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BOSTON COLLEGE ECONOMICS ASSOCIATION PRESENTS

THE EAGLETARIAN Fall 2011 Copyright 2011


The Journal The Eagletarian, sponsored by Boston College Economics Association, is an academic research journal in which Boston College students from all disciplines can contribute to the advancement of economic research. We serve to: 1) Provide awareness for the importance of economics in the real world. 2) Highlight the use economics in various academic disciplines. We hold the exclusive right to edit, print, and distribute all submissions once accepted. You may submit to The Eagletarian at bceagletarian@gmail.com.

The Organization The Boston College Economics Association was created to provide forums for discussion about economic issues among students, faculty, and the greater Boston College community. The Economics Association will facilitate this discussion through 1) luncheons in which we provide presentations through the Career Center and through the Economics Department 2) panel presentations and lectures, which increase contact between students and faculty as well as professions with experience in the application of economics, and 3) The Eagletarian.

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The Members Joseph Quinn, Ph.D., Faculty Advisor Sam Hocking, Co-President Sam Hocking is a senior in the College of Arts & Sciences majoring in Economics with a minor in Mathematics. His hometown is Randolph, NJ and he currently resides in Ignacio 32B. Sam has been a member of the EA for the four years that he’s been at BC and has helped coordinate multiple panels and other events hosted by the club. In addition to taking many econ electives, Sam has worked at the Center for Retirement Research and as a Research Assistant for Professor Fabio Ghironi. He also spent time interning at the Economist Intelligence Unit during his semester abroad in Beijing. His economic interests include Macro, International Trade and Finance, and basically anything involving China, about which he’s currently authoring a senior thesis analyzing the significance of the country’s financial sector. Jacklyn Murray, Co-President Jacklyn Murray is a senior in A&S majoring in Economics and History with a minor in American Studies. As the public relations chair her sophomore year, Jacklyn has been involved with the Economics Association for three years. After an internship in bank compliance, Jacklyn will be working in the legal and regulatory side of the financial services industry upon graduation. Bryan Patenaude, Senior Event Coordinator Bryan Patenaude is a senior in the College of Arts & Sciences majoring in International Studies and Economics with a minor in Italian. His hometown is Clifton Park, New York. Recently, Bryan has studied sustainable development at Venice International University in Italy and political economy at the Egalitcheff Institute for Comparative Political and Economic Systems at Georgetown University. Throughout his university career, Bryan has interned for US Senators, Goldman Sachs, The US Department of Homeland Security Private Sector Office, and Atlas Economic Research Foundation. His areas of interest include developmental economics, political economy, historesis, economic integration, and public-private sector interactions. 3


Matt LeBel, VP of Web Operations Matt LeBel is a junior in the College of Arts and Sciences majoring in Economics and Computer Science with a minor in French. He cofounded LeapTask in October, 2011 and looks forward to the beta launch this winter. He made this site. Stephen Sikora, Treasurer Stephen Sikora is a sophomore in the Carroll School of Management, concentrating in Finance and Economics. In addition to serving as treasurer of the Economics Association, he’s the secretary of Boston College Republicans, and is involved with the Student Admissions Program, Finance Academy, and Word of Mouth. He’s from Burlington, CT, where he was an active member of Boy Scouts, achieving Eagle Scout and summiting Mt. Washington and Mt. Elbert, the highest peak in the Rocky Mountains. Stephen intends to study abroad in London during his junior year, and looks to pursue a career in the financial industries after graduation. He’s interested in sports and financial economics, and is currently taking the International Political Economy seminar for credit. Jenna Grippo, Event Coordinator Jenna Grippo is a sophomore in the College of Arts & Sciences majoring in Economics. Her hometown is Westchester County, NY but she currently resides in Walsh Hall. It is her first year in the economics association and she hopes to provide new insight on possible events and make them more publicized around campus. Jenna is involved in Women in Business and Smart Women Securities. She also volunteers in the Student Admissions Program as a day visit host and greeter. Eric Parolin, Event Coordinator Eric Parolin is a junior in the College of Arts & Sciences majoring in Economics and Mathematics. His hometown is Amherst, New Hampshire and he currently resides in Edmonds 723. This is Eric’s first year with the Economics Association and he looks forward to coordinate exciting events this year and the next. Over the past summers Eric has worked with BAE Systems, a government defense contractor in New Hampshire. His interests are mainly macro oriented with particular interest in policy analysis and international trade and finance.

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Vinh-Khoi Le, Director of Design and Publication Vinh-Khoi Le is a junior in the Carroll School of Management, majoring in Economics and minoring in Mathematics. He has been the Director of Design and Publication for the Economics Association since the beginning of his sophomore year and has designed covers, logos, and flyers, formatted layouts, and copyedited research papers for The Eagletarian, Boston College’s premier economics journal. His other cocurricular interests are diverse, ranging from tutoring urban students at MATCH High School and researching about macroeconomic modeling techniques to graphic designing and dancing hip-hop. He plans to apply to law school in the upcoming fall and hopes to find employment in copyright infringement or corporate law in the future. Raissa Horimbere, Editor Raissa Horimbere is a freshman in the Carroll School of Management with a concentration in Finance, and a minor in Spanish. Her hometown is Silver Spring, MD and she currently resides in the CLFX freshman residence hall as a member of the Healthy Living community. This is Raissa’s first year as an Editor on the board of the BC Economics Association. Raissa is passionate about microfinance, which combines her interests in economic development and personal finance education. Raissa is a member of BC’s chapter of Smart Woman Securities, and volunteers around Boston on weekends. In her free time, Raissa enjoys running, watching sports, and spending time with friends and family. Jack L. Hill, Editor Jack Hill is a sophomore in the College of Arts and Sciences majoring in International Studies with a concentration in Economics. He wishes to become involved with the Economics Association as an Editor in order to gain a more in depth knowledge of finance and commerce in general. As a student, he was involved in Appalachia Volunteers, Model United Nations, Americans for Informed Democracy, Clough Center Junior Fellow, and BC Rhetorical Society. He also held a securities analysts internship position at RBC Wealth Management. He currently works as an editor for the Clough journal at Boston College.

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Table of Contents {01} Deregulation Of Domestic Infant Adoption Elizabeth Kroening

{17} The Minimum Wage Effect On Teenagers And Young Adults And Their Long-Run Adult Employment Prospects Nicholas Franco

{31} Privatization of Social Security: The Chilean Experience Jennifer Morton

{41} Pirate Hunting: The Economics of Piracy In Somalia Tara Sullivan

{61} Regulation of Restaurant Practices Sean Fitzgerald

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Deregulation Of Domestic Infant Adoption Elizabeth Kroening


Deregulation Of Domestic Infant Adoption Elizabeth Kroening

Introduction The current system of adoption in the U.S. is controlled by agencies, public and private.1 Birth mothers and adoptive parents are required to pass various eligibility tests to ensure medical, financial, and lifestyle stability. Agencies do not allow birth mothers to contact or contract freely with adoptive parents, and birth mothers do not receive monetary compensation for relinquishing their children other than medical pregnancy expense coverage. Birth mothers lack much incentive to relinquish their children and adoptive parents are penalized by agencies, in that they must wait in lines for up to seven years before they are matched with an infant and cannot seek out birth mothers independently. Estimates suggest that about 10-25% of married couples are looking to adopt domestically, but only between 1-2% have the opportunity (Bernal, et al., 9).2 This paper will focus on the demand for and supply of healthy, white infants in the United States, as an excess demand for this group began in the 1950s (Bernal et al., 4-5). As suggested by Judge Richard A. Posner, a deregulated free market for the exchange of parental rights is a policy that would combat the demandsupply disparity. It would allow for freedom of contract between birth mothers and adoptive parents, and would monetarily compensate birth mothers for their wages foregone due to pregnancy and medical costs. The deregulated free market I propose would retain the eligibility regulations of the current system. Despite positive welfare benefits of the market system, costs exist and are dominated by ethical and moral complaints. This paper will discuss the history of adoption in the United States and the state of the current system, and it will introduce the idea of a deregulated, free market for the exchange of parental rights. Its negative and positive aspects will be presented, and I will conclude that a deregulated, free market for the exchange of parental rights will significantly benefit the three parties involved in an adoption through diminishing the baby shortage and increasing welfare among birth mothers and adoptive parents. Background and Domestic Adoption Statistics An adoption is characterized by an exchange or “sale of parental rights;” “when a birth mother gives a child up for adoption, she legally transfers her parental rights to the adoptive parents” (Boudreaux, 1). Married couples rarely relinquish infants for adoption, so most of these transfers occur be(1) Some private “open” adoptions occur and will be discussed later. (2) I will not analyze adoption from abroad in this paper.

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tween single birth mothers and married (adoptive) couples. Infants are often available for adoption because their biological mothers do not have the desire or ability to raise children. In fewer cases, abuse, neglect, abandonment, or parental death is the reason for a child’s adoptability (Posner, 323). In every adoption, three principal parties are involved and can benefit from the transfer of parental rights: the infant, the biological mother, and the adoptive parents (Boudreaux, 4). Adoption is a very under-researched area in the United States, and national comprehensive data on the topic is limited to Census information. The U.S. Census 2000 (3) found that about 390,000 out of a total 20 million children under age six living in the U.S. were adopted. 4 Out of 1.586 million total adopted children in the U.S., only about 42,000 were under the age of one year (infants). Figure 1, below, was taken from the Census 2000 Special Report on Adopted Children and Stepchildren. Figure 1 – Percent Distribution of Children of Householder by Type of Relationship and Age: 2000

The percentage of children who are under age six out of the total adopted population is about 19%, while the percentage of children under age six out of the total population of biological children is 25%. In other words, the number of adopted children who are under age six is disproportionate to the number of biological children under age six, though they are expected to be very similar. These differences reflect adoption queue time, adoption finalization time, and the steady decrease in adoptable infants, on which I will elaborate later (Kreider, 3-4). History of Domestic Adoption Trends in the United States Child adoption trends in the United States have evolved over the past 150 years. Beginning in 1850, an increasing number of states required judicial (3) Census 2010 data is not yet available. (4) All adoption Census data presented here includes international adoptions as well as domestic adoptions, although the focus of this paper is on domestic adoption only. The percentage of infants adopted from abroad was 12.6% in 2000.

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supervision for infant adoption. These established the court’s duty to approve of adoptions and mediate the permanent legal transfer of parental rights from biological to adoptive parents. Throughout the nineteenth century, adoptions were relatively uncommon and informal. Greatly contrasting today’s shortage of adoptable, healthy, white infants in the United States, in the 1800s it was common to find unwanted homeless children living in disease-infested institutions (Bernal et al., 4-5). In the early 1900s, progress was made in the study of childhood and childcare. People generally accepted the theory that nurture is an important determinant of child development, and the quality of infant formula improved. Such advancements partly led to the 1920 to 1960 increased demand for adoption in the United States. If known, income and ethnicity were used to “match” adoptable infants with adoptive parents, and the mentally or physically disabled were considered “unadoptable” until the late 1960s. Today’s excess demand for healthy, white infants began in the 1950s (Bernal et al., 4-5). Below, Figure 2 shows the decreasing number of relinquished infants from before 1973 to 1995 as a percentage of total infants born to never-married women under the age of 45 years. It separates infants into black or white, and also shows the collective supply. I will discuss the importance of race later in the paper. Figure 2 – Percent of Infants Relinquished for Adoption by Never-Married Women under 45 Years

From 1960 to 2000, the domestic supply of healthy, white adoptable infants steadily and quickly declined, as shown in Figure 2. There are several hypothesized reasons for the declining supply, including increased use of contraception and the 1969-1973 legalization of abortion in many states. State level panel data from 1961 to 1975 shows that, “relative to other states, states that repealed abortion restrictions experienced a 34% decline in the adoption rates for unrelated white children, concluding that the estimated 4


effect of abortion legislation on adoption rates can account for much of the decline in adoptions during the early 1970s” (Bernal et al., 12). Women began taking much-improved precautionary measures to prevent pregnancy and could terminate pregnancy at their discretion. Figure 3, below, shows the dramatic increase in abortions after its legalization. Although this number has decreased gradually since 1985, it is still about 450,000 aborted infants greater than it was in 1973. Also adding to the decrease in adoptable babies, an increasing number of birth mothers began to keep their infants around the 1970s (Posner, 325). As evidenced here, most of the reasons for the supplydemand disparity are supply side issues. 5 Figure 3 – Number of Abortions in the U.S. by year, 1973-2005

Welfare programs such as the Aid to Families with Dependent Children may have contributed to the diminishing relinquishment rates from the 1960s onward. This was a federally mandated program that guaranteed cash assistance to children who are “‘deprived of parental support or care because their father or mother is absent from the home continuously, in incapacitated, is deceased, or is unemployed’” (Page and Larner, 21). It enabled mothers to keep their children because they now had funding to support them. Changing moral standards and an increasing number of jobs available to women in the 1980s and 1990s might have triggered the lower supply of infants available for adoption. In addition, the number of cohabitating couples living out of wedlock has increased in recent decades. Data on this is very limited before recent decades, but it suggests that rates were low before 1970 and have steadily increased since then, especially in the past fifteen years. The Current Population Survey estimated that in 1995, adult cohabitation rates were 2.9%, and increased to 4.7% in March 2005. The 2002 National Survey of Family Growth found that 50% of women aged fifteen to forty (5) Further theories exist for the reasons underlying the excess demand trend. Though the gap has widened, the number of families wanting to adopt in the United States has remained around two percent for decades (Williamson, 1). When women choose to “pursue professional careers before starting a family,” this “raises the demand for adoptable infants” because women’s ability to conceive decreases with age (Boudreaux, 2). This increase in demand is offset by couples who successfully use fertility treatments, but would have otherwise been infertile and looking to adopt (Prichard, 343).

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-four years had cohabitated at some point in their lives and that 9% were currently cohabitating (Stevenson and Wolfers, 11). This contributed to a greater number of intentional, or at least not unwanted, births by unmarried mothers, and thus a lower number of adoptable infants (Posner, 325 and Bernal et al., 13-14). Current System of Domestic Adoption I. Who Mediates the Adoptions? In the current domestic system, state-funded non-profit adoption agencies have a near monopoly on the exchange of parental rights, and 60-70% of these agencies are public (Posner, 326). Agency duties include gathering medical information from birth mothers, meeting with adoptive parents, conducting home studies, collecting fees, and matching parents with children. Approximately 30-40% of agencies are private, and while they serve as intermediaries, some contact is allowed between parents and mothers before adoption. Private agencies are a step toward an open market for the exchange of parental rights, but are still quite regulated by their state. A small amount (exact data not available) of adoptions take place with only the assistance of an attorney to conduct eligibility studies, allowing for full contact and information sharing between the parents and mothers (adoptionlounge.com). I believe this type of adoption is ideal for the United States, and I will later discuss its benefits and drawbacks in detail. II. How does the Agency Adoption Process Work? When prospective parents meet with agencies, confidential information on the parents’ race, income, and background is gathered. The federal government has requirements regarding eligibility for adoptions (including aspects of physical, mental, and financial well-being) that must be met by adoptive parents, and states are able to add any additional requirements. Prospective parents’ also undergo a home study. This evaluates their suitability as parents, financial stability, and preparedness for adopting an infant. Parents deemed eligible for adoption are then educated about the expectations of raising a child (adoptionlounge.com). Following the home study and upon being matched with an infant, parents attend a hearing and are either approved or not approved by court. Approval finalizes the adoption process and adoptive parents become legal guardians to the infant.6 Now responsible for the physical, emotional, and financial support of the child, the adoptive parents are free from the agency to make all decisions regarding the child’s upbringing (adoptionlounge.com). III. Payments for the Exchange of Parental Rights Domestic adoption agency prices typically range from $3,000 to $30,000 (6) Legal processes vary slightly from state to state.

