DRI-266 for week of 10-13-13: Don’t Raise the Debt Limit

An Access Advertising EconBrief:

[The following was completed one day before the debt-limit deal between Congressional leaders was announced on Wednesday, October 16, 2013.]

Don’t Raise the Debt Limit

The political melodrama now unspooling in Washington, D.C. is unique because it is playing on split screen. Our point of focus is the government shutdown – or rather, the partial shutdown, since somehow we just can’t seem to get the federal government shut down no matter how hard we try. Somebody can always find an excuse to fire up the machinery of government, cut checks, get them signed and sent out for some ostensibly vital purpose.

Meanwhile, up in the corner of our field of vision, always distracting our attention even though not occupying it fully, there is the debt-limit crisis. October 17 is the deadline for Congressional approval on raising the limit on the total volume of federal-government debt, thereby clearing the way for Treasury borrowing to finance expenditures in excess of revenue collections. The party line has it that failure to increase the debt limit by that date will put the U.S. government in “default” of its financial obligations to holders of its debt. The implication is that we have to borrow more money to pay the interest on the money we have already borrowed.

And what happens if we default on our debt? Well, opinions vary. They vary from “financial disaster” to “the end of life on earth.” According to Warren Buffet, the threat of default “should be like nuclear bombs… it should never be used.” Lloyd Blankfein of Goldman Sachs declares gravely that default would be “magnitudes worse” than the current shutdown in its effects. Perhaps sensing a need for escalation, former Treasury official and current BUP Paribas SA executive Tim Bitsberger ups the ante by stating that default “…blows Lehman out of the water” in its potential effects, implying that the 2008 financial crisis would be dwarfed in comparison.

Alternative to Default: Sales of Federal-Government Assets

If we’re not to default, what are we to do? En masse, the Democrat Party wants to simply raise the debt limit enough to get by the current fiscal year. That is what Congress has been doing for decades. That is what has enabled the culture of tax-and-borrow-and-spend – a culture that has made Washington, D.C. and environs the most prosperous, recession-proof habitation in the nation. Gradually, the Republican Party has evolved into a go-along-to-get-along enabler to this culture. They have tolerated vocal dissenters among their ranks because that provides convenient cover for the tacit collusion of the majority with the Democrats.

The recent emergence of the Tea Party and current mutiny led by Sen. Rand Paul and Congressman Ted Cruz has discomfited veteran Republicans almost as much as it has their opposition. But the mood of the general public – on both the political right and the left – is so dissatisfied with the status quo that the pols are bent on preserving that they are reluctantly contemplating the need for some sort of change. At the moment, though, the problem is getting past the immediate crisis.

That is now the motif of the governing process: a calendar dotted by scheduled crises and spotted by unscheduled ones. Its momentum is best characterized as a stagger from one crisis point to the next.

On the one hand, the Establishment – consisting of most of Congress and the entire Executive branch, plus all the bureaucrats, rank and file employees, lobbyists, contractors and news media – maintains that the only option is to raise the debt limit. They say this because the increase is the only option that would keep their world intact – at least for awhile. The alternatives would shake its foundations or topple them.

The general public is largely unaware of any third option beyond increasing the debt-limit and default. That is by design. The Establishment views any option averse to the current spending culture the way a vampire views the dawn.

Yet there is such a third option. It sticks out a mile. It is the option customarily exercised by private businesses overburdened with debt.

The federal government owns a huge portfolio of assets, both liquid and non-liquid. Its total value can only be estimated, but it is only modestly less than the estimated value of privately owned U.S. assets. The most cogent approach to the immediate – debt-limit – crisis is to begin selling off those assets to fund government operations. Government assets are more than ample to support annual operations, particularly due to the sequester’s success in temporarily reducing the deficit for this fiscal year.

Every year, some private companies work their way out of trouble this way. The key is acknowledging the company is in trouble, then taking steps to dig it out of its hole, rather than doing business as usual and hoping for miracles. Today, the federal government (along with many state governments) is in trouble. Like many corporate conglomerates, it is bloated and over-extended. It needs to stick to its core businesses and sell off its conglomerate holdings to those who can preserve them and make them pay off.

Over the course of this fiscal year, branches and agencies of the federal government can concentrate on raising revenue by selling liquid and non-liquid holdings. Meanwhile, Congress can tackle the job of cutting spending – a task too time-consuming to consummate prior to October 17.

And speaking of October 17 – the date itself has very little meaning once it becomes known that the government is selling assets and revenue is assured. Creditors – even bondholders – are more than willing to wait for a payment they know is coming, as opposed to a situation when everybody knows that incoming revenue is insufficient and somebody will inevitably get stiffed. That is why the option of asset sales is a viable way of rejecting a debt-limit increase.

The last thing Republicans should do is to raise the debt limit. This is an act of surrender to the spending culture, a can-kicking capitulation to the Establishment. It is not the failure to raise the debt limit that is irresponsible; it is the act of raising it that throws responsibility to the winds.

Estimates of the Federal Government’s Assets

At various times, estimates have been made of the federal government’s financial and tangible assets, both liquid and non-liquid. Despite the fact that they were often made when annual deficits were higher than the one projected for the coming fiscal year, the estimates invariably found that assets sales could easily support annual government operations.

Using mostly Treasury and Federal Reserve data from 2011, economist Robert Murphy identified federal government liquid assets of about $1.6 trillion. In June, 2011, the Treasury reported “international reserve assets” of $144.2 billion. They consisted of gold, securities, foreign-currency deposits of euros and yen, Special Drawing Rights [an international asset provided to governments by the International Monetary Fund] and IMF reserves. (The IMF assets were developed specifically to provide liquidity in emergencies like this one.) The official valuation is distorted, since the government’s 261.5 million troy ounces of gold was valued at a par value of $42.2 per ounce rather than its then-current market value of $1500 per ounce.

We can update Murphy’s numbers with some back-of-the-envelope calculations. Adjusting the numbers using a current gold price leaves non-gold assets of approximately $133 billion and a true valuation of roughly $337 billion in gold, yielding liquid assets of $470 billion+. Subsequently, gold has declined while the yen and euro have fluctuated in value. A current estimate of $450 billion would be conservative.

The Strategic Petroleum Reserve held about 726 billion barrels of recoverable oil. At today’s price nearing $100 per barrel, that would be worth about $72 billion. But since the oil is actually buried in salt caverns, Murphy suggested a discount of 25% to reflect recovery costs and time. Tack on another $58 billion to our current liquid-asset total, then.

The federal government owns offshore oil deposits whose estimated recoverable reserves total some 59 billion barrels. Murphy estimated the royalty income in years 8-38 of recovery at about $14 billion per year. He discounted that income at 5% and came up with $164 billion, which is an estimate of what the government might receive from selling the rights to that revenue for a lump sum.

So far, we have come up with nearly $675 billion. Murphy also found some $786 billion in “credit-market instruments” in Federal Reserve documents. These include $138 billion in agency-backed and GSE-backed securities and $355 billion in student loans. This total is much larger now, since the Fed has been buying mortgage-backed securities in order to support their market prices. He also included $55 billion in corporate (TARP) equities, which have mostly since been sold back into private hands. If we assume the changes cancelled out, we can stick with Murphy’s original $786 billion.

That produces somewhat less than a trillion and a half, far above the anticipated $650 billion deficit. It is reasonable to assume that the mortgage-related securities would be sold slowly over the course of the year and the full holdings might not be depleted, so as not to depress mortgage prices unduly.

We have not yet even touched the federal government’s huge land holdings. The government owns most of the state of Nevada, for example, among its 650 million acres of land. A couple years ago, then-OMB head Peter Orszag estimated that there are some 14,000 “excess” structures and 55,000 un-utilized or under-utilized structures and buildings in the federal government’s portfolio. These could and should be sold. The government’s power-generation facilities and the electro-magnetic spectrum are other lucrative holdings that are ripe for sale and privatization.

If we were to construct a net worth statement for the federal government, the bottom line would probably astound most Americans. Financial analyst John Rutledge has occasionally attempted it and come up with government asset valuations of between $150 and $200 trillion. (He estimates the value of private U.S. assets at $230-$250 trillion.) Thus, the potential for solving our debt problem completely by selling assets is clear. Of course, this would involve various technical and logistical complications. It would unquestionably alter the fundamental character of the federal government as it exists today. But isn’t it about time to do just that?

Arguments Against Selling Federal-Government Assets

The foregoing is persuasive. But it is only natural to wonder what drawbacks might lurk under its surface. In 2010, Treasury Secretary Timothy Geithner responded to calls for asset sales by pooh-poohing the idea. Holding a “fire sale” of government assets would damage “financial markets and the economy and undermine confidence in the United States,” Geithner maintained.

Each of these contentions deserves some scrutiny. It is perfectly correct that when a company starts selling assets, it tells the world that it is in trouble and it runs the risks that this knowledge will have adverse effects. Among other things, the company may now have more trouble borrowing money and its stock price may well decline (assuming the stock trades publicly). But these are not fatal flaws, merely tradeoffs; they have to be weighed against the risks of inaction.

The drawbacks of straightforwardness do not tell nearly as heavily against a country as against a single company. A company can sometimes hide its financial condition from the public and the markets, but a country can’t. We aren’t fooling anybody by sitting on our gigantic stockpile of assets; our credit rating has already been downgraded and our debt and deficit problems are open secrets. Sooner or later, our interest rates are going to rise – the only question is how much debt is weighing us down when they do. The world will have a lot more confidence in a United States that has finally started whittling down its debt than one that has buried its head in the sand while continuing to spend itself silly. This assessment is not merely speculative; two days before the financial equivalent of “Mayan calendar” oblivion, a Wall Street Journal headline reads “Uneasy Investors Sell Billions in Treasurys.” Apparently confidence in the debt-limit-raising approach is not exactly unshakeable.

Geithner’s warning about “damage to the economy” presumably derives from the Keynesian concept that government sales of assets to the public drain money from the circular flow of income and expenditure, thereby reducing income and employment. As Murphy points out, this requires us to believe that people would rather end the year with $650 billion or so of IOUs than $650 billion worth of valuable assets formerly managed (often mismanaged) by the government. How could asset sales “damage the economy” as much as the status quo of wasteful spending and debt accumulation?

