Can Government Make a Business Run "For The Good of Society" ?

The New York Post recently reported that a judge in Indiana has temporarily barred Starbucks from closing 77 Teavana stores that were failing because "the very profitable Starbucks could absorb the financial hit". Industry experts said the ruling will send a chill down the spines of distressed retailers, and with good reason! The prospect of not being able to shut down an outlet that is bleeding the rest of the business may have countless unintended consequences that will affect not just owners but consumers in general. Firms are likely to take this as a signal to be more cautious about opening up new stores, and become reluctant to invest, take risks, and employ people in the first place. Customers stand to lose.

Amidst the debate upon the justice of the justice in question, I heard a voice clamour, "The question is not of profit, but whether a business should be run for society or society should be run for business!" and to be quite frank the claim struck me at first as vacuous; professing much while saying very little. Yet we must admit that throughout history many governments have believed they were "serving society" (rather than the business community) by forcing companies to fix prices, continue operations at a loss, or even subsidising or bailing them out with public funds. Many have believed this is in the interest of "the greater good."

Could it be that government forcing Starbucks to maintain unprofitable stores - in some circumstances - would be good for society?

First we should examine the use of the word "society" itself. Rather than bring clarity, it obscures the issue, making it more difficult to apprehend the facts of the matter. Who exactly is society and how do we measure what is and isn't good for it? Society is made of a whole bunch of different individuals and groups with different interests, and what is good for one might not necessarily be good for another.

It's not that keeping a Teavana open despite the owner's desire to close it won't be good for anyone; clearly the proprietor of the shopping centres is willing to fight hard for what they stand to gain, and certainly regular patrons will be happy to be able to get their regular cup of chai before leaving a hard-days-shop. However, the point is the move privilege a few individuals who want to continue going to those outlets at the expense of everyone else in the area who has demonstrated that they would rather something else opens up in that space instead. Starbucks then will need to recuperate the loss somehow or other, perhaps by increasing prices slightly at all other locations. If the locality can only sustain the demand for three tea houses and the unprofitable Teavana happens to be the forth then they are also bleeding demand away from the other three, and so on. We can continue counting negative consequences to other parties.

If Starbucks are deprived of however many millions it costs to operate 77 unprofitable stores that is less money they have to invest in stores that are wanted by enough people to keep them afloat. It's less cash for shareholders who will take it out to the shops to spend it or reinvest it in other businesses, it's less for Starbucks customers who have to pay slightly more for a cup of coffee and therefore don't have to spend on something else, it's less for Starbucks employees who might have to forego a raise because there is less to go around..

Clearly the effect of this policy is not something that can be broken down into whether it ‘benefits society’ or not. All we can say is that it benefits some groups and harms others.

It seems ironic to me that most of those who will cheer on the judges ruling, forcing Starbucks to run 77 tea outlets - against their own interests - for the interests of others are probably the most likely to complain when a Teavana opens up that it will "drive out" locally owned tea houses (which are probably actually collapsing under the strain of the regulations they have to comply with, not being able to afford Starbucks team of expensive lawyers and accountants.) If anything you'd think this crowd would be cheering on the closures! As they carry with them a certain prejudice that whatever vexes big business is necessarily good for the rest of us, we can only conclude that supporting the ruling is less about what is good for society and more about what is bad for Starbucks.

Think Like an Economist

Occupational Licensing

In 2015 Obama sent his council of economic advisers out on a fact finding missions to discover why job creation was so hard for the administration and this council - made up of a bunch of Democrats, right - not ideological free marketeers - concluded that demands for mandatory occupational licensing were creating terrible cartels, excluding workers and getting in the way of regular people wanting to start up businesses.

There are over 800 occupations that might require a licence in some states in America including a tour guide, manicurist, dog walker, librarian, locksmith, dry cleaner, auctioneer, fruit ripener, plumber, private investigator, Christmas tree vendor, florist, interior designer, funeral director, cab driver, shampoo specialist, glass installer, cat groomer, tree groomer, hunting guide, kick boxer, real estate agent, tattoo artist, nutritionist, acupuncturist, music therapist, yoga instructor and mortician.