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and include the application fee, home study, court costs, parental counseling costs, and birth mother medical costs. 7 They range so widely because medical costs vary and those who are financially eligible for government aid pay prices on the lower end of the spectrum (Posner, 328 and adoptionlounge.com). In twenty-four U.S. states, birth mothers are forbidden to engage in private adoptions, meaning sell their parental rights for a monetary payment and contract with prospective adoptive parents independently. In order for a shortage (of infants) to persist, it is necessary that prices paid to suppliers (agencies) be held below market-clearing levels. The lack of public information coupled with the impossibility to put a price on a child’s life leads to no market-clearing price for parental rights (Boudreaux, 2). Problems with the Current System I. Lack of Economic Incentive for Biological Mothers For about sixty years, the demand for healthy, white infants has far exceeded the supply. To be sustainable, a rapidly growing and advancing society should aim to maximize the welfare of its population. Currently, the government-run, agency-based system of adoption is inadequate, as it does not provide enough incentives to improve the lives of many infants, adoptive parents, and biological mothers. There is no economic incentive for biological mothers to relinquish their newborns, since their compensation for doing so does not exceed coverage of medical expenses. But, mothers can receive money from welfare programs when they have a dependent child, and many are enticed by this option. This sometimes benefits infants, but can also have a negative effect when mothers use the money for their own personal purposes and neglect their children (Page and Larner, 22). Would-be adoptive parents are forced to wait in long queues for a child, often for as long as seven years. Many grow so discouraged by the line that they attempt to conceive naturally, even when medical reasons make this unwise (Prichard, 343). It is important to recognize that the queue does not represent all of those wishing to adopt, as some are deemed ineligible by agencies, some are discouraged by the wait time, and others adopt from abroad (Posner, 326). II. Pricing Agencies cannot transfer the free-market value of the child to the birth mother, as it would be very difficult to set a price on the joy and satisfaction brought to adoptive parents by their child (Posner, 328). Despite this, agencies often price discriminate; fees are dependent on adoptive parents’ income. Private adoption agencies “may have a sliding scale for fees depending

(7) This is not consistent between all states, as some do not set ceilings on chargeable fees

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on the adoptive family’s income” (adoptionlounge.com). Data taken from the website of one adoption agency, “Adoptions Together” is below (Figure 4): There is no explanation on the “Adoptions Together” website as to why such price discrimination occurs, but it is possible that the agency or federal government covers an amount of the adoption in proportion to income. 8 The increasing prices in proportion to income may reflect a decreasing amount of government or agency funding assistance. Whether payments are government/agency-assisted or not, the practice of price discriminating in the sale of parental rights based on income is unethical. It inadvertently places a higher value on a child adopted by wealthy parents than a child adopted by lowerincome parents, and charges wealthy parents a higher monetary price than lower-income parents. Figure 4 – Domestic Adoption Program Fees To complete a home study: $1650
 
 To enter the Domestic Program for placement services: -Clients pay 25% of the placement fee. The program deposit is nonrefundable, applied toward the placement fee. -The placement fee is on a sliding scale and is set according to net worth, if self employed, or gross annual income and additional financial information as established at home study. Fees for clients residing in Maryland, Virginia and Washington, D.C.* **All fees are subject to change without notice. Fees are effective January 1, 2010 It is the policy of Adoptions Together that adoption should be available to families from a broad socio-economic range. The goal of the agency is to help families explore their resources and overcome those obstacles. *DC resident fees are based on per capita income for a family of five. Each additional family member will reduce the fee by 5% per member. Income

Placement Fee

Deposit

Less than $45,000

$9,000

$2,250

$45,000 to $69,999

$13,000

$3,250

$70,000 to $89,999

$15,000

$3,750

$90,000 to $119,999

$17,000

$4,250

$120,000 to $150,000

$19,000

$4,750

Over $150,000

$21,000

$5,250

(8) In the past decade, parents have received up to $11,000-12,000 toward adoption fees if they are financially unable to cover the charges. “In March 2010, the Affordable Care Act was enacted, which increased an adoption tax credit. Available as it stands now through December 2011. Adoptive parents may qualify for the adoption tax credit if they pay their qualified adoption-related expenses. If they adopt a special-needs child, they may be able to claim the full amount of the credit (around $13,000) even if the amount of fees they paid are less than the tax credit amount or they did not have income taxes withheld” (http://www.adoptionassociates.net/ news/adoption_benefit_tax_credit_information/). In 1996 via the Adoptions Incentives Act, the U.S. Congress enacted a tax credit for adoptive parents, allowing up to a nonrefundable $5,000 for adoption expenses and up to $6,000 in tax deductions for the adoption of “special needs children” who tend to be difficult to place (Frasch, et al., 22).

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III. Transracial Adoptions Race is another substantial issue with the current system. Most of the adoptive parents waiting for a match are white, while most of the children awaiting adoption are of other races. 17% of adopted children under the age of eighteen are living in households of races different from their own, but only .7% of households containing members of different races contain adopted children (Kreider, 14, 18). Since the 1970s, whites have become much more open to transracial adoption, yet the amount of transracial adoptions in the United States remains at only 8% of all adoptions (Williamson, 3).9, 10 Until the 1994 passage of the Multiethnic Placement Act (MEPA), adoption policies and practices throughout the U.S. favored racial matching, as this was considered good social work practice and in the adoptable children’s best interests. MEPA disallows agencies from denying parenthood of a child whose race differs from the parents’ race purely based on race. However, race can still be considered (its weight is unspecified) when placing a child, and some agencies believe same-races matches result in a higher quality of life. Agencies often still place a high value on race as a determinant of child welfare because they are held accountable for their placements. Some do not (9) I could not find numerical data on birth mother and adoptive parent preferences, as adoption data is limited. Also, a thorough discussion of race and adoption is outside the scope of this paper. (10) A study published by academic journal Child Welfare suggests that this discrepancy stems from the racial attitudes of social workers. Reportedly, “43 percent of the caseworkers responsible for the longest-waiting black children in New York State expressed hostility toward transracial adoption” (Williamson, 3). Despite federal law prohibiting the use of racial criteria in parent-child matchmaking, some of the agencies at the core of the United States adoption system do not allow white adoptive parents to adopt non-white infants (Williamson, 3). Although findings exist, such as Loyola University – Chicago’s evidence that does “not seem to indicate that race is a reliable predictor of the happiness or success of adopted children,” the discrimination persists (Williamson, 4). The current legal system provides counseling to prepare parents adopting children of races different from their own, yet it discourages transracial adoption. Unless race ceases to be used as a ruling criterion, agencies illegally contribute to the increase in the supply of non-white infants and the increase in the queue of adoptive parents waiting for white infants (Williamson, 4). In 1996 via the Adoptions Incentives Act, the U.S. Congress enacted a tax credit for adoptive parents, allowing up to a nonrefundable $5,000 for adoption expenses and up to $6,000 in tax deductions for the adoption of “special needs children” who tend to be difficult to place (Frasch, et al., 22).

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encourage or allow transracial adoptions because they are concerned about their reputation and want to take a low-risk approach toward maintaining it (Frasch, 167).11 The Solution: A Deregulated, Free Market Private adoptions, allowed in about half of all states in the U.S. today, mimic the way in which a deregulated, free market would function. Private adoption fees generally range from $8,000 to $35,000, not much more than typical fees charged by agencies. These independent adoption fees include attorney fees and birth and medical expenses incurred by the birth mother, but do not cover other birth mother monetary opportunity costs (adoptionlounge.com). Prices in a deregulated, free market system would be agreed upon by adoptive parents and birth mothers in court. Typically, fees paid by birth parents would cover the mother’s monetary opportunity cost of giving birth and placing the child for adoption. Her monetary opportunity cost would include wages foregone and medical and birth expenses. Birth mothers would still be required to present medical data on her own and her infant’s health conditions in court, and some adoptive parents may be willing to pay more for a child who is of superior health. So, while prices would typically be limited to the mother’s financial opportunity cost, mothers with children of supreme health could possibly receive higher payments than mothers with children of (11)The following is an excerpt taken from an article by Leslie Doty Hollingsworth in the journal Social Work, Volume 43, year 1998: It has been suggested that adoption agencies, feeling the pressure of reduced fee income, found in the availability of children of color an opportunity to increase adoption fees. One writer suggested that as the United States became accustomed to children of color from other countries in its communities, it became easier to accept the transracial adoption of African American children. By 1971 transracial adoptions had reached an annual high of 2,574. Responding to this increase, a 1972 meeting of the National Association of Black Social Workers (NABSW) ended with a resolution opposing transracial adoption: Black children belong physically and psychologically and culturally in black families where they can receive the total sense of themselves and develop a sound projection of their future. Only a black family can transmit the emotional and sensitive subtleties of perceptions and reactions essential for a black child's survival in a racist society. Human beings are products of their environment and develop their sense of values, attitudes, and self-concept within their own family structures. Black children in white homes are cut off from the healthy development of themselves as black people. In response to that resolution, and to the Indian Child Welfare Act of 1978 giving tribal courts exclusive jurisdiction over American Indian child custody proceedings, some states established policies and procedures limiting transracial adoption and requiring that serious efforts be made to place children of color with adoptive parents of their own racial or ethnic group. Agencies specializing in same-race placements were established, and many traditional agencies modified their programs in the same direction. Some parents who had adopted transracially were offended, however, by the NABSW resolution, perceiving it as not based in truth and disagreeing with the assertion that they were not capable of parenting their adoptive children of color adequately.

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average or below average health at the discretion of the adoptive parents (Prichard, 345-348). With a deregulated market for the exchange of parental rights, birth mothers would independently contact adoptive parents. 12 To ensure parental eligibility, home studies and background checks would still be required under a deregulated market system and would be conducted by a new type of government-approved agency in the same manner in which they are conducted under the current system. These agencies would also provide safety checks of birth mothers’ homes. Adoptions would not be finalized unless all eligibility documents were presented and approved in court, the same way in which adoptions are finalized today. All communication between specific birth mothers and adoptive parents would be confidential between the two parties unless either wished to have it disclosed; agencies would not have legal access to this information. Negative Effects of the Free Market The ethical risks of the proposed deregulated market must be taken into account. The most common complaint about the market idea is that the model treats babies as commodities. This viewpoint says that by describing the adoption system economically, economists like Judge Posner create an incomplete model for the parent-child relationship. While the deregulated market model may maximize utility in terms of commodities, it “ignores completely the non-commodity values we find essential to any viable alternative to the existing adoption system” (Frankel and Miller, 101). Opponents fear that paying a market price for infants would result in parents viewing their child as a commodity. There is worry that parents may “regret the purchase, feeling cheated or overcharged. They may take their frustration out on the child, attempting somehow to extract more child for the dollar” (Frankel and Miller, 102). It is difficult to substantiate this viewpoint, because adoptive parents pay a price for their child under the current system as well; the possibility of parental regret would likely not increase with the implementation of a market system (Boudreaux, 8). Opponents contest that those who would become parents are those who could best afford the infants, rather than those deemed most fit to be a parent (Frankel and Miller, 101). This view is misguided, as Posner and his proponents emphasize that courts would retain their abilities to invalidate adoptions and prospective parents would still be required to pass a home study of eligibility. Great legal change would not be involved, but laws prohibiting birth mother and adoptive parent contract rights would be repealed. Mutu(12) It is possible that organizations would emerge in order to house databases of and advertise information on birth mothers. However, these organizations would function only as a liaison between birth mothers and adoptive parents and its members would not be present during meetings between the two parties.

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ally agreeable prices established based on the market, adoptive parents’ willingness to pay, and birth mother preferences would be established (Boudreaux, 10). Some also worry that the poor would be exploited and the rich would benefit. This argument is based on the idea that the poor would be more likely to relinquish a child for adoption because of the financial incentive, and the false assumption that the price of parental rights would increase. 13 However, no one would force a birth mother to choose adoption for her child; the system would still be completely voluntary. In terms of fairness, the current system would actually be improved by the elimination of price-discriminating agencies. In fact, “in every voluntary exchange, both parties are made better off” (Boudreaux, 7). The non-wealthy would be better able to afford parental rights if birth mothers were allowed to freely sell them (Boudreaux, 7). Another argument against a market for the exchange of parental rights is that women would intentionally become pregnant because they are attracted to the “profit.” This would generate a “baby industry” and create life for an unnatural purpose. While “intentional births by profit-seeking mothers” may occur, “it is difficult to see why this outcome is undesirable” (Boudreaux, 8). There are long queues of potential parents eager to adopt, and their happiness would likely not decline due to their child being intentionally born for the exchange of parental rights. Also, health eligibility requirements described earlier aim to dissuade drug addicts from getting pregnant for the purpose of financial compensation. Further, willingness to supply parental rights would vary with market price; if demand decreases, the price should decrease and make rational women less tempted to take advantage of the system (Boudreaux, 8). Another set of societal concerns deal with market failure. Many worry about the potential oversupply of adoptable infants that could result from the implementation of a market policy. The country may not be able to sustain a rapidly growing population, and this growth would be seen as a negative externality. Another potential outcome is that the supply of infants with highly desirable characteristics would flourish, while the demand for infants deemed “lower quality” would diminish. In other words, children suffering from birth defects, mental illnesses, and other undesirable characteristics would be less likely to be adopted than they are now. These are possible negative externalities of the proposed market for adoption and cannot be ignored. However, the pricing system as designed for the deregulated market allows for negotiation between birth mother and adoptive parents, so it is likely that “lower quality” children will still be adopted. Along with this, opponents worry mothers may be incentivized to not reveal negative information about their child. This is an ethical concern, but the new adoption process would continue to utilize physical and mental screenings of both mothers and children. (13) The expected price decrease will be discussed in the “Positive Effects” section.

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It would be difficult for a disability or negative quality to be unknown to the courts and adoptive parents (Prichard, 348). Positive Effects of the Free Market I. Adoptable Infant Supply Increase There are numerous expected positive effects of a deregulated market for infant adoption, the most anticipated being a decrease in the baby shortage. Birth mothers would no longer be excluded from payments and would seek to sell their parental rights for a profit, or at least to cover their medical expenses and foregone wages. A social benefit is that the number of abortions would decrease, as the financial opportunity cost of an abortion would increase. The supply of adoptable infants would rise to meet demand, and the queue would diminish to result in a wealth of satisfied couples (Boudreaux, 3 and Prichard, 345). In a free market for the exchange of parental rights, it is expected that those for which it is dangerous to produce would be more likely to adopt healthy infants rather than put themselves at risk by attempting a natural pregnancy. In addition, newborns would be “of a higher quality” in terms of attributes and health than existing newborns because there would be incentives for mothers to take care of themselves throughout pregnancy. Prices for parental rights in healthy infants would likely exceed those of unhealthy infants, so women would likely take prenatal care to ensure greater compensation. Those who would otherwise smoke or drink alcohol while pregnant would have financial incentive to cease this behavior. Drug addicts would probably not receive their full monetary opportunity cost (payments for wages forgone or even medical costs) of the pregnancy, so they would likely not choose to get pregnant for the purposes of relinquishing their newborn. Child abuse would be expected to decline; mothers who keep their baby under the current system for the financial reward provided by welfare programs such as the AFDC would be expected to sell their parental rights to an adoptive couple (Boudreaux, 3 and Prichard, 345). II: Price Decrease and Birth Mother Welfare Adoption and infertility treatments are somewhat substitutable methods of obtaining a child. With the increase in supply of adoptable infants brought about by a free market, the demand for now-costly infertility treatment would fall. Because fewer would be demanding the treatments, their price would decrease, making them more affordable to couples who would rather attempt to have a biological child than adopt (Boudreaux, 3). Similarly, the price of parental rights paid by the adoptive couple would decline (from the current $3,000-$30,000) because of new competition. The price would be expected to be equivalent to a woman’s opportunity cost of her time during pregnancy, including wages foregone for medical reasons. 13


Under the current system, the only income distributed to the mother is that which covers her pregnancy (medical) expenses, leaving the remainder of payments received to agencies to cover their costs. Under the deregulated adoption market policy, all of the income would be given to the mother to cover her expenses (and do as she pleases with the potential excess). In sum, prices paid by adoptive parents would decrease and money received by birth mothers would increase (Prichard, 346). Conclusion Despite the benefits of establishing a market for adoption, there are real ethical and practical concerns. A great worry is that by putting different prices on different infants, we would be violating the principle that all lives are equally and infinitely valuable. This is a real fear, but it is difficult to evaluate from an economic standpoint, as public policy cannot avoid costing and pricing whenever human lives are at stake (Prichard, 351). Adoption agencies today function solely to match infants with adoptive parents; parental rights are exchanged under the current system for a price. The market system would transfer payments to mothers (rather than agencies) and would allow for greater number of exchanges of parental rights due to the increase in supply previously discussed. With the removal of agencies, queues would shorten or disappear. The argument that the market should be avoided because it will attract couples looking to treat their child as a commodity is difficult to substantiate. Some biological parents presumably have the same “perverted desires” to have children, and there is no basis for predicting whether this small portion of the country’s couples would increase (Prichard, 353). Calling the “sale of parental rights” in a market “baby selling” makes people uneasy and provokes moral objections; some people’s initial reaction is that the system would mimic slavery (Williamson, 5). These objectors overlook the fact that agencies today are in the business of selling parental rights, and the new system would simply replace agencies with biological mothers. Further, parents make monetary decisions about and sacrifices for children on a regular basis. In our capitalistic world, “economic calculation is probably the single biggest factor influencing how many children couples have and when they have them. Why not use economic incentives to make adoption safe, legal – and plentiful?” (Williamson, 6). It is uncertain whether the market for parental rights is the best possible mechanism, as a ban on abortion or contraceptives would potentially lead to a more natural increase in the supply of adoptable infants. However, the value of the mechanism should be judged based on the welfare of biological mothers, unwanted newborns, and childless couples. Some market opponents believe it is unjust to create “unwanted” lives motivated by profit, and that the infants’ welfare is sacrificed at the expense of the adoptive parents’ 14


lives. While some mothers will give birth with the intention of selling their parental rights, the infants are very much wanted by an excess of adoptive parents. In fact, a positive effect is that the market system will still allow for freedom of choice in terms of abortion, but more birth mothers would choose to give their children lives because there will be incentives to do so. Those discouraged by the queue who attempt to conceive naturally under medically dangerous circumstances would instead be able to adopt. Under the existing system, “it is not at all clear what value is being preserved or promoted by means of denying this fundamental happiness to the large number of couples left childless” (Prichard, 354-355). Nearly all judicial safety regulations governing today’s domestic infant adoptions would be retained with the market system, though today’s agencies would be removed. With the mothers’ ability to communicate freely with prospective parents, allocative efficiency would increase dramatically (Williamson, 5). The market proposal entails freedom of contract and unrestricted prices. Increased information, a fair pricing system for parental rights, and the elimination of adoption agencies would bring immense societal benefits to the United States (Boudreaux, 10).

