescott’s model

Production Concepts in Not-for-profit Settings

StlFed-HigherEd  Productivity

(Also confer,  RAND – Higher Ed)

1.  What objectives matter in higher education?

2.  Using typical "outputs divided by inputs" measures, what are the main measures by which higher education productivity is considered low?


3.  What objectives may have become more important to higher education (undergraduate) consumers, and as a result important to administrators, over the last 40 years?


4. What adjustments to the basic measures of productivity need to be made to more yield more accurate estimates?

Summarizing an Empirical Study in Public Policy (Worth twice as many points as regular assignment)

Find an article that uses statistical methods to explore a topic in public policy.  Write a 2-3 page report summarizing the article.  In the report
1.  Explain the main question addressed by the article
2.  Summarize the data used (type of data, time frame)
3.  Explain the main statistical results (explain one table/figure at a time).  For example, "In Table 1, the author describes the average values of ...  These values indicate ...  In Table 2, the author presents a regression analysis where .... are used to explain ...  The regression model shows ...". 
4.  Explain the main findings of the article.  Explain the main weaknesses of the study.  Explain questions raised for future study.

Federal Reserve District Bank publications (for example, Federal Reserve Bank of St. Louis Quarterly Review) are a good place to look for studies.  Also, any peer-reviewed journal in economics or public policy is fine.  Below, I have listed some suggested topics with associated links. 

State economic (and other) performance using matched pairs  (e.g. State Growth Comparisons with Matched Pairs )
Presidential voting models
State budget forecasting
State regulatory indexes  Economic Freedom of North America
Federal-State dependence and interactions (Explaining state relative shares) 
Debt & deficits: Sustainability of Federal Deficits;    ;  Explaining Federal Deficits ;
Comparison of practices across states and their effects (line item vetos; non-traditional procedures; earmarking; accounting methods, ...) Chicago Fed;
Basis or impacts of sports subsidies 
-- State Budgets and Medicaid (Chicago Fed)
-- Approved Student Selection
Fiscal Survey of States, National Association of State Budget Directors)
Cost-Benefit Studies
    -- Portland Freeway
    -- Sacramento Transport Improvements
    -- San Marcos (TX) Bridge Overpass
--Bowling Green Minor League Baseball
-- Estimating Willingness to Pay for Non-market activities (e.g. life)
-- Social Security Problems or Solutions
-- Medicare or Solutions
-- Nationalized Health Care  (e.g. Fraser Institute Data)
-- Universal Health Insurance
-- Predicting Presidential Outcomes
-- Stadium Projects
-- Net Cost-Benefit of Government Spending (Track Back Via Marginal Revolution post)

Misc Links
Budgeting  ( Federal Budget Process ; Economic Report of the President; U.S. Budget & Citizen's Guide) State Budgets & Economy; Excel File with State Data)

Pharmaceutical Review -- Epstein Experiment (surgical procedures)

Identifying Policy Effects on Choices

NEA Funding & Charitable Donations (pp. 1-17) FRB

STL Fed – Economics of Charitable Giving

(Note: The FRB reading involves working through a mathematical theoretical model that is likely beyond the ability of most students in the course to develop or fully comprehend.  I do not expect you to be able to replicate the mathematics.  Nonetheless, this assignment is intended for you to make an attempt to understand the arguments developed.  The St. Louis Fed reading provides a very readable introduction to the logic and terms behind the more technical model.)

1.  What is the key question addressed?


2. Write down the equation(s) (and equation numbers) that identify the objectives of consumers/taxpayers and those that identify the direct constraints on their decisions.


3. What are the ways that public policy (NEA Funding) may influence the consumer/taxpayer constraints? 


4. Can you identify the equations that take into account these influences?

5. What are the limits of this model in examining the potential crowding-out effects of NEA?

Written Assignment : Antitrust Policy

District Court Decision: FTC v. Whole Foods (pp. 23-64).

1. List the main features of the FTC’s case that the judge considers.


2. What weakness does the judge highlight in the FTC’s economic reasoning and data support?


3.  Based on our discussion of the problem of “dynamics” in markets, what longer run impacts might not have received due consideration by the FTC?

Written Assignment Week 11: Public Provision & Public(?) Goods

(See Reading Below: “Cities Start Own Efforts to Speed Up Broad Band”)

1.  What are the basic characteristics of a public good – does internet infrastructure appear to meet these characteristics?


2.  Why might the private market fundamentals be different for a large city than a small or medium sized on like Chattanooga? 


3.  What are the economic incentives to construct telecomm networks?  What might the longer term implications of municipalities providing telecomm infrastructure be to network construction?


4.  Consider the earlier piece by Vernon Smith on electrical markets – what is the effect of government regulation that does or does not segment different aspects of the supply chain?


5. How might Coase criticize the approach taken by a local government like Chattanooga or offer an alternative way for the local government to try to improve telecomm infrastructure?

