The election is nearly upon us and now seems an appropriate time to remember why democracy is so messed up.
Imagine three voters with three different opinions about the Iraq war. Our voters are Abel, Bobby and Carl. Abel is a dove. Her first preference is to have a small number of troops in Iraq. If she can’t have her first preference, Abel wants to keep troop levels where they are now. Her last preference would be an increase in troop levels. Bobby doesn’t like change. He would like to see the number of troops remain as they are. If he can’t have this, his second choice is to increase the number of troops to many. His third preference is to decrease troop levels to few. Finally, we have Carl. Carl’s first choice is to have many troops in Iraq. But if he can’t have this, Carl would like to see few troops there. Comparing the current conflict to Viet Nam, Carl believes that the worst choice we can make is to leave troops at their current, intermediary level. For him, it is best to have either many troops or just a few. Summarizing, our voters have these preferences:
________Abel____________Bobby_____________Carl
1st_____Few_____________Current____________Many
2nd____Current__________Many_______________Few
3rd_____Many____________Few_______________Current
Let us assume that Abel, Bobby and Carl all live in a direct democracy governed by the simple majority rule. What will be the outcome of the election? Let us say that this November, the choice presented to the voters is between many troops and the current level (the option few troops is not on the ballot). Abel and Bobby will vote for the current level, winning the election over Carl’s vote for many troops. Let us then suppose that in December, there is another election, this one asking voters to choose between the current level and a lower level. Abel and Carl will then vote for few troops, beating Bobby’s vote for the current level. Finally, in January, voters are asked whether they prefer few troops to many troops. Now, Bobby and Carl will vote for many troops while Abel will vote for few.
So, without changing underlying preferences, voters will first vote to keep troops at the current level. They will then vote to decrease the level. Then they will then vote to put troops at the highest level. From there, they might vote to put troops back at the initial level. Voter theorists term this problem “cycling.” If we saw it in a person rather than an electorate, many of us would conclude that he or she were crazy! Someone preferring milk to juice and juice to water, ought to prefer milk to water! Notice, moreover, that each of the individuals in our little democracy has completely rational preferences. It is only when we try to aggregate preferences that we run into trouble. I should note that democracy doesn’t always produce this odd result. But it is quite possible under reasonable assumptions. Vote rules other than simple majority can make the cycling less likely, but none can rid us of it.
Perhaps we can avoid the problem by letting voters vote for all three options simultaneously? To see how this might work, assume that 30 percent of the public has Abel’s preferences, another 30 percent has Bobby’s and the remaining 40 percent have Carl’s. Now, if given all three choices, 40 percent of the public would vote for many troops, 30 percent would vote for current levels and another 30 percent would vote for few troops. The electorate would choose many troops. But, referring again to the chart, we see that though the election selected many troops, 60 percent of the public would have preferred current levels to more! (Gore supporters angry with their Nader-voting friends no doubt understand this frustration.)
As far as we know, this problem with democracy was first discovered by a French nobleman named the Marquis de Condorcet in 1785. Though cycling (also called Condorcet’s paradox) received some attention at the time, people seemed to forget about it. The mathematician, C.L. Dodgson (better known as Lewis Carol to readers of Alice in Wonderland) rediscovered the problem in the late 1800s. But again the idea was lost. The economists Duncan Black and Kenneth Arrow independently rediscovered the possibility of cycling in the middle of the 20th century. Though volumes have been written about the problem in academic forums, it has been almost entirely ignored in everyday discussions about democracy.
For me, cycling takes its place alongside many other problems with democracy such as tyranny of the majority and tyranny of the interest group. Given the fairly obvious undesirability of other forms of government, I suppose we are left to deal with it.
We can take solace in the fact that our Constitution severely curtails the power of everyone’s vote. We cannot, for instance, vote to deprive someone of life, liberty or property without due process. Nor can we vote to establish a religion or infringe upon the right to bear arms. There was a time when courts held that we could only vote to have government do those things which were specifically enumerated in the Constitution. So let us celebrate the Constitution which limits our power to vote and lament the passing of an age when the Constitution limited much more.

