Europe's super power is regulation

Economist: How Europe regulated itself into American vassalage:

Decades of over-regulating the old continent’s economy left businesses there unable to compete with American firms, which went on to trounce European ones even in their own backyards. ...

The annoying thing is that, taken individually, each piece of euro-regulation is laudable. Yes, Europe should aim for “net zero” carbon emissions by 2050. Of course regulating AI is sensible, lest the robots turn on us one day. Firm antitrust rules enforced by the EU have served consumers well, and so on. But taken together the effect has been a tangle of red tape that has left Europe awkwardly exposed. Efforts are afoot to get to grips with some of the more unappealing dependencies; next month the commission will unveil a “tech sovereignty package”. But it remains to be seen whether Europe can escape its role as a superpower in rule-making, yet a supplicant in everything else that matters.

Addessing Double Markups with the Zollverein

A new paper by Huning and Wolf explore how the Zollverein was formed. A point it makes is that this episode serves as one of history's most dramatic examples of solving the "double markup" trap. Before this 1834 customs union, the German lands were fragmented into hundreds of tiny states, each acting as a local monopoly over its stretch of road or river. As goods moved across borders, every state added its own high transit toll, essentially a successive markup on the wholesale cost. Just as a manufacturer and retailer both adding high margins can kill consumer demand, these "stacked" tolls inflated prices so severely depressed the volume of trade, leaving both the merchants and the states’ treasuries worse off than if they had coordinated.

 

The formation of the Zollverein effectively acted as a massive vertical integration project for the German speaking peoples. Internal customs barriers were abolished and replaced with a single, uniform external tariff with each state getting a share of the revenue based on its population. This eliminated the destructive cycle of successive markups, reduced final prices, and spurred a surge in cross-border trade. When independent entities in a supply chain (or a geography) stop competing for individual margins and start optimizing for the whole, the resulting efficiency gains can build an empire.

 

Is Tax Treament of Cannabis Punative?

I am posting about marijuana in honor of 4/20 day.

Marijuana has been decriminalized across many states but is still a as a federal controlled substance as an illegal Schedule I drug. As such, cannabis related firms are subject to section 280E of the tax code. As the Cannabis Business Times (CBT) reports:

... state-licensed cannabis operators are not permitted to make common or ordinary deductions on their federal tax returns. These deductions may include labor, legal fees, marketing, security or banking. With fewer deductions, cannabis operators, particularly those in retail, have an effective tax rate that at times can approach 70% or more.

This tax treatment was originally intended to be punitive and serve as a disincentive to conduct illicit drug-related business. CBT recommends rescheduling cannabis to Schedule III, so that firms would no longer be subject to 280E taxation. Reducing a 70% higher tax wedge would likely reduce prices and increase the quantity demanded. While decriminalized, federal tax treatment depresses demand.  

Substitutability Determines Elasticity

The WSJ recently reported on how the Iran war is disrupting energy markets, particularly in Asia and specifically for Liquefied Natural Gas (LNG).

Qatar suspended production even before Iran struck its giant Ras Laffan export facility, causing damage that will take years to repair and delaying its expansion plans. The lost supply is ripping through the global economy.

One ripple has been a doubling in prices in Japan and Korea.

These high prices have led many Asian customers to substitute toward alternatives, including clean renewables but also dirty coal. What was not a viable substitute at $11/BTU has become viable at $22/BTU. Inelastic LNG demand has become more elastic as a result, suggesting that prices may have plateaued at $22/BTU.

The alternatives to agreement determine the terms of agreement: Iran's alternatives are bad and getting worse.

WSJ:

“Iran insiders are rumbling about the looming economic catastrophe if Washington does not grant sanctions relief that would unlock prospects for economic recovery,” said Burcu Ozcelik, senior research fellow with the London-based Royal United Services Institute think tank. “Without the prospect of economic recovery, regime survival beyond the short term will face sustained structural and popular pressure.”...

“The attacks are not random,” said Kevan Harris, an authority on Iranian economic development and society at the University of California, Los Angeles. “They are targeting parts of the economy that are outward facing, that are bringing in foreign exchange which could be redistributed and directed at basic needs.” ...