Are Hurricanes Uninsurable?
by Holman Jenkins

It wasn't so long ago that insurers were pronouncing terrorism "uninsurable." But ask any insurer: Aon's Paul Bassett recently noted that the global war on terror had greatly reduced the threat of megaplots on the scale of Sept. 11, 2001.
Yes, suicide bombers and car bombs remain a threat, but not to the industry's capital base. Hurricanes are the new "uninsurable" now.
Here's a complicated story that only begins with warming ocean temperatures thought to justify an expectation of increased hurricanes. One risk modeler, Risk Management Solutions Inc., chucked out 100 years of hurricane data and brought together four climate scientists who probably wouldn't agree about much else but agreed that the next five years would see a higher-than-average number of hurricanes. Presto, a risk model employed by many insurers to set rates suddenly implies a 40% hike for Gulf Coast property owners.
A second factor: More hurricanes meet more people and property. Regionally speaking, Katrina came ashore in a low-rent neighborhood. Florida, a hurricane highway, represents an agglomeration of coastal property worth $2 trillion. New York City and Long Island offer a similar target. The Texas coast represents about $750 billion worth of bowling pins.
These scenic vicinities experienced building booms in the '70s and '80s, when hurricane activity was at low ebb. Beginning in the early 1990s, a series of devastating storms swept through, especially in Florida. Enter factor three: The willingness of the federal government to rush in with rebuilding aid far above even the billions in subsidized flood insurance already provided to coastal homeowners. Coastal development only quickened when it should have slowed.
Upping the ante were 9/11 and Katrina, which demonstrated to high rollers the federal government was incapable of not shelling out infinite sums to ease personal tragedies when bad things happen on a large scale (if you lose your house or loved one in an everyday mishap, of course, you're still on your own).
As anyone might have predicted, this dynamic is now unraveling the insurance industry's ability to help society control its risk-taking by properly pricing risk. Lloyd's Julian James put it this way late last year: "It seems to me that with $400,000 per family [paid out in the wake of the terrorist attacks and Katrina], if the government hands out checks, do people need insurance?"
In olden times, robber barons built their seaside mansions a safe distance from the ocean. Today's yuppies build their palaces right on the beach: FEMA reckons that a quarter of coastal dwellings will be destroyed in the next half century. The solution seems obvious: Restore the incentive for yuppies to behave responsibly like the robber barons.
This assumes two things: Insurers would have to be free to charge realistic rates, which is problematic given that rates in most states are approved by elected or appointed insurance commissioners, most of whom have their eyes on higher office.
It also assumes state courts will uphold insurance contracts -- a principle being tested in Mississippi, where Attorney General Jim Hood likens insurers to "Nazis in lockstep" and is pursuing civil and criminal complaints against them for refusing to pay for flood damage explicitly not covered in the policies they sold to homeowners.
The riskiest assumption of all is that property owners would be willing to pay "actuarially sound" rates rather than just skipping insurance and relying on a federal bailout in the wake of a big storm. Here's the real crux of the claim by some industry watchers that hurricanes have become effectively uninsurable.
In this camp is Robert Litan, a Brookings Institution economist who says bailouts have become politically mandatory and property owners expect them. So the only rational course now is to fund them in advance, with taxes borne mainly by those who benefit. Coming to a similar conclusion is Allstate CEO Ed Liddy, a one-man band who's been trying to drum up enthusiasm for a federal disaster insurance program.
He was a voice alone but lately has acquired allies in the form of State Farm and a few others. Mr. Liddy lays out an approach that, he claims, would tap all business and property owners in Florida who presumably benefit from coastal development even if their own property is inland. Folks in Peoria and Dubuque wouldn't be milked, as they are now, to subsidize the lifestyle of beach dwellers.
He also says his plan would mandate realistic insurance rates and impose damage mitigation measures to reduce the cost of hurricanes and discourage high-risk development.
Don't hold your breath for this part. Federal flood insurance was instituted in 1968 with the same good intentions -- to make property owners bear the cost of their own recurrent bailouts. Instead it became a subsidy to increased risk-taking. That program today is $21 billion in the hole, its shortfalls financed by taxpayers in Peoria and Dubuque.
Where's Al Gore when you need him? Mr. Liddy's plan may be a defensible concession to political realities, i.e., the inevitability of the federal government continuing to pay people to rebuild what storms knock down (see New Orleans). But it also makes an undesirable peace with over-development of coastal areas. The harder road of imposing market insurance rates on coastal property owners and ending taxpayer handouts would mean a lot of coastal development would come to a halt -- as it should.
In any case, all agree the debate won't be settled in an election year, and probably not until another hurricane forces the country to face up to how the rest of us have been taxed again and again to subsidize the high-risk lifestyles of those who plant themselves in the paths of hurricanes.