There is at least some superficial cogency to Geithner’s concern about financial markets, since some of the liquid assets in the federal portfolio were purchased in the first place to prop up the asset’s price. Clearly, selling will have the opposite effect, especially in quantity. This is why sales of mortgage-backed securities would presumably be strung out over long time periods, although the anticipation of continued sales would have the effect of driving down prices in advance of sales anyway. But the real issue is the legitimacy of the price itself. In effect, Geithner is admitting that the so-called housing “recovery” is really an artifact of government contrivance and will evaporate without it. How long is this supposed to go on, anyway? Is the tail of the housing sector supposed to wag the general economic dog forever? Orderly asset sales would seem the indicated exit strategy for this misguided policy.

Democrat arguments against government-asset sales are a pretext. The sales would represent a turning point in over a century of big-government, “progressive” policy. According to progressive doctrine, government is supposed to accumulate power, control and authority – not cede it.

The ironic thing is that asset sales would leave the skeletal structure of big government intact. The entitlement programs – Social Security and Medicare – would be untouched. Most of the regulatory agencies would be unaffected; only those entrusted with caring for assets that were sold off would be downsized or eliminated. (A major benefit of selling assets would be that the overhead expense of minding them could be offloaded.) Yet this minor impact on the welfare state has little effect on the Democrats’ intractable opposition to the idea. The fact that government does a perfectly terrible job of managing assets is also completely beside the point. Democrat policies are inherently designed to exploit the many for the benefit of the few and this demands not only big government but continually expanding government. Anything that threatens that, threatens their livelihood.

Hole Card?

A recurring theme among reactions to the prospect of default is incredulity that Congressional negotiators (read: Republicans) would be so reckless as to tempt fate by flirting with the debt-limit date. How dare they run even the tiniest risk of default?

For several years, the Federal Reserve has already been doing the unthinkable, more or less in plain sight but without provoking the same sort of outrage from the business and financial community. It has been “monetizing the debt” by buying new issues of federal-government debt directly from the Treasury using newly created money for the purpose. That activity has been technically illegal throughout the Fed’s existence, but the Fed circumvents the intent of the Federal Reserve Act by acquiring new issues directly from the primary dealers who transact directly with the Treasury. This was an important part of the QE (quantitative expansion) policy, which was designed to keep the federal-funds rate (thus, short-term interest rates in general) as low as possible. If the rest of the world was becoming reluctant to take on more and more U.S. debt – why, then, the Fed would just have to step into the breach. After all, it’s not as if the federal government should actually have to cut spending, is it?

Of course, there was the little matter of all that money that the Fed created. Ordinarily, the money would have had a multiple effect on the total money stock. The Fed formerly did its bond buying in the secondary bond market for the express purpose of creating reserves for banks to use as a reserve base for pyramiding loans to businesses and households. (Students will recognize the term “money multiplier,” used to estimate the amount by which the money stock increases based on an initial injection of money.) When the money was spent, this effect produced economic effects extending beyond the initial recipients of the spending. The trillions of dollars the Fed has recently created (some of which has financed U.S. government debt) would be sufficient to kindle hyperinflation when fed through an ordinary market process. Throughout history, this kind of money-creation has been considered strictly “the policy of the desperado,” as F.A. Hayek called it. Allan Meltzer, whose multi-volume history of the Federal Reserve has cemented his reputation as perhaps the world’s leading monetary economist, admits that despite his personal liking for Ben Bernanke, “It’s pretty hard for me to argue that if you have a few trillion dollars of excess reserves in the banking system, you think you’re doing it for the good of the economy.” Once again, though, the Fed has escaped censure for its actions thus far.

Doubtless this general insouciance is explained by the results. The created money and/or its loan potential has mostly sat idle in bank excess reserves, because a law change allowed the Fed to pay interest on money held in excess reserves by its member banks. Meanwhile, the bonds themselves have been quietly added to the Fed’s portfolio, where they have been quietly drawing interest. The Federal Reserve has now become one of the world’s leading holders of U.S. debt.

This raises an interesting possibility. Even though the Federal Reserve is a bank and operates as such, earning profits and suffering losses on individual transactions, it is not an ordinary bank. One quaint feature of its operations as a “quasi-public” institution is that it remits interest earned on its holdings of federal-government bonds to the Treasury. (It does this in spite of the fact that the Federal Reserve System is composed of its member banks and the Fed presumably has a fiduciary responsibility to them.) Thus, when the Fed buys bonds from the Treasury and holds them, that means the Treasury is getting interest-free financing for its deficit expenditures with money the Fed creates.

This raises the possibility that the Obama Administration’s debt-limit hole card may be an arrangement with the Fed that it will buy up all new debt in the coming fiscal year – and maybe more besides. Remember, the Fed was widely expected to end its program of quantitative easing in September, but continued it unabated, confounding markets and the public. Its explanation for this was confused – even normally tame Fed-watchers criticized Bernanke for leaving markets in the lurch. Remember, also, what everybody is most worried about – that default on our debt will take away the U.S. government’s ability to borrow.

Preempting the bond market is not something the Fed would normally be happy to do. U.S. Treasury bonds are traditionally one of the world’s leading fixed-income assets. People line up to buy them. Frustrating this demand would be unprecedented. But recently the Fed has been buying most of the new Treasury debt anyway; Bloomberg estimated that in 2012, the Fed was starving the market for Treasurys by soaking up 90% of new issues. In any case, the prospect of a debt default might be considered a big enough emergency to justify such high-handed action. And the Administration would be willing to consider any alternative to spending cuts or asset sales, as explained above.

The Fed’s actions are so outré and its politicization so apparent that this kind of hidden agenda makes about as much sense as any other explanation for its actions. It isn’t as if Bernanke’s tenure thus far has been squeaky clean and free of any taint of political collusion. Quite the contrary.

And this theory doesn’t argue in favor of raising the debt-limit, either. Thus, the verdict on the debt limit is clear-cut: Don’t raise it.

DRI-315 for week of 9-22-13: What Has Happened to the Labor Market?

An Access Advertising EconBrief:

What Has Happened to the Labor Market?

The performance of the labor market should be gauged using multiple indices, but is commonly judged by only one. The unemployment rate currently stands at 7.3%, having fallen from a cyclical height of almost 10%. Although that may seem like sizable progress, 7.3% unemployment is unheard of almost four-and-a-half years into a cyclical recovery. Even more startling is the swan-dive done by labor-market participation, which has declined to its lowest point since 1978. These data coincide with repeated extensions in unemployment-benefit tenure and increased enrollments in the food-stamp (SNAP) program. SNAP now provides food to about one in seven American families.

Taken together, these facts suggest an ominous change in the U.S. labor market. The Wall Street Journal recently brought that change into sharper focus by interviewing a leading expert-participant in the labor market.

Bob Funk owns Express Employment Services, headquartered in Oklahoma City, OK. EES is the fifth-largest employment agency in the country, with annual sales of $2.5 billion and 60 franchises scattered across the land. Funk estimates that EES will place about a half-million applicants in jobs over the coming year. Clearly, he has a vested interest, but that cuts both ways – his financial stake in the market hones his perceptions all the more keenly. And he cuts to the bone in his analysis of what is wrong with the U.S. labor market.

The Great Shift

Like many an interviewee, Funk is promoting a product in which he has a personal interest. EES will soon release a study called “The Great Shift,” which sounds the alarm about the deterioration of the U.S. labor market. Few men are better qualified to pronounce on this topic than Funk, whose company places both blue- and white-collar workers ranging from the lowest level maintenance worker to hard-hat construction workers to high-level executives.

In the simplest terms, the U.S. labor market is morphing from a market that works well into one that fails or works poorly. Many forces are bleeding the life out of the U.S. labor market. In the interview, Funk and interviewer Steve Moore highlight the most pernicious of these.

Loss of work ethic. “In my 40-some years in this business,” Funk declares, “the biggest change I’ve witnessed is the erosion of the American work ethic. It just isn’t there today like it used to be.” If this sounds suspiciously familiar, perhaps that is because it echoes the lament of every older man – successful or not – pining for lost youth. That is probably why it has not fired the imagination of the public at large.

But business owners have no trouble connecting with Funk’s message. Funk’s list of the specific attributes necessary to success on the job – being on time, taking a conscientious approach to the job, treating every task seriously and being willing to do anything including work overtime – will light a fire of recognition in the eyes of every employer who reads it.

According to Journal interviewer Stephen Moore, Funk “thinks the notion of the ‘dead-end job’ is poisonous because it shuts down all sense of possibility and ambition…If low-level employees show a willingness to work hard,” Funk maintains that “most employers will gladly train them with the skills to fill higher-paying jobs.” Neither Funk nor Moore trouble to explain why employers would be so generous, but the point is worth developing. Contrary to the impression created by politicians and the news media, most job training occurs on the job rather than in academic and vocational institutions. Since the employer will have to train anybody who fills a higher-paying position anyway, it will generally be easier and cheaper to train an internal candidate rather than import one who must be wholly indoctrinated into company procedures. But any employer wants a trainee whose can-do attitude, enthusiasm and demonstrated productivity make the investment in training odds-on to succeed. That’s why holders of so-called “dead-end” jobs can actually have a leg up on outside applicants, and why so many of the rich and famous got started at the entry level.

Alas, as Moore puts it, Funk “fears that too many of the young millennials who come knocking on his door view a paycheck as a kind of entitlement, not something to be earned. He is also concerned that the trendy concept of ‘life-balancing’ is putting work second behind leisure.”

Some readers will find this jaundiced picture too one-sided. Surely there must be some people who see openings for hard work as an opportunity for economic advancement and personal improvement. Sure enough, Funk unhesitatingly identifies just such a class of go-getters. “I guess I’m a little prejudiced to the immigrants and especially Hispanics,” Funk admits. (Note the refreshing use of the word “prejudiced” in its correct, non-pejorative sense.) “They have an amazing work ethic. They don’t want handouts and are grateful to have a job. Our company has a great success rate with these workers.” Moore, who has decades of interaction with academic and government economists, observes grimly that “this focus on work effort is seldom, if ever, discussed by policy makers or labor economists when they ponder what to do about unemployment. To most liberals, the very topic is taboo and is disparaged as blaming the economy’s victims.” Moore tactfully refrains from pointing out that the benefits of immigration, too, are taboo among mainstream conservatives; they see only a camera-negative vision of immigrants as criminal, disease-ridden, welfare-sucking, invasive forces of destruction.

The relative attractions of subsidized leisure. When Moore pressed Funk “to explain what Washington can do to get Americans back on the job,” Funk replied that “the first step would be to start shrinking the ‘vast social welfare state programs that have become a substitute for work. There’s a prevalent attitude of this generation of workers that the government will always be there to take care of them.'” Funk mentions unemployment benefits, health care and food stamps as examples of welfare-state subsidies that kill the incentive to take entry-level jobs, but he reserves special condemnation for the Social Security disability program.