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Bibliography Figure Citations: Figure 1: Kreider, Rose M. “Adopted Children and Stepchildren: 2000.” Census 2000 Special Reports. 2003: 3. Figure 2: “Voluntary Relinquishment for Adoption.” Child Welfare Information Gateway. (2005): 3 Figure 3: R.K. Jones et al., "Abortion in the United States: Incidence and Access to Services, 2005," Perspectives on Sexual and Reproductive Health. 40 (2008): 6. Figure 4: “Domestic Adoption Program Fees.” Domestic Adoption: Adopt an Infant. Adoptions Together. 2010. Web. http://www.adoptionstogether.org/Adopting.

Other Citations: “Adoption Costs.” Adoption Lounge. 2011. Web. <http://adoptionlounge.com/costs.php>. Bernal, Raquel, et al. “Child Adoption in the United States: Historical Trends and the Determinants of Adoption Demand and Supply, 1951-2002.” 2007. Web. <http:// www.economics.uci.edu/docs/THD%20workshop/f07/moriguchi.pdf>. Boudreaux, Donald J. “A Modest Proposal to Deregulate Infant Adoptions." Cato Journal 15.1 (1995). Web. <http://www.cato.org/pubs/journal/cj15n1-7.html>. Fedders, Barbara. "Race and Market Values in Domestic Infant Adoption." North Carolina Law Review. 88. (2010): 1688-1714. Frasch, Karie, et al. “Enhancing Positive Outcomes in Transracial Adoptive Families.” California Social Work Education Center. (2004): 22. Frankel, Tamar and Miller, Francis H. “The Innaplicability of Market Theory to Adoptions.” Hein Online. 99. (1987): 101-102. Hollingsworth, Leslie Doty. “Promoting Same-Race Adoption for Children of Color.” Social Work. 43. (1998). Landes, Elisabeth M., and Richard A. Posner. “The Economics of the Baby Shortage.” Journal of Legal Studies. 7.2 (1978): 323-348. Larner, Mary B. and Stephen B. Page. “Introduction to the AFDC Program.” The Future of Children. (Spring 1997): 20-27. Prichard, J. Robert S. “A Market for Babies?” The University of Toronto Law Journal. 34.3 (1984): 341-357. Stevenson, Betsey, and Justin Wolfers. “Marriage and Divorce: Changes and their Driving Forces.” Journal of Economic Perspectives 21(2)(2007): 27-52. Williamson, Kevin D. "Lost Generation-Adoption in America has collapsed; here's what to do about it." National Review 04 Aug 2008.

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The Minimum Wage Effect on Teenagers and Young Adults and Their Long-Run Adult Employment Prospects Nicholas Franco


The Minimum Wage Effect On Teenagers And Young Adults And Their Long-Run Adult Employment Prospects Nicholas Franco

This paper will examine the longer-term effects of increases in the minimum wage on teens and young adults years after the policy change. Earlier studies will explain why adults who were exposed to higher minimum wages as teens and young adults earn less, and work fewer hours. They will show that increases in the minimum wage will force firms to replace less educated workers with better-educated workers and cause unemployment. We will see that higher minimum wages incentivize teens to leave school and lower enrollment rates. Studies will show that these wage increases have different effects depending on a person’s gender, race and socioeconomic status. The studies will conclude that increases in the minimum wage adversely affect teens and young adults by decreasing overall school enrollment and work experience. These effects last long after the initial policy changes and result in lower earnings and fewer hours worked when they reach adulthood. Long-Run Employment Effects of the Minimum Wage The minimum wage is one of the most hotly debated topics in the field of public policy. Changes in minimum wage impact some of the nation’s most vulnerable citizens and can have important impacts that last well beyond the immediate changes. Teenagers and young adults are often the most affected by changes in minimum wage law both directly and indirectly. Directly, teenagers and young adults often see changes in their employment opportunities, hours worked, or hourly wages. Some individuals benefit from these changes at the expense of others depending on race, gender, socioeconomic background and education. Indirectly, these groups are induced by market powers to make choices they may not have otherwise made. Teenagers and young adults make different decisions regarding their education, skill attainment and their employment status because of changes in the market. Data on school enrollment, employment, and training and skill acquisition do not reveal much interesting information about its long-term effects when measured contemporaneously with changes in the minimum wage. A more useful examination of the data explores the question “What are the effects of a change in the minimum wage had in the long run?” This paper will examine the long-term effects on adult employment resulting from changes in the minimum wage policy. This paper will question the findings of earlier research that focused on more immediate effects instead of the lasting effects. The argument centers on the idea that exposure to a higher minimum wage at a younger working age will have a negative im18


pact on employment opportunities and earnings later in life. Much research in this area involves the impact on teenagers and how changes in policy affect their current decision-making and subsequent opportunities. The argument posits that young people exposed to higher minimum wages will suffer because of lower school enrollment, decreased market experience, diminished training and skill acquisition, and lower current labor supply. Studies yield varying results regarding the effects the minimum wage increase on enrollment, employment, market experience and training. Most studies do not examine the effects of the policy changes in the long-term and instead focus on the more immediate effect they have on teenagers and young adults. Earlier findings are useful to help determine the lasting effects of the policy changes since they largely examine the effect on teenagers specifically. Many articles also address how effects differ among teenagers and young adults from different socio-economic backgrounds and races. The problem, however, is that many of these studies present findings that contradict each other. The differences in methodologies, findings, and framing the issue have led to controversy in the literature. Both sides acknowledge that teenagers and young adults are the most important demographics to study because they are most directly affected by the minimum wage. Also, the exposure to these new wages will have lasting impacts on their professional careers. First we will examine teenage employment and the traditional economic model. We will hear arguments from both sides starting with one group of researchers who offer evidence that contradict the findings of the traditional model followed by a counter argument that teenage employment decreases for some, resulting in less work experience and training. Then we will look at teenage school enrollment in the conventional model and one argument that will find that there is no change in enrollment. We will then see defense of the traditional model and show that school enrollment decreases, resulting in less-educated workers. We will look at how the effects differ depending on race, gender and socioeconomic background. We will address the current disparities in the literature and explain why long-run findings are the most important contribution to existing literature. This examination of the longterm effects is conceptually unique and explores a much more relevant question than prior research. Effects on Teenage Employment Conventional economic models of the labor market suggest that a binding minimum wage forces firms to pay more for labor than the optimal market price. Firms then choose to scale back the number of employees or the number of hours. Wages will increase for those who continue to work, while other workers are laid off.

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Figure 1. The figure shows the supply and demand curves for labor and the effects of a minimum wage that exceeds the market clearing price for labor.

As Figure 1 indicates, setting the minimum wage (Wmin) above the market equilibrium (w*) results in unemployment. At the market equilibrium (w*), the number of workers willing to work at that price is represented by L*. When the minimum wage is set, labor is now more expensive for the firm, so they demand fewer workers (LD). Since the minimum wage is higher than w*, more individuals are now willing to work for this wage represented by L s. The unemployment is measured by the labor supply less the labor demand (L s â&#x20AC;&#x201C; LD). Any increase in the minimum wage will force firms to move left along their downward sloping demand curve and demand fewer workers. Empirical studies, however, have not supported this model. Findings suggest that teenage disemployment effects vary state to state. Card (1992a) finds that teenage employment fell in high-wage states (states with relatively higher average teenage wages), showed no significant change in mediumwage states, and actually increased in low wage states. This may be the result of firms buying labor at a binding minimum wage as monopsonies. This would explain the increased wages and increased employment for teenagers and young adults. One of Cardâ&#x20AC;&#x2122;s studies evaluated the effects of the 1990-1991 minimum wage increases on teenage workers in California who made up more than 50% of the minimum wage earners in the state. 1 Due to an economic boom, unemployment rates across the country were falling. The unemployment rate in California was falling more slowly than the national average. At the same time, teenage unemployment in California fell 3% while elsewhere it only fell 1.9%. Therefore, California teens experienced plummet(1) The increase in the federal minimum wage in 1990 and 1991 raised the minimum more than 25% over the two years. In 1990 the wage increased from $3.35 to $3.80 and in 1991 from $3.80 to $4.25.

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ing rates of unemployment compared to the rest of the country. Additionally, the change in the minimum wage increased average hourly earnings and average weekly hours worked. This totaled an 11% increase in weekly teenage earnings (Card, 1992b). So the case of California, with its high percentage of minimum wage earning teenagers, disproved that minimum wage hikes systematically lead to decreased minimum wage employment. A study by Katz and Krueger (1992) found similar results using survey data collected from fast food restaurants in Texas. The study concluded that overall employment across the industry stayed about the same despite the increases in the minimum wage in 1990 and 1991. The findings did indicate a shift from part-time employment to full-time employment. The authors acknowledged that since they used numbers relative to each establishment, they did not account for the possibility of restaurants shutting down and overall industry unemployment increasing. Additionally, they found that 10% of firms did admit to having to cut hours and shifts after the 1991 minimum wage hikes. (Katz & Krueger, 1992). Both this study and the California study found that while the sub-minimum wage is an option for many employers to use, very few actually take advantage of it. 2 Fewer than 5% of fast food establishments for the Texas survey used the sub-minimum wage out of fear that they would not attract teenage workers. Likewise, it would make sense for firms to save money by hiring 16 and 17 year olds at a sub-minimum wage instead of paying the full minimum wage to young adults, but the evidence does not suggest this to be the case (Card, 1992b). Results from the Neumark and Wascher study are not wholly different from these results. The findings indicate that the minimum wage has very small (but negative) effects on teenage unemployment. While the findings indicate a small unemployment effect overall, the reality is much more complex. The Neumark study disaggregates teenagers into four mutually exclusive categories: “enrolled and not working”, “not enrolled but working”, “enrolled and working”, and “neither enrolled nor working.” The article suggests that the increased minimum wage causes a substitution effect replaces “low-quality” teenage workers with “higher-quality” workers. The higher wage attracts teenagers who are still enrolled to take on more work either part-time or full-time. To make room for these workers, firms force out their current “low-quality” teenage workers who are not enrolled and just working. Since, presumably, those still attending school or attending for longer may be “smarter”, more educated, and more skilled; firms will replace the old workers with the new recently attracted workers. Additionally, they find that the

(2) The sub-minimum wage permits employment at a wage below the minimum wage. Vocational students, full-time students, and people mentally or physically handicapped can be paid a sub-minimum wage. The industries that can employ at this wage include retail, service, agriculture and institutions of higher education. (Department of Labor, 2011)

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likelihood of teenagers not enrolled and unemployed staying that way is significantly positive for the same reasons (Neumark & Wascher, 1995b). The article also shows a substitution effect in favor of older and “higherquality” workers. 16 and 17 year olds were less likely to transition from “enrolled” (whether employed or not) to “not enrolled but working.” 16 and 17 year olds were more likely to transition from “not enrolled but working” to “neither enrolled nor working.” Conversely, 18 and 19 year olds were much more likely to shift from “enrolled and employed” to “not enrolled and employed.” Also, they were less likely to transition from “not enrolled but employed” to “neither enrolled nor employed.” In other words, firms valued older and more educated workers (Neumark & Wascher, 1995b). Figure 2. 16-17 year-olds transition from “not-enrolled, working” to “not enrolled, not working.”

16 – 17 Year-olds E NW

E W

NE NW

NE W

Figure 3. 18 – 19 year-olds transition from “enrolled, working” to “not-enrolled, working.”

18 – 19 Year-olds

E NW

E W

NE NW

NE W

The Neumark and Wascher (1992) study asserts that teenage disemployment effects are stronger when the minimum wage is binding, as opposed to when a sub-minimum wage may be used. In contrast to the findings of Card, Katz and Krueger, they hypothesize that the sub-minimum wage does play a significant role in the employment of teenagers. They point out that there is 22


no evidence to suggest that sub-minimum wages ease the unemployment related to the higher minimum wage. However, the results do suggest that the sub-minimum wage plays an important role in mitigating the disemployment effect for teenager workers. Employment opportunities for teenagers and young adults set the tone for an individual’s future career opportunities. If the minimum wage has a limited or positive effect on teenage employment, as some studies suggest, it is likely that the skills and experiences acquired will increase opportunities and job options as an adult. On the other hand, if the minimum wage increase is forcing teenagers out of the labor force, they are not accumulating these important skills and experiences. This could haunt them in the future. Neumark and Nizalova (2004) suggest that this is exactly what is happening. The new minimum wages induces firms to replace current teenage and young -adult workers with “higher-quality” workers. The workers that are forced out miss out on valuable experience, training and skill acquisition. These shortcomings result in more difficult career prospects into adulthood. A wider use of the sub-minimum wage is offered as a possibility to help keep teenage employment steady during minimum wage increases, but other studies believe that it is too sparsely used to have much of an impact. Teenage Enrollment Changes in minimum wage policy can have an important effect on the decision-making of teenagers and young adults with regard to school enrollment. A study by Ehrenberg and Marcus (1982) show that these decisions will affect the individual’s wage growth in the years following the change in the minimum. The standard logic is that as the minimum wage increases, there become fewer opportunities for teenagers to find employment. Therefore teenagers decide to stay in school. We can refer back to Figure 1 to see how the traditional economic model suggests that increases in the minimum wage decrease employment opportunities. This shift is represented in Figure 1 as the movement from L* to LD. However, previous studies have found that the change in minimum wage policy has no significant effect on enrollment, positive or negative. Card (1992a) found that enrollment rates did grow faster in states that experienced the largest decrease in employment as a result of the minimum wage, but the results were not statistically significant. Largely, Card found enrollment rates to be unchanged and found no connection between the increase in the minimum wage and enrollment rates. In Card’s California study (1992b), he found that enrollment rates did fall when the minimum wage increased. Enrollment in public high school and undergraduate colleges fell 2% in the state while it was increasing 1.3% elsewhere. He did not find, however, that these changes in enrollment were directly related to the changes in the minimum wage. Similarly, Warren and Hamrock (2010) found that changes in the minimum 23


wage do not effect enrollment or graduation rates significantly. They find that the logic supporting a negative effect on enrollment rates is based on the assumption that teenagers do not weigh the opportunity costs of leaving school. Warren and Hamrock (2010) argue that the number of students actually induced to leave school as a result of changes in the minimum wage is very small. Other research suggests that increases in the minimum wage do have significant and direct impacts on teenage enrollment. Chaplin, Turner, and Pape (2003) found that minimum wage hikes decreased continuation ratios and induced teenagers to drop out of high school. 3 The higher minimum wage induces current students to work more and study less. Neumark and Wascher (1995a) find that increases in the minimum wage reduce the proportion of teens enrolled in school and increase the number who are “neither enrolled nor working.” This is a result of the substitution effect that firms use to their advantage. Since the minimum wage increase has taken more teenagers out of school and into the job pool, firms have more liberty to choose “high-quality” workers. Those workers are typically those being attracted away from school by the new higher wages. A 10% increase in the minimum wage increases the number of “not enrolled and not working” by 11.6%. Those who leave school to become employed force those who were “not enrolled but employed” out of their jobs. Those individuals then become become unemployed and not enrolled. Additionally, the teenagers who are already or become unemployed are less likely to return to school after the change in the minimum wage (Neumark & Wascher, 1995b). Figure 4. Increases in the minimum wage induce transitions from “enrolled and working” to “notenrolled and working” and further forces people to “not-enrolled and not working.”

Overall Minimum Wage Effects

E NW

E W

NE NW

NE W

(3) The continuation ratio is the proportion of students who graduate or continue to the next grade level in any given year (Chaplin, Turner, & Pape).

