2 SUMMER 2018 BRIEFLY NOTED CanYo urNeighborhood ......2 / Regulation / SUMMER 2018 BRIEFLY NOTED CanYo urNeighborhood BookieCompete WiththeInternet? BY IKE BRANNON In the olden days,

2 / Regulation / SUMMER 2018

B R I E F LY N O T E D

Can Your NeighborhoodBookie CompeteWith the Internet?✒ BY IKE BRANNON

In the olden days, people who wanted to bet on the local sportsteam had few options other than their neighborhood bookie, whocould usually be found ensconced in a local bar. With the right

introduction, he would gladly allow a gambler to place a bet on nearlyany event he wished, and would even extend credit.

IKE BR ANNON is president of Capitol Policy Analyt-ics, a consulting firm in Washington, DC.

Today, however, things are different.The mob, which was the primary sponsorof major sports gambling for most of thepast century, is quiescent and the humbleneighborhood bookie faces new competi-tion from sports books in Las Vegas andon the internet. With the Supreme Courthaving recently invalidated the 1992 Profes-sional and Amateur Sports Protection Act,which outlawed sports gambling in moststates, more states are likely to get in thegame. Legal internet wagering that doesnot involve overseas bookies will probablybecome possible in the near future as well.

In a world awash in legal betting andmore on the way, how are bookies faring inthe 21st century? Quite nicely, it appears.Despite some practices that seem almostantiquated, the economics of gamblingtilts toward the local, illegal betting syndi-cate in many places. Against the odds, thelocal bookmaker has prospered against thelegal competition.

Special odds, special customers / The firstadvantage that bookies have over Vegas andmuch of the internet is the ability to pricediscriminate, or offer different odds to dif-ferent customers. They do this in two dif-ferent ways. First, bookies usually increasethe point spread for the hometown teamto take advantage of those people who betwith their hearts instead of their heads. Forinstance, while the Chicago Bears may haveto win by 5 points over the Lions to pay off

for betters in Las Vegas, in Chicago theymay have to win by 8.

Aha, a clever person might say, why don’tI bet on Chicago in Las Vegas, where I get abetter point spread, and bet against Chicagoin Chicago, where the odds now favor theiropponent? This way, if Chicago wins bymore than 8 points I win in Vegas alone,if they win by less than 5 points I win inChicago alone, but if they win by a marginbetween 5 and 8 points I win in both places.

While this may appear to be a no-losesituation, it fails to account for the bookie’sfee for taking the bet. This cost—also knownas “vigorish” (after the Russian word for“winnings”) or “juice”—amounts to 10% ofthe bet in most places, an extremely durableand consistent percentage.

Koleman Strumpf, a Wake Forest Uni-versity economist, has researched the eco-nomics of gambling using private datafrom several bookies. He argues that theconstancy of the “vig” was partly theproduct of mob-coordinated collusion.Its existence means that unless the arbi-traging bettor can expect to have the finalpoint margin fall between the two pointspreads more than 10% of the time, thenthe transactions costs of the bets will eatup any profitable arbitrage opportunities.Strumpf found those arbitrage possibilitieswere invariably wiped out by the vigorish.

The local neighborhood bookie can alsoprice discriminate based on the idiosyncra-sies of individual bettors. If, for instance,a particular bettor always wagers on hisbeloved team, the point spread given to him

by the bookie will start to slide up abovewhat is given to other bettors. Indeed, oneof Stumpf’s sources of information is atranscript of an audiotape where two book-ies mock a regular customer for failing torecognize the relatively poor point spreadsthat they give him, spoken in languagereminiscent of The Sopranos.

Letting it ride / One myth that Strumpfdebunks with his research is the notionthat bookies go to great lengths to avoidputting themselves at risk from game out-comes. The point spread ideally is set sothat an equal number of bets is placedon both teams, leaving the bookie off thehook. However, prognosticating how peo-ple are going to bet is difficult, and havinga game with uneven bets is not unusual.However, should a bookie find himselfwith a lot more money riding on one side,he often doesn’t do anything about it.

What could he do? For starters, he couldchange the point spread to attract com-mensurately more bets on the low-moneyteam, but this exposes the bookie to a pos-sible disaster. Suppose a point spread thatfavored Oakland by 10 points over SanFrancisco drew $20,000 more in bets onSan Francisco on the first day. The bookiecould lower the spread to new bettors to 8points in the hope that this would balancethe bets on both teams. However, considerwhat would happen should Oakland win byexactly 9 points. He now has to pay the earlySan Francisco bets and the late Oaklandbets, and he’s out $40,000. To avoid suchpossibilities, many bookies refrain fromsetting the point spread until a day or twobefore the actual game, giving them timeto see how the point spread in Las Vegashas settled.

Bookies do not often lay off bets withanother book to insulate them from risk.With sufficient liquidity, an occasionalimbalance in bets ought to be somethinga bookie can withstand. Despite whatStrumpf regards as relatively low earningsfor such a service (he estimates averagebookie income of around $200,000, mostlytax-free of course), he suggests that theyusually do not face liquidity constraints.

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The competition / The biggestthreat to the neighborhoodbookie is the rise of offshorebetting houses that can bereached via the internet. Suchvenues remain far from thelong arm of the law (and themob, so far) and have severaladvantages. First, the internetgambling sites generate enoughvolume to compete on the vigo-rish, offering rates as low as 2%to high-volume betters. Second,the internet bookies can exploittheir vast data to exercise muchmore sophisticated price discriminationthan bookies.

One curiosity that Strumpf discoveredwas that neighborhood bookies are veryreluctant to store their data on computer,and almost to a man they continue to usethe same sorts of books used for the past100 years. They mayfind it easy to remem-ber that Neil from Carroll Gardens alwaysbets on the Knicks, but there probably areother gambling patterns they could exploitif they used computerized tools. The inter-net bookmakers are doing precisely that.

However, bookies are ahead of theinternet in offering credit to bettors. Thisservice is a way to develop loyalty amongcustomers, who are more likely to tryto bet their way out of a losing streak.Of course, collecting on a debt can betricky. One way that bookies deal withthis is through surrogates, who bringnew bettors to the bookie. In exchangefor providing the bookies with fresh bets,the surrogates receive a proportion of thelosses of their bettor. The beauty of thearrangement, at least for the bookie, isthat the surrogates are also on the hookshould the bettor attempt to renege on adebt. With such motivation, it’s clear whybettors fear the consequences of unpaidgambling debts. Such a system seems ill-suited to the faraway headquarters of theinternet gambling sites.

Congress appears unlikely to pass newlegislation that restricts gambling at thefederal level, although various stakehold-ers—mainly casinos—have begun to lobby

for restrictions to be placed on sports gam-bling in some way to limit their competi-tion from the internet or non-Vegas locales.