Funk considers disability, which now serves some 14 million recipients, the most-abused federal-government program. EES has discovered that over half of the disability claims filed by its workers are fraudulent, he claims. When the company challenges claims in court, “we win over 90% [of the time].”

Government regulation. Funk characterizes the Affordable Care Act (ObamaCare) as “an absolute boon for my business.” Why? The legislation requires businesses with 50 or more full-time employees to provide health care for their employees. ObamaCare defines “full-time” employment as 30 hours (!) or more per week. This has led to the already-notorious business categories known as “49ers” (businesses that cap their full-time employment at 49 workers) and “29ers” (businesses that cap their employee work week at 29 hours). “Firms are just very reluctant to hire full-time workers,” Funk says. “So they are taking on more temporary help, which is what we do.” While ObamaCare is statutory law, it will be implemented by an executive agency, the IRS. Its provisions have the substance of regulation and legislators were acting exactly as regulators do when they passed it. Indeed, the overwhelming public opposition to the bill gives it even more of the substance of regulatory fiat.

As Moore notes, “the hundreds of thousands of temporary workers [Funk] places in jobs are EEC employees. He pays their salary, benefits and payroll taxes and the firms that hire the workers reimburse EEC for those costs plus a commission. This feature of the temporary-worker industry allows companies trying to fill job openings to do so in a way that sidesteps ObamaCare’s mandates. After an on-the-job trial of several months, companies often offer the workers permanent positions.”

The function now performed by Funk’s temp agency was formerly performed routinely by business firms themselves without need for a middleman. Workers were hired under terms called “probation,” which stated that if the relationship did not prove mutually satisfactory they would be discharged. But the federal government overlaid the employer-worker relationship with so many “protections” ostensibly designed to promote worker security that businesses couldn’t discharge workers who didn’t work out without running the risk of a lawsuit. And a lawsuit was sure to result in either a settlement or a trial; either way the business would incur a significant cost. So businesses simply stopped hiring. Workers became more “secure,” all right – if they already had a job. But workers looking for a job became less secure, because businesses no longer had the choice of hiring on a hunch with the fallback option of discharging the worker if the hire didn’t work out. Apparently most people lost sight of the fact that the probationary period also gives a worker the same chance to try the job on for size. (The implicit stance behind government labor-market regulation seems to be that “fairness” demands gross asymmetry – employers must meet tremendous obligations while workers enjoy lots of “rights.” This implies that fairness and freedom are incompatible.) This is still another of the many ways in which government itself contributes to higher and longer unemployment through its own policies.

Fund adds “the problem isn’t just ObamaCare, though. It’s the entire assault on employers coming out of Washington – everything from the EEOC to the Dodd-Frank monstrosity. Employers are living in a state of fear.” One terrorized industry not mentioned by either Funk or Moore has been trucking, where the Department of Transportation has launched a veritable war on employment. DOT has revamped its regulatory modus operandi in favor of a statistical data base that has turned veteran drivers with previously spotless driving records into risky or even prohibitive employees. Frequent agency threats to require expensive health diagnostic checks for sleep apnea have cast a pall over the profession. DOT’s long delays in making up its mind on allowable hours of service for truckers left the industry hanging. And trucking firms have also felt the sting of the agency’s new regulatory scheme. Truck drivers already feel the breeze of a sword of Damocles swinging over their head, in the form of technological obsolescence impending due to eventual development of self-driving vehicles. The federal government acts as if duty-bound to beat technology to the punch by driving truckers out of the industry first.

The jobs mismatch. At one time, it was conventional thinking that an increase in job openings would lead to a decrease in unemployment and an increase in employment. The stunning exit of workers from the labor force has played hob with convention; the unemployment rate has fallen at the same time that the volume of employment has also declined sharply. When we probe for the reasons behind the out-migration of workers, the most striking datum is the mismatch between the types of workers sought and those now unemployed or no longer looking for work. When an unemployed worker’s job-search efforts are repeatedly met with rejection, surrender becomes easier to understand.

Funk claims that EES usually has around 20,000 jobs that it can’t fill owing to a lack of qualified applicants. Moore lists the most sought-after fields as “accounting (thanks to Dodd-Frank’s huge expansion of paperwork), information technology, manufacturing-robotics programming, welding and engineering. He’s mystified why EES has so much trouble filling thousands of information-technology jobs when so many young, working-age adults are computer literate.”

The idea of a mismatch between available job-seekers and available jobs has been around for at least a century. In economics textbooks, it is called “structural unemployment.” If the number of unfilled jobs is exactly equal to the number of unfulfilled job-seekers, this might mean that employer and employee just haven’t gotten together yet. But if this condition persists for a long while, this suggests that job and job-seeker are somehow incompatible. At first glance, this seems like the sort of problem that might arise in a modern economy due to the absence of central economic planning by government. After all, how do we know that the “right” number of engineers, accountants and welders will be trained and packed off to the labor market? Doesn’t this require rational planning by somebody – or bodies – who can see the whole “big picture” on a gigantic planning board?

It turns out that free markets are supremely qualified to handle this sort of problem because only free markets can transmit the information about the kind and quantity of jobs needed to the precise people who can help to solve the problem – namely, the would-be engineers, accountants, welders, et al. And the problems of matching are far too big to be solved by central planners – not merely too big, but too subtle and complex, as much a matter of subjective perceptions as objective information. That is why private for-profit agencies like EES, which exploit both the incentives and the information offered by the price system, outperform the state employment agencies.

The persistence of imbalances, whether structural or frictional, implies that prices are not being allowed to do their job. In the low-skilled segment of the market, the minimum wage is the longtime culprit. Recent increases in both the federal and state minimum wages would be bad enough under any circumstances, but in this climate they constitute criminal economic-policy malpractice. At the executive level, the recurring attempts to legislate CEO pay do nothing to improve the welfare of consumers but do hinder the workings of the market for executive talent.

It is the middle of the labor market that has suffered most conspicuously, and acutely, from meddlesome non-market forces. In order to get and hold a job as an accountant, engineer or IT specialist, fluency in mathematics is an absolute prerequisite. (Mere numeracy no longer suffices in accounting, since today’s accountant must command enough computer-related expertise to service his clientele.) The only thing American schools teach worse than mathematics is reading, which is another prerequisite for most high-end jobs. In contrast, foreign students tend to be well versed in mathematics, which explains the agitation to make visas available to high-skilled immigrants.  The educational deficit may not explain the entire skills deficit, but it is surely the beginning of wisdom on the issue.

The long-running failure of American public schools. Public-school reform in America now enters its second century. The breath of fresh competitive air blown in by charter schools and vouchers has brought the first genuine, effective reform to K-12 education. But the education establishment dies hard. With the death of the old telecommunications monopolies, teacher’s unions are the leading political force in many statehouses. The stubborn persistence of labor-market imbalances in math-, reading- and computer-skilled jobs has its corollary in the stubborn persistence of the political power of teachers’ unions.

How do teachers’ unions hurt educational performance? They are structured to favor incumbent teachers over newcomers, which means that they insist upon seniority as the basis for pay and advancement rather than actual teaching productivity. Even worse, it means that the tenure system reigns unchallenged. “Teacher is by far the most corrupt social institution in our time,” Funk flatly declares. “It doesn’t reward excellence or weed out bad teachers.”

Contrast tenure with the rule of free markets, in which business failure is penalized by financial failure. Success is rewarded with high(er) profits, which encourages entry of new firms and imitation by other businesses. All this is utter anathema to public schools, which abhor failure and exit by a public school – unless the school district itself decrees it for cost reasons, of course. There is no particular, automatic reward for successful teaching performance – in particular, no immediate and unequivocal financial reward for good teachers. (Indeed, in higher education it is axiomatic that good teachers usually fail to achieve tenure because they spend too much time concentrating on teaching and not enough worrying about the “research” that will lead to tenure.)

While it is true that change is finally coming, it proceeds at a glacial pace because it moves along the choked roadway marked “politics” rather than the speedy autobahn of free markets. Unions dictate the terms on which vouchers are allowed to exist (if at all) and operate; they dictate the funds allocated to charter schools. This is akin to running a poultry farm by appointing the fox foreman and letting him control access to the chicken house.

What Does This Pattern Remind You Of?

When we put the pieces of this labor-market pattern together, they form a familiar picture. For decades, Europe has produced the same picture: dreadful work ethic, open-handed government subsidies killing off the incentive to take entry-level jobs or work at all, smothering government regulation, declining academic performance, powerful unions blocking reform, increasing mismatch between available jobs and worker skills. Not only that, but the Continent’s long-running virus of sluggish growth and high unemployment has recently spread to the U.S.

Most ominous of all is the serial banking and financial crises experienced by countries within the Eurozone. They began with tiny, insignificant little Greece, whose troubles couldn’t possibly be big enough to harm anybody else. Besides, Greece was an outlier, an exception. Its people were exceptionally lazy, its banks horribly inept, its regulation unusually lax – or so the party line ran among the commentators and mainstream news media.

Soon, though, the financial woe spread to Portugal, Spain and Italy. France began to look shaky. Every few months a new crisis flared up. Each time, finance ministers and heads of state appeared to assure us that this new fix has achieved financial peace in our time – until the next crisis. And then came recession – again.

For years, the American labor movement has been holding up Europe as its model. Incredible as this may seem, labor leaders have pooh-poohed the high rates of unemployment and low rates of economic growth in Europe. They have maintained that people in Europe were happier than Americans. They were more secure. Wasn’t this worth putting up with a little more unemployment, a little less material wealth? Goods and services weren’t all that important, were they, when stacked up against the really important values in life?

Lately, though, we haven’t heard much of this rhetoric. Partly this was because riots and discord in Europe were blatantly at odds with the party line about the bovine placidity and content of the populace there. Partly it was because the American Left was now peddling a new party line about the rapine and plunder of the 99% by the 1%, and they needed to extend this paradigm internationally in order to demonize the phenomenon of globalization. And it’s pretty hard to harmonize the picture of happiness with one of rape and plunder.

The real importance of our growing resemblance to Europe, however, is that is raises the specter that we will follow in their financial footsteps. The mainstream news media has a history of disregarding the views of men like Bob Funk. But the carbon-copy example of Europe lends a chilling credence to his views. It happened there and is still happening there, which makes it that much tougher to pretend that it can’t happen here.

DRI-310 for week of 9-15-13: What is Wrong with President Obama’s Claim that the Government Rescued the American Economy?

