Saturday, February 26, 2011

Federalism and Interstate Competition

This morning's first panel:

Federalism and Interstate Competition
This panel will assess American federalism as a competitive institution that offers a marketplace of state regulatory regimes. With the recession impacting some states more heavily than others, it is time to ask whether interstate competition is good for the nation. Should state-by-state approaches to issues such as healthcare, financial regulation, environmental protection, and same-sex marriage be encouraged? Does competition among the states lead to the best outcome or a race to the bottom? How will events such as the recent recession and healthcare reform impact the marketplace of state regulation? 

Jonathan Adler, Case Western Reserve University School of Law
Clayton Gillette, New York University School of Law
John McGinnis, Northwestern University School of Law
Louis Michael Seidman, Georgetown University Law Center

Gregory G. Katsas, Jones Day

Professor Jonathon Adler

Professor Adler argued that interstate competition through federalism not only promotes markets, but also promotes better policy generally. 

Our constitution, he argued, assumes a federalist system. Most issues were left in the hands of state governments with plenary police power. The constitution authorized federal intervention only in limited circumstances. 

But federalism is not simply a constitutional issue; it is also good policy. The burden should be on those who want federal intervention to show its relative benefits. The benefits of decentralization are quite large:
  • Possibility of exit disciplines states from taxing too much, or from regulating too little.
  • Allows jurisdictions to respond to local differences; even if the harms of ozone pollution remain constant across cities, the proper way to resolve ozone pollution might vary.
  • Helps to solve the knowledge problem. The knowledge problem, Professor Adler argues, is the greatest problem with federal intervention. 
Professor Adler suggests that decentralization allows the states to function as laboratories, which creates information about the costs and benefits of different approaches, and also limits the downside exposure for teh country as a whole. 

While he believes that decentralized government ought to be the default, Professor Adler suggests that it is a rebuttable presumption. In some areas, such as interstate pollution, there might be an argument for federal intervention. But in those cases, we ought to consider what the federal intervention will actually look like.

Professor Adler notes that states compete across multiple areas; we should not ask whether a state should promote industry or the environment, but how to promote both. The problem of "race to the bottom" has not been empirically shown, instead the evidence suggests that state competition often selects an optimal rule.

In closing, Professor Adler argues that we need to consider the actual effects of a federal intervention, rather than how we want the federal intervention to go. 

Professor Clayton Gillette

Professor Gillette began by noting the familiar suggested benefits of interjurisdictional competition: allows states to compete for residents, both individuals and firms with different bundles of goods, services, and costs, and reduces the size and inefficiency of government.

Professor Gillette then argued that these benefits rely on highly stylized conditions, for example, perfect sorting requires lots of mobility, information, and freedom of choice. 

But even with imperfect satisfaction of these conditions, there is moderate empirical support that federalism creates many of its supposed benefits. 

Professor Gillette then argued that the recent fiscal crisis reveals the possibility that the state government could exploit the financial position of the federal government and that the latter might actually need protection from the former. 

Subnational governments provide the supposed benefits of federalism only to the extent that their expenditures match their costs. Superficially, this would appear to be required: state governments typically must have balanced budgets, and they cannot print their own currency. Professor Gillette argues that states often externalize costs both temporally and geographically. Temporally, but promising benefits to citizens and workers now that must not be paid for until much later (when the politicians are out of office), and geographically, but taking subsidies from the federal government. The federal government, for example, subsidizes the issuance of local debt by exempting it from federal tax.

The tenuous financial position of state and local governments has been widely reported. Professor Gillette suggests that to the extent that investors observe that these institutions, like Citibank, are "too big to fail," they may assume an implicit federal government bailout of any state that cannot meet its obligations.Given the external effects of a financial meltdown in California, New York, or Illinois, they might be right. At any rate, the state governments can use this implicit financial backing to continue to externalize their costs, and the supposed benefits of federalism might not appear.

Which leads to Professor Gillette's suggestion: If cost internalization is essential to well-functioning federalism, and states violate that principle, and if the federal government cannot commit not to bail them out, then maybe the federal government should take more authority over the financial position of the states. 

While Professor Gillette did not make this point explicitly, and while it may not help to say it now, I don't think that the problem of financial externalization necessarily follows from federalism. I would at least like to hear his thoughts on whether the federalist system was predestined to consolidation for some structural reason - for example, a national economy has made it impossible to control cost externalization, or rather the cost externalization was a result of positive policies by the federal government - for example, tax-exempt status of state debt and federal subsidies.

Professor John McGinnis

Professor McGinnis argued that jurisdictional competition is an effective to discover a good set of rights. 

Good societies, he argues, want to protect both liberty and other conditions for human flourishing. State governments compete also to provide rights, without turning into "license." The line between license and liberty, he concedes, is pretty hard to draw. 

Some rights are better protected at the federal level - and we have a process for that. The large consensus required gives us the confidence that the monopoly is justified. 

Unlike the monopoly of the federal government, states are in a competition. Federal law protects the freedom of movement, and citizens can leave states if the balance between liberty and license goes awry. 

Professor McGinnis then drew a distinction between voting and "foot-voting." Citizens are rationally ignorant when it comes to voting. The probability that any one vote will decide the contest is very small. On the other hand, a citizen has better incentive to gather information when it comes to leaving one state for another, because the citizen looks to gain the entire benefit of the move (rather than having it widely dispersed). 

