Iran, Economics, Politics

Viewed in terms of economics, this is a very odd war. While Iran has done some damage to American allies and bases in the gulf the total, measured in dollars or lives, is trivial compared to the damage the US has done to Iran. Yet Iran seems to be winning, judged by their escalating demands and the US pattern of threats not carried out.

The chief weapon of the Iranians against the US is their ability to close the strait of Hormuz. Viewed in economic terms it is a very odd weapon. Closing the strait raises the world price of oil and natural gas, which injures nations that are net consumers of them, including much of Europe — also China, by a large margin the world’s largest net importer. It has an ambiguous effect on net producers some of whose output normally goes through the strait such as our gulf allies and Iran itself; they sell less but at a higher price. It benefits net producers whose output does not go through the straits, including Russia, Canada and the US.1

The net effect is to benefit us, one ally and one rival, injure a more serious rival, and impose costs on traditional allies who have been visibly refraining from aiding the US in the war. Why should we care? Why should we act, as we have been acting, as though opening the strait is our most important objective in the war, for which we are willing to abandon some, perhaps all, of the objectives for which we started it?

An increase in the world price of something we export produces both benefits and costs for Americans. The benefits are larger than the costs, which makes it an improvement by the criterion of economic efficiency, but since they happen to different people they are a net worsening for some. America is a net producer of petroleum products but most Americans are net consumers, hence most Americans, hence most voters, are worse off when world prices rise. The efficiency criterion, in its more common but in my view less defensible Hicks/Kaldor version, is based on the ability of the gainers to compensate the losers, but in the real world they don’t.

That answers the puzzle in a naïve model of democracy, in which a democratic government does whatever a majority of voters prefer. A majority of voters want the world price of petroleum to be lower so the threat of making it higher by closing the strait is a way for Iran to pressure the US government.

But it makes the puzzle even more puzzling in a public choice model.

Consider the politics of tariffs. A tariff, a tax on imports, benefits (domestic) producers at the cost of domestic consumers. In most cases the net effect is a cost.2 Since for most imported goods most people are net consumers, losers outnumber gainers, hence on the naïve model tariffs should never pass. Yet Donald Trump, the politician Iran is trying to use the threat of closing the strait to persuade to do lots of things that they want him to do and he doesn’t want to do — the latest list includes war reparations, removing all US forces from the region, and agreeing not to say rude things about Iran or Islam — has made support for tariffs a central feature of his policy. Why?

It is an old questio since most countries have tariffs more than a century, arguably two centuries, since economists showed why they shouldn’t. The answer is the public choice model of democratic politics:

A legislator proposes a bill that inefficiently transfers income from one interest group to another; it imposes costs of $10 each on a thousand individuals (total cost $10,000) and grants benefits of $500 each to ten individuals (total benefit $5,000). What will be “bid” for and against the law?

The total cost to the losers is $10,000, but the maximum amount they will be willing to offer to a politician to oppose the law is very much less than that. Why? Because of the public-good problem. Any individual who contributes to a campaign fund to defeat the bill is providing a public good for all thousand members of the group. The same arguments used in Chapter 18 to show that public goods are underproduced apply here. The larger the public, the lower the fraction of the value of the good that can be raised to pay for it.

The benefit provided to the winners is also a public good, but it goes to a much smaller public--ten individuals instead of a thousand. A smaller public can more easily organize, perhaps through conditional contracts (”I will contribute if and only if you do”), to fund a public good. Even though the benefit to the small group is smaller than the cost to the large one, the amount the small group is able to offer politicians to support the bill will be more than the amount the large group will offer to oppose it.

The effect is reinforced by a second consideration--information costs. Assume that information about the effect of legislation on any individual can be obtained, but only at some cost in time and money. For the individual who suspects that the bill may injure him by $10, it is not worth obtaining the information unless it is very inexpensive. His possible loss is small and so is the effect of any actions he is likely to take on the probability that the bill will pass. The member of the dispersed interest chooses (rationally) to be worse informed than the member of the concentrated interest. This is rational ignorance; it is rational to be ignorant if the cost of information is greater than its value.

What Does Concentration Mean? So far, I have discussed only one characteristic of a group--its size. It is useful to think of the terms “concentrated” and “dispersed” as useful shorthand for the whole set of characteristics that determine how easily a group can fund a public good; the number of individuals in the group is only one of those characteristics.

Consider, for example, a tariff on automobiles. It benefits hundreds of thousands of people--stockholders in auto companies, auto workers, property owners in Detroit, and so forth. But GM, Ford, Chrysler, American Motors, and the UAW are organizations that already exist to serve the interests of large parts of that large group of people. For many purposes, one can consider all of the stockholders and most of the workers as “being” five individuals--a group small enough to organize effectively. The beneficiaries of auto tariffs are a much more concentrated interest than a mere count of their numbers would suggest. That may explain why such tariffs exist, even though the costs they impose on consumers of automobiles and American producers of export goods, both dispersed interests, are larger than the benefits to the producers of automobiles. (Price Theory, Chapter 19)

That explains why tariffs, which produce a large benefit for a small number of actors and a larger cost spread over a much larger number, are politically popular even though their net effect is negative. Why does not the same argument imply that an increase in the world price of petroleum, which produces a benefit for a small number of US producers and a smaller cost spread over a much larger number of US consumers, making the net effect positive, would be politically popular, a reason for Trump to continue the war rather than a reason to end it?

The answer is that in this case the conditions for the public choice model do not hold. The losers observe the cost every time they fill their tank, are told its relation to the war in the news that they regularly read or watch. They don’t have to coordinate to buy an end to the war, merely vote against the candidates of the party responsible for the war in the midterm elections to be held in the near future. The naïve model of democracy , “do whatever more voters are for,” is usually a poor predictor of what a democratic government will do but this time it works.

Which is why the threat to make America richer but most Americans poorer is a weapon for the Iranians.

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