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Vol. 6, No. 3 IDEAS AND UPDATES ON PUBLIC POLICY Spring 2002 Game theory, coming to a theater near you Summer's here! Let the Hollywood games begin

or his brilliant portrayal of the same strategy, the whole group will mathematician John Nash in be worse off, as everyone’s profit margin A Beautiful Mind, Russell F shrinks. Crowe won critical acclaim. Nash’s contribution to game theory Based on the popular biography by Sylvia — one that bears his name — finds that Nasar, A Beautiful Mind won the Oscar for in a particular game, if each player’s Best Picture in March. choice of action is a best response to the Nash’s is a classic story of the actions taken by other players, then this triumph of the human spirit over set of strategic choices comprises an adversity. equilibrium. Having pioneered work early in his In the OPEC game, if the member career in the emerging field of game nations do not have a mechanism in place theory, Nash overcame schizophrenia to guarantee cooperation, individual and, in 1994, along with two colleagues, members will find it easy and tempting won the Nobel Prize for Economics. to charge low prices. If everyone is The science of strategy, game when confronted with a set of choices on how charging a high price, one player will theory, attempts to understand, in to price their products. For example, consider benefit by charging a low price and mathematical terms, the actions of the incentive for an individual member nation securing more market share. If players in a set of games. Game theory of the Oil Petroleum Exporting Countries everybody is charging a low price, then examines the options for cooperation (OPEC) to cheat on pricing and production it is hardly profitable for someone else and competition between two or more agreements. If all OPEC members charge a high to do differently. Thus the low pricing players. The applications of game theory price, an individual member will be tempted option for every player is the best are numerous. Economists are interested to undercut prices a little and steal market share response to everybody else’s incentive to in game theory because it helps them from fellow members. But if everyone follows understand how competitors behave continued on page 4 From the Executive Director IN THIS ISSUE Trading principle for plunder on Beacon Hill Letters to the Editor eeding frenzy. That’s the settlement money and other funds, as explained on Readers respond to BHI...... 2 best description of how the ourF website: www.beaconhill.org.) Massachusetts legislature That’s a cut of about 0.7%. For a household that News F has dealt with the supposed made $50,000 in 2002, it’s the equivalent of having to FY '03 budget crisis. It would be funny if Florida STAMPs out sales tax get by on $350 less in 2003. No big deal, right? "reform"...... 3 it weren’t so dismaying. But the Massachusetts legislature, egged on by the Here’s what has happened: Because media and some business groups, has turned this of a temporary revenue shortfall, brought minor spending cut into a very big deal indeed. Analysis about by 9/11, the economic slowdown Fanning worries about “draconian” budget cuts, the Welfare reform, caseloads and and a weak stock market, the state would legislature is turning a $150 million spending cut into unemployment in MA ...... 6 have to cut spending from about $22.80 an excuse for raising taxes by more than $1 billion. billion in FY '02 to about $22.65 billion in In 2000, Massachusetts voters overwhelmingly BookMark FY '03, in order to avoid raising taxes. approved ballot measures to cut the income tax to 5% (This calculation assumes that the state Beyond the Dot.coms: would draw on reserves, tobacco The Economic Promise of the continued on page 5 Internet, reviewed...... 7 BEACON HILL INSTITUTE Letters to the Editor