Efficient Markets
The Welfare of American Investors

Behavioral finance, a developing field of academic research that emphasizes investor irrationality (and ignorance) and the inefficiency of markets, has been hailed by defenders of the SEC as offering a solid economic rationalization for our vast scheme of federal securities regulations. Even apart from the obvious implications for the regulatory system of ignorance and irrationality on the part of regulators, a closer examination of the logic of behavioral finance leaves little for the pro-regulation crowd to crow about.
Initially, behavioral finance emerged as an academic antidote to a claim of substantial market perfection in the finance field, the well-known "efficient market" theory of stock prices. Numerous "anomalies" or irrationalities were discovered in the market for securities, such as various kinds of over- or under-reactions to new information, herding behavior, endowment effects, January effects, weekend effects, small-firm or distressed-firm effects, bubbles and crashes -- to name a few.
Faulty Data
Most of these alleged peculiarities proved in time to be far less anomalous than was first thought. The data on which they were based were often faulty, or the econometric models were measuring the wrong thing, or various kinds of relevant transactions costs were ignored. The effects of irrational or uninformed behavior were often canceled out by opposite forces, and much of it was simply irrelevant. Furthermore, the behavioralists did not -- and do not -- have a general theory that can explain why financial markets work as well as they do. Some close approximation of the efficient market theory is still the most accurate and useful model of the stock market that we have.
Still, some of the behavioralists' criticisms stuck, especially in regard to crashes and bubbles, events that arguably should not occur in perfectly efficient markets. In this connection the efficient market theorists had no choice but to reexamine and refine their own models, which they have now done with some success. Perhaps the most important behavioralist contribution to economics has been their reminder that the market-model claim of rationality often does not comport with actual human behavior.
Economists frequently failed to qualify economic pronouncements as being limited in application to aggregate behavior. Too many assumed that if markets in the aggregate behave rationally, it must be because the "marginal" participant -- the trader who has the correct information about what a price should be -- was himself a perfectly rational maximizer. This better-informed and rational trader would always arbitrage away any discrepancies from efficiency that a market displayed.
But there is a vast difference between economics and psychology, and we can thank the behavioralists for forcing economics back into its correct posture of dealing with aggregate behavior. We can also thank the behavioralists for demonstrating that the marginal trader/arbitrage theory cannot explain all price formation, since we have no way, a priori, of knowing that this hypothetical individual will be rational. Nor can we any longer assume that the arbitrageur (apart from a purchaser of 100% of the securities of a given company) will have all the information necessary to set the correct price.
That discovery left a serious gap in economic theory. The efficient market mavens were indeed correct in their conclusions about aggregate market behavior -- but how could they explain this near perfection of functioning markets while irrational and less-than-fully informed individuals (so-called "noise" traders) were known to abound?
Traditional economics did contain the start of an answer to this question, most notably in F.A. Hayek's classic "The Use of Knowledge in Society" (1945). There, Hayek (addressing the then-pressing problem of countering socialist doctrine) made the astute observation that centralized or socialist planning can never be economically efficient because it was impossible for a central planner to accumulate all the information needed for correct economic decisions ("correct" in the sense of displaying efficient market allocations of goods). The critical information, he noted, is too scattered in bits and pieces throughout the population ever to be assembled in one person's mind (or computer). Diffused markets, on the other hand, function well because the totality of relevant information, even subjective preferences, can be aggregated through the price mechanism into a correct market valuation.
This insight of Hayek's has been a mainstay of market theory ever since it was advanced, but it remains merely an observation and a conclusion. It does not detail how new information gets so effectively impacted into the prices of goods and services. In other words, how does this "weighted averaging" get done? And why should we assume that the impact of rational participants would dominate that of irrational ones in markets?
Similarly, the efficient market theory was based almost entirely on empirical observations and did not offer a theory of how the market came to be so efficient. Subsequent literature examined the mechanisms of market efficiency (including insider trading), but these were again observational and descriptive works that did not even recognize the absence of a good theory of how new information gets properly integrated into a price. The implicit and often explicit theory of price formation was always the "arbitrage" notion, with the marginal trader calling the shots.
Enter now financial journalist James Suroweicki and his charming and insightful book, "The Wisdom of Crowds" (2004). The book opens with the story of a contest at a county fair in England in 1906 to guess the weight of an ox on display after slaughter and dressing. There were about 800 guesses entered in the contest both by knowledgeable people and by those who had no expertise in such matters. We are not told what the winning guess was, but we are told that the average of all the guesses (1,197 pounds) was virtually identical to the actual weight (1,198 pounds).
Similar results show up regularly in the relatively new use of so-called "prediction" or "virtual" markets, primarily employed today in predicting outcomes of political elections, sporting events, new product introductions or new movies. Though there are still some problems with the technique, these "markets" have proved in the main to be much more accurate than traditional interview polls. And these various illustrations of the wisdom of crowds suggest a solution to the problem of how correct prices are formed in financial markets beset by irrational and poorly informed traders.
* * *
Weighted-average results are similar to "correct prices," since informed investors can be assumed to invest more money if their confidence in the validity of their information -- or the intensity of their desire for the product -- is higher, thus imparting a weighted average element to each price. And while the actual weight of an ox is a more objective measure than the "correct" price of a security, the main difference may be between a static and a dynamic figure with the "correct price" of a stock being a kind of moving target.
The literature on prediction markets makes clear that the more participants in a contest and the better informed they are, the more likely is the weighted average of their guesses to be the correct one. That is true, ironically, even though the additional participants have even less knowledge than the earlier ones. The only requirements for these markets to work well are that the various traders be diverse and that their judgments be independent of one another. Clearly, there is still a lot more work of a statistical and mathematical nature to be done before the idea of the wisdom of crowds is turned into a full-fledged theory of price formation, but at least we have identified the problem and made a start towards a solution.
'Wisdom of Crowds'
The implications of what we already know of this "wisdom of crowds" approach to price formation, as against the traditional marginal pricing/arbitrage approach, are apt to be startling. We should rethink any current policies based on a view of pricing in which we exclude the best-informed traders and discard the wisdom of the many. For instance, we now have a new and more powerful argument than we had in the past for legalizing most insider or informed trading.
Since such trading clearly makes the market process work more efficiently, it aids capital allocation decisions and informs business executives through market-price feedback of the best predictions about the value of new plans. Furthermore, the Supreme Court's "fraud on the market" theory of civil liability under the federal securities laws and Congress's ideas of correct civil damage claims for insider trading no longer have any intellectual merit. The same is true of any other part of our securities laws implicitly based on the notion of the marginal trader as a rational arbitrageur of price.
The new approach would suggest that it is undesirable to have laws discouraging stock trading by anyone who has any knowledge relevant to the valuation of a security. Thus, assembly-line workers, administrative assistants, office boys, accountants, lawyers, salespeople, competitors, financial analysts and, of course, corporate executives (government officials are another story) should all be encouraged to buy or sell stocks based on any new information they might have. Only those privately enjoined by contract or other legal duty from trading should be excluded. The "wisdom of crowds" can do far more for the welfare of American investors than all the mandated disclosures and insider trading laws that the SEC and Congress can think up.
Mr. Manne, a resident of Naples, Fla., is dean emeritus of George Mason University School of Law. This is the first of a two-part series.

Power to the People

Telecom deregulation has been judged successful. Long-distance rates have declined and innovation has dramatically improved service. The deregulation of natural gas, airlines, trucking and the railroads during the Carter and Reagan administrations are successful experiments in institutional change. But restructuring electricity has a tarnished image, and many hold that market liberalization was a mistake.

The wholesale market has been volatile when seasonal energy supplies are tight. California served up an economic disaster when growth in demand and hot weather coincided with low water in the Pacific Northwest reservoirs that would have strained the old regulated regime. Finally, the Midwest-Eastern blackout happened, two years ago this Sunday.

Why? Is it because electricity cannot be stored for peak demand? Is electricity inherently different from the other targets of reform, and impervious to liberalization? Is it an aging and inadequate transmission grid?

It is none of the above. Hotel and transportation accommodations also cannot be stored, but competition in these industries has led firms to discover ways to dynamically price their products to respond efficiently to variations in daily, weekly or seasonal demand. Every industry is different, and this requires attention to the details of how they are restructured for governance by market property-right rules. And finally, the grid is inadequate only if you are wedded to the belief that it must never be bypassed by local energy sources or conservation from peak pricing to relieve congestion.
* * *
Many foreign countries -- the U.K., Chile, Australia and New Zealand -- have managed to liberalize electricity systems. There are no regrets in spite of mistakes, backsliding and learning bumps. Liberalization occurred because both U.S.-style regulation and foreign nationalization programs were judged serious failures.

From the beginning many foreign countries saw that restructuring must honor the technical difference between the wires business and the energy business. They severed that long enforced tie-in sale of energy with the wires monopoly, and alternative energy suppliers were allowed entry to compete with the distributors. In the U.S., we made the costly error of not embracing upfront the principle that the local monopoly wires business must be distinct and separate from the sale and provision of energy to retail accounts. Only in this way can you hope to see retail energy competition, and the unleashing of a trial-and-error discovery process in which firms search for the best means of matching dynamic pricing and monitoring technologies with consumer preferences.

Although some countries made the right decision, the devil is in the details, and we have all learned that implementing it successfully has not been easy. In New Zealand, exclusive energy-supply obligations were incrementally removed from the existing local wires companies to permit free entry of competitors, but in practice, entry penetration was agonizingly slow. It is not too hard to see why: The local wires companies, still supplying energy, are not motivated to make it easy for an entrant to compete away their customer accounts. To implement their menu of technologies, entrants must gain access to household wires -- historically accessed only by the distributor -- to install the switching or metering devices preferred by individual customers, and accounts must be transferred from the incumbent distributor to the new merchant supplier. The distributors have incentive to resist, delay and impede customer changeover.