Today, the Royal Swedish Academy of Sciences announced that it will award the 2004 Nobel Memorial Prize in Economics to Finn E. Kydland and Edward C. Prescott. Kydland and Prescott have made some fascinating and important contributions to macroeconomics over the past quarter century. They are often referred to as founding fathers of the Real Business Cycle school of macroeconomics. Earlier schools of thought had held that the economy grows at some underlying steady rate and that it was the macroeconomist’s job to make sense of fluctuations around this rate. Real Business Cycle theorists, however, reject the “underlying rate of growth” argument and instead claim that it is impossible to separate economic growth from economic fluctuations. In 1986, Prescott wrote: “The policy implication of this research is that costly efforts at stabilization are likely to be counter-productive. Economic fluctuations are optimal responses to uncertainty in the rate of technological progress.” In other words, policy makers should leave the economy alone and resist the temptation to “manage” economic growth. When politicians tinker with the economy, they create more problems than they solve. In an election season rife with rhetoric about stimulating the economy, it would be nice if someone paid attention to these insights.
Without question, Kydland (age 60) and Prescott (63) deserve their prizes. Still, as the Nobel cannot be awarded posthumously, it is disappointing to see that the Academy passed over some older and equally deserving scholars such as Armen Alchian (90), Thomas Schelling (83) and Gordon Tullock (82).
On a personal note, as an Arizona State alum, I am particularly proud that my school attracted Edward Prescott (though not before I graduated). Furthermore, I should disclose that as a current graduate student at George Mason, I am taking a class from Professor Tullock. (I have little reason to think the octogenarian will be surfing the web, so rest assured, I do not lavish praise in hopes of a higher grade!)

I’ve been reading Jim Powell’s FDR’s Folly. It is an economic history of the New Deal. First of all, I would highly recommend it to all interested in an economically and historically sound recounting of the New Deal. (If my word doesn’t carry enough weight, you may be interested to know that it comes recommended by two Nobel Laureates in Economics).
Anyway, I found a little tidbit about New Mexico rather interesting. There is a chapter which describes the way New Deal relief spending was hijacked by political interests, so that all too often aid went not to those in need but to those most likely to get the Roosevelt Administration reelected. Powell quotes historian James T. Patterson as writing, “Democrats in New Mexico, where politics were raw and open, were especially demanding. From the start Democratic Governor Arthur Seligman requested—and got—lists noting the political preference of all relief and [Civilian Conservation Core] workers in the state.”
Despite this obvious black mark, New Mexico did redeem itself. Disgusted with the way New Deal spending was being used for political purposes, the US Congress passed the Hatch Act in 1939. This prohibited federal employees and state and local employees administering federal programs from using their power to influence the outcome of a political campaign. It made it illegal for these employees to offer jobs to political campaign workers or to manage political campaigns. And the author of the Hatch Act? Why, Democratic Senator Carl Atwood Hatch of New Mexico, of course!

In its June 19th edition, the British magazine, The Economist offered its take on New Mexico’s political landscape: “The Spanish families and Indians were members of Roosevelt’s New Deal coalition and have remained Democrats since; in almost European fashion, they tend to view the government as beneficent. The Anglo newcomers are more dog-eat-dog individualists.”
The article (sorry for the subscription link) is the seventh in a series on swing states in the upcoming US Presidential election. In the by-line, New Mexico is said to be “perhaps the oddest of them all.” Well, no argument there!

“The second of July 1776 will be the most memorable epoch in the history of America. I am apt to believe it will be celebrated by succeeding generations as the great Anniversary Festival. It ought to be commemorated as the day of deliverance by solemn acts of devotion to God Almighty, solemnized with pomp and parade, shows, games, sports, guns, bells, bonfires and illuminations from one end of the continent to the other from this time forward, forever more. You will think me transported with enthusiasm but I am not. I am well aware of the toil and blood and treasure that it will cost us to maintain this Declaration and support and defend these States. Yet through all the gloom, I can see the rays of ravishing light and glory. I can see that the end is worth all the means. And that posterity will triumph in that day’s transaction even though we should rue it, which I trust in God we shall not.”
Such was the opinion of John Adams, expressed in a letter to his wife Abigail. No, John wasn’t wrong on his dates. The 2nd of July, 1776 was the day that Richard Henry Lee’s resolution declaring independence from Great Briton was actually adopted by the Second Continental Congress. Two days later, on the 4th, Congress adopted Jefferson’s draft of the actual document: “The Declaration of Independence.” Somewhat by historical accident, we have come to celebrate the later date and not the earlier one.
For more on America’s founding, including original documents, historical background, biographies and quotes, see some of the following:
The Founder’s Constitution (maintained by the University of Chicago Press and Liberty Fund)
From Revolution to Reconstruction (by the Department of Humanities Computing, University of Groningen, The Netherlands)
The Avalon Project (by the Yale Law School)
The Founder’s Almanac (by the Heritage Foundation)
Whenever you decide to celebrate, we at the Rio Grande Foundation wish you a very happy Independence Day!