An Access Advertising EconBrief:

What is Wrong with President Obama’s Claim that the Government Rescued the American Economy?

This week marked the unofficial five-year anniversary of the 2008 Financial Crisis, inaugurated by the bankruptcy of Lehman Brothers on September 15, 2008. In the world of politics and news media, disasters are celebrated as religiously as triumphs and advances. President Barack Obama delivered a solemn recapitulation of the Crisis and his administration’s actions over the ensuing five years. The President’s use of rhetoric has built a solid constituency that has swept him into the White House twice. A full understanding of economics allows us to understand why his actions (and his justifications for them) have been so popular, why his explanation of events is wrong and what the true nature of the Crisis was (and is).

The ICU Metaphor: Government as Emergency Physician, the Economy as Critically Ill Patient

President Obama described his primary duty as “making sure we recover from the worst economic crisis of our lifetimes.” By implying a crisis from which recovery is problematic, the President draws a clear analogy with emergency medicine. A patient faces a medical crisis; the doctor’s overriding goal is recovery; failure will result in death. Although the President mixes this metaphor several times, the basic structure of life-or-death emergency and problematic outcome is preserved.

In a medical emergency, a series of catastrophic events creates a crisis. This is the format in which President Obama recounted the economic history of the past five years. It was “five years ago this week that the financial crisis rocked Wall Street and sent an economy already in recession into a tailspin.” “…Some of the largest investment banks in the world failed; stocks markets plunged; banks stopped lending to families and small businesses.” And, hearkening explicitly to the medical metaphor, “the auto industry – the heart beat of American manufacturing – was flat-lining…By the time I took the oath of office, the economy was shrinking by an annual rate of more than 8 percent. Our businesses were shedding 800,000 jobs each month. It was a perfect storm that would rob millions of Americans of jobs and homes and savings that they had worked a lifetime to build. And it laid bare the long erosion of a middle class that, for more than a decade, has had to work harder and harder to keep up.”

In a hospital ER, a worst-case scenario will compel doctors to invoke the protocol known as “Code Blue,” a crash program to restore vital signs in the face of complete collapse. This was the Obama administration analogue: The federal government had to “…act…quickly through the Recovery Act” to “arrest the downward spiral” and “put a floor under the fall” by “put[ting] people to work…teachers in our classrooms, first responders on the streets.” The government “helped responsible homeowners modify their mortgages” and “jump-start[ed] the flow of credit.” Thanks to these and other measures, the President concluded triumphantly, “we saved the auto industry.”

Once the emergency has been met and the patient is out of immediate danger, doctors can then proceed with the process of rehabilitation. This may involve a hospital stay of short or long duration or possibly a trip to an outpatient facility and extended therapy. President Obama outlines his analogue of the American economy’s recovery after he saved it: The Obama administration “pushed back against the trends that have been battering the middle class… took on the broken health-care system…invested in new technologies… put in place new rules that we need to finalize before the end of the year, by the way, to make sure the job is done… and …locked in tax cuts for 98% of Americans.” All this was accomplished in exchange for “ask[ing] those at the top to pay a little more.”

How is the patient progressing, five years on? What is the economic prognosis? “So, if you add it all up, our businesses have added 7.5 million new jobs [over the last 3.5 years]” and “the unemployment rate has come down.” The housing market is “healing.” Financial markets are “safer.” Today, we “sell more goods made in America to the rest of the world than ever before… generate more renewable energy than ever before…produce more natural gas than anybody.” Why, “just two weeks from now, Americans [are] finally going to have a chance to buy quality, affordable health care on the private marketplace… we’ve cleared away the rubble from the financial crisis [and] begun to lay the foundation for economic growth and prosperity.”

In true doctorly fashion, the President issued some caveats. It seems that the “top 1% of Americans took home 20% of the nation’s income last year…most of the gains have gone to the top one-tenth of 1%.” Congress should be focused on issues such as “How do we grow the economy faster? How do we create better jobs? How do we increase wages and incomes; how do we increase opportunity… how do we create retirement security….” Government, of course, will have to make “the investments necessary” to achieve all these goals. Government will assume “the critical role in making sure we have an education system …for a global economy.” Congress will enable all this via the budget it passes – provided the quixotic Republicans don’t gum up the works with their monomaniacal insistence on “cuts” to trim the budget deficit. How can they say this when “the deficits are falling faster than at any time since before I was born”?

The Facts are Secondary

It would be easy to get hung up on the facts of President Obama’s “medical report.” Here and there he departs from metaphor to into boldfaced, bald-faced lie. Obama’s bland claim that “we saved the auto industry” doesn’t survive even a fast glance, unless the Ford Motor Company was exiled from the industry by a FISA court in the last five years. Ford didn’t receive any government subsidies, whereas General Motors and Chrysler each got a full-monte bailout makeover. It was telling that the former Big 3 all downsized to broadly similar degrees. In other words, they really underwent a reorganization process even though two of them were spared formal bankruptcy. Now, their lean, mean status has put them back on the front pages of business sections and spawned banner headlines reporting land-office sales of new models. The “salvation” of the auto industry can be ascribed to Ford’s refusal to be bailed out and the successful reorganization of the Big 2.

The President’s dire recollection of the imminent doom of investment banking is droll considering his unrelenting class-warfare assaults on Wall Street, the 1% and bankers generally. Ironically, the big banks who received bailouts were doing little investment banking at the time and are doing even less today. Moreover, neither Bear Stearns (whose failure was masked by its sale) nor Lehman Brothers qualify as among the biggest investment banks, so it is not clear which mega-bank failures the President is referring to.

These are mere quibbles, though, compared to the major point at issue, which is the fundamental basis of President Obama’s rhetoric. To what extent is his medical metaphor rooted in analytical reality?

The Utter Poverty of the ICU Analogy

It is likely that most of the President’s audience did not parse his metaphor as thoroughly as we are about to do. But they instinctively grasped that he was speaking figuratively. They probably experienced a déjà vu feeling of urgency, reminiscent of September, 2008 – a sense that something bad was happening and that something needed to be done quickly to stop it before the world fell apart. How apt was the President’s metaphor; how accurately did it depict the concrete economic reality? Was it true to reality or was it merely the language of political theater, intended to push the emotional buttons of his audience and achieve the desired effect?

The analogy between a modern economy – consisting of hundreds of millions of interacting individuals, and one single patient – suffering a critical illness and facing death – is very bad. There is little or no commonality between the two.

The patient is a single, holistic entity. The economy is an abstraction, made up of many millions of such entities. The patient’s existence is threatened. The economy’s existence is not threatened by a financial crisis, despite the apocalyptic language tossed about indiscriminately by the President. (To be sure, President Obama is only following the example set by Treasury Secretary O’Neill, who spoke darkly of “fac[ing] the abyss” and falsely warned Congress that unthinkable horrors would follow a failure to pass immediate bailout legislation.) The U.S. and every other advanced industrial nation have faced financial crises periodically since the 19th century. No nation has ceased to exist as a result of such a crisis. Indeed, as a first approximation, the individuals within the nation are not threatened with extinction by a financial crisis either, although many people may face a diminution in their standard of living.

A single patient is saved by doctors who utilize resources that originate outside the patient; e.g., outside his or her body. These include medicines, blood for transfusions, glucose and other basic forms of stabilizing fluids and numerous other forms of extraneous assistance ranging from diagnostic tools to organs for transplantation. A government instituting a “recovery program” – whether a Code Blue-type of emergency-bailout plan or intermediate assistance such as Fed Chairman Bernanke’s quantitative-assistance scheme or a longer term program for economic growth – can only use resources that originate inside the economy itself. The resources must come from somewhere and no government has the power to spontaneously generate resources out of thin air. Even money that is borrowed from foreign sources must be paid for by repaying principal and interest and in other ways as well. (A country that enjoys the privilege of “seigniorage” because its money is a “vehicle currency” held for transactions and investment purposes by foreigners may perhaps evade repayment longer than would normally be the case.) Really, “the economy” can be conceived in global terms, since the bailouts were a transnational operation on both sides.

Consider how hampered ER doctors would be if they had to rely on only the patient’s own resources and reserves of strength in fighting emergency illness or injury. Well, that is a fair analogy of the constraints governments face in “rescuing” their citizens from financial crises. Actually, that only begins to describe the limitations of government corrective action. Doctors can learn tremendous amounts about their patients via diagnostic tools like X-rays and cat scans and blood tests. But the information governments would have to know in order to “rescue” an economy is widely dispersed in fragmentary form among hundreds of millions of people. Not only that, much of that information is subjective and wouldn’t be useful to anybody except the particular individuals that possess it.

Doctors can rely on the patient’s help because the patient wants to live. The emergency efforts exerted by the hospital staff often succeed because they are a voluntary cooperative enterprise in which the patient fully cooperates. Governments operate on the basis of coercion and compulsion. This is necessary because governments can acquire resources to help some people only by taking resources away from other people. Coercion is a shaky basis for production and maintenance. If it were a superior form of economic endeavor, the totalitarian dictatorships of the 19th and 20th centuries would have been history’s great success stories. Instead, they were tragic, ghastly failures. The resistance to the bailouts of the big banks is only one of the pushbacks suffered by the federal government’s rescue program. The Fed’s Zero Interest-Rate Program (ZIRP) left millions of elderly Americans adrift without a suitable income-producing vehicle, given the artificially low interest rates imposed on fixed-income investments by the government policy. This population has become highly restive, not to say mutinous. Millions of Americans have left the labor force because the extension of unemployment benefits has made idleness more attractive than work – and because government regulation of the labor market has simply made job creation too costly and dangerous to businesses. These are all cases in which Americans oppose a program ostensibly designed to rescue them from economic emergency and privation.

This highlights the overarching dissonance in the Obama ICU analogy. Treating the economy as a single organic unity fulfills the old socialist dream originally enunciated by the French philosopher Saint-Simon, who declared that a nation should be run as though it were one single huge factory. The pretense that there really is a “nation as a whole” rather than a reality consisting of 312 million individuals allows governments to enact dreadful economic policies like the Economic Recovery Act. Pumping money into an amorphous entity called “the economy” ignores the individual interactions and logical connections that make up a functioning economy. We cannot even draw a useful analogy between the warring organisms within the human body and claim that government is helping the “good” organisms (e.g., people) against the “bad” ones for the good of the “whole body” (e.g., the nation). Doctors know how to separate good from bad organisms for the survival of a single patient; governments have no objective basis for transferring real income from some people to others for the good of the nation.