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Klermand and Karoly (1994) find that high school dropouts were much less likely to find stable jobs and were much worse off than other workers in their early 20s. In order to get ahead in a competitive economy, workers need at least a basic high school diploma or they will face limited career options and opportunities (Sherk, 2006). It is also possible that in these cases, a broader use and application of sub-minimum wages for teens may increase teenage enrollment since it will limit the incentives to drop out which will benefit them later in their careers. These studies bolster Neumark and Wascherâ&#x20AC;&#x2122;s point that the increased minimum wage does induce teens and young adults to leave school and pursue wages. While the potential gain from leaving school now for higher wages now is appealing to some, the longerterm effects will leave less educated adults hamstrung in the job market. Effects on Accumulation of Skills, Training, and Education For many teenagers, namely those who were already not enrolled and then are forced out of their jobs, the absence of skill acquisition and training can greatly hamper their long-run career opportunities. By deterring employment to these individuals and coaxing others out of school, the minimum wage increase dims the future career options of teenagers. Neumark and Nizalova (2004) find that the long-run negative effects of the hike are likely caused by decreased education and training. Both the lower levels of education and the lower degree of labor experience account for many long-term career problems. Neumark and Gardecki (1998) found that training and job market experience increase wages in the long run. According to the Neumark framework, enrollment and overall teenage employment are both adversely affected by the increase in the minimum wage. Teenagers exposed to this minimum wage have lower levels of education, less work experience, and less training and skills acquisition. The individuals carry these effects with them throughout their careers and they continue to affect the wages and opportunities of the individuals. Race, Gender, and Socio-Economic Effects The effects of the minimum wage on teenagers are not identical across all demographic groups. Ehrenberg and Marcus (1982) address the asymmetries of the impact of the minimum wage on teenagers from different financial backgrounds. They conclude that an increase in the minimum wage incentivizes teenagers from low-income families to leave school and pursue employment while it incentivizes teenagers from high-income families to stay in school and maximize their educational attainment. The reasoning here is that teenagers from low-income families are likely to depend more on their parttime employment as a way to support their education. When the minimum wage increases, the number of part-time employment positions decreases so individuals are forced to choose between working full-time or not at all. The 25


opportunity cost of dropping out increases for teenagers from high-income families, and since they can afford to be in school and not work, they do so. Ehrenberg and Marcus also examine how changes in the minimum wage policy affect males and females differently. As the minimum wage increase, enrollment of white males from high-income families increase while enrollment decreases as much as 3% for white males from low income families. Interestingly, these figures are exactly backwards for white females. Enrollment of white females from high-income backgrounds actually decreases slightly with a minimum wage hike, while the proportion of white females from low-income families enrolled in school increases about 3%. 4 They extend their study to racial background and found that in almost all cases for nonwhites, changes in the minimum wage did not significantly affect changes in their employment opportunities or enrollment. The one exception to this is for non-white males from low-income backgrounds. The data showed that an increase in the minimum wage would incite a shift from full-time enrollment to full-time employment for low-income non-white males. The shift would result in a 4.9% decline in enrollment and a 5.1% increase in employment for this demographic. Other studies have offered alternative views on the effect of changes in the minimum wage on other racial demographics. Neumark and Nizalova (2004) find that the lasting effects are much more severe for blacks. Black adults who were exposed to changes in the minimum wage as teens and young adults were found to have lower wages, work fewer hours, and have lower earnings. The estimates of the effects on whites from the same period were 1/4 to 1/3 as large. Some possible explanations for this include that minimum wages are more binding for blacks or that the unemployment effects can result in increased criminal activity. They recognize that higher wages may decrease some crime, but high unemployment will lead to its increase. Also, they predict that the justice system may treat blacks more harshly, which can explain the stark differences between blacks and whites. Jail time directly reduces human capital and a criminal record will make it harder to integrate back into the market later in life. Overall Effects Neumark, through a number of studies, sorts the effects into a framework that he believes clearly shows the effects of the minimum wage on teenagers and how that relates to success or hardship in the job market as an adult. His study with Nizalova (2004) finds that as teenagers (16-19) and young adults (20-24) are exposed to a higher minimum wage, the negative wage effects for later adult earnings are statistically significant. For exposure to the higher minimum wage during the teenage years, the results yielded a

(4) Ehrenberg and Marcus (1982) leave much of the results open to speculation for future works.

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1.3% decrease in adult wages and exposure during the young adult years led to similar but slightly less strong decreases. 5 More specifically, the study examines the actual wage effect on earnings and hours worked for adults. The evidence shows that for adults (defined in the study as 25-29 year olds) who were exposed to higher minimum wages as young adults, their average hours worked decreased 1.3%. Likewise, exposure to the minimum wage as a teenager accounted for 1.8% decrease in weekly earnings as an adult and exposure as a young adult reduced average earnings by 2%. They also acknowledge in their study that the results may be slightly skewed due to state-to-state migration. They expect that as the minimum wage changes, teenagers and young adults would move accordingly to minimize the negative effects of the higher minimum wage. They argue that it is rational for individuals to move to states that will not negatively impact their enrollment decisions, training, and skill acquisition. They argue that this migration does occur and it is understating the negative effects caused by the minimum wage increases. They suspect that the wage increase is actually causing a larger negative effect than the results suggest because individuals take action to minimize the negative effects (Neumark & Nizaolva, 2004). Conclusions The minimum wage debate rages on among policy makers and economists. Ask different minimum wage scholars on the effects of the minimum wage on teenage employment, school enrollment, training and skill acquisition and you are likely to get a variety of different answers. As frustrating as this may get, scholars in the field value the debate. With a topic as potentially influential as minimum wage policy, it is important that many sets of hands are running the numbers and checking each otherâ&#x20AC;&#x2122;s work. Ultimately, economists and policy makers, regardless of what their numbers and arguments say, want the same thing. They want to make minimum wage policy decisions that will be most beneficial (or least harmful) to those affected by it. The research does not point in any one or even two directions. To this point, the examination of the effects of the minimum wage in the long run seems like an extremely valuable test of minimum wage policy. One side of the discussion, though, dominates the literature. Neumark and Nizalova (2004) are the only researches to do an extensive examination of the longterm effects of the minimum wage. It will be interesting to see more research focus on individuals who were exposed to higher minimum wages as teens and young adults who are now adults well into their careers. Scholars who found that the minimum wage has no significant impact or even a positive (5) The higher minimum wage that teenagers and adults were â&#x20AC;&#x153;exposed toâ&#x20AC;? was the federal minimum wage increases in 1990 and 1991 (Neumark & Nizalova, 2004).

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impact on teenagers should apply the Neumark and Nizalova framework to their own research. If Neumark and Nizalova used these findings as precedents, they may have had drastically different results. A more expansive look at the literature should be done to clear up any debate and discrepancies among researchers. For now, the best evidence of the long-term impact of minimum wage increases is that presented by Neumark and Nizalova (2004). The majority of research on the topic focuses on the more immediate or contemporaneous effects of the minimum wage. The immediate effects on poverty, employment, teenage employment, and teenage school enrollment are all very important and valuable results to examine. What these studies fail to capture are the longer-term effects of the minimum wage and what role the change plays in the lives of those affected 5, 10, and 15 years into the future. Neumark and Nizalova’s (2004) research on the long-term employment effects of the minimum wage has been unique in its approach to the topic and has produced valuable and interesting results. Teenagers and young adults make up more than 50% of minimum wage earners (Sherk, 2006). The best examination of effects of the minimum wage should involve individuals in this demographic. Fortunately, many studies have focused their efforts specifically on the effects the minimum wage has had on school enrollment and teenage employment. These earlier studies found differing results across the board. They found different enrollment and employment effects, and different effects regarding race, gender and income background. Neumark and Nizalova’s (2004) paper has explored these previous findings and used them to draw important conclusions regarding the effect of the minimum wage in the long run. They hypothesize that individuals who are exposed to higher minimum wages as teenagers and young adults will experience adverse career effects well into adulthood. Since firms now have to pay more for the same labor, they demand “higher-quality” labor. The research suggests that “higherquality” workers are more educated. Teenagers and young adults choose to substitute work and higher wages for school enrollment. Firms replace their current “not enrolled” workers for those leaving school because of the new minimum wage. Also, market forces cause the demand for the relatively more expensive minimum wage workers to decline, reducing overall employment. Since overall employment decreases, opportunities for training, experience and skills acquisition decrease. These opportunities decrease drastically for both “not enrolled” categories since they are considered “lower-quality” workers. While these opportunities are going to some people, they are going to people who would otherwise be “enrolled.” The minimum wage increase reduces the educational attainment of the “higher-quality” workers. Also, those already “not enrolled” are not likely to return to school despite having fewer job options. This all translates into lower adult wages, working hours, average earnings, and opportunities for the individuals exposed to such 28


changes earlier in life. Additionally, these adverse effects were found to be even stronger for blacks (Neumark & Nizalova, 2004). These findings then would not support legislation to increase the minimum wage as the long term negative effects can be devastating to those affected and even more so for blacks affected. An examination of the Neumark and Nizalova (2004) article alone would make it clear that policy makers should not move to increase the minimum wage since the negatives seem to outweigh the positives. The change in the minimum wage will induce teenagers and young adults to make short-sighted choices that will ultimately harm their long-run career opportunities. The increase will negatively impact enrollment rates and employment rates for teens and young adults. The subsequent loss in education, training, job experience and skill acquisition lasts well beyond the immediate effects. These deficiencies result in lower wages, fewer hours worked and lower average earnings as they reach adulthood. These findings suggest that the most harmful effects of an increase in the minimum wage may not be realized until years later and therefore would be in the best interest of society to not increase the minimum wage.

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Bibliography Brown, C., Gilroy, C., and Kohen, A. (1982). The Effect of the Minimum Wage on Employment and Unemployment. Journal of Economic Literature, 20.2, 487-528. Web. 25 Feb 2011. Brown, C., Gilroy, C., and Kohen, A. (1983). Time-Series Evidence of the Effect of the Minimum Wage on Employment and Unemployment. Journal of Economic Literature 18.1, 3-31. Web. 25 Feb 2011. Card, D. (1992) Do Minimum Wages Reduce Employment? A Case Study of California. 1987-89. Industrial and Labor Relations Review 46.1, 38-54. Web. 25 Feb 2011. Card, D. (1992) Using Regional Variation in Wages to Measure the Effects of the Federal Minimum Wage. Industrial and Labor Relations Review 46.1, 22-37. Web. 25 Feb 2011. Card, D., Katz, L., and Krueger, A. (1994). Comment on David Neumark and William Wascher.Employment Effects of Minimum and Subminimum Wages: Panel Data on State Minimum Wage Laws. Industrial and Labor Relations Review 47.3, 487-497. Web. 25 Feb 2011. Chaplin, D., Turner, M., and Pape, A. (2003). Minimum Wages and School Enrollment of Teenagers: A Look at the 1990s. Economics of Education Review 22(1), 11-21. Deere, D., Murphy, K.M., and Welch, F. (1995). Reexamining methods of estimating minimumwage effects. American Economic Association, 85(2), 232-237. Ehrenberg, R., and Marcus, A. (1982) Minimum Wages and Teenagers' Enrollment-Employment Outcomes: A Multinomial Logit Model. Journal of Human Resources 17.1, 39-58. Web. 25 Feb 2011. Gardecki, R., and Neumark, D. (1998). Order from Chaos? The Effects of Early Labor Market Experiences on Adult Labor Market Outcomes. Industrial and Labor Relations Review 51.2, 299-322. Web. 25 Feb 2011. Gramlich, E., Flanagan, R., and Wachter, M. (1976). Impact of Minimum Wages on Other Wages, Employment, and Family Incomes. Brookings Institution 1976.2, 409-461. Web. 31 Jan 2011. Katz, L., and Krueger, A. (1992). The Effect of the Minimum Wage on the Fast-Food Industry. Industrial and Labor Relations Review 46.1, 6-21. Web. 25 Feb 2011. Klerman, J. A., and Karoly, L.A. (1994). Young Man and the Transition to Stable Employment. Monthly Labor Review 117.8 (1994): 31-48. Web. 26 Feb 2011. Neumark, D., and Nizalova, O. (2004). Minimum Wage Effects in the Longer Run. National Bureau of Economic Research Web. 25 Feb 2011. Neumark, D., Schweitzer, M., and Wascher, W. (2004). Minimum Wage Effects throughout the Wage Distribution. Journal of Human Resources 39.2, 425-450. Web. 25 Jan 2011. Neumark, D., and Wascher, W. (1992). Employment Effects of Minimum and Subminimum Wages: Panel Data on State Minimum Wage Laws. Industrial and Labor Relations Review 46.1, 55-81. Web. 25 Feb 2011. Neumark, D., and Wascher, W. (1995).Minimum-Wage Effects on School and Work Transitions of Teenagers. American Economic Review 85.2, 244-249. Web. 25 Feb 2011. Neumark, D., and Wascher, W. (1995). Minimum Wage Effects on Employment and School Enrollment. Journal of Business & Economic Statistics 13.2, 199-206. Web. 25 Feb 2011. Sherk, J. (2006). Raising the Minimum Wage Hurts Vulnerable Workers' Job Prospects Without Reducing Poverty. The Heritage Foundation. The Heritage Foundation. Web. 25 Feb 2011. <http://www.heritage.org/research/reports/2006/07/raising-the-minimum-wage-hurtsvulnerable-workers-job-prospects-without-reducing-poverty>. Solis, H.L. (2011). Subminimum Wage. United states department of labor. Retrieved April 7, 2011, from http://www.dol.gov/dol/topic/wages/subminimumwage.htm Warren, J. R. and Hamrock, C. (2010). “The Effect of Minimum Wage Rate on States’ High School Completion Rates.” Social Forces 88(3):1379-1392.

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Privatization of Social Security: The Chilean Experience Jennifer Morton


Privatization of Social Security: The Chilean Experience Jennifer Morton

Today, the United States faces a significant challenge: Social Security. Based on current figures and trends, a consensus exists that reform is necessary to prevent Social Security from collapsing. The only question is how much reform? While some advocate for simply altering the current system, many argue that a total overhaul is needed (i.e., a privatized Social Security system). When weighing the pros and cons of the potential changes, it is helpful to look at solutions developed in other countries to gain some insight from the successes and failures of these systems. An interesting case to study is the privatized Social Security program instituted in Chile. Chile is a pioneer in Social Security reform and has led the way for many countries, such as those of Eastern Europe, in evaluating a shift from a defined benefit system to a privatized, defined contribution system. The Old System and Its Problems Before switching to a privatized Social Security plan in 1981, Chile had a pay-as-you-go (PAYG) Social Security system much like that of the United States. As in the United States, Chile’s old system operated with many flaws. Not only did the system lack public support, but also it was even far more complicated than our current system. The Chilean system consisted of over 100 different retirement plans and, depending on each person’s occupation, and had varying contribution rates, retirement ages, and benefits (Idemoto, 2). Furthermore, “the funds were financed on a pay-as-you-go basis, with payroll taxes varying between 16 percent and 26 percent” (CBO, 5). The impact of this tax appears when compared to the current Social Security tax of the United States, a 6.2% tax paid by both employees and employers to total the 12.4% overall FICA tax. Moreover, the number of people contributing to the Chilean system was decreasing at the time (from 12 contributors per every retiree in 1955 to 2.5 contributors in 1979) because of a changing demographic as well as an increasing number of tax evaders (CBO, 11). Overall, Chile’s old system was unable to generate enough revenue to pay the immediate benefits of its retirees. “By 1980, the system was running a deficit equal to 2.7 percent of gross domestic product and discounted present value of the system’s contingent liabilities exceeded gross domestic product” (CBO, 12). To complicate matters, high administrative fees, most likely due to the aforementioned pressures on the system, took away from the already insufficient funds used to pay beneficiaries (Idemoto, 2). Confronting these problems, the Chilean government decided to replace the old, unworkable Social Security system with a new, much simpler, two-tiered, pri32


vatized plan. Recognizing that such a transition would be difficult and potentially frightening to certain segments of the population, the government allowed its citizens either to remain with the old plan or convert to the new one. Judging by the response of its citizens, the Chilean plan may be viewed as a stunning success, given that 98% of workers joined the new plan only four years after its enactment (EBRI, 1-2). The New System The new plan is known as the Pinochet Privatization Scheme. It calls for all workers to “contribute 10 percent of their wages, up to a specified ceiling, to a government-approved investment fund. Workers [are] required to pay another 3 percent to cover term life and disability insurance” (Idemoto, 2). When workers reach the retirement age, they have the option of choosing among many combinations of “phased withdrawals” and “indexed annuities” (CBO, 5). Meanwhile, private investment firms, known as AFPs (Administradoa de Fondos de Pensiones), manage these private accounts. The AFPs were designed to allow a person with little knowledge about investing to make educated investment decisions for his money. These aspects of private insurance allow the worker freedom to choose the firm with whom he invests, but some restrictions do apply to the AFPs. After signing with an AFP, the worker must remain with that firm for at least four months before he can switch to another firm. On the other hand, contributions (including voluntary contributions of up to 10 percent) are tax deductible. Once workers reach retirement age, they have two withdrawal options: they can either purchase an annuity or can withdraw money from their account based on a government-determined schedule. It is important to note, however, that once money is withdrawn from the account it becomes taxable as income (Idemoto, 2000: 2). Transition Issues Despite the potential benefits, however, the AFPs do create some drawbacks in the privatized system. Primarily, workers continue to face administrative fees (ranging from 2.5% to 3% of wages) that switching to a privatized system was supposed to avoid or reduce (CBO, 10). “In Chile, the country with the longest experience with private retirement accounts, those costs can be equivalently expressed as 1% of assets, which is similar to costs of mutual funds in the United States” (CBO, 10). Furthermore, an AFP is a business and accordingly seeks to attract the most investors possible and maximize profits (from both investments and administration fees). “[A]s a result of marketing enticements to switch AFPs, annual membership turnover rates exceed 30 percent and customers pay for related administrative costs” (EBRI, 4). Many of the AFP salesmen constantly compete by offering special deals to attract more customers, a circumstance which has lead to frequent switching between plans. 33


Furthermore, there are market risks and costs associated with investing with an AFP. Returns have not always been strong. In the mid-1990’s, workers actually lost a large amount of money. By the end of the decade, the government was asking its workers to postpone retirement until the market situation improved (Idemoto, 4). Clearly, the system is not yet perfect. Although some people see this tendency to respond to marketing inducements that encourage switching as a huge misuse of money and a major flaw of the system, most people view this situation as a minor setback that will become less important as the privatized system matures (EBRI, 4). Nevertheless, some very important and widely recognized consequences of the move to privatized Social Security must be assessed. Major concerns include: The high cost of transition to a privatized system; non-participation in the scheme; the effects on low/middle-income workers and women; and the vulnerability of workers to market risk (Idemoto, 2). Of these issues, perhaps the most basic and practical concern is the transition cost of switching to a privatized system. In the new privatized system, each worker is responsible for paying into his own private account. In the previous PAYG system, the government set aside a percentage of the worker’s yearly earnings in order to pay for his future benefits. However, any benefits that had been put aside by the government would be lost once the shift to a privatized Social Security system occurred. But that would not be fair to all the workers who had paid into the old system and would lose all that money they contributed when they were promised certain benefits when they retired. “[U]nder a newly privatized system, where workers’ contributions are diverted into individual accounts, cash must be found to fund the benefits of retirees and workers nearing retirement (who paid into the old system but didn’t have a chance to save up an adequate nest egg under the privatized system)” (Idemoto, 2). Thus the Chilean government had to devise a way to compensate those who had previously paid into the system. After much planning and consideration, Chile decided to do the following: Workers who participated in the old system may join the new system or remain in the old system. Those who join the new system receive "recognition bonds" for their contributions under the old system. The bond receives a 4 percent annual rate of return from the time the worker switches to the new system until he or she retires. Workers whose savings are not sufficient to finance a minimum pension receive additional resources from the government so that their retirement income equals the minimum pension of about 25 percent of average wages (CBO, 5).