Braintree volunteer program taxes, ways could be found to close the gap wants. If Mr. Belanger can see our other between spending and revenue, even in this arguments as “brilliant,” we hope he can makes "no economic sense" financial crisis. Some relatively painless means see this one as at least reasonable. It is easy to agree with Mr. Arlos on Editor: have already been suggested – like reducing the the desirability of ending free tuition for I am writing to express my concern lottery payout by $274 million, using $146 state employees attending state colleges. with the article entitled “Working off million from the tobacco settlement and taking There is little reason to believe that doing taxes” in your latest newsletter. I think $800 million or more from the estimated $2 so would undermine the state’s ability to the program is terrible economics and billion in the state’s so-called rainy day reserves. attract capable workers. And, let’s face it. terrible social policy and am very In addition, most citizens have their own This practice discriminates against private surprised to find an article praising this favorite pet peeve when it comes to state universities like Suffolk. On the other program in your newsletter. For a local spending. Their suggestions may save hand, we’re a little less eager to eliminate government to raise taxes to a confiscatory relatively small sums but these sums add up to state public relations offices. Considering level only to then turn its senior citizens substantial amounts. I would eliminate all how difficult it is to pry information out of into wage slaves at minimum wage in public relations and press secretaries from state state officials, it’s nice to have somewhere order to save their homes is abominable. agencies. to go where they can’t duck your questions. Furthermore, the work they do (according It would save over $10 million a year to As for the exact economic losses the to the article) is not wanted or needed by eliminate free and cut-rate tuition at state forthcoming tax hikes will inflict, the the town to the extent that it is available; colleges for government employees and their trouble is that no one else wants even to clearly an indication that the economics dependents. These colleges belong to all the ask that question, much less answer it. makes no sense. Also, to replace union people of the state, and fairness dictates that jobs (even partially) at union wages with one group should not automatically receive
non-union workers at minimum wage is financial benefits for which other people must underhanded union-busting, a violation compete. of any fair-minded collective bargaining The citizens of Massachusetts are not NewsLink is published quarterly agreement. selfish. They would not mind higher taxes if by the Beacon Hill Institute for Pub- I urge you to do some logical analysis they knew that all methods of increasing lic Policy Research at Suffolk Uni- of this program as you have so brilliantly productivity and eliminating waste and special versity. The Beacon Hill Institute fo- done in so many other areas of economic, privileges had been addressed. And neither are cuses on federal, state and local eco- political, and social policy. I look forward our citizens stupid. They can see through the nomic policies as they affect citizens to a future article that really “makes sense gloom-and-doom predictions that they are and businesses, particularly in Mas- for everyone.” asked to swallow so that public officials will sachusetts. The institute uses state- have an easier time extracting additional taxes. of-the-art statistical, mathematical Philip Belanger A fiscal crisis like the present deserves and econometric methods to pro- via e-mail statesmanship and it deserves sacrifice, but that vide timely and readable analyses sacrifice does not have to come from the that help voters, policy makers and children or the poor or the sick or the elderly. opinion leaders understand today’s Raising taxes should not be Nor should it come first from the taxpayers. leading public policy issues. first resort Peter G. Arlos PUBLISHER Editor: Berkshire County Treasurer DAVID G. TUERCK I do not know whether the Beacon Pittsfield Councilman-at-large EXECUTIVE DIRECTOR Hill Institute’s estimate that state tax increases will hurt the economy of EDITOR Massachusetts and cost jobs is accurate. BHI replies: FRANK CONTE The Institute has calculated that to keep We don’t think things work as Mr. DIRECTOR, COMMUNICATIONS & IS the income tax at 5.3% would cost $1.4 Belanger charges. As we see it, local billion in lost wages, result in 32,000 lost government is going to extract either money (ISSN 1094-0707) jobs, and cause $244 million in lost capital or the equivalent in donated time from seniors spending during the first year. Other tax ©2002 Beacon Hill Institute for and everyone else who pays taxes. So better hikes are estimated to have equally Public Policy Research, Suffolk that it offer a choice — pay or work — to devastating effects. University, 8 Ashburton Place, taxpayers. Seniors often have more time than What I do know is that the state does Boston, MA 02108-2770. Voice: money, and, under this program, they get to not have to risk such a scenario. If the (617) 573-8750; fax: (617) 720-4272; choose where they’ll work. When they pay first response of elected officials in e-mail: [email protected]; web taxes, on the other hand, the government takes difficult fiscal times were not to raise site: http://www.beaconhill.org. the money and spends the money where it PAGE 2 / SPRING 2002 NEWSLINK STAMP analysis informs debate on Flordia tax reform ast February, the Florida 6 percent sales tax such as legal work, The BHI analysis also found that the House of Representatives accounting and shipping. proposal would have raised the tax burden L turned back a sales tax Proponents argued that the tax plan, on all Florida households and would be overhaul that would have which proposed lowering the rate the rate to especially regressive since it would fall eliminated 35,000 jobs and cost $1.3 4.5 percent, would have harder on low- billion in payroll according to BHI’s State enabled the state to expand income households. TaxD Analysis Modeling Program. its tax base to cover more By raising Florida taxes Tuerck also By an overwhelming 99-0 margin, services not currently taxed. by $536 millon the so- suggested Florida’s the lower chamber defeated a plan by However, the plan also competitiveness Senate President John McKay that would poses a threat to the Florida called tax reform plan rating in the BHI have cut the state sales tax but would economy. Despite its claim would have caused the State Competitiveness have also eliminated dozens of of revenue neutrality, the Report 2001 would exemptions. Not a single House member proposal would double-tax loss of 35,000 jobs and improve if it cut spoke in favor of the proposal. In certain services such as $1.3 billion in payroll. taxes rather than addition, Governor Jeb Bush opposed the accounting. raised them. Florida tax plan. “It seems impossible ranks 36th overall. At the invitation of the House for me to believe this bill is revenue- leadership, David G. Tuerck testified neutral,” said David Tuerck, BHI Executive against the tax package outlining the Director who testified before the legislature dramatic loss in jobs and payroll. on February 20. “It’s quite a nice tax increase
The McKay plan would have for Florida households.” imposed a levy on nearly 1000 items and services currently exempt from Florida’s Media Mentions

