Alabama at the Crossroads: An Economic Guide to a Fiscally Sustainable Future

March 22, 2016

INTRODUCTION

Alabama currently lags behind its regional neighbors and the nation in economic growth and performance. For example, Alabama’s per capita personal income is $2,800 below the average of the rest of the states in its region and it ranks 45th in Forbes’s “Best States for Business.” This is because of Alabama’s poor performance in connection with several indicators of economic freedom, particularly its overspending, excessive regulation, and high public employment.

A new study for the Mercatus Center at George Mason University undertakes a comprehensive analysis of where Alabama stands today as well as the reforms necessary to put Alabama on the road to economic prosperity. Alabama must undergo comprehensive reform to expand economic freedom, which will lead to economic growth and prosperity.

STATE BUDGET

Alabama’s budget has experienced recent shortfalls leading to political gridlock, which demonstrates the need for a major budgetary overhaul to rein in spending and better streamline revenues and expenditures.

  • A lack of transparency in spending further exacerbates the situation: unlike the vast majority of states, Alabama does not have a consolidated budget, but rather a number of separate budgets and trust funds.
  • Each budget and trust fund receives its revenues from separate sources, and 85 percent of the state’s revenue is earmarked for a particular purpose—by far the largest percentage of earmarking out of all the states in the country.

Recommendations: Consolidate Alabama’s budgets into one general budget and curtail earmarking. Further, in order to limit the growth of state expenditures, several programs require long-term reform, such as Medicaid and others discussed below. Strict tax and expenditure limits, such as an expenditure limit that ties annual expenditure growth to the state’s population growth, would better align state expenditures with economic conditions. In addition, such limits would help minimize the negative effects that the business cycle can have on the state budget.  

RETIREMENT SYSTEMS

Alabama’s public pension system is severely underfunded, putting retirees and taxpayers at risk.

  • The funded ratio of the Retirement Systems of Alabama (RSA) has dropped precipitously as the actuarial value of assets in the Teachers’ Retirement System, the Employees’ Retirement System, and the Judicial Retirement Fund have declined while their liabilities have increased.
  • The declining funding health of the RSA has prompted a reliance on increasing state and employee contributions to the system.
  • In response to its declining funding health, the RSA has also increased its investment risk exposure—an exposure that taxpayers ultimately bear.

Recommendation: Transition new members of the RSA to private, defined contribution accounts, providing them with more portable and customizable retirement benefits.

ECONOMIC INCENTIVE PROGRAMS

Alabama currently offers a range of economic incentive programs, including film subsidies. This attempt to handpick economic winners and losers creates an unfair business environment and leads to cronyism.

  • Economic incentive programs are costly, impede economic growth, and undermine the free market by granting politicians the opportunity to play venture capitalist with taxpayer money. Alabama’s incentive policies tend to crowd out private investment and leave certain firms or would-be entrepreneurs at a competitive disadvantage.
  • Alabama has experienced a clear downward trend in net firm formation (for all firm sizes) in recent decades.

Recommendation: Eliminate Alabama’s economic incentive programs in favor of low, equal taxes, welcoming businesses of all varieties to Alabama.

PRIVATIZATION

Alabama’s government currently provides many services that can—and should—be provided by the private sector.

  • Many of the services Alabama provides are not proper functions of a limited government, meaning that state resources are being unnecessarily diverted from the core functions of government.
  • Privatization of these services can decrease their cost, improve their quality, and reduce the number of public-sector workers who must be supported by the private sector.

Recommendation: Privatize ABC liquor stores, golf courses, and other non-public goods, turning them over to the competitive market.

EDUCATION

Underperforming K–12 schools in Alabama leave youth unprepared for college or the workforce.

  • Only 20 percent of Alabama’s 2013 high school graduates were fully ready for college based on their ACT results. In addition, Alabama has one of the highest dropout rates in the nation. Between 2002 and 2012, roughly 30 percent of Alabama’s high school students failed to graduate within four years.
  • Higher standards, across-the-board reductions in class size, more stringent teacher qualification requirements, promises to improve political-administrative accountability based on test scores, and large per-pupil spending hikes have all failed to address Alabama’s education woes.
  • The one-size-fits-all approach demonstrably fails to provide the necessary flexibility to encourage experimentation and meet the diverse educational needs of parents and students.