Today, the opportunities for feedback on the experiments are greater than ever, and therefore the benefits to information from federalism are greater than ever. 

Professor McGinnis then applied his theory to a comparison with the Supreme Court's protection of rights under substantive due process. 

Some rights, he noted, have very high benefits an relatively few costs. He cites the cases of Griswold and Lawrence as examples. But he argued that the actual decisions themselves had small benefit, because they invalidated laws that were dead letters anyway. The norms that supported them were out of favor. Professor McGinnis chalks these results up to federalism, not to the cases that recognized them. Before Griswold and Lawrence, those who disagreed with the substantive rules of a state merely went elsewhere.

In contrast, some of the decisions that were not subject to wide consensus have had large effects whose value is open to question. Roe, he argued, made it impossible to experiment with different abortion regimes. Moreover, a universal rule is always difficult to reverse. Substantive due process deprives the nation of sober second thoughts that the competitive process permits. 

Professor McGinnis noted a number of parallels between markets and federalism. The most important, and least recognized, is that federalism encourages humility and experimentation. Anyone in business recognizes that not matter how great he thinks his idea is, to be successful it will have to impress others as well. Federalism creates a focus on concrete facts as well; it cultivates a "spirit of liberty that is not too sure it is right."

Professor Louis Michael Seidman

Professor Seidman disputed the focus on federalism per se, and argued that any discussion of federalism should rather focus on the ideas of substantive justice sought to be vindicated. Instead of talking about the constitution or political economy, we should rather be talking about the appropriate role of markets, whether and how much to redistribute, and what the extent of individual freedom ought to be.

In different times and different places, federalism has different relationships with ideas of substantive justice. 

Professor Seidman noted that discussions of federalism often retreat from talking about underlying policies, focusing instead on either the constitution or political economy. 

We ought not care particularly what the founders thought or wrote (even in the text of the constitution) because those ideas reflect ideas of substantive justice that have no application today.

We ought not talk about political economy either, because like constitutional law, it can't deliver on its promise to give us a disinterested and technocratic view of federalism without regard to substantive justice ideas.

Professor Seidman then took issue with specific arguments for federalism. He noted that the argument that interjurisdictional competition protects freedom does not suggest a stopping point. What is the appropriate level of government? The state? Why not the city or the block or the individual? The argument pushes toward radical libertarianism.

Instead, he suggested a counternarrative: the prisoner's dillema. In his example, both Virginia and Maryland want to enact a minimum wage, but each knows that if it does, all of the businesses will move to the other. Professor Seidman suggests that overall welfare would increase if the federal government (or interstate compacts) allowed the states to act in concert. And to counter arguments that this narrative applies only to collective democratic decision making, Professor Seidman adopted it to an example where each wants to deregulate heroin use, but doesn't want to go alone because it doesn't want to attract all the heroin users.

But the more fundamental question is whether freedom ought to be conceptualized as collective or individual action. We can't decide whether federalism creates a race to the top or bottom until we know what the top or bottom mean. And what kind of freedom we ought to have should be the question under debate, not whether federalism is appropriate or not.

Debate Highlights

Professor Adler noted that just as Adam Smith wrote that the biggest threat to markets are the competitors themselves, the biggest threat to federalism are the states. States don't like to compete, so they will seek federal polices that allow them to externalize costs, garner subsidies, and cartelize. The real lesson is that we ought to take is that it is important to keep them from getting wound together in the first place, because they're very difficult to unwind. 

Professor Adler took issue with Professor Seidman's prisoner dilemma story because it assumes a static world. The world we live in, by contrast, presents jurisdictions with the ability to maximize on multiple variables - it's not a binary choice between industry and the environment, but how best to maximize both. 

Professor Gillette noted that there is no reason to believe that national officials will have purer motives than the perverse motives of state officials.

Professor McGinnis argued that we might be able to constitutionally commit the federal government not to bailout the states. 

He also took issue with Professor Seidman's remarks, arguing that we live in a world where individuals are quite ignorant of the consequences of their institutions. It's hard for those citizens to make progress without the required facts, and federalism does a better job of acquiring and presenting those facts than a top-down organization scheme. Federalism also allows citizens to operate without relying on their vote to get them the principle of substantive justice they want. 

Professor Seidman suggested that proponents of federalism need a more concrete idea of what is and is not an externality, before using externalities to decide when federal government action is justified. He suggested that even though he lives in DC, the fact of mountaintop removal in West Virginia and banned gay marriage in Mississippi might be considered externalities to the extent they make him sad. The broader the definition of externality, he argued, the greater justification for federal control. 

Professor Seidman also argued that before we talk about how to operationalize any theory, we have to talk about what we want. Different ideas of substantive justice require different methods of operationalizing. Discussions of federalism, he argued, distract from the debate. He suggested that no person agreed with the substance of the healthcare law, but also wanted to see it rejected because it was unconstitutional.

I might suggest to Professor Seidman that the reason for this is not that people who dislike the bill are using the constitution as an excuse to get rid of it, but that those who like the bill are for the same or other reasons not terribly interested in constitutional constraints. Professor Seidman himself argued that it is bizarre to suppose that the blueprint for running the country today should be based on the views or text of a document written by people then who had a different idea of substantive justice. I wonder how far he would be willing to go down that road, but I imagine that not many would follow him. 

Professor McGinnis argued that the debate about whether or not we should follow a constitution is a debate for another panel, but suggested that the alternatives to constitutions (judges and legislatures) suffer from an institutional lack of information.