The great Virginian John Randolph of On May 3 Dr. Tuerck debated story about deficits,” which called into Roanoke once facetiously called spending Massachusetts House Speaker Thomas question the state’s fiscal crisis. other people’s money “the most delicious of Finneran on the “Blute and Ozone” morning And more significantly, the Boston Sunday all privileges.” By now, it is clear that the radio talk show program on WRKO 680 AM. Herald ran a major editorial on April 7 Massachusetts legislature finds great Dr. Tuerck questioned the House’s approval that used BHI’s tax analysis to warn delectation in raising taxes and spending of $1 billion in new state taxes. He also against higher taxes. On the heels of the more money. As the Beacon Hill debate challenged the House Speaker to provide an release of BHI’s report to Governor Jane heated up this spring, BHI found delicious economic analysis of the proposed tax Swift, The Boston Metro on March 12 also opportunities to argue against recently increases on job and payroll creation. published a story. proposed massive tax hikes. And the Finneran defended the economic Proposals to increase revenue were opportunities to place stubborn facts in the assumptions upon which the tax package was expanded to include the elimination of way of a runaway tax-hike train were many. based. Dr. Tuerck reappeared on the the the voter-approved charitable tax BHI Executive Director David G. Tuerck program on May 15. On April 30, Dr Tuerck deduction, another area of BHI expertise. hit the radio waves regularly to present the was a guest on the David Brudnoy Show on On May 4, 2002 Dr. Tuerck was quoted in institute’s extensive report, Holding WBZ-1030 AM. an article on the proposed eliminated of Taxachusetts at Bay, which outlined the job Meanwhile, Dr. Tuerck also appeared on the deduction. Previous to public and payroll losses associated with raising television to present the anti-tax side of the discussion about the elimination of the taxes. Dr. Tuerck appeared several times on debate. On May 1, Dr. Tuerck appeared on deduction, the Boston Globe featured Dr. Boston-based WBIX Business 1060 AM. On “News Night,” a New England Cable News Tuerck in a explanatory article entitled, May 8 Dr. Tuerck appeared on “The Boston program to discuss the ongoing tax increases. “Taxpayers to profit from generosity” on Business Journal AM Edition” with Dave The Neighborhood Network News interviewed February 24. Anthony & The Money Couple. On May 3 Dr. Tuerck for a news story that also appeared On March 28 The Boston Globe also and April 16 Dr. Tuerck appeared on “The on May 1. quoted Dr. Tuerck in an article on Bulldog Edition” with Ted Bunker to speak BHI’s tax analysis also appeared in the proposals to raise the cigarette tax in extensively about the proposed tax bills. print media. On May 4 the Boston Globe ran an Massachusetts. op-ed column by Dr. Tuerck, “Holes in their continued on page
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PAGE 3 / SPRING 2002 BEACON HILL INSTITUTE Hollywood Games to spend about $50 million in marketing. to place its remaining 14 films, some of continued from page 1 The movie shattered first-weekend records which include romantic comedies and in early May and was the fastest movie to docudramas. Starting a year in advance, charge a low price. Pricing low is the Nash reach the $200 million mark. But its release Dismal Science Cinema signals to other equilibrium in such a non-cooperative date was almost entirely based on the threat studios just how serious it is about setting. of having to compete against Attack of the launching a million-dollar advertising And while the highly rarefied Nash Clones, the latest Star Wars prequel campaign for the blockbuster. Other equilibrium may not find its star affixed described early on as “the franchise of studios will size up Rational on Hollywood Boulevard any time soon, franchises.” As we went to press, the huge Expectations’ status as a sequel, knowing it is clear that the big-time studios know George Lucas PR machine was already in that the earlier film had already a little bit about game theory. high pitch, with the creator appearing in captured an