This plan would prove to be very expensive; in fact, the transition costs will not be paid off until 2050, at which point there will no longer be workers in the previous system receiving benefits. However, although doing so was equally expensive, Chile raised funds by dramatically cutting public spending, raising taxes, reducing general benefits, selling government assets, and issuing debt through government bonds (Idemoto, 2). 34


With one hurdle successfully surmounted, other flaws in the privatized system have become apparent through the effects that the program has had directly on the poor and on women. First, there is the issue of people who do not participate in the privatized program and consequently strain the system. These non-participants are typically low wage earners who often hide their actual income to avoid putting themselves in a higher tax bracket and, therefore, being forced to pay higher taxes. Yet Chile has a minimum pension guarantee, under which the government subsidizes any workers who do not meet the minimum pension threshold (after 20 years of saving) towards that minimum. As the Congressional Budget Office has concluded, when these workers retire in the future, they will constitute major stress on the system since they will not have (and therefore must be provided with) the sufficient funds to retire (CBO, 14). Despite this minimum pension guarantee under the privatized system, poorer classes are still hurt economically because the privatized system does not allow for redistribution of income (which would provide a higher pension to the low wage earners), leaving workers less well-off than they would have been in the PAYG system. Furthermore, women also tend to suffer more under the privatized system than they would have under the PAYG system. Women often work in cycles (due to raising families) and accordingly there are time periods during which they are not earning an income. Under a PAYG system this is not normally an issue, as the government provides subsidies. Under a privatized system, however, no subsidies exist and women tend to suffer in terms of long-term pension benefits (Idemoto, 3). Recently, however, Chile has announced a “solidarity pension” that pays approximately $100 a month to unpaid homemakers 65 or older (Malinowski, 1). However, it is too soon to say definitively whether or not these changes will succeed in remedying the present gender inequality issue. Successful Transition Overall, the task was daunting but three major factors contributed to the successful transition of Chile’s former PAYG system to a privatized system. It is important, however, to remember that these factors were specific to Chile and may not be transferable to other countries, like the United States. One of the most important circumstances that enabled Chile to transition to a privatized system was that in 1996, Chile’s government was operating with a budget surplus of 2.2% of GDP, unlike that in the United States, which was running a small deficit (CBO, 4). Chile’s surplus allowed its government to enact the savings and subsidy mechanisms necessary to help with the transition to a privatized system (EBRI, 4). Some of the actions taken to reduce the impending transition costs included cutting social spending (i.e., on health care and education) in order to pay for the benefits of retirees, introducing a value-added tax (in 1975, six years prior to the installment of the privatized 35


plan), and raising the retirement age for men to 65 and 60 for women (under the PAYG system, retirement ages varied from 44 to 65) (Idemoto, 3). Furthermore, the government was able to subsidize the transition to the privatized plan by selling state-owned enterprises to the private sector and government bonds (which will be redeemed in the future using general revenue) to AFPS (Idemoto, 3). Although clearly successful for Chile, these actions that the government took to decrease spending and help fund the move to a privatized system may be less feasible for the United States. For example, U.S. researchers estimate that “even a plan to privatize 2% of the 12.4% Social Security payroll tax would cost $74 billion per year or 4% of the annual federal budget. This is a substantial loss of funding and would necessitate substantial general fund transfers, spending cuts, tax increases, benefit reductions, or some combinations of these options” (Idemoto, 4). Moreover, Chile’s move to a privatized system was done very quickly, smoothly, and painlessly, because the move was enforced by the military. At the time of the system’s transformation, Chile was operating under a dictatorship, which made the transition to a privatized system much easier, since there was no room for public dissent, which could have slowed down or possibly prevented the transition. In fact, the dictatorship went to extreme lengths to make sure that the plan was met with popular support and confidence in order to ensure the success of the transition to the privatized plan. Specifically, the government required workers’ wages to be raised 18 percent so that workers would be able to make the required contributions (10 percent of earnings) into the new defined contribution accounts. Furthermore, the government gave workers the option of remaining in the old system (until 1985— five years after the installment of the privatized system) or participating in the new one (in which case they issued bonds to workers who had accumulated benefits under the old plan) (EBRI, 1-2). Clearly, in a democratic country like the United States, such large, dramatic overhauls could not be enacted so quickly and painlessly. Here policy makers need to take into consideration the will of the voters who, if they do not support the proposed system, might pose a major threat to its ultimate success. For example, for any legislation to be passed in the United States, it must first be passed in both houses of Congress before the President signs the bill into law. In our constitutional form of government, the system of checks and balances can make it very difficult to enact such significant policy reforms. It is readily apparent from past political campaigns that any Social Security reform efforts faces much more potential opposition in the United States than it did in Chile. Finally, the state of Chile’s economy prior to the move towards privatization was a significant factor worth consideration. As Chile’s economy was not very developed before privatization, its growth potential was high. According to the Congressional Budget Office, “Gross domestic product (GDP) grows 36


more rapidly in the developing countries with smaller per capita GDP, reflecting the growth opportunities of economies that are still adopting more advanced technologies of production. The GDP of Chile…grew about 8% during the early 1990s…” (CBO, 4). Furthermore, “estimates suggest that the Chilean pension reform has raised national saving by 2 percent to 3 percent of GDP” (CBO, 9). In contrast, the shift to a privatized system in countries starting out with strong economies, like the United States, may be seen as less economically successful than in countries starting out with weak economies (ERBI, 4-5). For example, the “U.S. [enjoyed] a per capita GDP nearly 3 times that of Chile ($31, 500 vs. $12,500 in 1998)” (Idemoto, 4). Because the United States already had such a high per capita GDP, changes are much more difficult and expensive. Moreover, any change that raises GDP would have far less practical impact than improving Chile’s lower per capita income. Overall, however, the biggest reason that a shift to a privatized system may not be as successful in the United States is the significant difference between the Social Security systems of the United States and Chile. First and foremost, prior to the shift to a privatized system, Chile’s Social Security system was very inefficient and riddled with high administrative fees. In fact, “exorbitant management fees in Chile wipe out a significant portion of workers’ returns…[while in United States,] administrative fees...average 2.5 percent of assets per year” (Idemoto, 4). Compared to Chile’s program, the United States Social Security system is efficient, with low administrative fees. As previously discussed, the Chilean Social Security system had many funding issues that compounded to its inefficiencies, effectively crippling the system so that there was no means of paying out the funds that it owed to its beneficiaries. However, (although there are varying views), in the United States, if Social Security remains unchanged, the government will be able to continue running and paying its beneficiaries until 2037. In fact, if minor modifications were introduced to Social Security, the system could potentially be “self-sufficient and fully funded” until 2075 (Idemoto, 4). It is obvious that the current Social Security system in the United States, despite its shortcomings, is much stronger and more resilient than that of Chile, and therefore, the desirability and likelihood of a shift is questionable. However, despite the apparent differences in adaptability, it is still important for the United States to learn from the Chilean experience and come away with insights to better the existing American institution. The final factor that the United States needs to take into consideration when weighing the shift to a privatized system is the social obligations that it has to its citizens. Under a privatized plan like Chile’s, there is no redistribution of wealth as there currently exists in the system. How then would people of lower income brackets and women, who work less than men but live longer, be affected without such a progressive structure? By analyzing the Chilean experience we can see that both women and lower income earn37


ers suffered from the privatized system. Most likely, the same conditions would arise in the United States, as these groups of people would no longer benefit from the “progressive benefit structure…[and the] guaranteed inflation-adjusted benefit for life” (Idemoto, 4-5). At the same time, the United States would likely act to alleviate the resulting economic disparity within these less well-off groups. These concerns would have to be addressed through some sort of guaranteed benefits (perhaps according to economic status) ultimately would be financed through taxation. Funding, then, becomes the issue, as any sort of general progressive taxation and wealth transfer are likely to meet significant resistance. In addition, it is important to note how under a privatized system, people are bound to independent investing (i.e., workers are left to the “mercy of the market”) (Idemoto, 5). The market, which although in the long run tends to yield a high return, is risky in the short term. The United States would therefore need to consider any actions that it might have to take in order to help people whose investments may not have paid off and thus do not have enough money for retirement. On the other hand it is also important to consider that Chile offered a minimum pension guarantee that was taken advantage of by people who avoided paying taxes and consequently put a huge strain on the system (Idemoto, 5). When considering a possible shift to a privatized system, the United States needs to take the Chilean experience. It is important to continually question how transferable these practices are to the United States and how successful and beneficial such a change would be to the American people. It is imperative to recognize how all the factors above helped enable Chile to successfully create and implement its privatized system. It is crucial to remember that the actions Chile took to make the shift may not be applicable in another country. To understand fully the Chilean experience, it is necessary to analyze the environment in which it occurred. Whether or not the Chilean practices are transferable, they do provide a wealth of information and can help countries analyze their current systems and propose changes to strengthen them.

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Bibliography Citations: Employee Benefit Research Institute (EBRI), comp. "Chilean Social Security Reform as Prototype for Other Nations." EBRI Education and Research Fund 18.8 (1993): 1-8. Web. 10 Oct. 2010. Idemoto, Steve. "A Social Security Privatization in Chile: A Case for Caution." Economic Opportunity Institute (2000): 1-5. Web. 10 Oct. 2010. Malinowski, Matt. "Chile's Homemakers Sign Up for Pension Reform." Women's ENews. 13. Jan. 2009. Web. 25 Nov. 2010. Becker, Scott M., and Jan Walliser. "Social Security Privatization: Experiences Abroad." Congressional Budget Office (1999): 1-93. Web. 3 Nov. 2010.

Consultations: Barbara E. Kritzer, “Chile’s Next Generation Pension Reform,” Social Security Bulletin 68:2 (2008), pp. 69-84. Barbara E. Kritzer, “Social Security Privatization in Latin America,” Social Security Bulletin 63:2 (2000), pp. 17-37. Barbara E. Kritzer, “Privatizing Social Security: The Chilean Experience,” Social Security Bulletin 59:3 (1996), pp. 45-55. Butler, Stuart. "Social Insurance Needs Rethinking." The Heritage Foundation. 14 Aug. 2009. Web. 25 Nov. 2010. Piñera, José. "Empowering Workers: The Privatization of Social Security in Chile." The CATO. Journal 2-3 15 (1995/96). The Cato Institute. Web. 21 Nov. 2010. Piñera, José. "The Success of Chile's Privatized System." CATO Policy Report. The Cato Institute. July-Aug. 1995. Web. 21 Nov. 2010. Social Security Online - The Official Website of the U.S. Social Security Administration. Web. 06 Nov. 2010. (http://www.ssa.gov/). The Century Foundation. The Century Foundation. 2010. Web. 21 Nov. 2010.

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Pirate Hunting: The Economics of Piracy In Somalia Tara Sullivan


Pirate Hunting: The Economics of Piracy in Somalia Tara Sullivan

Piracy is not a phenomenon of the 17th century. Although upon hearing of a pirate one typically imagines a swashbuckling seaman swindling imperial Europe in the name of adventure and wealth, the pirate tradition, according to most historians, “is as old as ships and man’s acquisitive nature” (Bradford, 2007, p. 4). Indeed, historical accounts of piracy extend back to the ancient Greeks and continue up until the present day. Despite the brief decline in the prevalence of pirate activity from the 19 th through the 20th centuries, piracy has experienced resurgence in the past twenty years. In particular, piracy off the coast of Somalia has become a major international concern that has been inadequately addressed on the international stage. This paper will examine the effectiveness of several programs aimed at addressing piracy off the coast of Somalia, and will propose that the establishment of private shipping lanes and the use of convoys are the most effective measures for fighting piracy. Overview of Modern Piracy in Somalia Modern pirates are technologically equipped and understand the loopholes in international law through which they can avoid punishment. They are concentrated in a few areas around the world, including Nigeria, the Strait of Malacca, and, most significantly today, Somalia. It is here that a true pirate industry, which totals approximately $100 million a year in revenue, has emerged (Gettleman, 2011). Figure 1: Map of Somalia

Somalia is located on the Horn of Africa and borders the Gulf of Aden, a vital waterway for ships travelling from Asia to Europe. Almost 3.3 million barrels of crude oil, approximately 4% of daily global demand, travel through 42


the Gulf each day (Cummins, 2008). As can be seen in Figure 2, the Gulf of Aden is one of the most frequently travelled shipping routes in the world. The waters surrounding Somalia are crucial for the shipping industry; however, Somali pirates are hardly limited to the area immediately around the Horn of Africa. Recent pirate attacks have been reported in areas closer to India and Seychelles than Somalia. This is one result of a recent development within the pirate industry; it has become common for pirates to employ large “mother ships”, which can remain at sea for months at a time, allowing pirates to go on hijacking missions far away from shore. Figure 2: The trajectory of cargo ships carrying over 10,000 gross tonnage in 2007

The goal of modern piracy is not to steal boats, cargo, or people. Rather, pirates attempt to extract the highest ransom possible from the ship owner before escaping back to their mother ship or to shore. Hijackers will board ships armed with dangerous weaponry and hold the crew and cargo captive. They will demand a ransom payment from the owner of the ship, and will stay on board until this payment is received. 1 If necessary, pirates will bring the ship and captives back to shore for months until ransom is received. Pirates rarely kill their captives or steal cargo, as they want to simply leave the boat with the greatest ransom possible. The efficiency of the pirate industry has made it one of the largest sources of income in Somalia. There are tens of thousands of Somalis employed in the pirate business both on land and at sea (Gettleman, 2011). Piracy has increased dramatically in recent years. Appendix A shows maps of reported pirate attacks in 2005 and 2010, and Appendix B provides a graph (1) Although most countries contend that they do not pay ransom to pirates, there has been some speculation of this occurring in the past. Recently, Paul and Rachel Chandler, two Britons taken into captivity in 2008, were freed after living in captivity in Somalia for over a year. The British government holds that it did not pay ransom to Somali pirates, yet there has been some speculation that a portion of the money granted to Somalia in the form of aid over the past year has been given to pirates as ransom. See “Paul and Rachel Chandler’s Release Prompts Questions Over Ransom,” The Telegraph, 2 May 2011, <http://www.telegraph.co.uk/news/worldnews/ africaandindianocean/somalia/8133533/Paul-and-Rachel-Chandlers-release-prompts-questionsover-ransom.html>.