At home we have attempted to deregulate the provision of energy to retail customers by altering the regulation of local utilities to distinguish competitive (energy) components of the rate structure from noncompetitive (wires infrastructure) components, and to apply new rules for allocating costs to each. But there are complaints by retail energy suppliers that the wires companies and their regulators have used creative accounting to shift energy costs to the regulated price of wires in order to undercut energy competitors without sacrificing overall profit.

The Federal Energy Regulatory Commission got it right at wholesale level: They moved to require generation companies to be separated from the transmission grid. They understood that you cannot have a competitive wholesale market if generators also own transmission. This would allow energy production to be combined with the more limited contestability of the transmission grid and unnecessarily restrain energy competition in the wholesale market.

So why don't we just extend the FERC principle to the local wires and energy purchased by retail customers? The political and regulatory structure stands in the way. It would infringe states rights: FERC has jurisdiction over the interstate energy transmission system, but no authority over the local wires or retail energy competition on those wires. Each state long ago granted a franchised local monopoly to your utility company. This legally restricted service to one set of wires, but implicitly was interpreted to mean that each utility could tie customer purchases of energy to the rental of the wires -- a right they are loath to give up.
In the deregulation of telephones we had a preview of how a wires legal monopoly can be used to impede local competition in the use of the wires. Recall the time when no one except a serviceman from Ma Bell was allowed in your house to service the wires, and you were not permitted to install phones that had not been produced by Bell. The industry argument was that the "integrity and quality of the network" needed to be protected, but this was just an excuse for limiting competition for products and services that were separable from the regulated activity. This also impeded innovation, an unseen cost of limiting choice and entry.

The failure to liberalize the provision of retail energy is the fundamental reason that there has been so little technical innovation in the local distribution of energy to the end-use customers. The electronic age of switching, metering and monitoring has found little application between the end-use customer and the energy supply system. The dead hand of historical cost pricing is hostile to innovation. Without the free entry/exit trial-and-error discovery process there is no way to know how technology, pricing and differential customer preferences can be matched.

No state has yet tried a mandate to separate electricity from the wires monopoly to allow competition in energy sales. In the natural gas industry, however, one state has separated the customer's commodity purchases from the utility's delivery system. Georgia voted to separate the local pipes business from the sale of the natural gas that comes through the pipes. The rental rate for the pipes continues to be regulated as a monopoly, but there are now a dozen competing companies that supply the end-use customer with gas: Each pumps gas vapor into the distribution pool in response to its customers' decisions to burn gas. The gas is metered at the household and the company bills only its own customers.

The same model applied to electricity could yield great benefits since over half of total retail cost is the energy component and that is likely to grow.
Since peaking energy is much more costly to produce than base-load off-peak energy, competition would be expected to lower off-peak prices and raise peak energy prices to reflect their differential costs. But peak-energy pricing is only part of the story. The capacity of the grid is determined entirely by peak-energy demand. Reduce peak consumption and you relieve transmission congestion and increase reliability and security. Hence, regulatory reform needs to address how we price the wires infrastructure.

Suppose half the wires capacity cost is due to only six hours of peak demand -- the peak capacity being idle for 18 hours. Then those consuming power during one-quarter of the day should be charged for half of the capital cost of the wires. Such pricing is not only "fair," it conveys the right incentives for capital utilization. This principle is why hotel rates are so much higher at seasonal peaks. It's the peak renters that have required investors to build all the extra room capacity. Off-season renters are not the ones straining capacity and are charged less.
Competition naturally discovers this and prices reflect the opportunity cost of new capacity, not the irrelevant historical cost of the infrastructure.

It could pay a high-rise office-building owner to install a gas micro turbine for peaking energy, or install motion-sensitive light switches in all the offices, if in addition to the energy savings he could get a wires-charge rebate due to his reduced dependence on the grid which would accommodate growth without new investment. The fact that he cannot benefit tells you how regulation blocks innovation. We badly need changes in the local regulation of the wires that reward customers if they reduce their dependence on the grid. As for retail energy prices, why regulate them at all? Is there a state out there willing to mandate separation of the wires monopoly from energy provision, and allow free entry by retail energy merchants?
Mr. Smith, a professor at George Mason and the Rasmuson Chair at the University of Alaska, Anchorage, is a 2002 Nobel laureate in economics.