The practice of placing bets with localbookies is neither inherently more norless virtuous than betting in Las Vegas.Journalist Alan Erhenhalt noted in his1995 book The Lost City that the local bet-ting syndicate in Bronzeville, an African-American neighborhood in Chicago, wasa central ingredient of the close-knit com-munity of the 1940s and 1950s. To besure, some of the less salutary aspects oflocal bookmakers offend our sensibilities.But just as the mob was purged from LasVegas, could such heavy-handed tactics bepurged locally? The answer may depend onwhether bookmaking is legalized; the factthat sports gambling has long been largelyillegal explains why the mob is the greatestpurveyor of sports bookmaking.

Peoria tale / In the interest of full dis-closure, I should note that my great-grandfather and namesake operated agambling establishment in Peoria, IL inthe years before and during World WarII, and the money earned from this busi-ness paid for my college education andmy siblings’. Gambling was then legalin the city, but the mob provided andmaintained the slots for the saloon andran the constant poker game, splittingthe profits evenly with my great-grandfa-ther—net of the payoffs for governmentofficials, of course.

After the war, Peoria cracked down on

gambling for a very good reason:it was inexorably connected tothe organized crime and cor-rupt government that plaguedthe city. There appeared to be noway to combat the latter prob-lem without getting rid of gam-bling as well.

In the 1990s, legal gamblingreturned to Peoria in the form ofa riverboat casino, which thus farappears to be free of organizedcrime and has not appreciablyincreased the corrupt behaviorby government officials in the

area. Peoria has its share of citizens withgambling problems, of course, but the riv-erboat casino has provided entertainmentfor area residents as well, without the needto travel to an Indian reservation or LasVegas. The influx of tourists to Peoria (nottypically considered a tourist destination)has provided numerous well-paying jobsfor the community.

Peoria still has its share of neighbor-hood bookies, ubiquitous enough thateven I, a non-gambler who is now onlyan occasional visitor to my hometown,know more than one person there whotakes action on college football games.My friends in Peoria who take part in theweekly betting pools at our neighborhoodbar rarely go to the riverboat casino, and Idoubt they would do so even if the policebroke up their betting pools instead ofparticipating in them.

Just because something is impossibleto stop does not mean it should be legal,of course. At the same time, determiningthe legality of an activity based on the size(and political acumen) of the seller makeslittle sense. If gambling is fine for largecasinos and the government, it is difficultto see why a prohibition should exist forbookies or internet sites. Explicit legality(and not the tacit legality that exists inmost places) would quickly give recourseto gamblers worried about a kneecappingfrom Skinny Pete, being forced to payusurious interest rates, or other unsa-vory practices commonly associated withshady bookies.P

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How’s Your Trade War Going?✒ BY PIERRE LEMIEUX

Last March, after announcing tariffs of 25% on steel and 10% onaluminum, President Trump tweeted that “trade wars are good,and easy to win.” This seems predicated on the strange theory

that Americans win when their government impedes them from buy-ing what they want to buy.

PIERRE LEMIEUX is an economist affiliated with theDepartment of Management Sciences of the Universitédu Québec en Outaouais. His latest book is What’sWrong with Protectionism? Answering Common Objections toFree Trade (Rowman & Littlefield, 2018).

A national government imposing tariffs(or other customs barriers) uses its owncountry’s consumers and importers ashostages when it threatens foreign gov-ernments against harming its exporters.What a protectionist retaliation threat reallymeans is, “If you harm your own consumerswith your tariffs, I will hurt mine with mytariffs!” No wonder that protectionism wasdismissed by Adam Smith and David Humein the 18th century. Smith did concede thatretaliatory tariffs could be good—if theyprompted the targeted government to backoff—but he didn’t hold out much hope forthat happening.

Trade war casualties / Ask American steeland aluminum consumers if a trade waris good. Not unexpectedly, by the end ofApril, aluminum prices were up by about10% in America according to data fromInvestmentMine, a research consultant.American manufacturers of steel productsare complaining about higher prices fortheir input. According to the Wall StreetJournal, the steel and aluminum tariffsare the darkest cloud over the boomingchemical industry in America. Ultimately,of course, American consumers will paythe price.

Even from the very imperfect metric ofjobs, the steel tariff is very likely to be detri-mental. Many more Americans are occupiedin steel-using industries (around 2 million)than in steel-making (140,000). Economistsat the Federal Reserve Bank of New Yorkconcluded that “the 25 percent steel tariff is

likely to cost more jobs than it saves” (LibertyStreet Economics, April 19, 2018).

More important, the tariffs will destroyvalue by making consumers pay more thanthe real cost for what they want.

At the time of this writing in early May,it is still too early for a quantitative assess-ment of the effect of tariffs that Trumpimposed on washing machines in Janu-ary. (See “Putting 97 Million Householdsthrough the Wringer,” Spring 2018.) How-ever, according to preliminary data fromthe Bureau of Labor Statistics, the (domes-tic) producer price index of all majorhousehold appliances increased 1.3%between January and April, while house-hold appliance prices had been stable forseveral years before. As these data cover allmajor household appliances, they suggestthat the effect of the tariff on the price ofwashing machines is substantial—which isnot surprising as that was precisely the aimof the protection requested by domesticproducer Whirlpool.

Targeting China / Ask American farmers iftrade wars are good. China is the secondlargest market for American agriculturalexports (and was the largest as recently as2016). U.S. pork and sorghum have alreadybeen hit by retaliatory tariffs or “depos-its,” and threatened tariffs have reducedChinese purchases of American soybeansand corn. The Chinese market accountsfor half of American exported soybeans,the largest agricultural export. Americanfarmers are starting to hurt, but Trumpsuggested that they could be compensatedby special subsidies. So the U.S. govern-ment is going to tax Americans to offsetsome of the damage from taxing Ameri-

cans. “Saturday-morning-cartoon centralplanning,” quipped Sen. Ben Sasse (R, NE).

On the one hand, the U.S. govern-ment helps farmers, making them moredependent on government. For example,the Foreign Agricultural Service of theU.S. Department of Agriculture marketsAmerican agricultural products abroad,notably through its many offices in China.On the other hand, the same govern-ment impedes farmers’ exports throughits trade policy. Government planning hasnever been a model of rationality, exceptfrom the viewpoint of politicians andorganized interests.

Much could happen by the time thisarticle is released. The new 25% tariffs thatwere announced on $50 billion in Chineseimports could be imposed. A promisedretaliation by the Chinese governmentwould likely follow. More damage wouldbe done if the trade war intensifies. TheU.S. government has its sights set not onlyon China but also on Europe and on NorthAmerican Free Trade Agreement countries(and some other countries). The risk that atrade war could precipitate a recession is sig-nificant. Alternatively, trade tensions couldabate, perhaps because of stock marketresistance and pressure exerted on Trump.

Isn’t it astonishing that so muchdepends on one single man in Washing-ton, DC? In this respect, Trump may haveas much power over the national economyas his Chinese counterpart.