The Real Nature of Economic Crisis, Financial or Otherwise

Finance differs from non-monetary economic theory in dealing with the allocation of resources over time rather than at a single (hypothetical) point in time.  Thus, complicating topics such as saving, borrowing, interest rates and debt intrude on the analysis. A financial crisis occurs when a gross mismatch between the saving/investing and borrowing/lending desires of the public places financial institutions and mechanisms in jeopardy of failure. The only cure for the crisis is realignment between the value of goods people are willing to commit to future consumption and the value of goods producers commit to make available in the future. Proper alignment implies that the interest rates established in the markets for loanable funds equalize the amounts of borrowing people want to do for each future term to maturity with the amounts of money available for lending in the future. Sooner or later, there is no substitute for this curative process. When values are once again realigned, the resulting pattern of resources will require that businesses wrongly created and jobs formerly occupied due to the crisis will no longer exist. Once again, there is no substitute for this corrective process.

The U.S. has suffered recurrent financial crises throughout its history. Each financial crisis had one thing in common with all others. They all ended. The first financial crisis was in 1807. Another one – a big one – followed in 1837.The biggest one of all may have been in 1873. But none of them went on forever and none of them caused the death of the U.S. economy – whatever that might be interpreted to mean.

Keynesian economics was neither a necessary not a sufficient condition for recovery from a financial crisis. It was not necessary because Keynesian economics was not invented until 1936; numerous financial crises had come and gone by that time. It was not sufficient because the U.S. economy suffered financial crises after the invention of Keynesian economics that were unaffected, even worsened, by the implementation of Keynesian policies.

Bailouts of big banks were no more necessary than were the bailouts of GM and Chrysler. (Once again, blame should go primarily to the architects of these measures, Treasury Secretary O’Neill and Fed Chairman Bernanke – but the policies were wholeheartedly supported by President Obama.) These measures are often supported even by many so-called free-marketers, some of whom cite Nobel Laureate Milton Friedman’s claim that widespread bank failures triggered a massive decline in the money supply that caused the Great Depression. As an explanation of the Depression, Friedman’s view is misleading at best, but even if accepted it does not remotely justify bank bailouts. Friedman was famous for insisting that the Fed could, and should, have increased the money supply to counter the reverse-money-multiplier effects of the bank failures. His famous quip that the Fed could even drop money from helicopters if necessary illustrated his view that the Fed had countless ways to get money into the hands of the public. Bailing out banks – the realization of moral hazard under fractional-reserve banking regulation – has nothing to do with increasing the money supply. That is exactly what Ben Bernanke proceeded to prove with his program of quantitative easing. By creating money hand over fist after the banks had already been bailed out, Bernanke was closing the barn door after allowing the animals to escape!

Citations of Milton Friedman as authority for the bank bailouts by Ben Bernanke and other left-wing economists are an example of what the Soviet KGB used to call “disinformation” and what magicians refer to as “misdirection.” They are designed to confuse and mislead an opponent by presenting a false trail of reasoning and evidence.

The Real Threat to Life and Limb Posed by Economic Crisis

The only form of economic crisis that can, and has, threatened life and limb throughout human history is a monetary crisis. Only a monetary crisis can overturn the entire basis for trade or exchange, making it impossible or prohibitively difficult for people to exchange goods and services. This poses an immediate threat to life and limb because almost everybody specializes rather narrowly in their production. Specialization increases productivity and increases real incomes – provided people are able to exchange the fruits of their productive specialty for the consumption goods they love. But if and when they cannot do this, specialization turns into a nightmare. People cannot acquire the goods and services they know and love. At best, this is an incredible nuisance. At worst, it is a clear and present danger to life and limb.

Technically, it is true that an economy – or, more properly, a nation – will eventually recover from a monetary crisis, too. But prior to recovery, famine, pestilence and death may visit the nation beset by crisis. Ancient Rome was one nation felled by monetary crisis; the crisis not only caused havoc but weakened the Republic so much that it could no longer fight off its enemies. In Germany’s WeimarRepublic; the chaos caused by hyperinflation put the public’s sole focus on day-to-day survival. This completely delegitimized the democratic government and paved the way for Hitler. His authoritarian rule was seen as preferable to the ineffectual efforts of socialists who could no longer fulfill the promises of security that had won them election.

More recently, we have witnessed the devastating effects in such places as Zimbabwe, where hyperinflation was the last refuge of the scoundrel, Mugabe. The failure of investment projects financed by foreign loans, coupled with land-redistribution policies that dispossessed capable farming operations, had decimated the productive capacity of Zimbabwe’s economy. Unemployment reportedly approached 80%. To finance his administration’s regional wars and pay the government’s bills, President Mugabe permitted money creation on a scale not seen since the Weimar inflation. As we would expect, the result was the disintegration of trade and a retreat into dictatorship, subsistence, barter.

Thus, monetary collapse – not financial crisis – is the only real economic approximation to the emergency-threat-of-death metaphor rhetorically brandished by President Obama.

This is a sobering thought, since it suggests that America does, after all, face a potentially life-threatening menace in its not-too-distant future. It is the threat of hyperinflation and monetary collapse presented by the $4 trillion in excess reserves sitting on the accounts of American banks. This money is currently receiving interest, thanks to the change in policy allowing interest to be paid on excess reserve accounts. Should that status change, though, the money might be loaned out to businesses and promptly spent. This large volume of money chasing domestic goods would bid up prices with alacrity. The resulting hyperinflation would jeopardize the value of U.S. money. That is a disaster waiting to happen.

The threat is not in our past. It lies ahead of us, in our future. President Obama’s policies did not save us from it. Rather, they now threaten us with it.

Should we temper this conclusion with the reminder that the unprecedented money creation of the last few years is the work of the Federal Reserve and its Chairman, Ben Bernanke? Is the President exempt from criticism owing to the Fed’s independence from political influence and control?

President Obama has not moved to replace Bernanke. The President has not even expressed disapproval of the Fed Chairman’s policies. And the current favorite to succeed Bernanke early next year, Janet Yellen, is widely considered to favor even looser monetary policy than Bernanke, if such a thing can be imagined. Presumably, if President Obama disapproved, he could find another Fed Chairman. So far, there is no indication that he will do that.

Rhetoric Matters

The problem with President Obama’s recounting of events during and since the Financial Crisis of 2008 is not his errors of fact, glaring though they are. His rhetoric is built upon a superficially attractive but utterly wrongheaded metaphor – Obama Administration policies as ICU measures taken to rescue an economy that is likened to a critically ill patient. The metaphor leads directly to the wrong diagnosis of the Crisis and the wrong medicine for the patients, who are 315 million individuals rather than indistinguishable parts of one gigantic whole.

DRI-287 for week of 9-8-13: Stop the Presses! ‘Government Does Not Spend Money Wisely.’

An Access Advertising EconBrief:

Stop the Presses! ‘Government Does Not Spend Money Wisely.’

When somebody tries to persuade you that they are smart by telling you something you already know, you are not impressed. When they insist that they just learned it after spending years wielding their expertise on the subject, you react by considering them stupid rather than smart. Alternatively, you suspect them of dishonesty. And when your informants turn out to have been highly placed officials in the government, you fear for the future of the nation.

That is the position in which Peter Orszag and John Bridgeland place readers of their article, “Can Government Play Moneyball?” which appears in the current issue of The Atlantic magazine. Orszag and Bridgeland have determined that “less than $1 out of every $100 of government spending is backed by even the most basic evidence that the money is being spent wisely.” To a substantial plurality of Americans – perhaps even a thin majority – this is about as surprising as the fact that the sun rose in the east this morning. But it is ostensibly a stunning revelation to the authors, who profess that “we were flabbergasted by how blindly the federal government spends.”

Are the authors anthropologists who just now returned to the United States after spending the last 50 years on an isolated tropical island, studying the native culture? As John Wayne might put it, not hardly. Both men are “former officials in the administrations of Barack Obama (Peter Orszag) and George W. Bush (John Bridgeland).” Both have sterling educational pedigrees (one in economics, one in law) that equip them to understand the logic of markets and the workings of government.

Both inhabit the belly of the Establishment beast. Orszag is a prep-school graduate and cum-laude PhD product of the London School of Economics. He was Director of both the Congressional Budget Office (CBO; 2007-2008) and the President’s Office of Management and Budget (OMB; 2009-2010). Bridgeland graduated from Harvard University and the University Of Virginia School Of Law and held down several positions in the Bush administration, including Assistant to the President, Director of USA Freedom Corps and Director of the White House’s Domestic Policy Council. He also taught a seminar on Presidential decision-making at Harvard’s Kennedy School of Government. Since 9/11, he oversaw over $1 billion worth of spending on domestic and international service programs. He currently heads a public-policy organization (Civic Enterprises) and vice-chairs a non-profit business created to eradicate malaria in less-developed countries. He is also a noted educational activist who drew attention to the “silent epidemic” of high-school dropouts.

Given their backgrounds, we can assume that Orszag and Bridgeland are not fools. In the first paragraph of their article, they state that “the federal government” is “where spending decisions are largely based on good intentions, inertia, hunches, partisan politics, and personal relationships.” How, then, can Mr. Orszag and Mr. Bridgeland possibly claim to be surprised by what they found when they went to Washington? And what inferences should we draw from their attitude?

The Authors Already Knew That the Federal Government Spends Unwisely

From childhood on, the authors’ own experience already ratified the idiocy of federal- government spending long before they set foot in Washington, D.C. They experienced Social Security withholding from their earliest paychecks. Their schooling taught them the rudiments of the Social Security system and its mandatory character. Orszag’s economics training introduced him to Paul Samuelson’s famous article rejoicing in the Ponzi-like, pay-as-you-go funding mechanism, which Samuelson considered a stroke of genius because the U.S. birth rate was then producing ever-larger streams of payers relative to recipients. And both authors have watched the ensuing baby bust drive the system into actuarial insolvency, bringing the day of default ever closer. Orszag and Bridgeland know only too well that Social Security has long been touted as the crown jewel of 20th-century liberalism’s welfare state. LIkewise, both men have observed Medicare and Medicaid approaching a similar fate after previously attaining similarly sacrosanct status. These entitlement programs are de facto examples of government spending even though they are off-budget in the technical accounting sense. After observing these examples, why should Messrs. Orszag and Bridgeland have been shocked by anything else they found?

“In other types of American enterprise, spending decisions are usually quite sophisticated,” the authors observe. They are referring to American business, the vineyard in which both toiled prior to government service and to which they retreated to recover from the shock of their exposure to profligacy and waste. Corporations formulate a capital budget, in which potential investment projects are evaluated by comparing the present value of their costs and benefits. Shareholders calculate the best alternative use of their money in investment of equal risk and compare it with their rate of return, enabling them to judge the wisdom of their investment choice. Sole proprietors gauge the best alternative use of their labor time – perhaps working as an employee – and compare it to the earnings from their business. These are the ways used to gauge the wisdom and effectiveness of spending decisions in the private sector.