Recommendation: Systematically expand school choice in order to empower parents to hold schools accountable and use educational experimentation and innovation to meet the diverse needs of schoolchildren.

TAX REFORM

While Alabama’s tax revenues per person may be low compared to those of other states, Alabama’s tax rates are not. Furthermore, Alabama currently does not have tax and expenditure limits that would restrict the growth of government spending.

  • Low, fair, and straightforward tax structures expand states’ economies, attract residents and businesses, and eventually bring in more tax revenue.
  • In its 2015 State Business Tax Climate Index, the Tax Foundation ranks Alabama’s business tax climate 28th. Regionally, Alabama falls behind Florida, Mississippi, Tennessee, and Texas.

Recommendation: Eliminate loopholes and tax incentives in order to lower income and corporate tax rates for all Alabamians, offering a tax environment more conducive to economic growth and more competitive with Alabama’s regional neighbors.

REGULATORY REFORM

Excessive regulation is impeding business growth and innovation in Alabama, restricting entrepreneurship and job growth.

  • Alabama has the eighth-lowest rate of new entrepreneurs in the nation (tied with Kansas, Illinois, and Virginia), the absolute lowest opportunity share of new entrepreneurs, the fourth-lowest start-up density in the nation, and only one Fortune 500 company headquarters.
  • While regulatory agencies are statutorily required to make all economic impact studies available to the public, in practice this rarely happens, making the entire regulatory process less transparent and increasing the likelihood of regulatory capture. Where economic impact studies do exist, their content tends to be insufficient.

Recommendations: Sensibly reform business, alcohol, health, and labor regulations to remove the regulatory thickets entrepreneurs and business owners face. The state should also consider a complete overhaul of its regulatory review process. Although the de jure review process should work in theory, in practice the outcomes are far from what is intended. This leads to greater regulatory burdens and uncertainty in the marketplace, which slow business formation and, with it, economic growth. 

CONSTITUTIONAL REFORM

Alabama’s lengthy and complex constitution centralizes power and undermines the state’s ability to constrain and limit the size of state government.

  • Largely as a result of the concentration of power that the constitution granted and continues to grant to the state legislature, Alabama’s constitution is now the longest written constitution in the world at 276,006 words.
  • Alabama’s constitution denies local governments the opportunity to self-govern and to rapidly meet and deal with local problems as they emerge. Instead, the constitution bogs down the part-time state legislature by requiring it to address these local issues.

Recommendation: Undertake a complete constitutional overhaul to grant home rule to local governments, ensuring an effective delimitation of powers and empowering local authorities to deal with purely local matters. 

CORRUPTION

Relative to other states, Alabama has a deep-seated problem of political corruption.

  • The Edmond J. Safra Center for Ethics at Harvard University recently ranked Alabama as one of the most corrupt states in the nation, considering both illegal and legal corruption.
  • This corruption, largely driven by lack of transparency, inhibits economic activity by creating an unfair political, legal, and business environment.

Recommendation: Increase government transparency and openness, especially as it pertains to spending, legislative activity, economic incentive programs, and public pension management, in order to foster accountability and help limit growth-restricting corruption.

CONCLUSION

Alabama requires systematic reforms that expand economic freedom and put the state on the road to economic prosperity. Some of these are broad, structural reforms, such as overhauling the constitution and consolidating the budget, as well as tackling corruption. Comprehensive reforms of specific policy areas are also required. Policy issues in need of attention include public pensions, taxes, privatization, and the regulatory system.

On Your Mark, Get Set, Develop!

October, 2015

One of the lingering questions for development economists is that of economic transition and whether development can be promoted by a strong political leader. Earlier writings on leadership and economic development tend to fall into one of two camps: (1) leaders matter and can contribute positively to economic growth, or (2) leaders seldom have positive effects and, at best, can avoid doing a great deal of harm. This article establishes a third option—a middle-ground position—between these two views. Good leadership can, indeed, have a positive effect on economic growth but only during the initial moment when economic reform is up for grabs. Once the opportunity to implement sweeping reform has passed, interests become entrenched, and the opportunity for growth-enhancing reform passes. Bad leaders, on the other hand, can hamper economic growth in periods well beyond the ideal reform moment.