A trade war hurts consumers, but it alsodisrupts production. As supply chains havebecome more integrated (and efficient)across borders, more businesses are takingthe side of consumers over special inter-ests. In early April, 107 trade groups, ledby the National Retail Federation and theInformation Technology Industry Council,warned the U.S. House of Representativesagainst launching a trade war. It is becom-ing clear that the current protectionismonly benefits a small number of large pro-ducers and their few employees.

The Trump administration’s invocationof national security as justification forsome of the tariffs is mainly a protectionistexcuse. So are, in large part, its allegations


of Chinese intellectual property (IP) theft.“IP theft” covers many different things: (1)counterfeit or pirated products, (2) actualtheft (often cyber theft) of trade secrets,and (3) the Chinese government’s require-ment that foreign firms that establish apresence in China enter into joint ventureswith local firms, which often involve tech-nology transfers to the latter. The secondform of “IP theft” certainly looks like realtheft, but the first one is debatable, espe-cially under the absolutist, criminalizingview of the U.S. government. (Interestingly,as Stanford law professor Paul Goldsteinnotes, the U.S. government did not protectforeign copyrights until 1890 and waitedanother century before joining the majorinternational copyright treaty.)

Concerning the third form of IP “theft,”the “forced” technology transfer, of courseit’s not nice for the Chinese governmentto directly or indirectly require technologytransfers or provide “incentives” for them,as the U.S. trade representative often com-plains. But nobody is forcing Americanfirms to establish business in China. Onecan export to the Chinese market fromthe United States or else simply ignore theChinese market altogether. Technologytransfer is only one of the conditions thatprofit-maximizing corporations acceptvoluntarily in order to access markets inliberty-challenged places. None of thiswould happen in an ideal world, but theU.S. government should be content tomake America ideal for liberty.

Moreover, ordinary courts, even Chi-nese courts, are often available to enforceIP claims. International treaties couldaddress remaining problems. Using tradesanctions to solve problems of IP protec-tion, says Goldstein, “is like performingmicrosurgery with a sledge hammer.”

Free to consume and compete / One officialjustification for the trade war with Chinais that Chinese exporters are subsidizedor otherwise assisted by their governmentand thus have unfair advantages whencompeting against American companies.The fact that Chinese producers and Chi-nese taxpayers are forced to subsidize theirexporters does not justify the U.S. gov-ernment’s further reducing the freedomof Americans—their freedom to import,in this case. If other people’s oppressionwere a good justification for underminingliberty, trade and everything else would bea race to the bottom: the least-free in theworld would dictate everybody else’s levelof freedom. It would be better to let Amer-icans be free to import and let Americanbusinesses compete, even if they are not ona level playing field.

The notion of a level playing field ishighly suspicious anyway. Where in theworld or even inside America is there a levelplaying field? And how do you measurethe tilt of this metaphorical field? Is it atilt that average wages are 40% lower inMississippi than in California? Directlyor indirectly, governments intervene in theeconomy, including the federal and stategovernments in America. Public expendi-ture on education, for example, is higher inAmerica (4.2% of gross domestic product)than in Germany (3.7%). Would this justifyGerman firms complaining that they facean unequal playing field?

Moreover, if entrepreneurial privatecompanies need protection in order tocompete with Chinese state companiesor subsidized “private” ones, where is theadvantage of private enterprise? We mightas well install a Chinese sort of economyin America. In reality, the more Chinesefirms are dependent on—and run by—their

government, the less efficient they willbecome. The more state-controlled Chi-nese society becomes, the more likely Chi-nese taxpayers won’t be able to continuesubsidizing their government’s cronies.

Some may respond that there already isonly a relatively small difference of degreebetween Chinese and American state capi-talism. If that is the case, indeed, Americamight not be able to maintain its historicaleconomic advantage. But that would becaused by too little free enterprise here,not too much.

The U.S. government should not worryabout poor Chinese taxpayers and straight-jacketed businesses in China. We may hopethat they will improve their dire situationwith time. But there is little we can doabout what’s happening in China exceptto give an example of economic freedomand efficiency, which will not be done withprotectionism. But the U.S. governmentcan do a lot about freedom at home bynot impeding American consumers andbusinesses that want to import from, orinvest in, foreign countries.

Losing the war / Even if retaliation againstforeign protectionism were to succeed inopening trade, it would strengthen thefalse idea that what we give up in trade(exports) is more important that what weobtain (imports). As James Mill wrote inhis 1824 Elements of Political Economy:

When one country exchanges …, thewhole of its advantage consists in thecommodities imported. … This seems tobe so very nearly a self-evident proposi-tion, as to be hardly capable of beingrendered more clear by illustration;and yet it is so little in harmony withcurrent and vulgar opinions that it maynot be easy, by any illustration, to gain itadmission into certain minds.

Thus, a strategy of retaliation, even if suc-cessful in the short run, may actually com-promise free trade in the longer run.

A related question is whether Americacould lose the trade war by being sidelinedbecause American protectionism pushestoward the East the center of gravity ofP

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world trade. This is not impossible as faras formal trade agreements are concerned.From this point of view, pulling out fromthe Trans-Pacific Partnership might havebeen America’sfirst trade war defeat. Trumpmay now be realizing this, as he voiced awish to reenter the agreement. But it mustnot be forgotten that trade agreementsare not the essence of free trade, and thatthe Trans-Pacific Partnership was as muchabout regulating trade as about freeing it.

What’s important is whether Americansremain free to import and whether Ameri-can businesses can freely pursue oppor-tunities wherever they see them. Alas, thesame protectionism that leads the U.S.government to disengage from the formalworld trade system is likely to underminethe freedom of American consumers andbusinesses to make their own individualdecisions on where to buy or invest in thewide world.

Rent-Seekers InfiltratePublic Utility Regulation✒ BY KENNETH W. COSTELLO

Public utility regulators should stick to their knitting: setting justand reasonable rates and taking other actions that improve thelong-term welfare of utility customers. After all, the raison d’etre

for public utility regulation is to protect customers from “monopoly”utilities. Pursuing other purposes besides consumer protection only

KENNETH W. COSTELLO is a principal specializing inenergy and the environment at the National RegulatoryResearch Institute.

a high price, contrary to what some envi-ronmentalists have argued.

In combating climate change, somestates like California seem to adopt a moralimperative to eliminate both fossil fuelsand (puzzlingly) nuclear power from themix of a utility’s generation portfolio.Studies and real-world experience haveshown that such a scenario could drive upelectricity rates substantially, reduce thereliability of electricity service, and inflictharm on the overall economy.

Studies have also warned that reducinggreenhouse gas emissions to the so-called“80 by ’50” target” (i.e., reducing carbondioxide by 80% by 2050, the target of manyclimate advocates) would be prohibitivelyexpensive and hard to achieve withoutthe continued operation of nuclear powerplants. One can ask whether Californiaand other states are more intent on end-ing nuclear power than mitigating climatechange. They believe that aggressivelyswitching to renewable energy and electri-fication is the optimal strategy forfightingclimate change. All eyes will be on whattranspires in these “green” states from thisgrandiose experiment.