Cities Start Own Efforts
To Speed Up Broadband

CHATTANOOGA, Tenn. -- Internet traffic is growing faster than at any time since the boom of the late-1990s. Places like Chattanooga are trying hard not to get stuck in the slow lane.
Some 60 towns and small cities, including Bristol, Va., Barnsville, Minn., and Sallisaw, Okla., have built state-of-the-art fiber networks, capable of speeds many times faster than most existing connections from cable and telecom companies. An additional two dozen municipalities, including Chattanooga, have launched or are considering similar initiatives.
The efforts highlight a battle over Internet policy in the U.S. Once the undisputed leader in the technological revolution, the U.S. now lags a growing number of countries in the speed, cost and availability of high-speed Internet. While cable and telecom companies are spending billions to upgrade their service, they're focusing their efforts mostly on larger U.S. cities for now.
Smaller ones such as Chattanooga say they need to fill the vacuum themselves or risk falling further behind and losing highly-paid jobs. Chattanooga's city-owned electric utility began offering ultrafast Internet service to downtown business customers five years ago. Now it plans to roll out a fiber network to deliver TV, high-speed Internet and phone service to some 170,000 customers. The city has no choice but to foot the bill itself for a high-speed network -- expected to cost $230 million -- if it wants to remain competitive in today's global economy, says Harold DePriest, the utility's chief executive officer.
It's a risky bet. Some municipal Internet efforts, including wireless projects known as Wi-Fi, have failed in recent months. EarthLink Inc. confirmed last week it was pulling the plug on its wireless partnership with Philadelphia. A number of towns have abandoned a municipal fiber initiative in Utah, called Utopia, amid financial difficulties.
The latest efforts have aroused intense opposition from private-sector providers. Cable and telecom companies have successfully lobbied 15 state legislatures to pass laws preventing municipalities from entering the broadband business. Comcast Corp., Cox Communications Inc. and other cable and telecom providers have also filed lawsuits against existing projects, arguing they're an improper use of taxpayer money and amount to unfair competition. In Chattanooga, Comcast sued the city's utility late last month in Hamilton County Chancery Court.
"They don't know what they're getting into," says Stacey Briggs, the director of the trade group Tennessee Cable Telecommunications Association, of Chattanooga's plan. She says the utility has underestimated the costs involved, among other things.
Mr. DePriest counters that the suit is just a stall tactic: "So long as they can delay us they can hold on to their customers."
Such disputes take on greater significance as the Internet enters a new phase of explosive growth, much of it driven by user-generated video and images. More network and cable TV shows are also being shown online, and Web-enabled cellphones are bringing the Internet to new users in places like Africa.
According to a recent report by Cisco Systems Inc., total annual Internet traffic will quadruple by 2011, reaching a size of more than 342 exabytes (one exabyte is the equivalent of one trillion books of about 400 pages each).
Global Comparison
In the U.S., where most of the critical infrastructure that led to the creation of the Internet originated, questions persist about how well-positioned the country is today. South Korea, for example, now generates about the same amount of Internet traffic as the U.S., with just one-sixth the population.
In terms of adoption, or the percentage of households using broadband, the U.S. ranks 10th out of the 30 leading industrialized countries that are members of the Organization of Economic Cooperation and Development, a Paris-based research and policy group. The U.S. was among the leaders in this category at the beginning of the decade. The U.S. fares only slightly better in affordability, ranking 11th most affordable, behind countries such as Italy and Norway.
The U.S. has fallen behind in speed, too. In the same study, conducted by the Information Technology and Innovation Foundation, a nonpartisan think tank, the U.S. ranked 15th in the average advertised download speed, at 4.9 megabits a second. That's slower than the 17.6 megabits a second in France and the 63.6 megabits a second in Japan, which ranks No. 1 in this category. In other words, it takes a little over two minutes to download a movie on iTunes in Japan, compared with almost half an hour in the U.S. The average U.S. download speed is even slower, according to other estimates.
Chattanooga's Mr. DePriest compares his agency's plan for high-speed Internet to the rollout of electricity, which came to many parts of Tennessee only in the 1930s as a result of the creation by the federal government of the Tennessee Valley Authority. That was three decades after many businesses and homes in major urban areas like New York were first electrified.
The country's electricity at the time was largely provided by private companies, which denounced any government efforts to get into the business as "socialist" -- echoing the debate over municipal fiber networks today. Against this opposition, many public utilities, including Chattanooga's Electric Power Board, or EPB, were formed to help bring electricity to their towns and surrounding countryside.
Electricity, of course, would later be used for many home appliances that didn't exist at the time, from refrigerators and stereos to televisions and computers. Similarly, bringing fiber to the home is "not about what services are available now in the market, but about things that haven't even been invented yet," says Katie Espeseth, head of the Chattanooga fiber project.
City in Decline
The EPB views the fiber effort as central to the revival of a city long in decline. In 1969, Walter Cronkite announced on the CBS Evening News that Chattanooga had America's dirtiest air. The decline of passenger rail traffic and the local iron industry was followed by massive unemployment, the abandonment of downtown and soaring crime.
Today, after more than a billion dollars of investment, the city's downtown is coming back to life. While some factory buildings remain abandoned, others are being filled by high-tech start-ups, and by a handful of restaurants, coffee shops and galleries that cater to their young employees.
In a converted saddle factory here, Jonathan Bragdon, 38 years old, runs a 40-person company that he says couldn't exist without a lot of affordable Internet bandwidth. Seven of his employees live and work in other cities, including New York and Leeds, England. His business, called Tricycle Inc., transmits high-resolution 3-D simulations of carpeting to interior designers.
More important than download speed for such work is upload speed. Yet, on most connections it often takes longer to upload files to the Internet than it does to download them from the Internet. With Comcast, Mr. Bragdon was getting a download speed of eight megabits a second, but an upload speed of only one megabit a second.
About two years ago, Tricycle switched to the EPB's fiber network. Mr. Bragdon says that lowered his costs several-fold and gave him the flexibility to upgrade to speeds as fast as 100 megabits a second. "With the rivers and the mountains, young people want to live here," says Mr. Bragdon. "But you need good bandwidth to work here."
A Comcast spokeswoman says the company recently increased its speeds for small businesses to 16 megabits a second in many markets, including in Chattanooga, and upload speeds to two megabits.
Critics of the notion that Internet service in the U.S. is falling behind other countries say gaps stem from cultural and political differences. More than half the citizens of South Korea, for example, live in multitenant buildings of at least 50 units concentrated in large cities, making it easier and cheaper to connect people there, according to a report this month from the Information Technology and Innovation Foundation. In the U.S., by contrast, most people live in single-family homes.
Other countries, such as France, have benefited from increased competition by governments forcing their former telecom monopolies to open their networks to new providers. In the U.S., the regional successors to the former Ma Bell resisted such regulatory efforts, arguing it made little sense for them to invest in their networks if forced to share them with potential competitors.
As a result, in most markets in the U.S. there have been only two broadband providers, one telecom and one cable company. While some countries were aggressively trying to catch up to the U.S. Internet lead, "not much changed in the U.S.," says Susan Crawford, a professor of Internet governance at the Benjamin N. Cardozo School of Law in New York.
Change is finally starting to happen, as cable and telecom companies compete more aggressively in each other's traditional businesses. Bills are now making their way through Congress to remove the state barriers to municipalities offering broadband. And the Federal Communications Commission recently revamped its definition of broadband, which had been just 200 kilobits a second, to bring it more up-to-date. It now includes several tiers of speeds, starting at 768 kilobits per second.
Verizon Communications Inc. is in the midst of a $23 billion project, called FiOS, to bring fiber to the homes of more than half of its 33 million customers in 28 states by 2010. Comcast last month began boosting speeds on its network, and estimates 20% of its customers will have access to faster speeds by the end of the year.
Still, these ultrafast networks are destined only for certain parts of the country, such as major urban areas, at least for the foreseeable future. In large swaths of the U.S., particularly second- and third-tier cities and towns with more dispersed populations, providers consider deploying broadband less profitable.
In downtown Chattanooga, James Busch, a 37-year-old radiologist and medical-software entrepreneur, says when he opened his business, he couldn't find an Internet service that was fast enough. Comcast's plan was too slow and AT&T said it would take three months to build a dedicated higher-speed connection to his business, says Mr. Busch. AT&T says it now offers small businesses a download speed of six megabits a second, and upload of 512 kilobits a second.
Mr. Busch's clinic, located in a strip mall, consists of 10 radiologists who provide remote diagnoses for rural hospitals that can't afford their own radiologists. Transmitting the high-resolution medical imagery often requires a very fast speed, which he says the EPB network now provides him.
Losing the Advantage
"Information technology means a smaller country with fewer people can now do the same amount of work as a larger country," says Mr. Busch. "If we don't become more efficient, we lose our big-country advantage."
Late last month, the EPB raised $219 million through municipal bonds, which it says will primarily be used to upgrade its existing electrical system. The upgrade will involve laying a fiber network to create a so-called smart grid, which will allow the utility to remotely monitor and control how power is distributed, says Mr. DePriest. He acknowledges that once the fiber is laid it can be used to deliver TV, Internet and phone service, but says that is a separate venture altogether, and one which will require an additional $60 million to get off the ground.
In its lawsuit, Comcast argues the grid isn't Chattanooga's primary objective. It says the real goal of last month's bond issue was to bring Internet and other services to residents. If the utility fails to meet payments on the new debt, ratepayers would be stuck with the tab, says Comcast. "We believe the plans constitute a cross subsidy prohibited by Tennessee state law," says a Comcast spokeswoman. "Our intention is to ensure...that Comcast be allowed to compete in a fair environment.
Mr. DePriest remains undeterred. He expects to have most of the smart-grid network completed within three years, serving 80% of the city. "The issue is, does our community control our own fate," says Mr. DePriest. "Or does someone else control it?"

