DIMINISHING RETURNS. When sunsets might be useful.

Golden Gate sunset - Jan. 2014; © Bruce A. Smith 

The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first law of economics. ~ Thomas Sowell
The second lesson of economics is diminishing returns: adding more of a productive input will eventually result in a decline in the additional output produced. The second lesson of politics is to disregard the second lesson of economics. ~ C.B. Ladler

The Law of Diminishing Returns, a keystone proposition of economics, states that in all productive processes, adding ever more of one input (say, labor), while holding all others constant, will at some point lead to a decline in the additional amount of the resulting product.[1] The consequence of adding the last laborer is less than the added product when the second (or perhaps five hundredth) worker was added. There are many documented examples of this principle after it was described in the early 19th century by economists like David Ricardo and Thomas Malthus.

It remains relevant in the early 21st century. But politicians and bureaucrats either choose to not recognize its relevance, or more likely, falsely believe diminishing returns does not apply to programs and policies they deal with. Despite their hopes, diminishing returns always applies (in addition to the first lesson of economics – scarcity). Here are several examples.

The Value of a College Degree.  The US and many other nations have hugely benefited for a long time from improved and lengthened formal education of its citizenry. Two weeks ago the Obama administration publicly renewed its efforts to promote greater support for low-income youth to enter and graduate from college. Such support is important and needed. But well-meaning politicians never mention the changing labor market dynamics – based on the law of diminishing returns – that follow from ever-more college graduates entering the labor market.

As I've mentioned before, now that 30%+ of young adults (YA's) have college degrees there may be some downside consequences based on diminishing returns. The unemployment rate of YA's (20-24 years old) remains high: the Dec 2013 rate is 11.1%, much higher than the overall unemployment rate of 6.7%. However, with a B.A. degree, the current YA unemployment rate dramatically drops to 3.3%. At a macro level, having more college graduates continues to be demonstrably beneficial for many reasons.

 Nevertheless, from a micro perspective the relative value of completing college is lessening because the law of diminishing returns holds for B.A.'s as well as virtually every other good or service produced. Having a B.A. is becoming a new normal minimum requirement for a broader number of jobs, some of which have not historically required this skill level. For example, 15% of taxi drivers are college graduates. These B.A. job requirements were not present previously, when a smaller minority (roughly one-in-five in the 1990's) of young job market entrants was college graduates and when the US economy was growing strongly.

Now things are different. Having a B.A. is becoming less distinguishing. This is in part why employers can be choosier and state that a B.A. is needed for being a receptionist or gofer. And why YA's with B.A.'s may wonder where the superior job prospects long-promised by parents and teachers have gone. Their jobs (and wages) may not be as bright as expected. As even more YAs receive B.A.'s, graduates' initial career expectations may need adjustment.

Politicians pushing programs that support more college graduations should recognize both the macro and micro consequences. These politicians should also endorse policies that increase job-creation so the more-numerous folks with college degrees can actually find fulfilling jobs rather than be a call-center automaton with a B.A.

National Defense and Security.  Examples of diminishing returns inhabit every large, bureaucratic institution. Perhaps the preeminent illustration is the federal government's expenditures for national defense and security. These expenditures are the single-largest non-entitlement expense in the federal budget. Remember the $600 toilet seats the Department of Defense purchased in 1987 (which in 2013 would be worth $1,231)? They're still buying stuff like that, lots of it.

In fiscal year 2013 the government's "all-in" defense/security budget is $1.6 trillion. This includes expenditures for the DOD as well as NSA, CIA and DOD intelligence budgets. This colossal sum is equivalent to spending $182.5 million per hour every hour every day. It is impossible to imagine that diminishing returns are not very much alive and well inside this gargantuan level of spending. After all, Defense Secretary Chuck Hagel called the Defense Department “bloated” in a 2011 interview.

How could we diminish DOD's diminishing returns? By not reversing the Sequester-based DOD budget cuts – sadly, last week Congress overturned most of these cuts. Also, "unify" the military and intelligence services by combining the Army, Navy, Air Force and Marines into one integrated service, something Canada did with positive results over 4 decades ago. And really change procurement practices so no more generals (or privates) sit on $1,200 toilet seats. Yet attempts to reduce our defense/security budget are invariably met with misologistic statements of misguided vitriol that often boil down to diminishing returns be damned.

the Mars Rovers.  NASA's budget has been repeatedly cut by the Obama administration, much to the consternation of its proponents and contractors. One of NASA's impressively successful programs – the Mars rovers –illustrates how budget constraints can force an organization like NASA to evaluate the net benefit of each of its programs in order to eliminate expenditures where diminishing returns may be present. The Opportunity rover has been operating far beyond its expected lifetime. Opportunity has slowly motored in the Martian soil for 10 years doing experiments. It was designed to work for 3 months; its annual operating budget is $14M. Curiosity, a much more capable rover, will complete its 2-year mission in June; its annual budget is $67.6M.

As they do every two years, NASA officials will soon conduct a review of the spacecraft that have outlived their original missions. For the 2015 fiscal year, which begins Oct 1, NASA faces some difficult choices. Opportunity may still be knocking, but NASA's fiscal guillotine may kill it as well as Curiosity and other "extended missions" (budgeted at $140M this year) that don't measure up in terms of returns. The Opportunity cost may be too high.  Although painful, NASA's biennial review appears quite consistent with a goal of maximizing returns from available funds. More agencies should conduct such program reviews.