Whose benefit? / Before proceeding withany action, states should ask themselveswhat benefits electrification and high reli-ance on renewable energy offer relative tothe costs. It is unlikely that any state wouldrealize net benefits if the intent of theseactions is solely to mitigate carbon emis-sions. It is somewhat puzzling why a stateon its own (like California or New York),without cooperation from other states orthe federal government or other countries,would revamp its energy sector at a hightransition cost for a policy goal that wouldlargely benefit the rest of the world.

If I were a state regulator, I wouldthink twice before prioritizing climatechange over the economic welfare of thecitizens of my state, especially when itinvolves subsidies from those who standto benefit little. Isn’t constituent welfaresupposed to be the chief concern of stateutility regulators?

Within the regulatory agencies them-

mental consequences of major pipelineprojects, assessing their effects on climatechange—let alone measuring them—over-stretches the commission’s capability as aneconomic regulator. This should in no wayimply that we should refrain from mitigat-ing climate change, but that responsibilityshould fall on environmental agencies andother governmental entities with morecapability than FERC to address climatechange. Even if FERC has an accurate mea-surement of net changes in greenhousegas emissions (a big if) and a reasonableestimate of their effect on climate change,it is unclear how FERC should use thatinformation in pipeline certification.

There is enormous uncertainty overwhat effect a reduction in greenhouse gasemissions would have on the economyand society in general. We need to behumble about what we know about cli-mate change and not expend considerableresources—read: trillions of dollars—thatcould jeopardize people’s economic well-being. Make no mistake about it, viewingclimate change as an urgent problem thatmust be mitigated at any cost would carry

diminishes regulators’ ability to achievethis objective.

However, utility regulators have provensusceptible to rent-seeking efforts by vari-ous special interests at the expense of thegeneral public. For instance, some specialinterests succeed at persuading regula-tors—often with incomplete and slantedevidence—that the special interests’ favoredenergy technology would best serve societyand even save the world.

Climate change / The Federal Energy Regu-latory Commission’s recent developmentof gas pipeline certification exemplifiesthis. The agency is under pressure fromenvironmentalists to consider the climate-change effect of new pipelines. While onecan sensibly argue that FERC shouldignore concerns over greenhouse gas emis-sions, the courts so far have agreed withthe environmentalists.

Here’s the problem: even if FERC hasthe obligation to consider the environ-


selves, emphasis on special-interestdemands from clean air advocates, ven-dors, and others who are not utility cus-tomers has escalated to squeeze out publicinterest goals. Commissioners and man-agers are the guilty parties here, whethertheir political leanings are on the left orthe right. One example is interest groupsthat regard anything less than a maximumeffort to address climate change as a socialinjustice. But an obsession with climatechange can threaten other policy objec-tives, like reasonable and stable rates, eco-nomic growth, and reliable utility service.California and other states may be goingdown this primrose road.

As pressures intensify for more cleanenergy sources, utility regulators have hadto grapple more with the economic ineffi-ciencies of cost socialization and subsidies.One path is for regulators to encouragedistributed generation, electric vehicles,

and other new technologies, but not to giveaway the store. Cost subsidization can beunfair to some customers as well as to com-peting third-party providers. Regretfully,the evidence confirms that some stateshave been on the forefront of bad policiesthat have inflicted a regressive-tax-typewound on lower-income folks.

Utilities, regulators, and legislaturesdon’t have to be leaders in supporting newclean-energy technologies, especially thosewhose futures are in doubt. As “free riders,”they can learn from the experiences—bothpositive and negative—of so-called leadingstates while still contributing to greenhousegas reduction in the long run. The followerscan view activities in states like Californiaand New York as a public good. This pos-ture seems rational in view of the highlyuncertain future of most new technolo-gies and other developments in the electricpower industry.

Can We Cut GovernmentSpending?✒ BY RYAN H. MURPHY

Wealthier countries have larger governments. The questionis, why?

One explanation is that many of the goods that govern-ments spend money on are, in technical terms, superior goods, meaningthat when you are wealthier, you buy more of them as a percentage of

RYAN H. MURPHY is a research assistant professor inthe O’Neil Center for Global Markets and Freedom atSouthern Methodist University.

capacity, which is the ability of govern-ments to raise tax revenue, and thus growthe government through that mechanism.

Wagner’s Law, named for turn-of-the-20th century economist Adolph Wagner,posits a direct correlation between a society’swealth and the size of its government. IfWagner’s Law generally holds, it could leadto a certain amount of defeatism amongfree-marketersandotheradvocatesofsmallergovernment. Over the long term, total gov-ernment spending has comprised a growingpercentage of U.S. gross domestic product,as depicted in Figure 1. Inevitably increasingpublic spending is one possible reading ofRobert Higgs’s “ratchet effect” found in his

classic work Crisis and Leviathan, where crisesratchet up the size and scope of governmentunder “emergency” provisions, but publicspending never returns to pre-crisis levelsonce the emergency ends. More recently,Will Wilkinson of the Niskanen Center pro-claimed, “There’s simply no path here tosmaller government [for the United States].”

But Wagner’s Law, if stated as literallytrue and inevitable, is wrong. There areperiods of time in which national incomeincreases but government spending as apercentage of GDP falls, as reflected in theearly- to mid-1980s and mid- to late-1990sin Figure 1. The issue, then, is of degree:how frequently can government spendingfall in the long run in wealthy countries,and by how much?

International data / To get a sense of howoften wealthy countries violate Wagner’sLaw over time, one can look at how oftengovernments cut the size of their statesin the very long run. I did this using datafrom the most recent Economic Freedomof the World report published by the Fra-ser Institute (along with other EconomicFreedom Network think tanks, includingthe Cato Institute). The specific data Iexamined were:

■ government consumption—that is,government spending on goods andservices used for direct satisfaction—as a percentage of all consumption

■ transfers and subsidies as a percentageof economic output

■ government investment—that is,government spending on productiveassets—as a percentage of all investment

Country tables in the current edition of theEconomic Freedom of the World report providedata for the years 1980 and 2015, so thoseare the years I compared for this research.

Table 1 lists the 24 members of theOrganization for Economic Cooperationand Development in 1990, along withtheir GDP per capita in 1980 (in 2010U.S. dollars). Three sets of columns givethe three measures of government spend-ing listed above in both 1980 and 2015. Ifthe strong version of Wagner’s Law were

your income. Others posit that publicinvestments in education and health con-tribute to economic growth by improvingproductivity, which in turn increases grossdomestic product per capita. Alternatively,wealthier countries are able to “buy”more of something called “state capac-ity,” which is what academics call the abil-ity of governments to accomplish whatthey set out to accomplish. Half of thisis clearly a good thing because it meanshigher quality courts and legal systems.But the other side of state capacity isfiscal



to hold, the 1980 figures would alwaysbe smaller than their 2015 counterparts.Government consumption and spendingon transfers and subsidies are the clearertests of the hypothesis, although all threemeasures should be given some weight ifWagner’s Law is to mean that increases inthe size of government are inevitable.