New Wave of Nuclear Plants Faces High Costs

A new generation of nuclear power plants is on the drawing boards in the U.S., but the projected cost is causing some sticker shock: $5 billion to $12 billion a plant, double to quadruple earlier rough estimates.
NRG Energy Inc. hopes to add two units to the South Texas Project nuclear site.
Nuclear power is regaining favor as an alternative to other sources of power generation, such as coal-fired plants, which have fallen out of favor because they are major polluters. But the high cost could lead to sharply higher electricity bills for consumers and inevitably reignite debate about the nuclear industry's suitability to meet growing energy needs.
Nuclear plants haven't been built in meaningful numbers in the U.S. since the 1980s. Part of the cost escalation is bad luck. Plants are being proposed in a period of skyrocketing costs for commodities such as cement, steel and copper; amid a growing shortage of skilled labor; and against the backdrop of a shrunken supplier network for the industry.
The price escalation is sobering because the industry and regulators have worked hard to make development more efficient, in hopes of eliminating problems that in the past produced harrowing cost overruns. The Nuclear Regulatory Commission, for example, has created a streamlined licensing process to make timelier, more comprehensive decisions about proposals. Nuclear vendors have developed standardized designs for plants to reduce construction and operating costs. And utility executives, with years of operating experience behind them, are more astute buyers.
Now, 104 nuclear reactors are operating in the U.S. Most are highly profitable but that was not the case until fairly recently. For the 75 units built between 1966 and 1986, the average cost was $3 billion or triple early estimates, according to the Congressional Budget Office. Many plants operate profitably now because they were sold to current operators for less than their actual cost.
The latest projections follow months of tough negotiations between utility companies and key suppliers, and suggest efforts to control costs are proving elusive. Estimates released in recent weeks by experienced nuclear operators -- NRG Energy Inc., Progress Energy Inc., Exelon Corp., Southern Co. and FPL Group Inc. -- "have blown by our highest estimate" of costs computed just eight months ago, said Jim Hempstead, a senior credit officer at Moody's Investors Service credit-rating agency in New York.
Moody's worries that continued cost increases, even if partially offset by billions of dollars worth of federal subsidies, could weaken companies and expose consumers to high energy costs.
On May 7, Georgia Power Co., a unit of Atlanta-based Southern, said it expects to spend $6.4 billion for a 45.7% interest in two new reactors proposed for the Vogtle nuclear plant site near Augusta, Ga. Utility officials declined to disclose total costs. A typical Georgia Power household could expect to see its power bill go up by $144 annually to pay for the plants after 2018, the utility said.
Bill Edge, spokesman for the Georgia Public Service Commission, said Georgia "will look at what's best for ratepayers" and could pull support if costs balloon to frightening heights. The existing Vogtle plant, put into service in the late 1980s, cost more than 10 times its original estimate, roughly $4.5 billion for each of two reactors.
FPL Group, Juno Beach, Fla., estimates it will cost $6 billion to $9 billion to build each of two reactors at its Turkey Point nuclear site in southeast Florida. It has picked a reactor design by Westinghouse Electric Co., a unit of Toshiba Corp., after concluding it could cost as much as $12 billion to build plants with reactors designed by General Electric Co. The joint venture GE Hitachi Nuclear Energy said it hasn't seen FPL's calculations but is confident its units "are cost-competitive compared with other nuclear designs."
Exelon, the nation's biggest nuclear operator, is considering building two reactors on an undeveloped site in Texas, and said the cost could be $5 billion to $6.5 billion each. The plants would be operated as "merchant" plants and thus would not have utility customers on the hook to pay for them, as is the case in both Florida and Georgia. Instead, they would have to cover expenses through wholesale power sales.
Several things could derail new development plans. Excessive cost is one. A second is the development of rival technologies that could again make nuclear plants look like white elephants. A drop in prices for coal and natural gas, now very expensive, also could make nuclear plants less attractive. On the other hand, if Congress decides to tax greenhouse-gas emissions, that could make electricity from nuclear plants more attractive by raising costs for generators that burn fossil fuels. Nuclear plants wouldn't have to pay the charges because they aren't emitters.
Some states are clearing a path for nuclear-power development, even before costs are fully known. They are inspired by a growing fear of climate change. "The overwhelming feeling in Florida is that nuclear power is popular and that's why it's going to go ahead," said J.R. Kelly, head of the Office of Public Counsel in Tallahassee, which represents consumers. "Our main concern is the tremendous cost."
In Florida, state officials are allowing utilities to collect money from customers to cover development and construction costs. In the past, regulators typically required utilities to bear the costs until plants were finished.
Many utilities said they are watching with interest. Ralph Izzo, chief executive of Public Service Enterprise Group Inc. in New Jersey, said his company may not be big enough to build a nuclear plant, even though it is a nuclear operator. "We're concerned by the rise in construction costs," he said.

Markets for the Poor in Mexico
June 30, 2008
Helping the poor may be virtuous, but when the poverty industry starts losing "clients" because the market is performing good works, watch out.
Compartamos Banco knows what it's like to have a tarnished halo. The Mexican bank specializes in microfinancing for low-income entrepreneurs in a country that never used to have a financial industry serving the poor. Compartamos not only figured out how to meet the needs of this excluded population, but also how to make money at it.