audience. They will also An examination of how studios take note of Dismal Science Cinema’s strategize in their choice of release ability to live up to its promise to dates illustrates the point. Game spend heavily on advertising. Not theory can explain why you did not known for its parsimony, Dismal see Spider-Man go head-to-head Science makes what’s called a against the latest Star Wars prequel “credible commitment.” These two from 20th Century Fox, LucasFilm’s pieces of information are reliable Attack of the Clones, on the same indicators of whether Dismal Science opening holiday weekend. will release Rational Expectations on the much-sought-after 2003 July 4th Which way do we go? weekend. Once Dismal Science Each major studio releases commits to this date, the studio’s approximately 15 films a year remaining films will then be including one or two potential distributed optimally throughout the blockbusters. Until recently, each rest of the year. Meanwhile, other major studio preferred to release their studios will plan accordingly. anticipated blockbusters close to four Knowing that the revenues will be major holidays: Memorial Day, the Fourth televised one-on-one interviews and other limited by the presence of the 800- of July, Thanksgiving and Christmas. promotions just before the May 16 release. pound gorilla, Rational Expectations, the Why are these times critical? People like Hollywood studios go to great lengths rest of the studios aim for an early June to go to movies on holiday weekends. to avoid such head-to-head holiday release. If a rival studio, 20th Century Because during these times, moviegoers weekend release competition. Theoretically Keynes, finally realizes it can’t compete are less likely to think about which film they could collude and stay out of each with its own blockbuster, To Demand is they’ll take in; they flock to the megaplex other's way. But the anti-trust laws negate Divine, it pulls out of the holiday or local theater with little regard for the that option. The studios can’t coordinate competition — opting for a greener latest movie reviews. their schedules without getting into trouble. pasture and the next-best alternative of For a studio, holiday weekends mean This places the studios in a tight bind, receiving a larger portion of a smaller a huge chunk of the revenue pie is up for since without coordination, the absolute pie of revenues on a non-holiday grabs. Moreover, the first weekend for any worst scenario could happen: all the weekend. movie can draw a significant portion of potential blockbusters could, in principle, the film’s final revenues. Thus, no one be released at the same time! So what’s the Meanwhile, Back in Hollywood … studio wants to find its blockbuster going alternative? They try to schedule their films Sometimes studios gamble by up against a competing studio’s by signaling. trying to position their release based on blockbuster. So the game begins with the genre. Even the hot and heavy movie producers asking themselves, “Do thriller Rational Expectations may not I want to be in the thick of competition The thrill of the race have the field to itself. A rival studio, and release my movie during a holiday Let’s take a hypothetical example. Liquidity Films, may gamble on the fact weekend?” Or, “Do I really want to spend When a major well-financed studio, let’s call that its movie, Friedman in Love, will find all that money advertising my movie?” it Dismal Science Cinema, enters the 2003 a niche for filmgoers who don’t like Or, “Am I better off releasing the show on Fourth of July holiday-weekend action movies. a non-holiday weekend?” It’s a game that sweepstakes, it possesses private Recent trends suggest that year- starts several months and sometimes a information about its featured film, Rational round releases have eclipsed the year or more in advance of a release. Expectations, a sequel to an earlier holiday release game playing. Both How much is at stake? Take Spider- blockbuster, Adaptive Expectations (no continued on page 5 Man for instance. The movie cost Sony comparison to Dickens intended). Dismal about $150 million to make. Sony expects Science Cinema is also thinking about how