These measures of government spend-ing differ in terms of how much theyeach vary across countries. A change offive percentage points represents a greaterchange for one type of government spend-ing than another. To better express howbig the changes that occurred in govern-ment spending from 1980 to 2015 reallywere, I calculated the standard deviationof each variable in 1980. I then divided thechange from 1980 to 2015 by this standarddeviation. For example, in Belgium, gov-ernment consumption as a percentage oftotal consumption increased from 21.55%in 1980 to 31.82% in 2015. As the standarddeviation among these countries in 1980was 5.72%, Belgium’s 10.27% increase cor-responds to 1.80 standard deviations.

Table 1 highlights the countries andvariables that declined from 1980 to 2015.It does indeed seem difficult to cut govern-ment consumption. Of the 24 countries,only three—Canada, the United Kingdom,and the United States—cut governmentconsumption over this time period. Thecuts in the UK and the United States werenot at all trivial, though, amounting to

more than half a standard deviation apiece.Still, if this were the entire story for gov-ernment spending, it would give somecredence to the defeatist story regardinggovernment spending.

However, between 1980 and 2015, eightof the 23 countries for which completedata are available cut their transfers andsubsidies as a percentage of GDP, and asignificant majority—19—cut their govern-ment investment as a percentage of totalinvestment. Of those latter countries, 14cut government investment by more than astandard deviation. The only country thatincreased government investment by at leasta standard deviation was Greece.

What caused this decrease in spendingis rather obvious: the West decided to stopplaying soft socialism at the so-called “com-manding heights” of the economies andprivatized a number of government func-tions. That very recent historical episode,in which nearly every advanced economy inthe world washed its hands of so much stateownership, certainly appears like it shouldcount as a cut to the size of government.

Why did it happen? / There may be someamount of substitution between thesethree areas of government spending, ofcourse. Only one country, the UK, cut itsspending across all three areas. Canadais one of a handful of countries that cutits transfers and subsidies to a nontrivialdegree and also cut its government con-

sumption, but its government investmentticked upward. So how should we inter-pret these numbers?

First, it is absolutely not true that thereare inevitable barriers to reducing govern-ment investment. And there is plenty ofopportunity for more reductions: public–private partnerships, which promise toshift many of the tougher issues regardinginfrastructure to the private sector, are onlynow beginning to get off the ground. Evenin the United States, which never went tothe soft socialist extremes that much ofEurope did, there are plenty of opportuni-ties to privatize infrastructure—especiallyin airports, a step already taken in manyareas of the world.

Second, despite the headwinds of ris-ing entitlements for the elderly across alladvanced economies, there are several exam-ples of countries that have managed to cuttransfers and subsidies over the last 35 years.

Third, cutting government consump-tion may offer a tougher task, but thereare clear policy proposals to do so on thetable right now. These include the termi-nation of various privileges enjoyed bypublic sector unions, which in turn couldlead to expenditure cuts. But it would besomewhat surprising if government con-sumption is the higher-hanging fruit incomparison to transfer payments, giventhe demographic challenges that facenearly all of these countries.

Another point of interest is that coun-tries with a legal system originating in Brit-ain—in this sample, Australia, Canada, Ire-land, New Zealand, the UK, and the UnitedStates—are disproportionately representedamong the countries in cutting spendingover this time period. The importance oflegal origins in determining institutionalquality and outcomes is a recentfinding insocial science, and it is possible that this isanother instance of that effect coming intoplay. If this is the case, this is another fac-tor supporting the prospects of U.S. cutsin government spending.

Conclusion / There is little reason forsmall-government advocates to be pessi-mistic about the prospects for reducing

Figure 1

U.S. Government Expenditures as a Percentage ofGross Domestic Product

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 201510

15

20

25%


government size. Government investmenthas fallen tremendously throughout theWest, and transfers and subsidies seem tofall if there is the political will for it. Thecategory of government spending that hasbeen more stubborn in the recent past isgovernment consumption, but this is withtwo caveats: it actually fell in the UnitedStates between 1980 and 2015, and thereare rather clear-cut ways for dealing withthis particular set of issues, including miti-gating the effects of public sector unions.While ultimately there may be more impor-tant priorities than reducing the rate atwhich government spending grows, theidea that government spending cannot ever

be reduced is not supported by the analysis.The late public choice economist Rob-

ert Tollison once said, “We’re all part of theequilibrium.” By that he meant that eventhough it may not look like public policythink tanks and other academic institu-tions have much of an effect on policy,their actions contribute to whatever publicpolicy equilibrium we experience. Thisnotion is supported by recent research onthe effects of op-ed writing on public opin-ion. It would be safe to assume that if freemarket intellectuals cease to make the casefor less government spending, we shouldexpect more government spending in thefuture than we would have otherwise.

READINGS:

■ “Foreigners Show Airport Privatization Works,”by Nick Zaiac. American Institute for EconomicResearch, Jan. 1, 2018.

■ “Investment in Human Capital,” by Theodore W.Schultz. American Economic Review 51(1): 1–17 (1961).

■ “The Economic Consequences of Legal Origins,” byRafael LaPorta, Florencio Lopez-de-Silanes, and AndreiShleifer. Journal of Economic Literature 46(2): 285–332(2008).

■ “The Long-Lasting Effects of Newspaper Op-Edson Public Opinion,” by Alexander Coppock, EmilyEkins, and David Kirby. Quarterly Journal of PoliticalScience 13(1): 59–87 (2018).

■ “What If We Can’t Make Government Smaller?”by Will Wilkinson. Defending the Open Society (Nis-kanen Center), Oct. 19, 2016.

Table 1Categories of Government Spending by OECD Country

Country GDP perCapita, 1980(Thousandsof 2010 U.S.

dollars)

Government Consumption as a %of Total Consumption

Transfers & Subsidies as a % of GDP Government Investment as a %of Total Investment