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illustrating the increase in pirate attacks from 2000 to 2009. Somali pirates are currently holding 51 vessels captive; these vessels range in size from oil tankers to fishing ships. Approximately 819 people are being held hostage by pirates. On average, hostages are held for approximately six months (Gettleman, 2011). Appendix C provides an illustration of the types of vessels and the number of people held hostage off the coast of Somalia in February, 2011. The pirate industry has been growing every year, and despite international efforts to combat this growth, there has been little success in curbing Somali piracy. Pirates and Adam Smith To address piracy, one must first understand its causes. Peter Leeson (2007, 2009) has analyzed the economic decision-making of pirates and contends that the “invisible hook” determines pirates’ economic activity in much the same way as Adam Smith’s invisible hand drives rational individuals in the marketplace.2 However, Leeson differentiates between the invisible hand and the invisible hook by claiming that this hook organizes criminal groups in a way that does not lead to cooperation in the marketplace or the satisfaction of other consumers (P. T. Leeson, 2009, p. 4). According to Leeson, piracy is not simply banditry; rather, it is a system of organized crime governed by complex relations within piratical society (P. T. Leeson, 2007). Although the invisible hook does not promote societal interest at large, it considers pirates as rational economic decision makers and promotes the interest of the pirate community.3 Although Leeson’s analysis concerns pirates of the past, his framework is useful model for understanding modern piracy. Pirates in Somalia are rational actors making economic decisions. There are very few economic possibilities in Somalia. Despite the fact that their behavior is often considered detrimental for the shipping industry, piracy has grown to be a crucial dimension of the Somali economy (Gettleman, 2008). Somalia is often considered to be the epitome of a failed state. Jeffrey Gettleman contends that “since 1991, Somalia has not been a state so much as a lawless, ungoverned space on the map between its neighbors and the sea” (Gettleman, 2009). Indeed, ever since the fall of the Somali government twenty years ago, there has been virtually no organization to the Somali (2) “Every individual… neither intends to promote the public interest, nor knows how much he is promoting it… he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” Adam Smith, The Wealth of Nations, Book IV, Chapter 1 (3) Leeson also argues that the invisible hook can lead to socially desirable outcomes. For instance, in the 17th and 18th century the pirate industry exhibited levels of racial toleration and democratic decision maker that was extremely unique for the time.

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state.4 The per capita income in Somalia is a mere $600, well below the $2 a day poverty line. Without a functioning government, there are little to no funds set aside for education and infrastructure. Nearly 2 million Somalis depend on World Food Program Supplies (“No Stopping Them,” 2011). Within the context of this society, piracy has emerged as a comparatively lucrative source of income in what is an otherwise barren economy (Gettleman, 2008). Is Piracy a Problem? As mentioned above, piracy is a resilient crime. It is highly adaptable to new circumstances and will most likely never be fully eradicated. The prevalence of piracy has ebbed and flowed throughout time, and piracy in Somalia is merely the latest reincarnation of an old tradition. For this reason, there are serious questions as to who, if anyone, should be responsible for combating piracy in the Gulf of Aden and the Indian Ocean. It is estimated the pirates cost the shipping industry approximately $238 million in 2010 (Bowden et al.), an amount that is dwarfed by massive commercial shipping revenues. Although pirates hold 52 vessels acquired throughout the Indian Ocean, this number is miniscule compared to the 21,000 ships each year that pass through the Gulf of Aden alone (Gettleman, 2011). Generally, commercial ships are willing to deal with the risk of piracy. Their odds of encountering pirates are extremely low and, if hijacked, most companies are willing to pay the ransom fee in order to have their crew and cargo returned safely. Piracy has, however, been growing and changing at an alarming rate. In 2005, the average ransom paid to pirates was a mere $150,000; it has since grown to $5.4 million (Bowden et al.). Recent trends in piracy have also shown it transforming into a more violent industry. The murder of four Americans off the coast of Yemen on February 22 occurred amidst a general increase in violent pirate attacks (Johnson, 2011). With the tremendous growth in piracy, “pirates have been getting more vicious; reports have emerged of beatings, of being hung upside down, even of being forced at gunpoint to join in raids” (Gettleman, 2011). The increase in pirate attacks has led many to avoid traveling through the Gulf of Aden altogether. 5 Piracy has also negatively affected insurance premiums for ships travelling in and around the Gulf of Aden. The cost of insurance for ships travelling in this region is estimated (4) Following the 1991 civil war in Somalia in which the communist party was overthrown, the Somali state crumbled. While the Transitional Federal Government is often recognized as the primary Somali government, the Puntland and Somaliland regions have broken away and are run as semi-autonomous states. There was a brief period of stability in 2006 following the election of the Islamic Courts Union, however this regime was subsequently removed from power following the Ethiopian Intervention towards the end of that year. (5) Several large tanker lines, such as the Norweigian fleet of 90 tankers Odfjell and Europe’s largest ship owners, AP Moller-Maersk have diverted their fleets away from the Gulf of Aden and are instead circumventing Africa. Those in smaller boats such as yachts are also more likely to avoid the region. The report by Bowden et al. hypothesizes that 10% of the decrease in Suez canal revenues is attributed to the avoidance of pirates.

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between $459 million and $3.213 billion, depending on the size of the ship and the value of the cargo. Of course, the question remains as to whether Somalis want the pirate industry to be diminished. As piracy is perhaps the only form of business in an otherwise barren economy, the pirate industry does much more than simply provide revenue to pirates and corrupt government officials. The pirate industry has brought much-needed revenue to Somalia. There is often a minieconomic boom each time a ship returns from a successful hijacking as pirates spend their earnings in small towns along the Somali coast. 6 Yet the arguments against piracy outweigh the arguments for it. Although the revenues from piracy may bring some activity to Somalia, it nevertheless remains a stagnant economy. The lack of any shipping industry has resulted in high food prices and low levels of revenue (Gettleman, 2008). Because of this dearth in economic activity, it is estimated that the Somali economy has lost a potential $1.25 billion in revenue as a result of piracy (Bowden et al.) While successful pirates may have acquired large amounts of cash in short periods of time, this has not brought about either political stability or growth in industry. While piracy may provide a boom to the economy in the short run, the damage it does to Somalia is much more damaging in the long-run. It affects both the Somali economy directly by devastating the shipping industry and by reinforcing Somalia’s reputation as a failed state where industry is unable to grow. Without some sort of intervention, these trends are likely to continue, as piracy becomes more common and spreads to other parts of the globe. 7 It is necessary to address piracy now in order to ensure the safety of maritime travel. How to Fight a Pirate The current strategy for coping with piracy is to take one’s chances. There is less than a 1% chance that a ship will be successfully hijacked on each voyage (Zimmerman, 2009). Many companies and individuals are willing to take their chances in the Gulf of Aden and the Indian Ocean. The high ransoms mentioned above only affect a few unlucky ships, while most pass unharmed. However, for the reasons mentioned in the previous section, not doing anything is not the ideal way to deal with pirates. Not addressing the piracy problem not only ignores the growing scope of piracy, it also neglects the human dimension of those taken hostage. While this may not be an easily quantifiable problem, it is an important consideration when evaluating the necessary response to piratical activity. (6) As mentioned in the above footnote regarding the “invisible hook” theory, piracy can have positive externalities. In the 17th and 18th centuries, this came in the form of wellfunctioning piratical democracy and tolerance of other races. The small booms in the Somali economy, although unsustainable, can be considered positive externalities for Somali piracy.

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Another potential way of dealing with the pirate problem is to re-route ships. However, re-routing ships to circumvent Africa is extremely expensive and is estimated to cost between $2.34 billion - $2.95 billion for ships. Furthermore, the expanding reach of Somali pirates has made even ships that circumvent Africa vulnerable to the threats of piracy (Bowden et al.). For example, the Sirius Starr, a 320,000 ton oil tanker, was hijacked by pirates despite having traveled around the Cape of Good Hope (Bowring, 2008). Avoiding the Gulf of Aden is no longer a sufficient strategy for avoiding piracy. Although piracy is an international concern, it is difficult to ascertain the most effective means for combating it. A major reason for this difficulty is the lack of any legal structure in Somalia itself. Although the locations of pirate havens are by no means a secret (Gettleman, 2010), there is no legal framework within the Somali state to challenge their authority. Somali piracy cannot be properly addressed by the Somali state. If there is to be a concerted effort to fight piracy, it must be done on a transnational level (Kraska & Wilson; S. J. Hansen, 2009, p. 43). It is possible to reduce piracy in the short term, so long as it is the result of transnational cooperation. Fifteen years ago, the Strait of Malacca, the 550 mile seaway that cuts between Malaysia, Indonesia, and Singapore, was plagued by pirates. As can be seen in Figure 2, this passageway is a vital shipping lane. It is also an ideal location for pirates to stake out potential victims. The Strait is surrounded by dense tropical forests that provide ample hiding places, while the narrow strait makes finding potential victims easy. For this reason, the Strait of Malacca before 2004 was considered as treacherous as the coast of Somalia is considered today. In order to combat widespread piracy, Malaysia, Indonesia, and Singapore coordinated a joint naval operation in order to fight against pirates (Dickinson, 2009). The results have been significant. As a result of international collaboration and cooperation, the number of attacks in the region has fallen dramatically (â&#x20AC;&#x153;Piracy Prone Areas and Warningsâ&#x20AC;?). For this reason, international cooperation, such as that utilized in the Strait of Malacca, is often considered the most effective means for fighting piracy. The key to reducing pirate attacks in the Strait of Malacca was multilateral cooperation among the three states involved. Figure 3: Strait of Malacca

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Many suggestions for international cooperation are based on naval operations. A recent suggestion for fighting piracy on an international scale was put forth by Jon Peppetti, who proposed that an extremely large global maritime security network would be the most effective tool for combating pirate activity off the coast of Somalia (Peppetti). Peppetti conjectures that it would take a proverbial “1,000 Ship Navy,” a concept advocated by Admiral Mike Mullen, or a “navy of navies” in which every developed naval force participates in order to adequately fight piracy. 8 Peppetti describes the reasoning behind this global maritime security network as follows: At base, the idea of the 1,000 ship Navy is founded on the notion that in this era of globalization, the lifeblood of that globalization – trade – must flow freely and unencumbered. For that reason, the fundamental goal in the 1,000 ship Navy is to increase the security of the maritime domain so that the maritime commons may be safely used by all nations. (Peppetti) A similar suggestion proposed by Roger Middleton would see the creation of a UN or African Union coast guard to patrol the Somali coastline (Middleton, 2008). There are currently naval operations attempting to combat piracy in the Indian Ocean. However, they are not unified under a single operation, nor is the system extensive enough to make a significant impact on piracy. Currently three naval operations are working to curtail piracy around the Gulf of Aden: NATO’s Operation Ocean Shield, the EU’s Operation Atlanta, and the U.S. Combined Task Force 151 (European Affairs, 2010). The existence of three separate missions to fight piracy is less effective than consolidating efforts underneath one unified operation, as was the case in the Strait of Malacca. Therefore the naval system as it is now has not been effective in fighting pirates (Seibert, 2009). It is also difficult for these missions to work effectively over such an expansive area. Moreover, such efforts are costly; it is estimated that the cost of these missions is approximately $2 billion per year (Bowden et al.). While collaborative naval efforts may have been effective in fighting piracy in the Strait of Malacca, it does not seem to be a viable solution for the Indian Ocean. The reach of Somali pirates is far too broad for naval operations to adequately attack their operations. Forces close to the shore cannot prevent piracy that occurs in the middle of the Indian Ocean. Max Boot accurately describes the inability to act effectively: (8) The U.S. Navy was, in fact, created in order to fight the threat of Barbary pirates during the late 18th century, following the capture of several American ships in the 18 th century and the imprisonment of several citizens in Algiers. See Bradford, Alfred S. Flying the Black Flag: A Brief History of Piracy, Westport, CT: Praeger, 2007, Chapter 21: New Nation, New Victim, pp. 151-159.

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Most of the naval ships now stationed off the Horn of Africa are not convoying merchant vessels, hunting down pirate ships, or bombarding pirate lairs. Instead, all they are authorized to do is float around in an attempt to deter pirates from striking and respond to distress calls when they do strike. These are fools' errands when undertaken by a dozen or so ships scattered across an area four times the size of Texas. The pirates are equipped with satellite phones and GPS devices and are sophisticated enough to monitor naval movements and strike when and where patrollers are absent. (Boot, 2009) Naval missions do not seem to be the most appropriate way for addressing the problem of piracy in the Indian Ocean. Yet another suggestion for discouraging piracy includes combat missions in Somalia. However, it is often believed that employing brute force would do more harm than good. Ever since the Battle of Mogadishu in 1993, American forces have been hesitant to interfere directly with the lawless Somali state. 9 Moreover, a combat mission or an airstrike on the pirate havens in Somalia would most likely put the hostages on the ground, as well as innocent Somali citizens, at risk (Menkhaus, 2009). Even if one assumes that naval operations are successful at finding pirates, new problems emerge concerning how to punish them. A major problem with piracy is the great deal of difficulty involved in developing a framework within which to punish piracy. It is only possible to call an act “piracy” if a ship has been caught in the act. A ship carrying only AK-47s and hand grenades cannot be prosecuted for piracy if it claims to only be fishing (Kontorovich, n.d., p. 257). Furthermore, if pirates are caught in the act, a new question emerges as to where and how to prosecute them. 10 There is no legal structure for the prosecution of pirates within Somalia, and oftentimes Kenya has been the state responsible for organizing trials in exchange for financial support from richer nations (“No Stopping Them,” 2011). However, Kenya has been growing more reluctant to take on new piracy cases, and other international actors have been hesitant to prosecute pirates on their own soil (“Q&A: What do you do with a captured pirate?” 2011). Prosecuting pirates can be (9) The Battle of Mogadishu in 1993 began as a humanitarian mission to provide assistance to Somalis suffering from famine following the onset of the Civil War. As there was no effective government in Somalia after the overthrowing of the communist regime, it was hoped that U.S. assistance would pave the way for a transition to a peaceful, democratic Somali state. This operation became infamous for the fighting that ensued after two Black Hawk helicopters were shot down in a battle that became the bloodiest two days of American fighting since the Vietnam War. (10) Piracy is one the few crimes that falls under universal jurisdiction. Any sovereign nation can prosecute pirates. However, sorting out the legal issues involved with prosecuting pirates can often take weeks or months, if pirates can be prosecuted at all (“Q&A: What do you do with a Captured Pirate?”).

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expensive, difficult, and can lead to unwanted asylum requests from pirates (Kontorovich). Therefore, if a 1,000 Boat International Navy or a UN Coast Guard were to operate in the waters around Somalia, international provisions would have to be developed in order to provide them with the ability to catch and prosecute pirates. There are several economic suggestions aimed at fighting piracy in Somalia. For example, it is often suggested that cutting off the flow of money to Somali pirates would be an effective way to place a chokehold on the piracy industry (Totten & Bernal, 2010). Unfortunately, given the nature of the piracy industry and the state of Somali banking, this is not a viable option. There is very little record of ransom money once it enters the economy, and therefore, tracking accounts from Somalia would be next to impossible (Menkhaus, 2009). Others have suggested that the cessation of ransom payments could lead to a decline in pirate activity. This would most likely lead to pirates killing crew members and stealing ships and perhaps even cargo. This type of action would not reduce piracy so much as it would serve as an incentive for pirates to modify their behavior in negative ways (Middleton, 2008). Privatize the Fight against Pirates The lack of state authority combined with the efficiency of the pirate industry make the goal of reducing piracy in Somalia a daunting task. Although it is widely recognized that international cooperation and Somali state building are necessary in order to combat piracy, the means by which one can achieve these goals are hazy. Somalia has been a lawless state for twenty years, and it is difficult to imagine a stable government developing in the near future. Even if the countries surrounding Somalia agreed to undertake a concerted effort to fight piracy, this transnational cooperation would be ineffective without development and changes within the Somali state itself. For this reason, government operations have not been successful at deterring piracy, and perhaps private forces should begin to be utilized in the fight against Somali pirates. It is important to mention that not all private forces are effective at fighting pirates. For example, private security firms may not be helpful in deterring piracy. Commercial armed contractors have been utilized for several years in the fight against piracy. It is thought that by providing security personnel to those traveling through the Gulf of Aden, pirates will be less likely to attack (â&#x20AC;&#x153;A mercenary solution to Somali piracy,â&#x20AC;? 2010). Therefore, if commercial vessels are sufficiently protected, piracy will come to be seen as a less desirable source of revenue (Toomse, 2009). However, private security firms are extremely expensive. For example, a security detail of three men costs upwards of $21,000. Furthermore, while these forces may be effective at counteracting piracy on individual ships, they do not deter piracy as a whole. It is also pertinent that smaller yachts and fishing vessels may not be able to af50


ford the high premium and will therefore remain vulnerable to pirates. 11 Moreover, it is possible that the use of private security forces may lead to a greater deal of violence on ships. As pirates perceive that vessels are equipped to sufficiently fight back, pirates may respond accordingly by using a greater degree of force in their quest to acquire ransom (Chalk, Smallman, & Burger, 2009, p. 5). Private security companies have been utilized by the three territories within Somalia. Somaliland, Puntland, and the Transitional Federal Government have all contracted private security companies for security issues on land and at sea. However, the employment of these firms by local governments has weakened territorial sovereignty and undermined already weak states, without actually deterring piracy (S. Jarle Hansen, 2008, p. 586). Privatizing the fight against piracy in this manner does not address the root cause of piracy. The failed Somali state has left little room for other economic opportunities. If the level of piracy is to be reduced to an acceptable level, it must be accompanied by a reasonable level of state development. It must be noted, however, that public efforts to combat piracy have often been unproductive or inefficient. Naval flotillas cannot be effective when attempting to combat piracy if the reach of pirates is broad. Moreover, the Somali state has for the past twenty years been trapped in its ineffective condition as a failed state. The problem of piracy will not dissipate on its own in the short-run. To reconcile these dilemmas, one must learn to look at piracy in a different way. Although a great deal of academic literature has been written in recent years examining the psychology of piracy and the effectiveness of antipiracy measures, little has been done to combine these two approaches. In order to effectively deter piracy, it is vital that one look at a pirate for what he is: a rational decision maker. Therefore, to effectively change the behavior of a pirate, one must improve other economic opportunities while simultaneously making piracy a less desirable pursuit. What is intriguing about piracy is that it occurs in the high seas in regions that no one country controls. In this way, the efforts to combat piracy are merely a reincarnation of the tragedy of the commons situation. Because no one owns the areas in which Somali pirates operate, no one is willing to take the necessary steps to combat them. Take, for instance, the unwillingness of international actors to prosecute Somali pirates. The expense associated with their trials, along with the questions of international law that necessarily come into play, have made most countries wary of seriously punishing piratical behavior. However, like most tragedy of the commons problems, the most (11) The private security contractors that have been used in the fight against piracy, such as Blackwater, have not fared particularly well in the pirate-fighting industry. Most shipping companies are unwilling to employ the expensive security firms and are more willing to risk travelling out into the ocean without professional security assistance.