A federal judge has ruled that a sex-discrimination suit against Wal-Mart Stores can proceed as a class action, which could lead to a huge loss for the megastore. Up to 1.6 million women could join the class action, and at a few thousand apiece it could cost Wal-Mart billions.
Baltimore trial lawyer Peter Angelos made enough from his asbestos lawsuit work to buy the Orioles. Lawyers’ fees in this case could buy the entire American League.
This is not the first big case involving women’s wages. Coke, Home Depot, and Texaco have paid more than $100 million each in such lawsuits.
Now I don’t want to quarrel with any of these decisions. Who knows what went on? How could American courts be wrong? But I call your attention to a larger version of this alleged discrimination, the oft heard claim that women earn, on average, 70 percent of men’s salaries. NBC News this evening cited this figure as a virtual national scandal. Should an Equal Rights Amendment pass, you can bet that lawsuits would follow gigantic enough to make Senator John Edwards dance with anticipation
Any economist worth his or her salt will immediately wonder where this 70 percent number came from and how it would be changed if it accounted for differences in experience, education, difficulty of jobs, and the other factors that affect the demand for a person’s labor. This requires rigorous analysis, not just quoting some data.
But where do you find such analysis? Well, you go to one of my favorite websites, www.iwf.org, the home page of the Independent Women’s Forum. This organization published a report called “Women’s Figures” that challenges the 70 percent shibboleth, and they keep up to date on other such issues, presenting a clear, market oriented analysis in a lively format. Yes, they are conservative women!
Maybe women economists should get a raise!

I remember a critic once hissed, “Ronald Reagan was two-thirds show and one-third substance.” I’ve often wondered how someone could dismiss Reagan’s substance so readily. Most of us are passively swept along by the tumultuous currents of history. A very few are audacious enough to defy the currents and determine their own course. Ronald Reagan went further. He not only went his own way, but he brought history with him.
When he came to office, unemployment was climbing near 8 percent and the economy was sinking. Meanwhile, inflation was soaring at 12 percent per year. In today’s prices, gas was selling for $2.87 a gallon and interest rates were at 21 percent (the highest level since the Civil War).
The dominant macroeconomic school of thought, Keynesianism, could not even account for simultaneous economic stagnation and inflation. But Reagan listened to a new generation of economists which included Milton Friedman, Robert Lucas and Robert Mundell. They counseled tight monetary policy to break the back of inflation and an easing of the tax burden to free the economy.
Reagan stood by Federal Reserve Chairman Paul Volker as he sharply reduced the supply of money. The President then ushered (cajoled) historical 25 percent tax cuts through Congress. The monetary policy change promised to be painful in the short run. Unemployment soared to nearly 11 percent, and the economy dipped deeper into recession. Despite flagging government revenue, Reagan stayed the course: he would not go back on the income tax cuts.
When the last of the tax cuts finally came into effect in 1983, everything turned around. The economy suddenly grew at a 4.3 percent annual growth rate. GDP then leapt ahead at a 7.3 percent clip the following year and remained strong there on out. Gas prices and interest rates steadily declined. Unemployment began falling too, reaching a low of 5 percent by 1989. The stock market more than doubled in value under his watch. What’s more, inflation remained in check.
In foreign affairs, Reagan was equally influential. He launched the nation on the largest peacetime military buildup in U.S. history and began talking tough about the evils of totalitarian communism. He challenged the decades-old belief that the only way to avoid nuclear war was an offensive strategy called “mutually assured destruction” (MAD). Instead, he proposed a defensive strategy, the Strategic Defense Initiative. And in pure Reagan form, he even promised to share the technology with the Soviets. Eventually, Reagan found “peace through strength.” He and President Gorbachev would negotiate the first-ever reduction in strategic arms.
Between 1974 and 1980, 10 nations had fallen under communism. After 1980, not one more nation would fall. During his two terms, dictatorships collapsed in Chile, Haiti, and Panama. Nine more nations moved toward democracy: Bolivia, Honduras, Argentina, Grenada, El Salvador, Uruguay, Brazil, Guatemala, and the Philippines. Nicaragua soon followed. Within three years after Reagan left office, the Soviet Empire itself had dissolved and Eastern Europe was liberated. In 1975 the late Senator Daniel Patrick Moynihan had written that, “Increasingly, democracy is seen as an arrangement peculiar to a handful of North Atlantic countries.” By the early 1990s, that was no longer true.
Not all was good. Like every other president in the 20th century, Reagan presided over an expansion in government. In 1989, the federal government was almost twice its 1980 size. Welfare reform would have to wait for another president. And we are still waiting for Social Security reform. He launched an expensive but ultimately futile War on Drugs. And, of course, there was the gross mismanagement that led to the Iran-Contra Affair.
For better or worse, Reagan cast a long shadow. He virtually towers over the latter-half of the twentieth century. So how on earth could he be considered “one-third substance?” The answer lies in the other two-thirds. For all his substantive influence on history, the Reagan “show” was even larger. He was a showman and proud of it. Somehow his Midwestern tongue made complicated economic doctrine and grand historical visions accessible to the common ear. And it is in his mellifluent voice that freedom found one of its greatest spokesmen.