1980 2015 Differencein StandardDeviations



Australia 29.79 23.23 23.99 0.13 10.10 12.75 0.41 28.40 12.27 -1.83

Austria 27.63 24.82 27.44 0.46 22.10 25.62 0.55 44.50 12.98 -3.57

Belgium 27.43 21.55 31.82 1.80 26.00 28.71 0.42 26.80 10.21 -1.88

Canada 31.77 28.83 26.92 -0.33 14.50 9.62 -0.76 12.60 16.11 0.40

Denmark 36.38 34.01 35.23 0.21 20.80 21.10 0.05 25.00 18.80 -0.70

Finland 25.66 24.93 30.60 0.99 14.30 23.74 1.47 23.30 19.93 -0.38

France 26.96 23.55 30.28 1.18 26.10 28.27 0.34 27.40 16.76 -1.21

Germany 26.06 26.30 26.30 0.00 17.60 25.68 1.25 25.70 10.83 -1.68

Greece 19.14 14.69 22.34 1.34 8.59 22.51 2.16 32.00 47.58 1.77

Iceland 26.65 22.21 31.86 1.69 10.60 8.70 -0.30 15.30 20.00 0.53

Ireland 17.11 21.96 26.89 0.86 17.50 16.51 -0.15 24.60 9.57 -1.70

Italy 24.45 19.75 23.69 0.69 20.90 24.94 0.63 25.90 13.25 -1.43

Japan 25.49 14.29 25.83 2.02 9.20 23.75 2.26 19.60 15.93 -0.42

Luxembourg 42.64 17.75 36.14 3.22 N/A 22.00 20.86 -0.13

Netherlands 30.08 22.22 36.22 2.45 29.40 24.61 -0.74 14.80 18.19 0.38

New Zealand 22.38 22.59 24.56 0.34 21.90 14.06 -1.22 30.80 16.66 -1.60

Norway 48.54 28.57 35.16 1.15 22.10 17.68 -0.69 35.90 21.10 -1.68

Portugal 12.39 16.76 21.59 0.85 16.30 20.61 0.67 42.20 13.56 -3.25

Spain 17.44 16.45 25.11 1.52 12.30 21.23 1.39 27.10 11.04 -1.82

Sweden 31.09 36.25 36.53 0.05 24.70 20.59 -0.64 41.20 19.29 -2.48

Switzerland 54.89 16.68 17.36 0.12 13.40 14.93 0.24 N/A

Turkey 4.99 15.89 18.52 0.46 6.00 14.65 1.34 40.00 21.66 -2.08

UnitedKingdom

21.87 26.62 22.99 -0.64 15.80 15.15 -0.10 29.10 16.25 -1.46

UnitedStates

28.73 21.21 17.50 -0.65 10.90 14.87 0.62 17.71 16.10 -0.18

SOURCE: Economic Freedom of the World: 2017 Annual Report, Fraser Institute, Sept. 28, 2017.



USDA Is Supposed toRegulate Animal Health,Not Animal Happiness✒ BY HENRY I. MILLER AND JEFF STIER

Last December, regulators at the U.S. Department of Agricultureruffled a lot of feathers by withdrawing a regulation published onthe final full day of the Obama administration that would have

created new requirements for producers of “organic” eggs and poul-try. Called the Organic Livestock and Poultry Practices (OLPP) rule,

HENRY I. MILLER , a physician and molecularbiologist, is the Robert Wesson Fellow in ScientificPhilosophy and Public Policy at Stanford University’sHoover Institution. JEFF STIER is a senior fellow at theConsumer Choice Center.

it would have, among other things, speci-fied that to boast the coveted “USDAOrganic” seal, animals would need to beraised with certain minimum amounts ofspace, light, and access to the outdoors.

USDA officials offered several ratio-nales forfirst delaying and then withdraw-ing the Obama rule. First, they arguedthat by being overly prescriptive, the rulecould discourage the development of new,innovative organic farming practices thatwould both meet humane standards andalso keep costs under control. Second,the Trump USDA interpreted the relevantenabling statute more narrowly than theprevious administration and judged thatthe rule exceeded statutory authority.Finally, the USDA said that “withdrawalof the OLPP also is independently justifiedbased upon USDA’s revised assessments ofits benefits and burdens and USDA’s viewof sound regulatory policy.”

The notice itself included many pas-sages justifying the withdrawal, including:

■ “The OLPP final rule consisted, in largepart, of rules clarifying how produc-ers and handlers participating in theNational Organic Program must treatlivestock and poultry to ensure theirwellbeing…. [The Agricultural Market-ing Service] is proposing to withdrawthe OLPP final rule because it now

believes [the Organic Foods ProductionAct (OFPA)] does not authorize theanimal welfare provisions of the OLPPfinal rule. Rather, the agency’s currentreading of the statute, given the relevantlanguage and context, suggests OFPA’sreference to additional regulatorystandards ‘for the care’ of organicallyproduced livestock should be limitedto health care practices similar to thosespecified by Congress in the statute,rather than expanded to encompassstand-alone animal welfare concerns.”

■ “USDA believes that it may not lawfullyregulate outside the boundaries oflegislative text … and that it lacks thepower to tailor legislation to policygoals, however worthy, by rewritingunambiguous statutory terms. Rather,USDA believes it may properly exercisediscretion only in the interstices createdby statutory silence or ambiguity andmust always give effect to the unambig-uously expressed intent of Congress.”

■ “The OLPP final rule is a broadlyprescriptive animal welfare regula-tion governing outdoor access andspace, transport, and slaughter, amongother things.… USDA’s general OFPAimplementing authority was used asjustification for the OLPP final rule….But nothing in Section 6509 authorizesthe broadly prescriptive, stand-aloneanimal welfare regulations containedin the OLPP final rule. Rather, section6509 authorizes USDA to regulate withrespect to discrete aspects of animal

production practices and materials:Breeder stock, feed and growth promot-ers, animal health care, forage, andrecord-keeping. Section 6509(d) is titled‘Health Care.’ Subsection 6509(d)(1)identifies prohibited health care prac-tices, including sub-therapeutic dosesof antibiotics; routine synthetic internalparasiticides; and medication, otherthan vaccinations, absent illness.”

Fundamental problem / Many large-scaleorganic egg producers applauded theUSDA’s withdrawal of the OLPP rulebecause it would have required themto modify their facilities at significantexpense. But proponents of the rule criedfoul at the change in course. For them, therule would have been afinancial boon, inas-much as they were already generally con-forming to the standards they had spentyears lobbying for. The rule would have per-manently protected their businesses fromlarger-scale producers who sought to enterthe organic marketplace with innovativeanimal welfare approaches.

The Washington Post quoted the outragedcomments of Jesse Laflamme, co-ownerand CEO of egg producer Pete and Ger-ry’s Organics: “What’s so upsetting is thatthere is such a gap between what organicconsumers expect and what these factoryfarms are producing.”

Therein lies the fundamental problemwith the premise of government standardsfor organic agriculture, whether it involvesthe production of meat and eggs or farm-ing of grain, fruits, and vegetables. Theentire enterprise is driven more by whatthe purchasers of organic products expector feel, rather than any evidence-basedcriteria. They often resemble the membersof a religious cult. People should be freeto exercise their beliefs, to be sure, but thegovernment should not be in the businessof codifying or promoting them.

Why, then, did the USDA becomeinvolved in organic certification in thefirstplace? When the organic standards werepromulgated in 2000, then–secretary ofagriculture Dan Glickman was unequivo-cal about the fundamental meaningless-


ness of the organic designation:

Let me be clear about one thing, theorganic label is a marketing tool. It isnot a statement about food safety. Noris “organic” a value judgment aboutnutrition or quality.