PAGE 4 / SPRING 2002 NEWSLINK

Plunder Despite all this, the hope for principled continued from page 1 government in Massachusetts has not died. It is hard to say which is Perhaps, indeed, it will turn out that this more dismaying: this rush and to provide a tax deduction for particularly atrocious exercise in bad to raise almost every tax charitable contributions, both of which government is just what the state needs in the House of Representative overturned order to awaken itself to life’s realities. imaginable or the insult- in the blink of an eye. Once they had this There was a sense, after the 2000 election, ing rhetoric with which tax hike under their belts, our insatiable that all was well in Massachusetts. The tax the legislature has sold solons just couldn’t restrain themselves. cuts passed in that election marked the Thus we had a proposal to abolish culmination of a process that had eliminated the whole scam to voters. Proposition 2 1/2. Another to raise the some of the worst anti-growth features of the sales tax a penny (call this the Southern state tax code. Our own State Competitiveness New Hampshire Economic Revitalization Report of last year showed that Massachusetts additional assistance to local Act). Still another to raise the auto excise could hold its head high among other states, governments and at least a fifth of the tax. Hundreds of amendments to fund ranking second, Medicaid budget. It’s time to pet spending ideas. The list goes on. as it did, for its put an effective restraint on the It is hard to say which is more ability to growth of tax revenues. Perhaps depressing: this rush to raise almost every compete for the goal should be to drive the tax imaginable – and to do so well beyond workers and state budget down to some the requirements of the budget–– or the capital. really low number, say, $20 insulting rhetoric with which the Now we billion, and leave it there for a legislature has sold the whole scam to the find that the tax- few years to see just how cost public. Then there were the and-spend beast effective state managers can be. demonstrators, arriving with potted had only gone If the legislature and the various plants and cell phones to place their into hiding. That claimants on state funds are demands before the legislature. Trampled it was there all going to complain about paltry beneath the feet of this throng of special along awaiting a budget cuts, maybe we should pleaders was the express will of the chance to come give them some real cuts to voters. out of its lair and complain about? jump on the Stay tuned. This issue will not Hollywood hapless taxpayer. go away. We will, in any event, do all continued from page 4 So it’s time to think big. Time to get rid we can to make sure it doesn’t. of prevailing wage laws and project labor David G. Tuerck But recent evidence indicates that the agreements. Time to get rid of the Quinn bill, four major seasons are still pivotal. The studios still play to win the big game around four major release seasons. Make them listen! One soon-to-be released film, Men in Black II, cleared the field for Contributions of all sizes from individuals, foundations and corporations this July 4 weekend by the sheer support the Beacon Hill Institute. To make a contribution just use the drawing power of stars Will Smith postage-paid envelope in this newsletter. and Tommy Lee Jones. Insiders didn’t even try to challenge Men in Yes, I want to support the Beacon Hill Institute. I enclose my check for $______Black II’s “credible commitment.” Which goes to show that game Name (please print) ______theory is a concept that is hardly alien to Hollywood. Address ______

Darlene C. Chisholm, PhD, Associate City, State, Zip ______Professor of Economics at Suffolk University, assisted in the Phone ______Fax ______preparation of this article. Please make checks payable to Beacon Hill Institute at Suffolk University. All contributions are tax deductible under section 501(c)(3) of the IRS code, as gifts to Suffolk University. Beacon Hill Institute, Suffolk University,
8 Ashburton Place, Boston, MA 02108-2770.