The Oxford Handbook of Austrian Economics is available through Oxford University Press.

Editors: 
People: 
Christopher Coyne
People: 
Peter J. Boettke

Evolving Views on Monetary Policy in the Thought of Hayek, Friedman, and Buchanan

December, 2016

Attempting to find the technically optimal monetary policy is futile if the Federal Reserve’s independence is undermined by political influences. F. A. Hayek, Milton Friedman, and James Buchanan each sought ways to improve the performance of the Federal Reserve. They each ended up rejecting the possibility that technical refinement or minor reforms might be sufficient. After properly accounting for the concerns of robust political economy, each concluded that a fundamental restructuring of our monetary system was necessary. Friedman turned to binding rules, Buchanan to constitutionalism, and Hayek to competing private currencies. We synthesize their contributions to make a case for applying the concepts of robust political economy to the Federal Reserve through the adoption of professional humility, creative thinking, and an emphasis on the politically possible, not the politically acceptable.

Gauging the Perception of Cronyism in the United States

October 17, 2012

Cronyism is ubiquitous across all political systems. Whenever political actors intervene in economic affairs, they provide the incentive for businesses to take legal (cronyism) and/or illegal (corruption) action to ensure that political actors intervene in their favor. Yet only recently have economists started to seriously study cronyism and its prevalence and economic impact. The lack of scholarly work is largely because cronyism, like corruption, is notoriously difficult to measure, and unlike corruption, cronyism is not illegal, making it even more difficult to define and measure because there are no court or indictment records. This paper surveys the research on cronyism and the available methods of measuring it—in particular, using surveys to measure the perception of cronyism. We also make suggestions for improving our measurements of cronyism.

The defense of free markets and limited government from Adam Smith and David Hume forward hinges on the key assumption that businesses in the pursuit of profit will serve the public interest. Instead of legislating against or awaiting a transformation of human nature, Smith and Hume argue that capitalist institutions harness human self-interest to advance the well-being of all. As Smith famously states, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”[1] Most economists accept the argument that under market institutions, profit-seeking businesses will generally serve the interests of consumers. Yet profit seeking will not serve consumers if businesses can secure from government monopoly privileges or other regulations inhibiting their competitors. Such a mixed or politicized economic system has been dubbed crony capitalism, or cronyism, to distinguish it from a system of free markets and limited government.

While economists have been aware of cronyism since the beginning of economics, it has only recently become the focus of economic research. Several strands of literature in economics establish the general costs of cronyism and provide guidance for its scholarly investigation. The public choice analysis of rent seeking examines competition for favors or transfers from government and the costs of the transfers and lobbying activities.[2] The analysis of corruption, illegal attempts to secure favors from politicians, establishes the negative impact on the investment environment of bribes for favors.[3] And economic freedom has been strongly linked to prosperity and growth,[4] yet as cronyism expands in a country, economic freedom will decline. The actual measurement of cronyism has proven difficult because the parties involved tend to hide their actions.[5] Cronyism can also be obscured by public interest or consumer protection rationales for regulation, as Yandle’s example of the bootleggers and Baptists emphasizes.[6] 

This paper explores avenues for measuring cronyism as a means of advancing this new line of research. Although economists’ focus on cronyism is relatively recent, extensive literature exists on the related topics of corruption and rent seeking, and any attempt to investigate cronyism should be informed by these literatures. A first challenge is to distinguish cronyism from corruption and rent seeking, a task we consider in section 1. We consider in section 2 some general insights on the costs and measurement of cronyism offered by the corruption and rent-seeking literatures. Our focus then turns to the measurement of cronyism. Scholars have found surveys to be an effective means to measure corruption; surveys could also be used to mea- sure cronyism. Public perceptions of cronyism are important for the future of the free market economic system. Does the public consider cronyism to be endemic to or a corruption of capitalism? The public’s perception of cronyism will likely affect the future course of policy and may offer clues about how crony influences could be ameliorated. Section 3 discusses the reasons why perceptions of cronyism matter. Section 4 reviews some of the available evidence on insider and public perceptions.