Capitalism is bringing financial services to the poor in Mexico. But will nonprofit groups allow it? The Americas columnist Mary Anastasia O'Grady speaks with James Freeman. (June 30)
As a result, the bank has been growing fast. With an average loan size of only $450, it now has more than 900,000 clients – 15 times as many as it had in 2000.
This strong growth suggests that the bank's for-profit model makes both borrowers and lenders better off. Yet the triumph is not good news for everyone. In the economic sector that Compartamos serves – those making about $10 a day – the international charity brigade is at risk of becoming obsolete. Perhaps this explains why people who make their living giving away other people's money are badmouthing Compartamos for the vulgar practice of earning "too much" profit.
Lending to microenterprises took off some years ago as economists recognized that the poor, just like the middle class, can make productive use of credit. The most famous microfinancier is Muhammad Yunus, founder of the Grameen Bank and winner of the 2006 Nobel Peace Prize.
Compartamos got its start in southern Mexico in 1990 as a nonprofit providing working capital to small businesspeople like food preparers, vendors and handicraft producers. Its funds initially came from private-sector charity and governments, and its clients were – and still are – largely female. This group is often illiterate but it is also entrepreneurial and, as it turns out, a very good credit risk. In lieu of collateral, the bank typically accepts the credit of a group of entrepreneurs who effectively co-sign for a peer.
Compartamos Banco makes money and so do its clients.
After 10 years, Compartamos was financing 60,000 microborrowers. But it recognized that the need for its service was much greater. In 2000, to raise new capital, it formed a for-profit company to utilize private-sector capital as well as loans and grants from government agencies and charities. In 2002, it issued $70 million in debt, and four years later its client base had grown to more than 600,000.
By 2006, bankers in the developing world who had traditionally ignored the "C" and "D" economic classes – with "A" being the wealthiest and "E" being the poorest – began to realize that lending to lower-income entrepreneurs is good business. One reason for the change was that computer software advances enabled banks to handle small accounts more efficiently.
What was once written off as an unviable market became a hot opportunity, and Compartamos was well positioned to capitalize on it in Mexico. Last year the company launched an initial public offering that was oversubscribed 13 times. That's when the do-gooders stepped in to question the company's ethics.
In a commentary published last June on the Compartamos IPO, Richard Rosenberg, a consultant for the Consultative Group to Assist the Poor – not part of the World Bank but housed on its premises – observes that the demand for shares in the company was driven, in part, by "exceptional growth and profitability." He then ruminates for some 16 pages on whether Compartamos's for-profit model is at odds with the goal of lifting the poor. A similar, though far less rigorous, challenge to Compartamos titled "Microloan Sharks" appears in the summer issue of the Stanford Social Innovation Review.
Get the latest information in Spanish from The Wall Street Journal's Americas page.
In his "reflections" on "microfinance interest rates and profits," Mr. Rosenberg writes that "overcharg[ing]" clients under a nonprofit model is OK because it is done for the sake of future borrowers. But when profits go to providers of capital through dividends, then there is a "conflict between the welfare of clients and the welfare of investors." It's not the commercialization of the lending, we're told, but the "size" of the profits that must be scrutinized.
What seems to elude Mr. Rosenberg is the fact that there is no way for him to know whether there is "overcharg[ing]" or by how much. That information can be delivered only by the market, when innovative new entrants see they can provide services at a better price. This has been happening since for-profit microfinance began to emerge, and the result has been greater competition. Rates have been coming down even as the demand for and availability of services have gone up.
How much better it would have been, Mr. Rosenberg suggests, if Compartamos had raised capital through "socially motivated investors" like the "international financial institutions" – i.e., the World Bank and the like. How much better indeed, for him and his poverty lobby cohorts, but not, it seems, for Mexico's entrepreneurial poor.

Special-Interest Secret
May 12, 2007; Page A11
Behind every policy that does more harm than good, there's a special interest that favors it anyway. The steel tariff was bad for consumers, steel-using industries and foreign steel producers, but the steel lobby still pushed for it. Farm subsidies are bad for both taxpayers and unsubsidized farmers, but in 2002 the American farm lobby got a 70% increase in government support. The minimum wage is bad for consumers, employers and low-skill workers who get priced out of their jobs, but unions are hard at work to raise it again.
When special interests talk, politicians listen and the rest of us suffer. But why do politicians listen? Social scientists' favorite explanation is that special interests pay close attention to their pet issues and the rest of us do not. So when politicians decide where to stand, the safer path is to satisfy knowledgeable insiders at the expense of the oblivious public.
This explanation is appealing, but it neglects one glaring fact. "Special-interest" legislation is popular.
Keeping foreign products out is popular. Since 1976, the Worldviews survey has always found that Americans who "sympathize more with those who want to eliminate tariffs" are seriously outnumbered by "those who think such tariffs are necessary." Handouts for farmers are popular. A 2004 PIPA-Knowledge Networks Poll found that 58% agree that "government needs to subsidize farming to make sure there will always be a good supply of food." In 2006, the Pew Research Center found that over 80% of Americans want to raise the minimum wage. It is safe to assume, then, that few people want to abolish it. These results are not isolated. It is hard to find any "special interest" policies that most Americans oppose.
Clearly, there is something very wrong with the view that the steel industry, farm lobby and labor unions thwart the will of the majority. The public does not pay close attention to politics, but that hardly seems to be the problem. The policies that prevail are basically the policies that the public approves.
No wonder special interests so often get their way. They do not have to force their policies down the public's throat, or sneak them through Congress unnoticed. To succeed, special interests only need to persuade politicians to swim with the current of public opinion.
Why would the majority favor policies that hurt the majority? There is a good reason. The majority favors these policies because the average person underestimates the social benefits of the free market, especially for international and labor markets. In a phrase, the public suffers from anti-market bias.
Economists have spent centuries explaining how markets channel greedy intentions into socially desirable results; how trade is mutually beneficial both within and between countries; how using price controls to redistribute income inflicts a lot of collateral damage. These are the lessons of every economics textbook. Contrary to the stereotype that they can't agree, economists across the political spectrum, from Paul Krugman to Greg Mankiw, see eye to eye on these basic lessons.
Unfortunately, most people resist even the most basic lessons of economics. As every introductory teacher of the subject knows, students are not blank slates. On the first day of class, they arrive with strong -- and usually misguided -- beliefs about economics. Convincing students to rethink their anti-market views is no easy task.
The principles of economics are intellectually compelling; but emotionally, they fall flat. It feels better to believe that greedy intentions imply bad consequences, that foreigners destroy our prosperity and that price controls are a harmless way to transfer income. Given these economic prejudices, we should expect policies like steel tariffs, farm subsidies and the minimum wage to be popular.
None of this means that special interests don't matter, but it does put their activities in a new light. Special interests do not have to sneak behind the majority's back; they just need to ask for the right favor in the right way. The steel lobby could have demanded a big handout from the federal government. But that would have struck many voters as welfare for the rich; steel-makers can't expect the same treatment as farmers, can they? Instead, the steel lobby took the crowd-pleasing route of blaming foreigners and asking for tariffs. Tariffs were less direct than a naked subsidy from Washington, but they enriched the steel industry without alienating the majority.
If special-interest legislation were fundamentally unpopular, public relations campaigns would be futile. They would serve only to warn taxpayers about plans to pick their pockets. Since the public shares interest groups' critique of the free market, however, there is room for persuasion. Left to its own devices, the public is unlikely to spontaneously fret about the plight of the steel industry. But a good public relations campaign can -- and often does -- change the public's mind. Once the public actively supports an interest group, even politicians who would prefer to leave the market alone find it awkward to block government intervention.
In many cases, though, a public relations campaign is overkill. Special interests can make money by maneuvering around the indifference of the majority. Even though most people are protectionists, for example, they are fuzzy about specifics. Which industries need protection? How much? Should we use tariffs, quotas or what? To most citizens, these are mere details; within broad limits, they will accept whatever happens. As far as special interests are concerned, however, these details mean the difference between feast and famine. When it is time to determine details, special interests have a lot of influence -- in large part because no one else cares enough to quibble.
In a monarchy, no one likes to blame the king for bad decisions. So instead of blaming the king himself, critics point their fingers at his wicked, incompetent and corrupt advisers. While this is a good way to keep your head, it is hard to take seriously. Kings often make bad decisions; and in any case, if his advisers are hurting the country, isn't it the king's fault for listening to them?
In a democracy, similarly, no one likes to blame the majority for bad decisions. So instead of blaming the majority, critics point their fingers at special interests. But this too is hard to take seriously. The majority often makes bad decisions; and in any case, if special interests are hurting the country, isn't it the majority's fault for listening to them?
We often ponder special-interest politics in order to solve a mystery: "Why aren't policies better?" Realizing how many bad policies are here by popular demand turns this question upside down. The real mystery is not why policies aren't better. The real mystery of politics is why policies aren't a lot worse.
Mr. Caplan, an associate professor of economics at George Mason University, is the author of "The Myth of the Rational Voter: Why Democracies Choose Bad Policies" (Princeton University Press, 2007).