We know these methods work well because the United States became the world’s leading economy midway through the 20th century after carving a small foothold on the North American continent in the 17th century. Other countries imitated our methods and enjoyed similar success. Countries rejecting our methods generally failed. Even the few Scandinavian countries that built successful welfare states did it by utilizing relatively free markets, while countries that moved away from free markets by nationalizing industry (such as Great Britain and Argentina) experienced drastic declines in their living standards).

The federal government – and government generally – has no rational method for evaluating its spending decisions. Private businesses spend money in order to create value for consumers. They gauge the success or failure of their spending by the size of their profits. The federal government ostensibly spends money to benefit the same people served by private business. But the federal government does not earn profit, thus cannot gauge its success by its profits. There is no true owner of its assets – when something is “publicly owned,” nobody owns it and nobody has an incentive to maintain it, husband its productive potential and maximize its value. The government does not normally sell its output to private citizens at prices that are free to fluctuate in accordance with the supply and demand for that output; thus, it cannot use price fluctuations to gauge the success of its efforts. Even if politicians wanted to, they have no way to gather the information necessary to tailor government spending to the desires of all their constituents, in the fashion of markets. Since no human being or institution possesses a complete picture of reality, both incentives and institutions must be favorably attuned to allow our subjective perceptions to satisfy individual wants. Free, competitive markets calibrate the key variables to produce this result while government fails utterly. The last thing politicians, bureaucrats and government employees can afford is a thoroughgoing analysis of government programs, their results and the reasons for them.

So politicians clasp hands earnestly to their breasts and swear to spend money for the benefit of “the 99%, not the 1%,” or “Main Street, not Wall Street.” That is, they profess “good intentions.” They pass baseline budgeting rules declaring that spending on federal programs must always rise by a certain percentage every year, no matter what (e.g., “inertia.”) Politicians spend money on electric cars and wind farms and ethanol subsidies because they have “hunches” that these measures are the wave of the future. First-year legislators are told that they must agree to support the spending programs of their incumbent colleagues in order to gain support for their own legislative proposals, thereby establishing “partisan politics” as a potent force behind wasteful spending.

The authors actually provide a specific example to bolster their choice of “personal relationships” as a roadblock to wise spending. In 2003, Bridgeland and officials at OMB judged that the Even Start Family Literacy Program was a waste of money. Why? Because the children and parents who participated in it showed no more gains in literacy than did those in a control group used for comparison. So the program was marked for elimination. “But Even Start was founded in 1989 by Bill Goodling, a well-liked Republican who had been the Chairman of the House Education and the Workforce Committee, and had previously served as a teacher, principal, and school superintendent in Pennsylvania. So Congress continued to fund this ineffective, if well-meaning, program to the tune of more than $1 billion over the life of the Bush administration.”

Orszag and Bridgeland left out a few important spending determinants from their list. For years, “fraud” and “abuse” have figured prominently in task-force reports on federal-government spending. Both men will recall the infamous “bridge to nowhere” of a few years ago. Fraud has risen to mammoth proportions in the Medicare and Social Security programs. Nothing was said about “graft” in the article, but the movie Mr. Smith Goes to Washington was released before both authors were born and it is safe to assume that both have seen it.

All in all, the faux outrage expressed by Orszag and Bridgeland lacks credibility. Their years of service in government allowed them to fill in the blanks of their indictment, but produced no other added value. They knew going in that the federal government was every bit as wasteful as they now portray it. Their disingenuous attitude – I’m shocked – shocked! – to find gambling going on here! – is borrowed from Claude Rains in Casablanca.

This is bad enough. Their proposed solution is worse. Citing “baseball’s transformation into ‘Moneyball’ as a case of private-sector spending sophistication, they aver that “the lessons of moneyball could make our government better.” You heard right. They don’t want to make government spend less. They want to make it spend better.

“Moneyball” in Government? Why Not “Nomoneyball?”

Orszag and Bridgeland maintain that “the moneyball formula in baseball – replacing scouts’ traditional beliefs and biases…with data-intensive studies of what skills actually contribute most to winning – is just as applicable to the battle against out-of-control health-care costs.” Their argument for assembling expert knowledge and applying it via central planning goes back at least as far as the “soviet of experts” advocated by institutional economist Thorstein Veblen in the early 1900s.

The problem is that it isn’t expert knowledge that is lacking as much as the “particular knowledge of time and place” conveyed by the price system and utilized best by the individual patient and doctor. That truth has already dawned on many doctors, patients and policymakers such as John Goodman of the National Center for Policy Analysis. Obamacare already embodies the demand for government-chosen best-practices medicine, but those choices will be made using the criterion of statistical significance. This is a recipe for disaster, since medicine in fields such as oncology has moved rapidly in the direction of individually tailored drugs and therapies rather than the “one-size-fits-all” approach implied by statistical regression. By its very nature, government action must involve coercion when flexibility and feedback are what is most urgently needed.

Thus, by applying the “moneyball” formula to health care, the authors are actually embracing the pretense of effectiveness in spending rather than the genuine article. They should be arguing for a return to the price system instead. “It is indisputable, however, that a move toward payments based on performance would harm some businesses. If most of your profits come from a medical device or procedure that …doesn’t work all that well, you’re likely to resist anyone sorting through what works and what doesn’t, never mind changing payment accordingly. Health-care interests are wise to invest millions of dollars in campaign contributions and lobbying to protect billions of dollars in profits.” The authors have just made the case against involving the government in health care and in favor of allowing free markets to work. Free markets are the best device ever invented for enforcing “pay for performance.” Leaving government out would eliminate campaign contributions and lobbying completely. As we will soon see, the authors’ method would accomplish none of these objectives.

The Moneyball Hook

The selection of “Moneyball” as the authors’ marketing hook reveals their lack of purpose. They try to persuade their readers by connecting emotionally rather than rationally. Moneyball was a tactic used successfully by one baseball team (the Oakland Athletics) during one pennant race. Its name derives from a book, but the authors picked it because of the successfully movie adapted from it.

Selling “free markets” would make perfect logical sense, since this is the same device that disciplines spending for thousands of businesses around the world. It has worked for centuries. But as a marketing concept, it has no sex appeal. No recent movie used it; no top-40 recording gyrated to it; no leading rap group is named for it. And the authors are only trying to sell a concept; they are not really trying to succeed in reducing spending or improving its quality.

How do we know the authors are not really trying? They tell us – not in so many words, but indirectly.

The System is Rigged Against Spending Changes or Reductions

The authors relate the history of so-called attempts to evaluate government-spending programs and jettison the ones that aren’t working. During the Clinton administration, the Government Performance and Results Act directed Congress “to provide for the establishment of strategic planning and performance measurement in the Federal Government.” The use of vague, circumlocutory language is a classic bureaucratic way of avoiding clarity and specificity – in this case, of avoiding commitment to eliminating wasteful spending. Sure enough, no link was established between performance assessments and continued funding by Congress.

The Bush administration, egged on by Bridgeland, established the Program Assessment Rating Tool (PART). This specifically identified programs that were not working as intended and tried to get them improved or discontinued.

Or did it? It seems that the assessment process has five possible outcomes. A program could be declared “effective,” “moderately effective,” “adequate” or “ineffective.” The fifth possibility was “results not demonstrated” due to insufficient data for evaluation. It is clear that four of the five possible outcomes were designed to justify continued funding, while even a rating of “ineffective” would not necessarily lead to termination of a program but would rather call for “improvement.” Not surprisingly, of the 1,000 programs assessed during Bush’s tenure, only 3% were adjudged “ineffective.” And Congress apparently ignored OMB’s recommendations to reform or abolish even that paltry percentage.

The reader might pause to consider that restaurants serving very good food go broke every day; an Internet review of “effective,” “moderately effective” or “adequate” would probably be the kiss of death in that business. And the people doing the rating have only their own inner fidelity to truth and honesty as an incentive to be honest in their evaluations – the institutional incentives for the federal government to discipline its own spending range from slim to none.

Beginning in 1990, the federal government has actually tested 11 large social programs, comprising some $2 billion in aggregate annual spending; using randomized controlled trials of effectiveness. The trials tested the results of spending by comparing the effects to those experienced by a control group who did not receive the benefits of the spending. 10 of the 11 programs showed either no effects on recipients or only a weak positive effect.

In some cases, programs were found to do positive harm. Government funding of so-called “Scared Straight” programs was found to “make kids about 12 percent more likely to commit a crime.” 21st Century Community Learning Centers, an afterschool program designed to improve academic performance of elementary-level students, has failed to affect academic outcomes but has increased the number of school suspensions and other behavioral infractions. Even this verdict of counterproductive was not enough to kill funding for the Learning Centers, which were saved by the intercession of then-gubernatorial candidate Arnold Schwarzenegger of California and are still receiving $1 billion in federal funds today.

Are the Authors As Mad As Hell? Are They Not Going to Take It Any More? Not Even Close

 

You might suppose that by now Messrs. Orszag and Bridgeland are mad as hell and aren’t going to take this any more. No, unlike Howard Beale, Network‘s “Mad Prophet of the Airwaves,” the authors are mildly irritated and ready to offer constructive alternatives. By golly, a non-profit organization called Results for America “is calling for reserving 1 percent of program spending for evaluation: for every $99 we spend on a program …we would spend $1 making sure the program actually works.” Don’t you just love those calls for action? Don’t you just love those non-profits?

“The more evidence we have, the stronger it is; and the more systematically it is presented, the harder it will be for lawmakers to ignore.” Uh… haven’t you just been telling us that they’ve done just that, for decades? “Still, linking evaluation to program funding will be tough, as both of us have seen in practice, again and again.” Aha. So the upshot of the authors’ ineffectual whining is that we’re supposed to do more of what’s conclusively failed in the past, but expect a different outcome this time. This is the operational definition of insanity – as if we weren’t already being driven insane by the actions of government gone wild.

Grasping at straws, the authors ask hopefully (drum roll, please):”What if we had a Moneyball Index, easily accessible to voters and the media, that rated each member of Congress on their votes to fund programs that have been shown not to work?” At ages 44 (Orszag) and 53 (Bridgeland), respectively, the authors are not too young to recall Sen. William Proxmire of Wisconsin, whose “Golden Fleece” awards were designed to attract media attention to Congressional spending projects that Proxmire felt were wasteful or even counterproductive. Awardees included a science grant to study why people fall in love, a study of Peruvian brothels (which proved particularly popular with its researchers) and a study of the buttock dimensions of airline stewardesses. (Proxmire’s awards were handed out from 1975 to 1987, when the job description of “airline stewardess” was still operative.)