Columbia University Professor of economics Xavier Sala-i-Martin offers a humorous rebuttal to Keynesian economics. The rest of his website is equally entertaining.

Have you seen the transcript of the 1967 CBS “Town Meeting of the World?” Well worth the read. Don’t miss Reagans’s last word!

“There’s no free lunch,” reported retiring State Representative Max Coll in a recent interview with the Albuquerque Tribune. Well, that sounds like something an economist would say! Unfortunately, the representative went on to comment, “If you’re going to cut taxes someplace, you’re going to have to raise them somewhere else.”
I thought the fiscal coin had two sides: taxing and spending?
Read the full story here.

The State Investment Council has just agreed to lend $7.5 million at zero interest for three years to finance the production of a movie to be filmed in New Mexico. The film will tell the inspiring story of a man and his grandson who drift into Mexico and both fall in love with the same prostitute.
The opportunity cost of making such a loan is around $1 million, that being the returns that could be had by investing the money elsewhere. There is also an element of risk to be considered: presumably the loan is unsecured by property, and who knows how the production company figures its profits and hence its ability to repay the loan.
It’s said that 97 film jobs will be brought into the state, but only for the duration of shooting. That figures out to about $10,000 per job, some or perhaps most of which will go to movie makers brought in from Hollywood.
Is this a good deal for New Mexican taxpayers? Probably not. But as usual, we aren’t given enough information by the state to make a reliable calculation.
But one thing is for sure: No one will ever make a film in New Mexico without first paying a visit to Santa Fe to pick up some free money.

Have you ever wondered what New Mexico might be like had its state government not grown so fast? We can get some idea by looking to our neighbor to the north. Colorado has imposed tax and spending limitations by rule since 1992. These limitations are known by the acronym TABOR (Taxpayers’ Bill of Rights). State spending is limited by TABOR to the rate of inflation plus the rate of population growth. In essence TABOR holds real state spending per capita constant.
Suppose New Mexico had implemented a TABOR in 1992. What would now be the size of its general fund budget as constrained by the rates of growth of population and the price level? Population has grown by an annual average of 1.6 percent in the period from July 1992 to July 2003. The price level has grown by an annual average of 2.6 percent from February 1992 (index of 138.6) until February 2004 (index of 186.2) as measured by the consumer price index. A New Mexico TABOR would have limited general fund average annual growth to 4.1 percent (1.6% population growth plus 2.6% inflation).
Since the New Mexico general fund budget was $2,044.9 million in FY 1992, TABOR would have limited it to $3,447.8 million for FY05 (beginning July 1 2004). Contrast that with the actual FY05 budget of $4,380.6 million! TABOR would have saved the taxpayers $932.8 million. That works out to be $491 for every man, woman and child in New Mexico. According to our estimates such a saving would have permitted a gross receipts tax rate reduction of some two and one-half percent! The gross receipts tax we pay would be more in the neighborhood of four and three-quarters percent rather than six and one-quarter percent. Now that would promote economic development!
Some other observations based on the general fund budget over time: The budget has grown at a rate of 6.0 percent annually since 1992 (rather than at a TABOR constrained 4.1 percent). The Medicaid portion of the budget has grown at an annual average rate of 13.3 percent and it increased 16.3 percent for FY05. We predicted the Medicaid budget would be out of control without real reform. Governor Johnson was able to hold general fund spending to an average annual rate increase of 5.0 percent during his eight years in office (nice going, Governor J). He was able to hold Medicaid’s average annual increase to 11.2 percent.