On the back of people's justified fears of disastrous bridges being built by unqualified tradesmen and hapless patients being sliced open by quacks, government - with the help of protected industries - have managed to sell the myth that mandatory occupational licensing increases the safety and quality of services. People assume that if the government says its fixed its fixed. The reality is that mandatory occupational licensing far reduces the number of practitioners operating in any sector, and when consumers have less choice they have to take whatever they can get at whatever price they have to pay. As a result the quality of services can actually go down and prices up.

This is borne out by the empirical data:

After compiling a meta-analysis entitled, "Rule of Experts," S. David Young concluded “…most of the evidence suggests that licensing has, at best, a neutral effect on quality and may even cause harm to the consumers... The higher entry standards imposed by licensing laws reduce the supply of professional services…. The poor are net losers because the availability of low-cost service has been reduced.”

Stanley Gross of Indiana State University, had to concur, “…mainly the research refutes the claim that licensing protects the public.”

More recently economics PhD. Morris Kleiner released two publications (2006, 2013) for the Upjohn Institute for Employment Research demonstrating that licensing occupations does more to restrict competition that to ensure quality.

On a free market, the poor may have to sometimes settle for inferior services - but often that is better than no service at all which might be what they otherwise receive. Even so, the price of most services will come down over time if a multiplicity of firms are offering similar services: if not in price then in real terms as wages rise. There are more risks though. When people can’t buy services they might try to do their own work, their own electrical work, plumbing or dental work, this has often happened in the past, and sometimes the consequences can even be fatal.

Still, most people find it difficult to imagine how society might be protected from quacks without government-mandated occupational licences, so lets have a quick review of some of the market can account for this:

Market Competition. Consumers provide a large degree of regulation over markets by not repeatedly buying poor services and advising other customers of what to buy and what not to buy.
Consumer Watchdogs. Customers want to know which services offer the best value for money and are quick to consult experts in magazines or online for good information before they choose a provider.
Employer Discretion. Employers do not want to take on a poorly qualified civil engineer or plastic surgeon.
Registration. Third parties or groups of experienced practitioners can create registries of bonafide service providers. If a complaint is lodged against someone on the registry the administrators can investigate the case and strike them off if they are guilty or give them a warning.
Private Certification. In the absence of mandatory government licensing consumers will often want assurance from credible sources that the services they are going to pay for are of high quality - and more importantly - safe. Third parties can offer to certify practitioners that meet their standards.
Litigation. Customers already have protection under the law against faulty products or false advertising even in the absence of mandatory occupational licensing. The threat of being sued for causing damages is enough to deter most companies from releasing harmful products, if the threat of killing off their customers is not enough already.
Contracts. Customers can make explicit contacts with service providers to ensure they have recourse if they don't get what they think they are getting. If a company says the customer is getting x but gives them y the contract clearly delineates who is in the right and who is in the wrong.
Bonding. Individuals can engage in agreements in advance that involve third parties to ensure that payment is transferred when it is supposed to be.
Insurance. Customers can insure themselves against receiving faulty goods or receiving harm from services. In some cases the insurer will be able to bring litigation against the service providers for damages incurred offering a deterrent against providing poor services.
Jail. If the fact that it is not profitable in the long-term to kill of your customers is not enough to deter greedy capitalists from selling products that are physically harmful, the prospect of a jail term just might be.

Occupational Licensing simply come down to the government abolishing someone's right to provide services to someone else who is willing to buy those services, and then selling it back to that person at a fee. This is usually at the cost of several years in some educational institution where education in the necessary skills is dragged out over several years and supplemented with a whole bunch of written work that is superfluous to the exercising of those skills. The sum result of these policies are to drive otherwise capable people out of their passion because they are not academic, can't afford the education or the time off work, or can't look at another educational institution after the horrors of school. Willing students are saddled with debts and loss of work experience while they study and expect to recoup expenses from customers. All of this drives up the cost of products, reducing living standards for average people.