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effective way to ensure the proper care of a good is to ensure it is owned. Similarly, the best way to combat piracy is to make someone or something responsible for the oceans in which piracy occurs. In this way, it would appear that the best way to combat piracy is to utilize private actors in order to protect against piracy. As has already been mentioned, this does not mean the contracting of individual security firms by individual ship-owners. Moreover, only protecting individual ships is not effective for deterring piracy as a whole and would most likely endanger those who cannot afford to protect themselves. Leaving the fight against pirates to private security firms would not be effective for diminishing piracy in the Indian Ocean. The proper way to utilize private actors to counteract piracy is twofold. Firstly, private shipping lanes established in the Gulf of Aden would be effective at combating piracy. While international coordination can be effective for fighting pirates in narrow straits, international coordination is not an option in the Gulf of Aden in the same way it was in the Strait of Malacca. The Gulf of Aden is bordered by Yemen in the North and Somalia and Djibouti in the South. Yemen is a country that faces its own political difficulties and currently has one of the highest unemployment rates and one of the lowest levels of GDP per capita in the world (Yemen). Djibouti is extremely small and one of the least populous nations in Africa (Djibouti). Somalia, Yemen, and Djibouti are not equipped to monitor and protect the Gulf of Aden in the way Indonesia, Malaysia, and Singapore were able to monitor the Strait of Malacca. The establishment of a private shipping lane would be extremely effective for counteracting piracy in the Gulf of Aden. Figure 4 provides a map of what this private shipping lane could look like. In this example, the shipping lane begins at the Port of Djibouti. This lane would then continue straight through the Gulf of Aden and past the Horn of Africa. The owner of this shipping lane would be responsible for ensuring the safe passage of all ships between the Indian Ocean and the Bab-el-Mandel strait, the strait in between Djibouti and Yemen that connects the Gulf of Aden to the Red Sea. Such practice would generate revenue by charging ships in the Gulf of Aden a toll for safe passage. Tolls would have to be adjusted for type of ship and length of voyage. This toll would be modest compared to the cost of hiring security personnel or the cost of rising insurance premiums. The toll could be paid at one of the several ports in Djibouti and Yemen, the main ports being the Port of Djibouti, the Port of Aden, and the Port of Mocha at the edge of the Bab-elMandel Strait.

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Figure 4: Map of the hypothetical private Shipping Lane running through the Gulf of Aden. The dark red shows the paths ships could travel to or from. The lane must expand after passing the horn of Africa in order to allow for convoys to travel to different destinations and to accommodate ships travelling to the Gulf of Aden.

However, it would be impossible to fully eradicate piracy utilizing only private shipping lanes. It is unrealistic to assume that a private company could guide each and every ship to its destination. For this reason, convoys must also be utilized in order to fight piracy. Convoys involve groups of several ships travelling together. It is thought that travelling in the same convoy would prevent pirates from attempting to attack any one ship in the group. Because the private shipping lane cannot continue indefinitely, it is important that convoys are utilized in order to fully protect against pirates. Convoys leaving together from one of the major ports surrounding the Gulf of Aden would be able to pass through the private shipping lane and then continue onto their destination within their pack. 12 Ships travelling throughout the Indian Ocean would be highly encouraged to travel in packs as well. Convoys are often considered to be one of the most cost-efficient ways for protecting ship owners against piracy.13 (12) There is, of course, the question of whether such convoys would be private or public. Convoys led by naval operations off the coast of Somalia have been successful. For this reason, convoys could be utilized effectively if organized in the public realm. However, this paper holds that privatization is often the most effective means by which tragedy of the commons problems can be addressed. Convoys organized in the private realm would introduce competition to the business of safe ocean travels, thereby keeping prices low for consumers. Ships establishing a private shipping lane would be using this lane to lead convoys; the two operations would not be independent of one another. Furthermore, the costs of such a program would be concentrated in the private realm, not the public. (13) It is, of course, important that ships in a convoy follow certain precautions in order to ensure safe passage. Section 9 of the BMP: Best Management Practices 3 (Version 3, Edinburgh: Witherby Seamanship International Ltd, June 2010, pp.21) suggests several self-protection measures that ships can take in order to better protect themselves against piracy. Perhaps the most significant recommendation is for ships to travel quickly, as there have been virtually no successful pirate attacks on ships travelling faster than 18 knots. Furthermore, ships can take certain precautions, such as lining the sides of their ships with barbed wire and glass shards and using sonic and laser cannons, to protect themselves against pirate attacks; see â&#x20AC;&#x153;Topic: Piracy, Graphic: Pirate Attacks off Somalia, Der Spiegel International, <http://www.spiegel.de/international/ world/bild-755340-154501.html>. However, the most significant problem with equipping boats to protect against pirate attacks is that these measures can be expensive. Small ships may be able to line their ships with barbed wire, but sonic cannons would be less economical.

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Discouraging piratical activity through the establishment of private shipping lanes and the increased use of convoys could benefit the Somali state. Firstly, business activity that had been previously scared away by pirates may return to Somalia. Secondly, the establishment of private shipping lanes could be used as a way to benefit the Somali state. An organization that is interested in keeping the value of the ocean high and is liable for accidents that occur would spend the necessary dollars to eliminate piracy. The privatization of shipping lanes in the Gulf of Aden could be extremely beneficial for the development of the Somali state. Peter Leeson hypothesized that, if the land off the coast of Somalia and the high seas were auctioned off, the proceeds could be allocated for Somali development and growth (P. Leeson, 2009.) This extra income could replace the much needed tax revenue necessary for building infrastructure and for education. Or, as Leeson points out, the money could be saved with an international institution until the Somali state is prepared to undertake the proper and fair allocation of this resource. It has often been contended that a necessary step for the development of Somalia would be to improve maritime commerce. Michael Lyon Baker argues that if other economic opportunities existed, piracy would not be as much a concern in Somalia. For this reason, developing ports and improving maritime governance would be extremely useful for reducing the prevalence of piracy in Somali while encouraging economic growth (Lyon Baker, 2010). In this way, eliminating piracy off the coast of Somalia through the privatization of the ocean can go a long way towards moving Somalia away from its status as a failed state and resolving the economic concerns that initially pushed many Somalis toward piracy. Leeson contends that the privatization would be key to diminishing the dominance of the pirate industry in Somalia, for “establishing private property rights where they don’t currently exist is the solution to about 90 percent of the world’s economic problems. Piracy is no exception” (P. Leeson, 2009). The creation of private shipping lanes and the use of convoys would not only be the most effective way to combat piracy, but it could also be an efficient way to drive Somalia towards a future existence as a functioning state.

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Bibliography Figure Citations: Figure 1: Map of Somalia CIA World Factbook: Somalia, April 6, 2011. <https://www.cia.gov/library/publications/the-worldfactbook/geos/so.html.> Last accessed April 19, 2011. Figure 2: Trajectory of Ships Carrying over 10,000 Gross Tonnage Kaluza, Pablo; Kölzsch, Andrea; Gastner, Michael T.; and Blasius, Bernd. “The complex network of global cargo ship movements,” Journal of the Royal Society: Interface (July 6, 2010) 7 : 1093-1103. Figure 3: Strait of Malacca “World Oil Transit Chokepoints,” U.S. Energy Information Administration, February 2011, <http://www.eia.doe.gov/countries/regions-topics.cfm?fips=WOTC#malacca>. Figure 4: Map of Private Shipping Lane Google Maps, <http://www.maps.google.com>.

Source Citations: A mercenary solution to Somali piracy. (2010, December 20). The Economist. Retrieved from http://www.economist.com/blogs/theworldin2011/2010/12/ mercenaries_hunt_somalias_pirates Boot, M. (2009). Pirates, then and now: how piracy was defeated in the past and can be again. Foreign Affairs, 88(4). Bowden, A., Hurlburt, K., Marts, C., & Lee, A. (n.d.). The Economics Cost of Maritime Piracy (One Earth Future Working Paper). Oceans Beyond Piracy. Retrieved from http:// oceansbeyondpiracy.org/documents/The_Economic_Cost_of_Piracy_Full_Report.pdf Bowring, A. (2008, November 25). The Price of Piracy. The Wall Street Journal. Bradford, A. S. (2007). Flying the Black Flag. Westport, CT: Praeger. Chalk, P., Smallman, L., & Burger, N. (2009). Countering Piracy in the Modern Era. Notes from a RAND Workshop to Discuss teh Best Approaches for Dealing with Piracy in the 21st Century. Presented at the Piracy Reconsidered: Perspective for the 21st Century, Arlington, VA: RAND Corporation. Cummins, C. (2008, September 8). Piracy Grips Gulf of Aden. Wall Street Journal. Retrieved from http://online.wsj.com/article/SB122083029536208391.html Dickinson, E. (2009, June 1). Gates highlights an anti-pirate success story. Foreign Policy. Retrieved from http://blog.foreignpolicy.com/posts/2009/06/01/ want_to_fight_pirates_look_south Djibouti. (n.d.). . CIA World Factbook. Retrieved from https://www.cia.gov/library/publications/ the-world-factbook/geos/dj.html European Affairs. (2010). Led By The EU, International Efforts to Stem Maritime Piracy Begin To Pay OFf. European Institute. Retrieved from http://www.europeaninstitute.org/October2010/led-by-the-eu-and-nato-international-efforts-to-stem-maritime-piracy-begin-to-pay -off.html Gettleman, J. (2008, October 30). Somalia’s Pirates Flourish in a Lawless Nation. The New York Times, A1. Gettleman, J. (2009, April). The Most Dangerous Place in The World. Foreign Policy, (171), 60-9. Gettleman, J. (2011, February 26). Suddenly, a Rise in Piracy’s Price. The New York Times. Retrieved from http://www.nytimes.com/2011/02/27/weekinreview/27pirates.html Hansen, S. jarle. (2008). Private Security & Local Politics in Somalia. African Political Economy, 118, 585-98. Hansen, S. J. (2009). Piracy in the greater Gulf of Aden: Myths, Misconceptions and Remedies ( No. 2009:29). Retrieved from http://www.nibr.no/uploads/ publications/26b0226ad4177819779c2805e91c670d.pdf Kontorovich, E. (n.d.). A Guantánamo on the Sea ”: The Difficulty of Prosecuting Pirates and Terrorists. California Law Review, 98(1), 243-76.

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Kraska, J., & Wilson, B. (n.d.). Fighting Pirates: The Pen and the Sword. World Policy Journal, 25 (4), 243-276. Leeson, P. (2009, April 13). Want to Prevent Piracy? Privatize the Ocean. National Review Online. Retrieved from http://www.nationalreview.com/corner/180288/want-prevent-piracyprivatize-ocean/peter-t-leeson Leeson, P. T. (2007). An-arrgh-chy: The Law and Economics of Pirate Organization. Journal of Political Economy, 115(6), 1049-94. Leeson, P. T. (2009). The Invisible Hook: The Hidden Economics of Pirates. Princeton, NJ: Princeton University Press. Lyon Baker, M. (2010, October 4). Swapping Pirates for Commerce. Foreign Affairs. Retrieved from http://www.foreignaffairs.com/articles/66762/michael-lyon-baker/swappingpirates-for-commerce Menkhaus, K. (2009, April 17). The Seven Ways to Stop Piracy. Foreign Policy. Retrieved from http://www.foreignpolicy.com/articles/2009/04/16/the_seven_ways_to_stop_piracy? page=0,0 Middleton, R. (2008). Piracy in Somalia (Briefing Paper). Chatham House. No Stopping Them. (2011, February 3). The Economist. Retrieved from http:// www.economist.com/node/18061574 Peppetti, J. D. (n.d.). Building the Global Maritime Security Network: A Multinational Legal Structure to Combat Transnational Threats. Naval Law Review, 59, 63-104. Piracy Prone Areas and Warnings. (n.d.). . ICC Commercial Crime Services. Retrieved from http:// www.icc-ccs.org/home/piracy-reporting-centre/prone-areas-and-warnings Q&A: What do you do with a captured pirate? (2011, January 25). BBC News. Retrieved from http://www.bbc.co.uk/news/world-africa-11813168 Seibert, B. H. (2009, March 30). When great powers compete, the pirates win. Foreign Policy. Retrieved from http://experts.foreignpolicy.com/posts/2009/03/30/ when_great_powers_compete_the_pirates_win Toomse, R. (2009). Piracy in the Gulf of Aden. Baltic Security and Defence Review, 11(2), 169-85. Totten, C., & Bernal, M. (2010). Somali Piracy: juristdicitonal issues, enforcement problems, and potential solutions. Georgetown Journal of International Law, 41(2), 377-48. Yemen. (https://www.cia.gov/library/publications/the-world-factbook/geos/ym.html). . CIA World Factbook. Zimmerman, P. (2009, April 14). Convoys Are an Answer to Piracy. The Wall Street Journal. Retrieved from http://online.wsj.com/article/SB123966729406515295.html

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Appendix Appendix A Growth of Piracy from 2005 – 2010 Pirate Attacks in 2005, according to the International Maritime Bureau, as reported by ICC Commercial Crime Services

Pirate Attacks in 2010, according to the International Maritime Bureau, as reported by ICC Commercial Crime Services

Source: “IMB Live Piracy Map 2011”. ICC Commercial Crime Services, 2011. <http://icc-ccs.org/ piracy-reporting-centre/imb-live-piracy-map/>.

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Appendix B

Source: Percy, Sarah and Shortland, Anja. The Business of Piracy in Somalia. Discussion Papers 1033, DIW Berlin, Berlin: July 2010. <http://www.diw.de/documents/vortragsdokumente/220/ diw_01.c.366661.de/v_2010_percy_pirates_oxford_dp1033.pdf>.

Appendix C

Source: Marsh, Bill and Garapolo, Scott. â&#x20AC;&#x153;Held Hostage off Somalia,â&#x20AC;?The New York Times, February 26, 2011. <http://www.nytimes.com/interactive/2011/02/27/weekinreview/27piratesgraphic.html>.

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Appendix D Decline in Piracy from 2005 – 2010 in the Strait of Malacca Pirate Attacks in 2005, according to the International Maritime Bureau, as reported by ICC Commercial Crime Services

Pirate Attacks in 2010, according to the International Maritime Bureau, as reported by ICC Commercial Crime Services

Source: “IMB Live Piracy Map 2011”. ICC Commercial Crime Services, 2011. <http://icc-ccs.org/ piracy-reporting-centre/imb-live-piracy-map/>.

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Regulation of Restaurant Practices Sean Fitzgerald


Regulation of Restaurant Practices Sean Fitzgerald

A recent trend in state legislation attempting to curb the “obesity epidemic” in the United States involves placing mandates on restaurants forcing them to better inform and protect the consumer through ingredient selection. Mandates on restaurants are not new and vary greatly - from restrictions on restaurant atmosphere like the nearly ubiquitous smoking ban to the recent legislation restricting ingredients such as foie gras in Chicago – yet, each mandate significantly alters the product provided by a restaurant (that of a dining experience). By regulating restaurants, the government limits the abilities of certain these firms to exist at lowest possible cost (for example by banning cheap and readily available trans-fats in foods) as well as in exchange for the societal benefits of prolonged consumer health and improved quality of life. The artificial trans-fat ban is not a typical wealth redistribution program. The government perspective considers the cost of obesity in society which contrasts starkly with the restaurateur’s perspective fixated on the costs and benefits of the next plate to leave the kitchen. 1 In the past, state governments have taken many different courses of action in regulating restaurants including health standards, sanitation practices, 2 and liquor licensing. Recently, state governments have become more active in targeting obesity through legislation designed to curb eating habits. This includes mandating that restaurants post the calorie content and other key nutritional information about their meals in plain sight to the customer before he or she orders (Barron NYtimes 2008). This law went into effect in 2008, but to understand the justification for it, the costs and proposed benefits must first be elucidated. According to a 1998 study, obesity in the United States cost approximately $99.2 billion. In direct medical costs, $51.6 billion. The other $47.6 billion comes from indirect costs including $3.9 billion in reduced productivity. These numbers are enormous and account for 5.7% of total health expenditure in the United States (Wolf and Coditz 1998). The government views these numbers as an externality reaching beyond the individual consumer and burdening society. In 1998, Medicare and Medicaid paid $37.6 billion to cover obesity-related treatments (Finkelstein et al. 2003 from Matsa and Anderson 2007). While restaurants are not entirely responsible for this increasing problem (increased sedentary lifestyle, food price discrepancies be(1) This does not hold in less competitive restaurant markets like small, rural towns where regular customers are crucial to a restaurants’ survival. However, for the purposes of this investigation the reader can assume the restaurant market in discussion is modeled after New York City, arguably the most competitive restaurant market in the world, in addition to being home of the first artificial trans-fat ban in the United States. (2) “Employees must wash hands” signs are ubiquitous nowadays.