When Gregory Mankiw, President Bush’s Chairman of the Council of Economic Advisors recently noted the benefits of outsourcing jobs, politicians crawled over one another to be the first to denounce his idiocy. Senators Clinton, Kennedy and Schumer, for example, wrote “[we are] troubled by the astonishing statement of…Gregory Mankiw, that ‘outsourcing is just a new way of doing international trade’.” Read the story here.
I must give the press some credit. The media have not let the senators get away with their blithe dismissal of Mr. Mankiw. After all, Mr. Mankiw is hardly some right wing nut (Look at what he named his dog!). What’s more, the Chairman is in rather good company. On his side are the vast majority of Ph.D. economists (for evidence on the extent of the profession’s faith in free trade see the Survey of Americans and Economists on the Economy, 1996). Luckily, the press has actually picked up on this. See, for example, this story by the AP, and this one in our own Albuquerque Journal.
The basic economic story is not terribly complicated: barriers to trade do two things: they raise profits for a select few (steel workers, farmers, etc.) and they raise prices for consumers at large. What is more, it can be shown with minimal recourse to graphing paper that when we add up all the price increases and compare them with the profit increases, the price increases outweigh the profit increases.
Unfortunately, most economists want to stop the story there, assuming they have won over the skeptic. They should not assume so. I suspect that when he or she hears this story, the average America says “So what? If we remove the trade barrier, someone will loose their job. I’d rather have 50,000 consumers pay one extra dollar for a product, than have one worker loose a $30,000 job. I don’t care that the barrier is more expensive, the benefits are everything to the worker.” This is actually a good point.
But there is a better counter point. The economy is constantly changing. Ninety percent of Americans were once farmers. Now a tiny fraction of Americans work on the farm. Thousands were once blacksmiths. Now almost no one is. These changes had to come. And they will have to come for other industries too. But every year we leave steel tariffs and farm subsidies in place is another year that we encourage 18 year olds to go into the steel and farm industries. We are lulling millions of workers into industries that cannot support them.
The inevitable result will be too many steel workers and too many farmers. When those industries collapse, millions will lose their jobs at once. Is that compassion?
My compliments to Anthony J. Evans of The Filter for pointing out Mankiw’s Animal Spirit.

Last week I visited an eye clinic in Albuquerque. As I was completing the paperwork prior to my exam, a young woman entered the office. She was visibly upset because she had been unable to obtain new glasses under her old prescription. She was informed that opticians in New Mexico are prohibited from filling eyeglass prescriptions that are more than one year old. It turns out that her prescription was about 13 months old.
Isn’t it wonderful that we have the all-knowing state to decide her trade-off between the expense of another eye exam, fulfilling her old prescription or going without? The optometrist’s administrative assistant explained to me that some states are much less efficient than New Mexico, allowing as much as two years before mandated expiration of a prescription!
Who do you think benefits from this restriction on free choice in the marketplace? Who loses? If the overall losses are greater than the benefits, how could such a restriction be passed by our legislature?

There are many things to appreciate about America’s decentralized, federalist system. One is the fact that we can all learn from the mistakes of another state or local government without having to bear the bad consequences. Arizonans, Texans and Coloradoans, for example, have benefited from New Mexico’s experiment in socialism-lite. They have seen that New Mexico’s high tax rates and bloated government spending have made the state one of the poorest in the nation.
But even New Mexicans can learn from others. This county in North Carolina has recently decided to impose a hotel tax. Never mind the fact that the county has no hotels. They put the tax in place for “down the road,” according to Jeff Jennings, the Chairman of the County’s Board of Commissioners. How many hotel managers do you suppose will be eager to move into this county? I’d guess that the commissioners will have to look WAY down the road before they see any tax revenue from their new tax.

Economic Freedom Promotes Prosperity
The Rio Grande Foundation’s research and educational activities are based on the principle that:
Increased individual liberty leads to increased prosperity, individually and collectively, so long as voluntary contracts are enforced and well-defined property rights exist.
This principle is derived from a sound empirical foundation and examination of incentives. When societies are ranked by an index of economic freedom over the long run, we find their ranking of prosperity to be in nearly one-to-one correspondence with their degree of economic freedom. The more economic freedom there is, the better-off people are. That fact deserves notice in New Mexico!
The link between freedom and prosperity is not surprising when we compare incentives that guide individual behavior. Behavior is quite different for different degrees of economic freedom. But those differences are usually overlooked by decision makers, so the freedom-prosperity link also is usually overlooked. Lacking a careful examination of incentives, it often seems plausible that increased taxation and/or regulation will achieve a worthy goal (such as improved safety, environment, or transportation; or increased economic development; or helping the poor). On the contrary, economic freedom usually guides people to coordinate their activities in ways that better achieve these worthy goals.
The following graph depicts the empirical relationship between economic freedom and peoples’ well-being for states in the region. As the size of government increases, economic freedom decreases. And the greater is the size of government the less prosperous are the state’s people. New Mexico needs to reduce the size of government and move up the hill toward prosperity.

We should be aiming for G* if we are going to maximize well-being. Unfortunately, however, we are sliding down the slippery slope toward serfdom. For more on the link between economic freedom and prosperity go to Economic Freedom of North America, New Mexico 2000, or Economic Freedom of the World.