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Daniel J. Smith and Daniel Sutter discuss Tornado Recovery in Joplin, Missouri on KZRG

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Jun 28, 2012
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Tornado Recovery: How Joplin Is Beating Tuscaloosa

Friday, April 13, 2012

This article was written by Daniel J. Smith and David T. Beito. It was originally published in The Wall Street Journal

Last April 27, one of the worst tornadoes in American history tore through Tuscaloosa, Ala., killing 52 people and damaging or destroying 2,000 buildings. In six minutes, it put nearly one-tenth of the city's population into the unemployment line. A month later, Joplin, Mo., suffered an even more devastating blow. In a city with half the population of Tuscaloosa, a tornado killed 161 and damaged or destroyed more than 6,000 buildings.

More than 100,000 volunteers mobilized to help the stricken cities recover. A "can-do" spirit took hold, with churches, college fraternities and talk-radio stations leading the way. But a year after the tragedies, that spirit lives on far more in Joplin than in Tuscaloosa. Joplin is enjoying a renaissance while Tuscaloosa's recovery has stalled.

In Joplin, eight of 10 affected businesses have reopened, according to the city's Chamber of Commerce, while less than half in Tuscaloosa have even applied for building permits, according to city data we reviewed. Walgreens revived its Joplin store in what it calls a "record-setting" three months. In Tuscaloosa, a destroyed CVS still festers, undemolished. Large swaths of Tuscaloosa's main commercial thoroughfares remain vacant lots, and several destroyed businesses have decided to reopen elsewhere, in neighboring Northport.

The reason for Joplin's successes and Tuscaloosa's shortcomings? In Tuscaloosa, officials sought to remake the urban landscape top-down, imposing a redevelopment plan on businesses. Joplin took a bottom-up approach, allowing businesses to take the lead in recovery.

"Out of the heartbreak of disaster," declared Tuscaloosa Mayor Walt Maddox several days after his city's tornado, "rises an extraordinary opportunity to comprehensively plan and rebuild our great city better than ever before." In this transformative spirit, Tuscaloosa's city council imposed a 90-day construction moratorium in the disaster area, restricting commercial and residential redevelopment until officials could craft and adopt a long-term master plan. Many of the restrictions remained long after the moratorium officially expired. Joplin, by contrast, passed a 60-day moratorium that applied only to single-family residential structures and was lifted on a rolling basis, as each section of the city saw its debris cleared, within 60 days.

The Alabama city's recovery plan, "Tuscaloosa Forward," is indeed state-of-the-art urban planning—and that's the crux of the problem. It sets out to "courageously create a showpiece" of "unique neighborhoods that are healthy, safe, accessible, connected, and sustainable," all anchored by "village centers" for shopping (in a local economy that struggles to sustain current shopping centers). Another goal is to "preserve neighborhood character" from a "disproportionate ratio of renters to owners." The plan never mentions protecting property rights.

In Joplin, the official plan not only makes property rights a priority but clocks in at only 21 pages, compared with Tuscaloosa's 128. Joplin's plan also relied heavily on input from businesses (including through a Citizen's Advisory Recovery Team) instead of Tuscaloosa's reliance on outside consulting firms. "We need to say to our businesses, community, and to our citizens, 'If you guys want to rebuild your houses, we'll do everything we can to make it happen,'" said Joplin City Council member William Scearce in an interview.

Instead of encouraging businesses to rebuild as quickly as possible, Tuscaloosa enforced restrictive zoning rules and building codes that raised costs—prohibitively, in some cases. John Carney, owner of Express Oil Change, which was annihilated by the storm, estimates that the city's delays and regulation will cost him nearly $100,000. And trying to follow the rules often yielded mountains of red tape, as the city rejected businesses' proposals one after another.