It’s worth repeating: the organic label isno more than a marketing tool. And it’s acynical one, because so many unsuspect-ing consumers are ripped off by the higherprices of organic products, without pal-pable benefit. That’s why, far from settingmore rigid standards for the organic label,the feds should fully extricate themselvesfrom defining “organic.” That definitionwould be best adjudicated by the market,at the expense of those who are willing topay the premium.

Organic agriculture has morphed intoa massive special-interest bonanza. Annualsales of organic food in the United Statesnow exceed $40 billion. Federal spending onorganic agriculture has mushroomed from$20 million in the 2002 Farm Act to morethan $160 million in the 2014 version (withfurther increases under consideration). Andaccording to the USDA, during the Obamaadministrationthe USDA“signedfivemajororganic trade arrangements and has helpedorganic stakeholders access programs thatsupportconservation,provideaccesstoloansandgrants, fundorganicresearchandeduca-tion, and mitigate pest emergencies.”

Free to choose / The government shouldnot be putting its thumb on the scales inthose ways. It is especially noteworthy thatother, analogous special interests—such asthe producers of kosher and halal foods—don’t receive similar government benefits.And for that they are better off.

There are enough kosher food–certi-fying organizations to meet a very widerange of belief systems, for example, andconsumers are free to choose products onlyfrom groups that meet their standards.This approach allows those who seek toadhere to the strictest standards to havecertifying agencies on which they can rely,while also allowing those who accept morerelaxed standards to have a wide range of

affordable products that meet their reli-gious needs. They are, in Milton Fried-man’s memorable phrase, free to choose.

This democratized private-sectorapproach has had the effect of expandingthe market for fresh kosher meat in theUnited States. In smaller communitiesthat can’t support a market for the signifi-cantly more expensive “glatt” kosher meat(which must meet the strictest standard),kosher consumers can go to Trader Joe’sstores throughout the country and pur-

chase meat that satisfies a more basic andaffordable kosher standard.

Some of this stratification is taking rootin the organic industry already. Some true-believers are promoting a kind of stricter-standard, “organic-plus” designation.That’s fine: as long as the government isn’tinvolved and there isn’t fraudulent advertis-ing, we don’t care if, in order to avoid earthlycontamination, organic-plus produce isrequired to be produced on the moon.

The private-sector approach to certify-ing faith-driven food purchases expandsthe market and keeps cost down by allow-ing consumers to pay premiums thatreflect their beliefs. And it doesn’t costnonbelievers a penny.

Organic food companies know this.That’s why those who favor the OLPP are sooutragedabout itswithdrawal.Withoutnew,more rigid, federally mandated standards,they’re forced not only to compete amonga range of organic options, but also have tojustify the higher cost of their own productsthrough marketing—at their own expense.

Organic boosterism at the federal levelis not without consequences. Consumershave been snookered into believing thatorganic food is healthier, safer, or better forthe environment than non-organic options,although the scientific evidence argues oth-

erwise. Lower crop yields are inevitable givenorganic farming’s systematic rejection ofmany advanced methods and technologies.Those lower yields, in turn, increase thepressure for the conversion of more land tofarming and more water for irrigation, bothof which are serious environmental issues.

Because prices for organic food are muchhigher, those misconceptions eat away atconsumers’ buying power. And whileorganic marketers like to promote the ideathat “organic” implies “locally grown,” the

United States is actuallya net importer of organicgoods, including (suppos-edly) organic grains fromcountries like China,India, Turkey, and Roma-nia,withnowaytobesurethose countries adhere to“organic” standards that

even remotely resemble those in the UnitedStates. Moreover, there is documented wide-spread cheating in the organic designationof eggs, milk, and imported grains.

Let’s return to the OLPP rule and theUSDA’s decision to withdraw it. The with-drawal elicited bitter condemnation frommany organic farmers and the OrganicTrade Association, whose long-standinglobbying for the rule was rent-seeking, pureand simple. The group knows its constitu-ency, whose views were reflected in a March2017 survey by Consumer Reports. In thatsurvey, some 60% of Americans said that itis extremely or very important that animalsused to produce organic food “are raised onfarms with high standards for animal wel-fare.”Further,54%saidthat it is extremely orvery important that eggs labeled “organic”come from hens that are “able to go out-doors and move freely outdoors.”

We support the withdrawal of the OLPPrule, but see it only as a first step in endingthe federal imposition of belief-based food-production standards. If industry and con-sumers want such standards, they are freeto form nongovernmental entities at theirown expense to develop whatever rules orsets of rules they prefer. If they do so, we—asbelievers in market-driven solutions—willgladly give them our blessing.

As long as the government isn’t involvedand there isn’t fraudulent advertising,we don’t care if“organic plus”produce isrequired to be produced on the moon.



The New Perils of DataLocalization Rules✒ BY IKE BRANNON AND HART SCHWARTZ

Our increasingly connected globe has resulted in more databeing generated each and every year, a progression that hasbecome geometric. The world produced more data in 2017

than in the previous 5,000 years of recorded human history combined,according to Art Landro, the CEO of Sencha, a company that develops

IKE BR ANNON is president and HART SCHWARTZ isa senior analyst for trade and data analytics with Capi-tal Policy Analytics, a D.C. economic consulting firm.

data-centric websites and applications.What’s more, the value of data in the

aggregate has increased over time, ascomputing power and human ingenuityadvanced in tandem to apply the data toanswer a myriad of questions, includingsuch important issues as drug efficacy,crop fertility, weather forecasting, and—ofcourse—consumer and voter behavior. So aswe produce more data, we are doing morewith it as well—or at least not disposing of it.

As data become more valuable, govern-ments across the globe have respondedby asserting more control over the dataproduced in their jurisdiction. Often theserules require that companies collectingdata in a country also maintain the datain that country. Governments often justifythese “data localizations” requirementsby appealing to the need to ensure cyber-security or maintain the privacy of citizens.

There are certainly a range of legitimateinterests in the realm of sovereignty, secu-rity, and human rights that may conflictwith economic considerations. But broaddata localization requirements can tip into“data protectionism” whose effect maybe to impede the continued growth ofinternational trade. The U.S. InternationalTrade Commission (ITC) reports that halfof all global trade in services depends onaccess to cross-border data flows.

In short, the rhetoric and motivationsfor continued actions to restrict dataflowsacross borders should always be subject tostrict scrutiny.

ization worldwide. By their estimation,such measures have grown sharply over thelast few years in apparent lockstep with thegrowth of data.

Increasing data localization has imposedhigher costs on multinational firms thatoperate across borders. By constraining thefreedom to share data across locales aroundthe globe, these regulations force firms tohire more people in the country where thedata originated rather than permittingcompanies to locate the operations wheretheir staff is best-equipped for the particulartask. Such restrictions concomitantly limitpotential productivity gains and essentiallyforce firms to make costly investments inlocaldata infrastructuretocomplywith localcontent laws. Ultimately, other businessesand their consumers pay the costs of datarestrictions via higher prices and less choice.In the long run, such rules ultimately createsmaller, less robust markets across the globe.