The authors should ponder Proxmire’s fate. After a dozen-year run in which he actually succeeded in killing a few small-scale raids on the public treasury like the above examples, Proxmire’s career ended at age 74 in 1989. He didn’t retire due to age; his well-publicized physical-fitness regime made him perhaps the best-conditioned Senator. Instead, he was “retired” by the government-spending Empire, which struck back at him electorally when he finally lampooned a few too many of their pet projects. It should also be remembered that Proxmire, the scourge of wasteful spending, was a consistent supporter of dairy price-supports.

So much for “public shaming.” There is little point in shaming people who have no shame. Is there a group more institutionally bereft of shame than the U.S. Congress, whose poll approval rating hovers near single digits yet adamantly refuses to reform themselves?

Too Little, Too Late, Too Ineffectual

Figuratively speaking, Orszag and Bridgeland are canvassing the Titanic lifeboats to recruit passengers to go on iceberg watch. If there was ever a time to fussily insist upon substituting wise spending for wasteful spending, it expired nearly a century ago. Today, the Federal Reserve is directly buying new Treasury debt to the tune of a trillion dollars per year. Banks are husbanding $4 trillion or so in excess reserve accounts. The Fed has been desperately pegging short-term interest rates as close to zero as possible for years. It has not been trying to “stimulate the economy,” because it has encouraged banks to hold the reserves rather than loaning them out. (Had they been loaned out, we would have experienced hyperinflation.) Rather, it has been trying to buy time during which the Treasury can pay the lowest possible interest on outstanding debt, so as to keep interest payments from overwhelming the federal budget.

Orszag and Bridgeland should be advancing on the federal budget with a meat ax, intending to decapitate entire cabinet-level departments. They should be screaming at the top of their lungs in press conferences, not daydreaming about cutesy marketing ploys like “Moneyball” in the pages of a left-leaning opinion journal like The Atlantic (circulation: 400,000+). And they should have started their campaigns while still in government, not after bailing out to the private sector. The fact that two former “spending czars” – heads of CBO, OMB and DPA – were too timid to speak out against runaway spending while in government and still didn’t come within shouting distance of the whole truth years after leaving the bureaucracy tells us that there is no hope at all of reforming government from the inside. That is, the real shocker about this article is not even what the authors say; it is what they have refused to say.

What really motivated Orszag and Bridgeland to speak out? After all, they could have simply sat silent. Perhaps they were caught between two alternatives, like Buridan’s Ass. As members in good standing of the Establishment, they couldn’t simply up and admit that the federal government is one big welfare project – not for the purported beneficiaries, the program recipients, but for government employees who pick up paychecks while performing work of little or no true value. Yet neither could they do nothing while watching their country go down the drain. This half-hearted, empty-headed response was all they could muster.

DRI-326 for week of 9-1-13: Quantity vs. Quality in Economists

An Access Advertising EconBrief:

Quantity vs. Quality in Economists

Students of economics have long complained that economics texts focus too much on quantity and not enough on quality when evaluating goods. The same issue arises when comparing economists themselves. The career of Nobel Laureate Ronald Coase, who died this week at age 102, is a polar case.

Economists advance by publishing articles in prestigious, peer-reviewed journals. The all-time leader in the number of articles published is the late Harry G. Johnson. Despite dying young at age 53, Johnson compiled the staggering total of 526 published articles during his lifetime.

The use of advanced mathematics and abstract modeling techniques has enabled economists to rack up impressive publications scores by introducing slight mathematical refinements that add little to the substantive meaning or practical value of their achievement. When asked to account for the comparative modesty of a list of publications only one-fourth the size of Johnson’s, Nobel Laureate George Stigler countered, “Yeah, but mine are all different.”

Coase stands at the other extreme. His complete list of articles numbers fewer than twenty, but two of those are among the most-frequently consulted by economists, lawyers and other specialists, not to mention by the general public. He published a long-awaited, widely noticed book in 2012 despite having passed his centenary the year before. His life is an advertisement for the value of quality over quantity in an economist.

Another notable aspect of Coase’s work is its accessibility. In an age when few professional contributions can be read and understood by non-specialists, much less by interested non-economists, Coase’s work is readily comprehensible by the educated layperson. Now is the time to rehearse the insights that made Coase’s name a byword within the economics profession. His death makes this review emotionally as well as intellectually fitting.

Why Do Businesses Exist?

At 26 years of age, Ronald Coase was a left-leaning economics student. He pondered the following contradictory set of facts: On the one hand, socialists ever since Saint-Simon had advocated running a nation’s economy “like one big factory.” On the other hand, orthodox economists declared this to be impossible. Yet some highly successful corporations reached enormous size.

Who was right? It seemed to Coase that the answer depended on the answer to a more fundamental question – why do businesses exist? Be it a one-person shop or a huge multinational corporation, a business arises voluntarily. What conditions give birth to a business?

Coase found the answer in the concept of cost. (In his 1937 article, “The Nature of the Firm,” Coase used the term “marketing costs,” but the economics profession refined the term to “transactions costs”.) A business arises whenever it is less costly for people to organize into a hierarchical, centralized structure to produce and distribute output than it is to produce the same output and exchange it individually. And the business itself performs some activities within the firm while outsourcing others outside the firm. Again, cost determines the locus of these activities; any activity more cheaply bought than performed inside the firm is outsourced, while activities more cheaply done inside the firm are kept internal.

Like most brilliant, revolutionary insights, this seems almost childishly simple when explained clearly. But it was the first lucid justification for the existence of business firms that relied on the same economic logic that business firms themselves (and consumers) used in daily life. Previously, economists had been in the ridiculous position of assuming that businesses used economic logic but arose through some non-economic process such as habit or tradition or government direction.

Today, we have a regulatory process that flies in the face of Coase’s model. It implicitly assumes that markets are incapable of correctly organizing, assigning and performing basic business functions, ranging from safety to hiring to providing employee benefits. To make matters worse, the underlying assumption is that government regulatory behavior is either costless or less costly than the correlative function performed by private markets. As Coase taught us over 75 years ago, this flies in the face of the inherent “nature of the firm.”

The “Coase Theorem”

In mid-career, while working amongst a group of free-market economists at the University of Virginia, Ronald Coase made his most famous discovery. It assured him immortality among economists. Just about the best way to make a name for yourself is to give your name to a theory, the way John Maynard Keynes or Karl Marx did. But in Coase’s case, the famous “Coase Theorem” was actually devised by somebody else, using Coase’s logic – and Coase himself repudiated the use to which his work was put!

To appreciate what Coase did – and didn’t do – we must grasp the prior state of economic theory on the subject of “externalities.” Tort case law contained examples of railroad trains whose operation created fires by throwing off sparks into combustible areas like farm land. The law treated these cases by either penalizing the railroad or ignoring the damage. A famous economist named A. C. Pigou declared this to be an example of an “externality” – a cost created by business production that is not borne by the business itself because the business’s owners and/or managers do not perceive the damage created by the sparks to be an actual cost of production.

Rather than simply penalizing the railroad, Pigou observed, the economically appropriate action is to levy a per-unit tax against the railroad equal to the cost incurred by the victims of the sparks. This would cause the railroad to reduce its output by exactly the same amount as if it had perceived its sparks to be a legitimate cost of production in the first place. In effect, the railroad “pays” the costs of its actions in the form of reduced output (and reduced use of the resources necessary to provide railroad transport services), rather than paying them in the form of a fine. Why is the former outcome better than the latter? Because the purpose is not to hurt the railroad as retaliation for its hurting the farmer, the way one child hurts another in revenge for being hurt. A railroad is a business – in effect, it is a piece of paper expressing certain contractual relationships. It cannot feel hurt the way a human being can, so the fine may make the farmer feel better (if he or she received the fine as proceeds of a tort suit) but does not compensate for the waste of resources caused by having the railroad produce too much output. (“Too much” because resources will have to be devoted to repairing the damage caused by the sparks, and consumers value the resources used to do this more than the farmer values the loss.) In contrast, when the costs are factored into the railroad’s production decision, everybody values the resulting output of railroad services and other things as exactly worth their cost.

Of course, the catch is that somebody has to (1) realize the existence of the externality; and (2) calculate exactly how much tax to levy on the railroad to neutralize (or internalize) the externality; and then (3) do it. In the manner of a philosopher king, Pigou declared that this task should be assigned to a government regulatory bureaucracy. And for the next half-century (Pigou was writing in the early 1900s), mainstream economists salivated at the prospect of regulatory agencies passing rules to internalize all the pesky externalities that liberals and bureaucrats could dream up.

In 1960, Ronald Coase came along and gave the world a completely new slant on this age-old problem. Consider the following type of situation: you are flying from New York to Los Angeles on a low-price airline. You have settled somewhat uncomfortably into your seat, survived the takeoff and are just beginning to contemplate the six-hour flight when the passenger in front of you presses a button at his side and reclines his seatback – thereby preempting what little leg room you previously had. Now what?

This is not actually the example Coase used – it was used by contemporary economist Peter Boettke to illustrate Coase’s ideas – but it is especially good for our purposes. Using the same logic Coase applied to his examples, we reason thusly: It would be completely arbitrary to assign either of us a property right to the space preempted by the seatback. Why? Because the problem is not to stop bad people from doing bad things. Instead, we are faced with a situation in which ordinary people want to do good things that are in some sense contradictory or offsetting in their effects. On the airplane, my wish to stretch out is no more or less morally compelling than his to recline. The problem is that  we can’t do both to the desired extent at the same time without getting in each other’s way; e.g., offsetting each other’s efforts.

Indeed, this is true of most so-called externalities, including the railroad/farmer case. Case law usually treated the railroad as a nefarious miscreant imposing its will on the innocent, helpless farmer. But the railroad’s wish to provide transport services is just as reasonable as the farmer’s to grow and harvest crops. It is not unthinkable to enjoin the railroad against creating sparks – but neither should we overlook the possibility of requiring the farmer to protect against sparks or perhaps even not locate a farm within the threatened area. Indeed, what we really want in all cases is to discover the least-cost solution to the externality. That might involve precautions taken by the railroad, or by the farmer, or emigration by the farmer, or payment by the railroad to the farmer as compensation for the spark damage, or payment by the farmer to the railroad as compensation for spark avoidance.