PAGE 5 / SPRING 2002 BEACON HILL INSTITUTE

Media Mentions reported on the study. The Metro also carried In its January issue, Health Care News, continued from page 3 a letter on a later day critical of the BHI study. the monthly newspaper for health care Pacific Radio International’s Marketplace reform published by the Heartland Beyond Beacon Hill tax talk interviewed John Barrett about “sin taxes” for Institute, covered a report prepared by BHI Highlights from other BHI research also a story it carried on April 4 that appeared that said single-payer health care in madeA their way into the news. On May 5, the nationally and was cited on American Health Maryland would cost the state as many as Boston Herald ran a column by Tuerck critical Line, a wire service. 117,000 jobs and almost $5 billion in lost of the state’s Medicaid rebate program for Boston Globe columnist Steve Bailey on payrolls. prescription drugs, “FDA’s drug policy bad February 22 cited an update of a BHI study On January 12 Quincy’s Patriot Ledger for our health.” that said the costs of the Massachusetts referred to BHI’s report, entitled Cashing in The Worcester Business Journal Turnpike were higher than the New York on Cable: Warning Flags for Local Government, interviewed BHI research economist John Thruway, New Jersey Turnpike and in an article on the entrance into the cable Barrett on BHI’s study, And Then There Were Pennsylvania Turnpike. TV business by the Town of Braintree. Nine: The States vs. Microsoft for its May 8 On February 21 Florida’s St. Petersburg issue. The same interview was also part of the Times, The Orlando Sentinel and South Florida Continuing Coverage State Competitiveness newspaper’s May 10 radio show in Worcester Sun-Sentinel.com mentioned Dr. Tuerck’s role Report 2001 County called “Business Beat” on WICN 90.5 advising the state’s legislature on a proposal On April 14 the Star Tribune of FM. The Boston Sunday Globe ran a column by to increase taxes. Dr. Tuerck said the tax Minneapolis, MN carried a story saying John Barrett on the Microsoft anti-trust increase bill would cost Florida 35,000 jobs that Minnesota ranked ninth. On April 13 litigation on May 12. and $1.3 million in annual payrolls. Maine’s Bangor Daily News ran an article On April 12 the Boston Herald reported Boston Herald columnist Cosmo Macero highlighting that Maine was ranked the 19th on a BHI study concluding that forcing Jr. quoted Dr. Tuerck in a February 20 column overall best state in which to do business in Microsoft to offer a stripped-down version of on the tax rollback as saying: “If 59 percent of the country. A March 30 Boston Herald Windows in an anti-trust lawsuit will cost the voters decide they want a tax cut, then editorial cited the report in an editorial software developers and consumers millions everyone has a responsibility to respect that saying that per capita income has increased of dollars. The Boston Metro on April 12 also decision." from 1980 to 1999.

that welfare caseloads were highly insensitive to changes in the Welfare reform's success unemployment rate and that there would have been 68,548 welfare cases even if the unemployment rate had gone to zero. Massachusetts Welfare Caseloads and Unemployment Rates This suggests that, before welfare reform, a sizeable number of January 1983 - February 2002 what could be considered chronic recipients were unwilling to 120,000 10 join the workforce. MA Welfare Reform

100,000 Starting in late 1988, a statewide recession forced the

8 Rate Unemployment unemployment rate to rise dramatically. This rise in

s

d a 80,000 o unemployment added previously employed Massachusetts

l

e

s

a residents to the welfare rolls, culminating in a high of 114,671

C 60,000 6 welfare cases in May 1993. Soon thereafter, the state’s economy began to rebound and welfare cases started to drop back toward 40,000 its pre-recession level. 4 20,000 In November 1995 the state passed welfare reform, mandating work requirements and time limits. Thereafter the 0 2 7/83 11/95 2/02 story changed dramatically. Caseloads began to fall in line with Source: U.S. Bureau of Labor Statistics, Mass. Division of Employment and Training the decreasing unemployment rate. A statistical analysis applied Massachusetts Department of Transitional Assistance to data for the post-welfare reform period shows that welfare In November 1995, Massachusetts enacted welfare reform as part caseloads have become highly sensitive to the unemployment of an effort to decrease long-term dependency. An analysis of monthly rate and that the core group has diminished. In other words, unemployment and welfare caseload data for the period of July 1983 to welfare reform has succeeded in removing the disincentive to February 2002 in Massachusetts (see chart) illustrates the changes brought work and, in the process, reduced dependancy on goverment. about by welfare reform. From July 1983 through mid-1988 the number of Our findings further suggest that a federal proposal to tighten welfare recipients was virtually unchanged even as the state unemployment work requirements would further reduce welfare caseloads. rate was dropping. A statistical analysis applied to that period of time shows

PAGE 6 / SPRING 2002 NEWSLINK More than a bubble: The Internet's still a big deal Beyond the Dot.coms: The Economic Promise of the Internet.  Robert E. Litan and Alice M. Rivlin, Brookings Institution Press, 2001, 130 pages Reviewed by Frank Conte