Estimated economy-wide losses / Severalorganizations have conducted economet-ric studies to understand the economy-wide effect of data localization measures.Table 1 shows thefindings of the EuropeanCenter for International Political Economy(ECIPE) along several key metrics.

Other research echoes ECIPE’sfindings.In 2014 the ITC found that “foreign digitaltrade barriers” depressed U.S. gross domes-tic product by 0.1–0.3%, which amounts tobetween $16.7 billion and $41 billion perannum. A study conducted in 2016 jointlyby the Center for International GovernanceInnovation (CIGI) and Chatham Houseestimated that digital trade barriers reducedGDP by 0.10% in Brazil, 0.55% in China,0.48% in the EU, and 0.58% in South Korea.

Payment companies in China / The opera-tions of digital payment companies inChina are an excellent example of thebusiness strategy quandaries presentedby data localization measures. Digital pay-ments in China have been rising at a stun-ning rate, from 6.3 per Chinese residentin 2011 to 26.1 in 2015. Considering thatin developed countries such as Germany,France, and the United States, 200–400

Typesofdatalocalization / James Kaplan andKayvaun Rowshankish, partners with theconsultingfirm McKinsey & Co., suggest inan article published in the Global Commis-sion on Internet Governance that there are fourmain categories of data localization, listedbelow from most to least stringent:

■ Geographical restrictions on data export(“data copy cannot leave”), which forceforeign companies to create separatein-country servers or other infrastruc-ture to hold the data. South Korea andEgypt impose a variant of this.

■ Geographical restrictions on data locationrequire foreign companies to retain alocal replica of the data. Indonesia andMalaysia impose such rules on busi-nesses operating within their borders.

■ Permission-based regulations mandatethat foreign companies must gain con-sent from their customers for cross-border data transfer. Brazil, Argentina,Switzerland, and Luxembourg eachrequire some sort of permission beforedata can be transferred.

■ Standards-based regulations allow for-eign companies to move data freelybut companies must ensure securityand privacy for customers.

Data localization can also be classifiedaccording to whether it is absolute or con-ditional. Absolute measures stipulate thatsome combination of data storage, process-ing, and access must occur locally. Con-ditional measures, in contrast, effectivelyban the exit of data from the jurisdictionby placing extremely restrictive conditions.

The ITC tracks the growth of data local-


such payments are made annually perperson, and considering the 1-billion-plus Chinese population, the long-termgrowth potential in China is enormousfor the digital payments industry.

The market includes more than tradi-tional payments from transaction charges,transfer fees, interest income, andmaintenance fees. These data canbe monetized into many lucrativeincome streams, including targetedadvertising for merchants basedon smartphone location, custom-ized information on likelihood ofrepayment, and precise measure-ments of customer tolerance offinancial risk.

Developing the full scope of thebusiness model depends upon theownership of the data streams, andthat is now problematic for non-Chinese companies. Last year Chi-na’s new Cybersecurity Law tookeffect. Of particular concern is amandate that “critical information infra-structure” must store personal informa-tion and other important data on serversphysically located within mainland China.This clearly constitutes a data localiza-tion provision, and a very wide assortmentof digital activities could be subject to itbecause of the vagueness of the provision.

Foreign companies thus must installand maintain data servers within China andaccept the risk of unpredictable penalties asa result of the open-ended nature of the leg-islation. This makes sustained investmentvery challenging. Kaplan and Rowshankish,the McKinsey consultants, state:

Executives reported that they havesevere difficulties gaining a clear andcomprehensive view of the full setof regulations. Many are worded sovaguely that it is impossible, they say, topredict what is and is not allowable.…The uncertain environment makes itparticularly difficult to plan and executelarge technology investments.

How can digital payment companiesinvest in China in such a climate? Manyfind they have little choice but to submit: if

companies choose not to participate, theircompetitors can potentially grab the mar-ket and use afirst-mover advantage to reapa windfall as the value of data explodes.

Policy options / The preponderance ofglobal trade restrictions creates difficult

tradeoffs for tech companies and othermultinationals that depend on data fortheir business. Governments face difficulttradeoffs as well. They wish to attract for-eign investment while protecting their cit-izens according to their own national val-ues of privacy, security, and human rights.They wish to adjudicate data-related dis-putes in their own domestic legal systems,and in a post–Edward Snowden world,they desire to avoid foreign surveillanceof domestic data.

Attempts to regulate this situationthrough trade agreements have runaground. To some extent these failuresreflect the underlying difficulty of reconcil-ing commercial and noncommercial data.Only a fraction of the growing volume ofcross-border data flows is of a financial,commercial, or transactional nature. Mostpersonal data take the forms of emails,videos, text messages, and phone calls.

Typically, trade agreements conductdispute resolution through panels of tradelawyers. But when cross-border data leadsto disputes involving civil matters such astorts or criminal matters such as harass-ment, and when these disputes would

normally engage local courts in domesticlegal systems, trade lawyers cannot appro-priately handle such matters. In additionto the practical difficulties involved inharmonizing enforcement across widelydiffering domestic judicial systems, thelarger Westphalian nation-state principle

of noninterference in the internal affairsof other nations presents another obstacle.

Nevertheless, for the continued growthof global trade, some type of reciprocatedbalancing must take place between theneeds of global businesses and the preroga-tives of sovereign governments. Perhapsthe place of departure could involve, atleast initially, recognizing the sheer mul-tidimensional complexity of the matter.Progress toward new solutions may pro-ceed from awareness that most cross-bor-der dataflows are not in fact trade-related.

Could it be possible, then, to imagine aworld in which each differentiated dimen-sion of cross-border data is regulated by aseparate type of agreement, within a dif-ferent sphere of international law? Couldlaw enforcement, trade, cybersecurity, andother domains each receive their ownseparate international agreement, so as toavoid the pitfalls of previous attempts at“all-in-one grand bargains” that fall apartif any one element cannot be agreed? In aworld in which economic protectionismis on the rise, finding a new path for-ward for “data protectionism” is of greatimportance.

Table 1Predicted Losses in Case of Economy-Wide Data Localization

Lost GDP Lost consumerwelfare

Lost wages perdata worker (% of

monthly salary)

Lost domesticinvestments

Brazil -0.80% $15 billion -20% -5.4%

China $63 billion -13%

European Union -1.10% $193 billion -5.1%

India -0.80% $14.5 billion -11% -1.9%

Indonesia -0.70% $3.7 billion -12.6%

South Korea -1.10% $15.9 billion -20% -3.6%

Vietnam $1.5 billion -3.1%

Source: European Center for International Political Economy (ECIPE)

Documents

2 SUMMER 2018 BRIEFLY NOTED CanYo urNeighborhood ......2 / Regulation / SUMMER 2018 BRIEFLY NOTED CanYo urNeighborhood BookieCompete WiththeInternet? BY IKE BRANNON In the olden days,