Lessons of a Food Fight
August 29, 2007; Page A14
Lawyers for the Federal Trade Commission apparently can't believe their "gotcha" haul of off-color statements by Whole Foods CEO John Mackey wasn't enough to block his merger with Wild Oats, a competing chain, in the absence of serious antitrust evidence.
Wailed the agency to an appeals court last week: The judge who refused our injunction request ignored the substance of our case!
He sure did. Judge Paul Friedman barely eluded the pith of the FTC's complaint, a private email from Mr. Mackey to his board in which the hyperbolic CEO said the acquisition would "eliminate a competitor" and "avoid nasty price wars."
You can find Judge Friedman's opinion at the Web site of the U.S. District Court for the District of Columbia. He found, in essence, that no amount of blather by Mr. Mackey in a state of competitive heat can overcome the relevant facts: Whole Foods competes against the entire universe of food retailers, not just Wild Oats, even if both happen to style themselves "natural foods" supermarkets.
"The evidence before the court demonstrates that other supermarkets . . . compete today for the food purchases of customers who shop at Whole Foods and Wild Oats and that Whole Foods' customers already turn for some of their food purchases to the full range of supermarkets," wrote the Clinton appointee.
Duh. But the agency did succeed at least in its primary tactical aim, embarrassing Mr. Mackey. Not only was it able to flaunt his unguarded memo to his board. It disclosed his habit of unwisely posting his anonymous thoughts on a Yahoo message board. It even managed "inadvertently" to leak some of his company's confidential information to the press.
It wasn't Judge Friedman's job to ask why FTC would bring such a frivolous case in the first place. At times like these, one must consult the work of James Buchanan, who won a Nobel Prize for applying what economics tells us about incentives to the behavior of government officials. To wit, they are people, and frequently behave like people. They don't necessarily get up everyday thinking, "What can I do today to advance the general welfare?" They frequently think: "What can I do to advance my own interests? What can I do to extort tribute from the private sector? What can I do to blackmail politicians into increasing my resources and privileges? What can I do to manipulate the media?"
Antitrust agencies are especially prone to these habits because, frankly, they lack useful ways to occupy their time. So few are the opportunities in a modern economy for businesses to create meaningful, exploitable, durable monopolies, trustbusting agencies must employ bold ingenuity to keep themselves and the Washington antitrust community busy. In this regard, a landmark in bar-lowering was the surprise success of the FTC's 1997 move to nix a merger of Staples and Office Depot, two office supply chains in a world full of office supply retailers, on grounds that they offered consumers a unique "shopping experience."
We've been off to the races ever since. That's how we got the Whole Foods case, in which the agency argued the chain must be regulated as a potential monopolist because some Whole Foods shoppers (its "core customers") might refuse to shop elsewhere even for lower prices and better service.
The appeal of such reasoning to trustbusters is obvious: Successful differentiation through mere marketing can be reason enough to subject a company to antitrust regulation. By such logic, Ford might be a monopolist if some number of customers refuse to consider anything but a Taurus, no matter how serviceable the substitutes from Toyota, etc.
Alas, such regulatory grabs are especially common in the waning days of a weakened administration -- see the FCC's sudden enthusiasm for wireless "open access" or the Justice Department's play for new regulatory authority over the porn film industry.
For better and worse, antitrust seldom rises to the level of a threat to the general prosperity, giving politicians little reason to blow the whistle. Our over-the-rainbow solution would be simply to cancel the antitrust laws, and leave it to Congress to legislate singly in the case (if it ever arises) of a true monopoly that threatens the public good. An absurd prescription? Check out "Does Antitrust Policy Improve Consumer Welfare?" by Brookings Institution economists Clifford Winston and Robert Crandall. It can be found in the fall 2003 Journal of Economic Perspectives.
We won't expect such lessons to trickle down anytime soon, but Europe also offers a variation worth considering. Unlike their U.S. counterparts, Europe's trustbusters can be sued for damages when found to have abused their discretion and authority.
A seminal verdict came in a ruling last month in favor of Schneider Electric, a French company that had been forced to unwind a merger at great cost on sloppy antitrust analysis. People who work in government may be acting in good faith and concerned with the public good. The Schneider case shows that it's unwise to give them credit for doing so in advance of, or contrary to, the evidence.
Once we get over such naive sentiments, there's much to be said for enforcing accountability by making regulators liable for damages when they don't act in good faith in carrying out their public mandates.