"It's just been a hodgepodge," says Mr. Carney. "We've gotten so many mixed signals from the get go. The plans have been ever-changing." Boulevard Salon owner Tommy Metrock, one of the few business owners to rebuild on Tuscaloosa's main thoroughfare, McFarland Boulevard, says the restrictions created "chaos" as people put their livelihoods on hold while the city planned.

Joplin took a dramatically different approach. According to interviews with local business owners, right after disaster struck the city council formally and informally rolled back existing regulations, liberally waving licensing and zoning mandates. It even resisted the temptation to make "safe rooms" a condition of rebuilding.

The owner of one Joplin construction company told us that when it came to regulations, the "city just sort of backed out. . . . We had projects that we completed before we got building permits." Said another Joplin resident: "When you have the magnitude of that disaster, really the old ways of doing things are suspended for a while until you create whatever normal is. . . . The government was realistic to know that there is a period of time when common sense, codes and laws that are in place to protect people are suspended for the sake of the greater good."

Despite it all, Tuscaloosa officials are determined to stick to their plan. The final version of Tuscaloosa Forward is on track for approval by the City Council. The city is banking on defraying its costs through as-yet-unreceived funding from the Federal Emergency Management Agency (FEMA), the Department of Housing and Urban Development, and other federal bodies. As Tuscaloosa Forward bluntly acknowledges, full implementation of the plan is impossible without "public subsidies to leverage private capital."

Last year's decentralized volunteer response seems to be entirely forgotten by city officialdom. As Mayor Maddox recently said: If Tuscaloosa "had a trained FEMA corps on the ground" when the tornado struck, "they could have taken over organizing the volunteers immediately."

In an age of mounting deficits and limited federal attention spans, hoping for more subsidies from Washington, D.C. is a risky bet at best. Joplin's safer wager is in the good sense and independently generated resources of those individuals and businesses most directly affected by nature's fury.

The Impact of Nobel Prize Winners in Economics

October 26, 2011

The authors assess the impact of two groups of economists; mainline economists who regard economics primarily as the science of exchange and mainstream economists who perceive economics primarily as the science of choice. To control for scholarly quality they investigated the citation impact of Nobel Prize winning economists, who were broken up into the two groups according to their approaches to market failure arguments. The authors found that over the period from 1970 to 2007 mainline economists had more of an impact than mainstream economists did. 

 

Private Solutions to Public Disasters

May, 2010

"Private Solutions to Public Disasters: Self-Reliance and Social Resilience" is a chapter in the book The Economics of Natural and Unnatural Disasters, edited by William Kern.

 

Private Solutions to Public Disasters: Self-Reliance and Social Resilience

July, 2009

The authors explore how entrepreneurs, not government policies, save lives after a natural disaster, such as Hurricane Katrina.    

Read the full article at SSRN.com.

Citation (Chicago Style)

Boettke, Peter J. and Smith, Daniel J., Private Solutions to Public Disasters: Self-Reliance and Social Resilience (July 2009). GMU Working Paper in Economics No. 09-29.

Robust Political Economy and the Federal Reserve

February, 2011

The economics profession not only failed to predict the recent financial crisis, but has been struggling in its aftermath to reach a consensus on the cause(s) of the crisis. While competing narratives are being offered and evaluated, the narrow scope of the debate on strictly technical aspects of monetary policy has precluded the examination of broader questions of political economy that may prove to be of greater import. Attempting to find the technically optimal policy is futile when policy is crafted and implemented in a contemporary democratic setting characterized not by omniscience and benevolence, but by fallibility and competing special interest factions. Nobel Laureates Milton Friedman, F.A. Hayek and James Buchanan each sought ways to constrain a monetary authority and each ended up rejecting the possibility of doing so. We incorporate their experiences to make a case for applying the concepts of robust political economy to the Federal Reserve. Robust political economy calls for relaxing idealized assumptions in order to seek out institutional regimes that can overcome both the epistemic and motivational hurdles that characterize contemporary democratic settings.  

Read the full article at SSRN.com.

Citation (Chicago Style)

Boettke, Peter J. and Smith, Daniel J., Robust Political Economy and the Federal Reserve (February 19, 2011). GMU Working Paper in Economics No. 11-08.

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