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tween healthy foods and non-healthy foods, technological changes in food processing, mass proportion cooking may also be part of the cause: see Anderson and Matsa 2007 and Cutler, Glasser, and Shaprio 2003), concurrently increasing trends of restaurant portion sizes (Young and Nestle 2002) and weight-to-height ratios leave restaurants as a viable scapegoat to the problem for most policy makers (Cutler, Glasser, and Shaprio 2003). Additionally, eating-out has become a common occurrence in modern city-living as the number of home-cooked meals is decreasing. New Yorkers in particular derive a third of their caloric intake from restaurants, street vendors and other sources outside the home (http://www.nyc.gov/html/doh/downloads/pdf/ cdp/calorie_compliance_guide.pdf). This makes restaurants a crucial bottleneck point in obesity legislation. By reducing caloric intake at the distribution point, legislators hope to prevent rather than treat obesity. This strategy is best understood in a broader context of state budgets. Since prevention is far cheaper than post-hoc treatment, restaurants must cope with the demands of state governments reacting to rising Medicare and Medicaid costs brought on by increasing obesity. Calorie posting mandates and ingredient bans are two such demands. As menu calorie postings are generally less imposing demands and were enacted first in New York and have since spread rapidly to Philadelphia, California, and even national reform legislation, they will be considered first. Ingredient prohibitions will be considered next as they restrict the essential and defining characteristic of restaurants, the food. Finally, these systems of legislation will be compared to Denmark which has had great success for both restaurants and consumers in curbing trans-fat intake during recent years after passing a nationwide artificial trans-fat ban. In 2006, the New York City Department of Health and Mental Hygiene with the help of Mayor Bloomberg proposed an ordinance mandating that every “covered food service establishment that holds a health department permit and belongs to a group of 15 or more such establishments under a parent name must post calorie content prominently on menus and menu boards. This includes mobile vendors.” (http://www.nyc.gov/html/doh/ downloads/pdf/cdp/calorie_compliance_guide.pdf). This health ordinance covers only restaurant chains but will likely go into effect for non-chain restaurants eventually, but the New York State Restaurant Association is continuing a series of appeals based on First Amendment Rights. The National Restaurant Association is on record opposing the legislation because “Restaurants should have flexibility and freedom in how they may choose to provide nutrition data to their customers. The National Restaurant Association opposes any proposal that includes a one-size-fits-all menu-labeling approach” as inappropriate regulation for all restaurants (Food Politics). For example, chain restaurants can more easily comply with menu-postings because there is usually one common menu board and products change infre63


quently. Conversely, independent chef/proprietor restaurants often have rotating or seasonal menus and must print and distribute new menus. Additionally, the ingredients are often fresh and not standardized for commodification in terms of both size and fat content (each cut of meat and each fish filet are different) making it difficult to keep calorie content consistent and prohibitively expensive to have all of the dishes analyzed (Dwyer 2008). Thus independently owned firms are put at a slight disadvantage by this legislation. Currently, the FDA is preparing strict rules for calorie postings on menus that would specify if restaurants can use a range of values to describe the calorie content and other format-related issues (Food Politics). This tightening legislation would make it even harder for independent proprietor restaurants to comply with the mandates. Comparatively, menu changes are a small percentage of total overhead costs for most restaurants yet, the market is inefficient because of incomplete information. This is an asymmetric problem in that consumers are generally uninformed about the food they eat. The calorie posting legislation seeks to correct this absence of information by informing consumers of the true cost of the food they eat before they decide. The true cost would take into account the opportunity cost of eating healthier options thereby reducing the risk of long term health consequences. However the restaurant associations would prefer that individual firms be allowed to provide this information in their own way – at lowest cost. Currently, restaurants can provide this information online, through written inquiry, or even by simply asking staff members on premises. Calorie posting mandates are too strict for all firms to follow acceptably, and some restaurants would likely be assessed fines between $200 and $2,000 for inappropriate postings. Furthermore, the main externality of such incomplete market information–obesity–is unaffected by calorie postings. Studies at New York University and Yale University found that calorie posting did inform consumers, but this led to even less healthy purchases at four leading fast-food chains in a comparison of 1,100 receipts from low income restaurants. In a four week period, the average calorie count per meal increased from 825 to 846 compared to a constant control group (Hartocollis 2009). The New York City government recently attempted to correct this inconsistency by providing context information. A New York Subway now features posters informing riders that an average health caloric intake is 2000 calories per day. However, information may not be the most effective strategy for altering consumer habits. Renowned behavioral economists George Lowenstein and Peter Ubel give a straightforward explanation for the obesity trend – prices. Exit-interview data corroborates their theory as many of those interviewed reported ignoring the high number of calories in light of the number of dollars (Hartocollis 2009). Chain restaurants are able to sell cheap food for many reasons increasing economies of scale which are beyond the scope of this discussion. 64


The bottom line is the means of production are not ideal for selling healthy food. In fact, Michael Pollan reports (via the World Watch Institute) that the actual cost of beef would increase to between double or triple current prices if full costs of production were internalized (http:// www.pccnaturalmarkets.com/issues/farmland/cost_food.html 2010). In response to calorie posting mandates, some restaurants are adjusting their menus to appeal to health-conscious consumers. Le Pain Quotidien reportedly has removed certain high calorie options from its menus and is adjusting portion sizes within meals (e.g. serving a larger salad in place of a smaller slice of quiche) (Severson 2008). Shrinking portions of foods would be one potential source of cutting costs that, if relayed directly to lower prices for the customer, would impact the demand for healthier food habits if not the food substance itself. While health standards provide minimal protection against repugnant food sources and define broad categories of food, they do not limit the market to healthy foods. Since limiting unhealthy food is not a feasible solution in the market, alleviating the price difference between organic food and non-organic food through subsidies is a viable option for healthier home consumption. However, the restaurant industry has a system already in place for regulation of the quality of ingredients that is far more precise than FDA food inspections. This allows an ideal avenue for more direct regulation than calorie postings. Local health inspections are regular, thorough, and easily retrained in light of new legislation. Carried out by expert inspectors, health inspections provide local governments a means of regulation with very small transitional costs. Ingredient surveillance is one application of this direct regulatory process. Ingredient bans are the most impactful way of altering restaurant action by directly regulating the essence of a restaurant. The major ingredient ban considered here is the trans-fatty acid ban, but more ingredients are coming under the auspices of government intervention such as foie gras in Chicago which banned duck liver in response to the cruel conditions the animals endure. However, this law was greatly protested by individual restaurateurs throughout Chicago and was finally repealed in light of City Mayor Richard Daleyâ&#x20AC;&#x2122;s opposition to the ban (2008). The artificial trans-fat ban is more prominent and easier to analyze simply because of the lack of cultural attachment to trans-fats as an ingredient and the existence of several readily available substitute goods. Since its inception, the artificial trans-fat ban in New York State has been fought contentiously in the legal system as a violation of First Amendment rights (Food Politics). However, this regulation is in full effect for restaurants with fines already being distributed. At the turn of the century, the estimated daily consumption of artificial trans-fats was almost six grams per day. Transfats have been used since the early 1900â&#x20AC;&#x2122;s as a smooth room-temperature solid fat that helps give food specific textures and flavors. For example, many 65


baked good frostings require trans-fats to hold their shape at room temperature. French fries are crispy in part due to trans-fats in the frying oils. Awareness about the cardiovascular health hazards of trans-fats has increased since initial findings in the late 1980’s and now 68% of consumers are cognizant of the association between trans-fat and health risks (Tan 2009). This is due to in part to strictly enforced labeling restrictions on products containing artificial trans-fats and high profile lawsuits like the $8.5 million McDonald’s paid for false marketing its fries and political pressure on Crisco producers Proctor & Gamble– arguably the original source of artificial trans-fats in the American diet – who have since changed the formula of the original product to reduce levels of trans-fat to less than 7% by weight (Severson and Warner 2005; FDA 2003). The emergence of products proudly displaying “Trans-fat free” in 2003 on their packaging led to an overall increase in public awareness that targeted consumers when they were shopping (Choi 2008). This contextual and inadvertent marketing campaign was successful with nearly 50% of shoppers claiming to look for trans-fat free products after seven years (Tan 2009). Public opinion quickly shifted to restaurants, as many consumers wanted regulations in the food service industry. The ban itself on restaurants is slightly more contentious (the Restaurant Association lobbied heavily against it) but has also been hailed as a success in terms of immediate implementation. In 2007, restaurant compliance was at 94% out of 3,300 New York City restaurants surveyed (Tan 2009). The adaptation was quick, but not without cost. Substitutes for the formerly ubiquitous partially hydrogenated oils (the main commercial source of trans-fats) alter the taste, consistency, and cooking process of many foods and cost much more than the industrially produced liquid. High-oleic canola oil is one substitute good considered by McDonalds for use in fryers, but it costs 20 cents more than the formerly used trans-fat laden oil. With the massive scale of McDonald’s global operation, the 20 cents accumulates $70 million in additional costs (Severson and Warner 2005). Simplot – a private frozen French fry manufacturer – developed a trans-fat free fry that costs 50% more than the average frozen French fry. These costs are cause for hesitation and resistance within the food industry. Eventually, consumer demand and a lower-cost blended oil mixture of canola, corn, and soybeans justified the costs of switching to a new trans-fat free frying oil (AP 2007). This is a remarkable finding because it means that the consumer demand for healthier ingredients was worth more than $70 million to McDonald’s in addition to transitional costs. This transition has precedent. Panera Bread Company – a chain of artisanal style soup and sandwich cafes – eliminated trans-fat from its menu and reported a 35% increase in revenues equal to $71 million dollars the next quarter (http:// www.panerabread.com/pdf/pr-20071003.pdf from Tan 2009). Panera was better positioned to eliminate trans-fats as the food it provides is rarely fried 66


and therefore likely incurred less transitional cost, but the report is compelling nonetheless. There are several confounding factors in this analogy in particular Panera’s image and target demographics are different than McDonald’s and may be more responsive to changes in ingredients. However, McDonald’s would not need to replicate the astounding 35% increase to cover its costs of transition and prior evidence of healthy changes to the menu have been correlated with increased profits. Following the addition of salads to the menu in 2003, McDonald’s reported a 13% increase in profits (Ladika 2003). McDonald’s has also been attempting to recreate its image as a more diverse provider of foods than simply burgers and fries. Likewise, independent restaurants must also remove trans-fats from their menus. Finding alternative preparations for foods will be difficult and alter the market but will affect all independent restaurants equally, unlike the calorie posting legislation. These transitions will most likely result in portion shrinking or a slight increase in prices to offset costs at least until cheap substitutes or new techniques have been found. These techniques are already being explored in Denmark, which instituted an artificial trans-fat ban nationally in 2003, and has had great success (Tan 2009). Albeit the native Scandinavian diet is naturally healthier and more complete than the average American diet, this does provides an optimistic viewpoint with which to compare the New York ban. In Denmark, the restaurants were spurred to comply with regulations by the threat of media backlash upon failing trans-fat inspection. This is a promising sign, as media coverage of the New York ban has been encouraging of the change. One key difference however, between Denmark and New York is the food culture. The natural Scandinavian diet is heavily based on seafood rather than grain and beef. The food culture in Denmark is also much more progressive as evidenced by the S. Pellegrino ranked #1 restaurant in the world, Noma which is located in Denmark and is known for its experimental techniques even under heavy restaurant regulations (S.Pelligrino 2010). Food is in the national consciousness of Denmark in way that is completely foreign to the United States and it may be just as important as any of the other factors considered above. Tan notes that the New York ban does not yet include pre-packaged or manufactured foods because the FDA has jurisdiction over these products, while in Denmark, oversight of restaurants is unified under the Danish Nutrition Council (Tan 2009; Stender, Dyerburg, and Astrup 2006). Restaurants are increasingly falling under regulation for reasons of public policy. Most recently, the trend of obesity-curbing legislations have been impacting restaurants in several ways, including mandated menu-posting of nutritional information and banning the use of ingredients like artificial transfats. While forcing restaurants to bear the cost burden of informing customers may not be the most efficient way to curb obesity, it is the most costeffective for local governments. Information alone is not enough to curb con67


sumer habits, especially without context. Direct intervention is more effective, but may have consequences more far reaching. The ideal way to curb obesity is to bring about changes through price subsidies (making optimally nutritional food compellingly affordable) and raising cultural food awareness in general. Given the circumstances, the ultimate goals of policy makers may be unattainable through these methods. However, marginal success is achievable and the results have been convincing enough thus far that legislation imitating that of New York City is appearing around the country.

(8) The U.S. Navy was, in fact, created in order to fight the threat of Barbary pirates during the late 18th century, following the capture of several American ships in the 18 th century and the imprisonment of several citizens in Algiers. See Bradford, Alfred S. Flying the Black Flag: A Brief History of Piracy, Westport, CT: Praeger, 2007, Chapter 21: New Nation, New Victim, pp. 151-159.

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Bibliography Anderson, Michael L., and David A. Matsa. 2011. "Are Restaurants Really Supersizing America?" American Economic Journal: Applied Economics, 3(1): 152–88. <http:// are.berkeley.edu/Papers/anderson08.pdf> Barron, James. “5 Restaurants in Manhattan Get Citations Over Calories”. New York Times. May 6, 2008. Choi, Esther. TRANS FAT REGULATION: A LEGISLATIVE REMEDY FOR AMERICA’S HEARTACHE. Southern California Interdisciplinary Law Journal [Vol. 17:509 2008]. Dwyer, Jim. “Now on the Menu, Full Disclosure, and It’s Not Appetizing”. New York Times. December 19, 2008. Federal Food and Drug Administration Department of Health and Human Services. 21 CFR Part 101: “Food Labeling; Trans Fatty Acids in Nutrition Labeling; Consumer Research to Consider Nutrient Content and Health Claims and Possible Footnote or Disclosure Statements; Final Rule and Proposed Rule”. 2003. Hartocollis, Anemona. “Calorie Postings Don’t Change Habits, Study Finds” New York Times. October 6, 2009. Hewlett, E., Burton, S., & Kozup, J. (2008). How Modification of the Nutrition Facts Panel Influences Consumers at Risk for Heart Disease: The Case of Trans Fat. Journal of Public Policy & Marketing, 27(1), 83-97. Ladika, Tomislav. “Healthy menu items contribute to profit rise for McDonald's”. The Michigan Daily, October 22, 2003. Lowenstein, George and Ubel, Peter. “Economics Behaving Badly” New York Times. July 14, 2010. Nestle, Marion. Food Politics. Calorie Labeling posts 2006-2011. <http://www.foodpolitics.com> Pollan, Michael. “The True Cost of Food”. 2010. <http://www.pccnaturalmarkets.com/issues/ farmland/cost_food.html> Robert H. Eckel, Susan Borra, Alice H. Lichtenstein, and Shirley Y. Yin-Piazza “Understanding the Complexity of Trans Fatty Acid Reduction in the American Diet: American Heart Association Trans Fat Conference 2006: Report of the Trans Fat Conference Planning Group” Circulation 115: 2231-2246 San Pellegrino 100 Best Restaurant Rankings: <http://www.theworlds50best.com>. 2010. Section 81.50 of the New York City Health Code. <http://www.nyc.gov/html/doh/downloads/pdf/ cdp/calorie_compliance_guide.pdf> Severson, Kim and Warner, Melanie. “AMERICA'S OIL CHANGE: Losing Trans Fats; Fat Substitute, Once Praised, Is Pushed Out of the Kitchen”. February 13, 2005 Severson, Kim. “Calories Do Count”. New York Times. October 28, 2008. Stender, Steen, Dyerburg, Jorn, and Astrup, Arne. “Consumer protection through a legislative ban on industrially produced trans fatty acids in foods in Denmark”. Taylor and Francis Group. <http://www.foodandnutritionresearch.net>. 2006. The Associated Press. “McDonald’s Selects New Oil for Frying”. January 30, 2007. Young, Lisa and Nestle, Marion. The Contribution of Expanding Portion Sizes to the US Obesity Epidemic. February 2002, Vol 92, No. 2. American Journal of Public Health 246-249.

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The Eagletarian 2011  

The Eagletarian, sponsored by Boston College Economics Association, is an academic research journal in which Boston College students from al...