ho would have imagined that the What counts in the final analysis is productivity, “creative destruction” waged by which enables a nation to increase its standard of The authors boldly proclaim the dot.com companies upon the living. Once ridiculed, Old Economy companies W old regime of the bricks and that the “Internet is likely to like Fedex and GM and older sectors, such as mortar establishment would, in an Internet transportation, and even the government will add roughly 0.25 to 0.50 per- minute, consume hundreds of e-commerce deploy the Internet to increase productivity for companies? the benefit of everyone by using fewer inputs to cent a year to US productivity Today dot.com companies are the butt of bad produce more goods and services. The authors growth (above what it other- jokes. In hindsight, the notion of bypassing the boldly proclaim that the “Internet is likely to add shopping experience with the click of a mouse roughly 0.25 to 0.50 percent a year to US wise would be) over the next appears all too foolhardy. Who would buy productivity growth (above what it otherwise groceries, furniture, pet food or clothes on the web? would be) over the next five years.” Even in five years.” A trip to the mall, despite the traffic, is far more sectors that are difficult to quantify, i.e. rewarding that the endless search for the best transportation, productivity increases will spill affair with paper; she is not about to throw out bargain on Amazon. Moreover, the serendipity of over as inputs into other sectors such as her checkbook nor her cancelled checks. And shopping in a comfortable downtown area is far manufacturing. promises about the paperless office results in more more enchanting than losing oneself in a deluge The authors pose a formidable question: paper prompting the joke: “We will have a of information. “Will productivity move back up to the paperless office when we have a paperless Yes, the dot.com stock market bubble burst growth path of the last half of the 1990s, bathroom.” and the cyber-optimists at Wired magazine look or will it fall back to the lower Litan and Rivlin believe that the health care foolish. But that’s missing the point. The rates of the previous twenty sector savings could reach $27 billion if health Internet remains a pervasive force in years?” insurance claims were shifted to the web. While economic life. That’s the conclusion reached After stalling in they argue this could potentially lower costs for by two astute economists, Robert Litan 1972, American business, they largely ignore the fact that such cost and Alice Rivlin , who argue forcefully productivity roared savings would be temporary. They also suggest in their recent work, Beyond the back in 1996 at a 2.5 that telemedicine shows great promise. But one Dot.coms, that the economic benefits percent rate for five years. can only imagine the licensing and liability issues of the Internet revolution are as Most economists attribute associated with giving medical advice via e-mail. subtle and significant as they this growth to massive Government is an area that, the authors are over-hyped and oversold. investment in Information believe, will realize cost savings. The Internet helps As economists, Litan and Technology (IT). This continues to government disseminate reams of information; Rivlin do not believe that the Internet has puzzle economists, because but the Internet has not slowed down the growth overturned veritable economic principles. They computers appeared on the economic of cost of government at all levels. Dealing with have a sense of proportion. In terms of size, e- scene far before the latest productivity the government whether in person or on the web commerce remains a small part of the overall surge. This phenomenon led Nobel laureate appears to be a deadweight loss. Reforming tax economy – accounting for less than $200 billion in Robert Solow to famously proclaim “We see policy would be a good idea. Eliminating sales a $10 trillion economy. The Internet will not repeal computers everywhere but in the productivity taxes would end the Internet state sales tax debate the business cycle even though inventory statistics.” but place greater emphasis on income taxes. reductions can be expedited. Nor will Moore’s Law Nonetheless the authors are optimistic. Litan and Rivlin believe that the successful – where computing power doubles every 18 “There is every reason to believe that the Internet Dell computer made-to-order model can be months – overturn recessions. Nor are price will continue to add to productivity growth, applied to manufacturing, particularly to the discounts the perfect measure of performance. The regardless of what happens to the NASDAQ.” automobile industry. But this is futile thinking price reductions promised by the web, while Whether this is sustainable remains, despite the given the general labor inflexibility of the desirable, are not the Holy Grail: “Although the authors’ predisposition, a tough question. automobile trade unions. For example, efforts to Internet may reduce profit margins among Some obstacles clearly stand in the way of outsource spare parts, a key to Dell’s just-in-time suppliers somewhat, any resulting reduction in the authors’ hypothesis. It is true that some success, are often met with resistance. prices that they charge will not directly reduce the transactions can be handled more efficiently with Additionally disenfranchising automobile quantity of inputs required to generate the same web-based technologies than paper. But dealerships – that is, taking out the middlemen – level of output – that is, they will not increase American consumers lack faith in credit card may prove more be difficult than diminishing the productivity. Instead, any cost savings from lower transactions on the web, even though they are as role of a stockbroker. supplier profit margins will represent a transfer of secure as conventional ones. Secondly, the income from suppliers to producers.” American consumer has, despite the latest gadgets of convenience, a long-standing love continued on page 8