The Major League Baseball season.  Following a long tradition, Major League Baseball's 2014 season will again be 162-games long. This year, spring training games begin on Feb 26. The season-opening game will be played on Mar 22 down under in Australia (who'd of guessed). US fans will see the Dodgers and Padres play on Mar 30. The season ends on Sep 28. The Red Sox won the last year's World Series on Oct 30; break out the Halloween candies. The full baseball season is thus 8 months long!

It may once have been America's national game, but really how many fans really want to wear down jackets and gloves to baseball games amid snow flurries in places like Minneapolis, Chicago, Boston and Toronto at the beginning (or very end) of the season? The 2013 season saw fan attendance drop slightly, compared to 2012. No surprise.

I have a suggestion; reduce the number of games in the season. A century ago, major league baseball teams were playing 140-game seasons, which seems far more reasonable (unless you're an owner or player). Don't you think that diminishing returns becomes well-entrenched even before 140 games, and certainly by the 162nd? Isn't baseball supposed to be a summer game? Shorten the season; reduce diminishing returns; make each game worth more.  

Nth-Stage Regulations. Regulations affecting our behavior surround our every move. New or revised regulations grow more numerous with every tick of the clock. A number of them are essential (like environmental and airplane safety regulations– although I'm not so sure about allowing cell phones to be used in a flying airplane), many others may be less indispensable. Safety regulations continue to be added, like having turn signal displays within a car's side mirrors that have diminishing marginal benefit than prior regulations. Should we stop augmenting regulations because we may have reached diminishing returns? That is a fraught question, and was behind rules that sometimes require cost-benefit calculations to be made before certain new regulations are enacted.

An example of an N'th stage regulation includes a mother who has petitioned the Food and Drug Administration to prevent American firms from using artificial dyes to color M&Ms and other candies. Her son apparently has a very rare, hyper-allergic reaction to such dyes but loves, really loves, this chocolate. So she has to buy European M&Ms for him that don't have "bad" dyes. She wants to stop Mars from using artificial dyes (as has been allowed by FDA regulations) in all US-made M&Ms, so she won't have to keep buying European M&Ms to keep her son's meals happy. Wow.

Corporate and Personal Subsidies.  Finally, there's the swampy morass of subsidies. However well-intentioned they may have been when inaugurated, subsidies are also subject to diminishing returns for those who pay them – us taxpayers. Subsidies here include not just tax breaks, R&D and price supports, but direct payments as well. In general, people and businesses believe government-provided subsidies are wasteful and unfounded – and offer unequivocal evidence of diminishing returns that they'd rather not pay for (and unintended consequences). That is unless you are receiving a particular subsidy; in which case it is wholly and forever appropriate. Subsidies are a fine example of fiscal beauty being in the eye of the beholder.

Illustrations are legion: mortgage interest subsidies for home-owners are estimated to cost $70 to $100 billion annually. Subsidies to the oil and gas industry cost an estimated about $4B a year – and have been provided for more than 80 years. Agricultural subsidies for producing food for livestock and humans are worth up to $35B per year, not including numerous US tariffs that raise the price of imported food. Renewable energy producers (like home-owners and businesses who have installed solar and wind energy systems) have received federal subsidies worth about $50B over the past 30 years – roughly $1.7B a year. Boeing recently used the threat of moving to a nonunion, low-wage state to win a record subsidy package – $8.7B from Washington State – to remain in Everett, WA.  

After one starts identifying government subsidies it's hard not to believe that virtually all consumers and businesses are receiving several sorts of subsidies. Justification for subsidies, especially for "infant industries" like petroleum and solar that haven't been infants for a long time, is ultimately not founded on economics, its politics. So it goes, despite diminishing returns.

Subsidies present a good case for introducing sunset provisions at the beginning of subsidy expenditures. After a specified number of years (say 10 for oil/gas and solar/wind), the subsidy would stop. In a variant of this idea, California's solar subsidy was designed to diminish over time and end when a specified amount of solar capacity had been reached. Such fiscal sunsets elicit howls of outrage from recipients, but would give them plenty of time to prepare for the day when they would have to survive without public fiscal support, saving taxpayers millions.

Having sunsets on solar (and other) subsidies is a good idea.


A JAN 29 ADDENDUM.  Here's another subsidy story, but with a twist. In 2012 Congress passed the Biggert-Waters Flood Insurance Reform Act, a law that rectified a significant taxpayer subsidy for homeowners in flood zones whose houses were damaged – not too surprisingly –when flooding occurred. The fund that provides payments for flood damage was $24 billion in debt after paying out megabucks for costs from Hurricanes Katrina, Irene, Isaac and Sandy. The new law was designed to have the folks who chose to locate homes in flood zones pay more for their flood insurance themselves; and as a consequence we taxpayers wouldn't pay as much in the future. Sounds good so far. Except when flood-prone homeowners received their new federally-backed flood insurance policies, they found premiums had risen, quite a bit, as they were destined to with the reform law. An example, a flood-insurance policy that used to cost $600 per year now cost $4,500. The flood-prone homeowners were incensed; and let Congress know how they felt about losing their subsidy. Guess what? Congress is now about to pass another law(with 180 sponsors)  that would block, repeal and/or delay the reform law. We unflooded taxpayers never had a chance.  
  

 

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[1] See Economics, by Paul Krugman and Robin Wells, (2nd ed.)Worth publishers, 2009.