Iranian oil that can’t be exported will fill the country’s storage tanks in two to three weeks, which would force the country to shut-in its oil production, data provider Vortexa said. Shut-ins in turn can damage fields and reduce their future output, analysts said. ...

Complicating Iran’s recovery is a host of economic and social ills that predate the recent war, including a worsening banking crisis. Pressure from international sanctions and economic mismanagement pushed Iran last year into an economic unraveling and drove hundreds of thousands of protesters into the streets.

The government’s own internet blackout—now at six weeks and counting—is contributing to the economic damage. Businesses rely on it to communicate with overseas customers and to complete orders, and a tech sector employs tens of thousands of Iranians.

UPDATE from The Free Press

So now is the time to think big. This would entail making three basic demands of Iran’s regime: release political prisoners, end the execution of protesters, and turn the internet back on. In exchange, the U.S. can offer to lift sanctions and unfreeze assets the regime needs just to pay the salaries of government employees.

“The president has real leverage to call not for just a halt in executions, but to seek the termination of the death penalty for certain ‘offenses’ in Iran,” said Behnam Ben Taleblu, a research fellow at the Foundation for Defense of Democracies. He added that a precondition for the next round of talks should be to restore internet access for Iranians, which has been cut off now for nearly two months. In addition, Ben Taleblu said, Trump should demand the release of political prisoners arrested after the June 2025 war and more recently after the national uprisings and state-led massacres in January. He estimates 21,000 Iranians were arrested in June, and that more than 50,000 have been arrested since January.

WH Smith Divisional Incentives

High powered incentives appear to have backfired for WHSmith. In its North American travel retail division, performance evaluation and rewards were tied to aggressive profit targets. These appear to have encouraged managers to recognize income early, particularly from supplier rebates. On paper, the division looked like a strong performer. In reality, profits had been pulled forward, inflating results by tens of millions of pounds. When compensation is tightly linked to a single, measurable outcome like short-term profit, employees rationally focus on maximizing that metric, even if doing so decreases overall profitability.

Managers did not commit outright fraud but made possibly defensible accounting choices. While headquarters wants sustainable profitability, accurate reporting, and long-term relationships with suppliers, division managers are rewarded based on short-term profitability. The result is a predictable reallocation of profitability to where it will enhance compensation. This is a reminder that the problem is not just bad actors, it is often good agents responding optimally to poorly designed incentives.

Profit-Cap Evasion through Vertical Integration

Insurers offering Medicare Part D face a form of profit regulation in which federal reimbursement rates are tied to costs. This provides an incentive to inflate costs. In a new paper, Kakani et al show that firms shifted where they take their profits to an unregulated upstream affiliate. Higher pharmacy prices by affiliated pharmacies represent higher costs to insurers, some of which will be reimbursed through higher insurance prices. Moreover, "We detect larger price increases by insurers that were at greatest risk of exceeding the allowable profit level. More than one-fifth of these higher prices were borne by the federal government." 

The effect of California's $20 minimum wage

From MarginalRevolution:

...prices [of Food Away From Home or FAFH] rose, quantity demanded fell, and that’s what killed the jobs—not robots replacing workers.

In terms of welfare, the bulk of employed workers get an 8% wage increase, a small minority get disemployed. The big transfer was from consumers to workers. California has roughly 39 million residents, all of whom face 3.3–3.6% higher FAFH prices. The transfer is likely regressive — lower-income households spend a larger budget share on fast food specifically. So the policy effectively taxes low-income consumers generally to raise wages for a subset of low-income workers, while eliminating jobs for another subset. Your mileage may vary but I don’t see this as a big win for workers. ...

Changes in top income tax rates over last 20 years

WSJ:  

Democrats warn that tax cuts will slash state revenue and services to the bone, ... Republicans caution that higher taxes will risk an exodus by wealthy residents who create jobs.

Elizabeth Warren's plan to keep poor people in apartments, and out of homes

The Free Press:

...“Warren is deliberately trying to choke off investment in the construction of new single-family rental properties. This is profoundly regressive. Why is it OK for large investors to build and rent out apartments but not single-family homes?” He adds: “Warren’s policy effectively helps rich people keep working-class renters out of their towns.” ...

BOTTOM LINE: More investment increases supply which reduces price.