PAGE 7 / SPRING 2002 of this, trade is being lost to the US where taxes women in the early 1990s, while German In Point of Fact are lower, the general climate more favorable women spent a third more time in unpaid to business and where many wealthy art home production than American women. axing anything that moves like collectors live. The report said that the EU had In the U.S. wages and taxes also come bullets. ignored basic economic principles and not into play. In Europe, even many low- California State Sen. Don Perata taken into account the effect of its own taxes. skilled workers have good educations T (D-Oakland) introduced a bill “Red tape and taxes cost Europe lead in art and demand high pay. If a women can recently that would levy a 5-cent tax on every market,” The Daily Telegraph, March 8, 2002. earn only a bit more by working outside bullet sold in California. Perata said he wants the home than she would have to pay a the money to pay for hospital trauma centers, Compared to paying taxes, cleaning the kitchen is a cleaning lady, “it doesn’t make sense to some of which are facing budget problems. better deal. hire the cleaning lady,” points out “There’s no reason why the general public It’s conventional wisdom among economists Freeman. Also, taxes on a second earner’s should be paying for gunshot victims. It is an that Europe isn’t as good at generating jobs as wages are so high in Europe that it often avoidable injury. It is a preventable injury and the U.S. is. Some evidence: Only 64 percent of doesn’t pay for both members of a couple therefore I think it’s fair to fix a very small tax the adult population under the age of 65 is to work. on the sale of bullets,” Perata said. employed in Europe, compared with 74 percent “Many Europeans opt for “State Senator Calls For Tax On in the U.S. But according to a study by Richard housework," Margaret Popper, Bullets,”Associated Press by way of B. Freeman, a Harvard University economist, BusinessWeek, April 1, 2002. SanDiegoChannel.com, April 1, 2002. and Ronald Schettkat, an economist at the Netherlands’ Utrecht University, the lower “Free” medicine is expensive but don’t take The Aesthetics of the Laffer Curve. employment-to-population ratio in Europe our word for it. Europe's $11.5 billion-a-year art market has lost partially reflect that Europeans perform work The Uncompensated Care Pool was its supremacy to the United States because of at home for themselves, such as food started 17 years ago to spread the cost of high taxes and stifling European Union preparation, that Americans pay others to do. treating the poor more evenly among bureaucracy, according to a recent report. Since In the early 1990s, Americans spent 59 percent hospitals. Because of new cost controls 1998 America has increased its share of the of their work time in paying jobs outside of imposed by private and government international art market by seven percent and their home, while Germans spent 52 percent insurers, the free care program now pays last year overtook Europe with a lead of 47 of their work time on work at home for some hospitals better than private percent to 45 percent. “European taxes and themselves. That difference is even greater for insurance companies do. Free care is one regulatory structures have led to a widely held women. American women spent 44 percent of the few systems left that pay hospitals perception that Europe is a complicated, costly more time in market activities than German a percentage of what they charge rather place to do business,” said the report. Because than the negotiated rates typical under managed care. Massachusetts free care BookMark ‘’is mind-bogglingly generous,’’ said continued from page 7 Randall J. Bovbjerg, a health policy researcher at The Urban Institute in Litan and Rivlin do not engage in the kind 1 Robert J. Gordon, “Technology and Economic Washington, D.C. ‘’Is that too much? The of irrational exuberance found in numerous books Performance in the American Economy, ” in people in Texas think so. They would extolling the radical nature of the Internet. This is Technological Innovation and Economic Performance, never pay for a system like that. People one of the virtues of the book. But their expectations Benn Steil, David G. Victor, and Richard R. Nelson, really like their health care in about productivity need to be tempered. There is eds., Princeton, Princeton University Press, Massachusetts.’’ some evidence that the productivity gains of the late pp. 49-73. A version can also be found at, http:// “Mass. free care turns divisive: Some 1990s may be short-lived, if not illusory. One faculty-web.at.northwestern.edu/economics/ hospitals benefit; others protest prominent New Economy critic, Robert J. Gordon gordon/Tech&Econ.pdf of Northwestern University, has noted that the
changes,” Liz Kowalczyk and Anne productivity revival–“is narrowly based in the Barnard, Boston Globe, April 17, 2002. production and use of computers” rather than across
all sectors.1

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