We see a real problem with this with the FDA when they allow highly dangerous foods - and people presume "the government has taken care of it, if it was dangerous it would be off the market" - when the opposite is the case. They have also held (and continue in some cases to hold) life-saving drugs off the market for decades at the expense of countless lives. They also have the monopoly on this service so it's impossible to compare their performance with any other agencies that might have had a much better record of making good judgements of food and drugs. With a multiplicity of firms acting in the sector you could compare their history for a sense of which might be the most reliable when it comes to what.

Beauty Salon Economics

One of the most fundamental things about economics which most people who are passionate about politics do not understand is that the economy is not just like a chess board where you can move one piece with deterministic and predictable consequences. On the contrary, an economy is an intricate fabric of interrelated institutions and actors all of whom act relative to one another. Any one move creates a cascade of domino effects. If the price of milk changes dramatically then orange juice sales might be affected - you just never know.

The role of a good economist is to be able to follow the threads of consequences liable to result from a policy so that the short-sightedness of policy-makers (and would-be policy makers) seeking some immediate and favourable end does not result in a multitude of negative unintended consequences into the bargain. (Clearly this goes to the very heart of why I called this blog Seeing the Unseen.)

Many policies can end up having the opposite effect from what is intended.

For example, supposing some of the fancy hair salons are getting irked because cheap salons are popping up everywhere and giving people poor quality haircuts. They're giving the whole industry a bad name. So a coalition goes to the government to pass standards and licensing laws in the hairdressing industry (in some places you currently need a license to braid hair.) That's going to improve the quality of haircut going around, right?

Not necessarily. Now all the hair salons have to send their employees to college for two years to get a license, and when they graduate they are expecting much higher pay because they just sunk two years into an education which they didn't see  any money during. Some of them went out drinking with their student loans, the rest still had rent to pay, and most of them accumulated debts. What's more the salons need to consult special accountants or lawyers to make sure they can prove that they are adhering to the new regulations - even the ones who are way ahead of the law and already providing far better conditions and services than what has been mandated. These professionals often charge upwards of $100 an hour. Many independent salons simply can't afford the increase in costs and have to close down entirely; others have to jack prices up to pay for the extra costs of compliance and staff. In some areas only one salon is left standing and since people have less choice they can afford to let standards slip.

With the price of haircuts going up lots of people decide to go without. They cut their friends hair at home, badly. Or they get pretty good at it and don't have to go to the hairdressers any more but take longer to prepare for going out and miss out on the chat and gossip. What's more everyone who does still go for a professional haircut has less left over to spend on a manicure or something else nice, so other industries also suffer. You can add to that the marginal increase in taxes to pay the civil servants in the new public body which acts as a regulator for the hairdressing industry. Now those people are involved in busy work instead of making commodities and providing services that improve people’s living standards in real terms and rather than paying into the public purse they are a net drain on it.

I choose a relatively trivial example (no disrespect ladies) because it's perfectly illustrative of how a seemingly simple and innocuous policy suggestion - mandatory hairdressing licenses - can generate more than its fair share of consequences. An alternative is for a series of private watchdogs to certify only hairdressers that meet their standards and give the ones who do an official number and sticker to put in their window; because they are competing they have to keep the costs of certification to a minimum (no $100 an hour fees), and people who are not fussed to pay extra for a certified cut can take a risk on somewhere cheaper or go by word of mouth.

Occupational licensing makes for an interesting case because it is almost ubiquitously considered in the public interest and even necessary to prevent catastrophe, and yet there is actually zero evidence that it leads to a higher quality of service provision. Zilch!

Usually all it means is that instead of taking budget options people with fewer means have to go without any services at all! This is a topic to which we will have to return to in more detail, check back! :)