 

In general, it is crazy to expect an uninvolved third party – particularly a government regulator – to divine the least-cost solution and implement it. The logical people to do that are the involved parties themselves, who know the most about their own costs and preferences and are on the scene. These are also the people who have the incentive to find a mutually beneficial solution to the problem. In our airline example, I might offer the man in front of me a small payment for not reclining. Or he might pay me for the privilege of reclining. But either way, we will bargain our way to a solution that leaves us both better off, if there is one. One of us would object to any proposed solution that did not leave him better off.

Of course, it would be useful for bargaining purposes to have an assignment of property rights; that is, a specification that I have the right to my space or that the man in front of me has the right to recline. That way, the direction of compensatory payments would be clear – money would flow to the right-holder from the right-seeker.

What if bargaining does not produce an efficient outcome, one that both parties can agree on? That means that the right-holder values his right at more than the right-seeker is willing to pay. But in that case, no government tax would produce an efficient outcome either.

On the airline, suppose that I value the leg room preempted by the reclining seat at $10. Suppose, further, that airline policy gives him the right to recline. If I offer him $6 not to recline, he will accept my offer if he values reclining at any amount less than $6 – say, $5. Notice that we are now both better off than under the status quo ante bargain. I get leg room I valued at $10 – or course, I had to pay $6 for it, but that is better than not having it at all, just as having the airline’s cocktail is better than being thirsty even though I had to pay $5 for it. He loses his right to recline, but he gets $6 instead – and reclining was only worth $5 to him. He is better off, just as he would be if he accepted an airline’s offer of $500 to surrender his seat and take a later flight, as sometimes happens.

We cannot even begin to estimate how many times people solve everyday problems like this through individual bargains. The world would be vastly better off if we were trained from birth in the virtues of a voluntary society where bargaining is a way to solve everyday disputes and make everybody better off. That training would stress the virtues of money as the lubricant that facilitates this sort of bargain because it is readily exchangeable for other things and because it is the common denominator of value. Instead, most of us are burdened by an instinctive tribal suspicion that money is evil and bargaining is used only to seek personal advantage at the expense of others. Experienced businesspeople know otherwise, but throughout the world the Zeitgeist is working against Coase’s logic. More and more, government and statutory law are held up as the only fair mechanism for resolving disputes.

University of Chicago economist George Stigler used Coase’s logic to devise the so-called Coase theorem, which says that when the transactions costs of bargaining are zero, the ultimate price and output results will be the same regardless of the initial assignment of property rights. This is true because both parties will have the incentive to bargain their way to an efficient improvement, if one exists. The assignment of property rights will affect the wealth of the bargainers, because it will determine the direction of the money flow, but economists are concerned with welfare (determined by prices and quantities), not wealth. No government regulatory body can improve on the free-market solution.

Coase disagreed with the theorem named after him – not because he disputed its logic, but because he foresaw the results. Economists would use it to look for circumstances when transactions costs were low or non-existent. Instead, Coase wanted to investigate real-world institutions such as government to compare its transactions costs to those of the market. He knew that real-world transactions costs were seldom zero but that government solutions almost never worked out as neatly in practice as they did on the blackboard. In fact, he invented the phrase “blackboard economics” to refer to solutions that could never work in practice, only on a theoretical blackboard, because real-world governments never had either the information or the incentive necessary to apply the solution.

Why China Became Capitalist

Ronald Coase devoted his last years to learning how and why China evolved from the world’s last major Communist dictatorship to the world’s emerging economic superpower. In Why China Became Capitalist, he and his research partner Ning Wang delivered an account that contravened the popular explanation for China’s rise. China’s ruling central-government oligarchy has received credit for the country’s emergence as the growth leader among developing nations. Since the Communist Party retained political control throughout the growth spurt, it must have been responsible for it – so the usual explanation runs. Coase and Wang showed that government’s presence as the agency in charge of political life does not automatically entitle it to credit for economic growth.

The death of Mao Zedong in 1976 rescued China from decades of terror, famine and dictatorship. Mao’s designated successor, Hua Guofeng, was an economist who outlined a program of state-run investment in heavy industry called the “Leap Outward.” This resembled the various Five-Year Plans of Soviet ruler Joseph Stalin in general approach and in overall lack of results. Hua’s successors, Deng Xiaoping and Chen Yun, abandoned the Leap Outward in favor of an emphasis on agriculture and light industry. Although Deng was the political figurehead who garnered the lion’s share of the publicity, Chen was the guiding spirit behind this second centralized plan designed to spur Chinese economic growth. It placed less emphasis on production of capital goods and more on consumer goods. Chen allowed state-controlled agricultural prices to rise in an effort to stimulate production on China’s collective farms, which had failed disastrously under Mao, resulting in approximately 40 million deaths from famine. He also allowed state-run enterprises a measure of autonomy and private profit, heretofore unthinkable under Communism.

Although these central-government measures were the ostensible spur to China’s remarkable growth run, Coase and Wang assign actual responsibility to the resurgence of China’s private economy. Private farms had always existed as part of the nation’s 30,000 villages and towns, much as neighboring Russians continued to nurture their tiny private plots of land alongside the Soviet collective farms. And, just as was the case in Russia, the smaller private farms began to outdo the larger collectives in productivity and output. Mao fanatically insisted on agricultural collectivization, but his death freed private farmers to resume their former lives.  By late 1980, the Beijing government was forced to officially acknowledge the private farms. In 1982, China formally abandoned its costly experiment with collective agriculture and de-collectivized its farms. Official grain prices were allowed to rise and grain imports were permitted.

Agriculture wasn’t the only industry that flourished at the local level. Small businesses in rural China labored under official handicaps; their access to raw materials was not protected and they had no officially sanctioned distribution channels for their output. But they bought inputs on the black market at high prices and groomed their own sales representatives to scour the nation drumming up business for their goods. These local Davids outperformed the state-run Goliaths; they were the real vanguard of Chinese economic growth.

Growth was slower in China’s major cities. Mao had sent some 20 million youths to the countryside to escape unemployment in the cities. After his death, many of these youths returned to the cities – only to find themselves out of work again. They demonstrated and formed opposition political movements, sometimes paralyzing daily life with their protests. This forced Beijing to permit self-employment for the first time – another Communist sacred cow sacrificed to political expediency. This, in turn, created an urban class of Chinese entrepreneurs. This led to yet another government reaction in the form of Special Economic Zones, somewhat reminiscent of the U.S. “enterprise zones” of the 1980s. Economic freedom and lower taxes were allowed to exist in a controlled environment; Chinese officials hoped to encourage controlled doses of capitalist prosperity in order to save socialism.

Gradually, the limited reforms of the Special Economic Zones became more general. Increased freedom of market prices was introduced in 1992, taxes were lowered in 1994 and privatization of failing state-run enterprises began in the mid-1990s. For the first time, China began to replace local and regional markets with a single national market for many goods.

Coase and Wang identify perhaps the most important but least-known capitalist element to arise in China as the improved pursuit of knowledge. They accurately attribute the recognition of knowledge’s role in economics to Nobel Laureate F.A. Hayek and note the increasing popularity of books and articles by Hayek, his mentor Ludwig von Mises and classical forebears such as Adam Smith. The economics profession has pigeonholed the subject of knowledge under the heading of “technical coefficients of production,” but the authors know that this is only the beginning of the knowledge needed to make a free-market economy work. The knowledge of market institutions and the dispersed, specialized “knowledge of particular time and place” that can only be collated and shared by free markets are even more important than technical knowledge about how to produce goods and services.

The upshot of China’s private resurgence has been to make the country a “laboratory for capitalist experimentation,” according to Coase and Wang. That laboratory has brewed a recipe for unparalleled economic growth since the 1990s, leading to China’s admittance into the World Trade Organization in 2001. The final piece of the puzzle, the authors predict, is a true free market for ideas – the one thing that Western economies have that China lacks. When this falls into place, China will become the America of the 21st century.

Thus did Ronald Coase add a landmark study in economic history to his select resume of classic works.

Quality vs. Quantity

Never in the history of economics has one economist achieved so much productivity with so little scholarly output. Ronald Coase economized on the scarce resources of time and human effort (ours) by devoting the longest career of any great economist to specializing in quality, not quantity, of work.

DRI-309 for week of 8-25-13: What Does ‘Social’ Mean Today?

An Access Advertising EconBrief:

What Does ‘Social’ Mean Today?

For decades, European political parties have rallied around the banner of “social democracy.” Today, Catholic churches throughout the world solemnly urge their congregants to work for “social justice.” Businesses have long been advised to practice “social responsibility.” Certain investment funds are now organized around the principle of “social investing.” Celebrities advertise the possession of a finely honed “social conscience.”

The rhetorical weight carried by the word “social” has never been heavier. Judging by this, one would suppose that the adjective’s meaning is well-defined and universally understood. Assuming that to be so, it should be relatively easy to explain its meanings above, as well as many other similar ones.

That turns out to be far from true. A great economist and social theorist called “social” the great “weasel word” of our time. In the words of the old popular song, how long has this been going on?

Well over two hundred years, believe it or not. The great English philosopher Lord Action accurately observed that, “Few discoveries are more irritating than those which expose the pedigree of ideas.” Those people who invoke the word “social” as a holy sacrament will be outraged to learn its pedigree. For the rest of us, though, the knowledge should prove illuminating.

“What is Social?”
One man above all others made it his business to learn the history and meaning of the word “social.” F.A. Hayek was a leading European economist before World War II, and among his friends were the Freiburg School of German economists who styled themselves the “Soziate Marktwirtschaft” or “Social Market” economists. Why, Hayek wondered, didn’t they simply call themselves “free-market” economists? What magic did the word “social” weave to gain precedence over the idea of freedom?

Over the years, Hayek morphed from world-class economist to world-renowned social philosopher. His fascination with the rhetorical preeminence of “social” eventually produced the article “What Is ‘Social?’ What Does It Mean?” It was published in 1957, then reworked and republished in 1961. In it, Hayek performed feats of semantic archaeology in order to expose the pedigree of “social” in economics and political philosophy.

Hayek’s research produced a scathing assessment. He declared that “the word ‘social’ has become an adjective which robs of its clear meaning every phrase it qualifies and transforms it into a phrase of unlimited elasticity, the implications of which can always be distorted if they are unacceptable, and the use of which…serves merely to conceal the lack of any real agreement between men regarding a formula upon which… they are supposed to be agreed.” It is symptomatic of “an attempt to dress up slogans in a guise acceptable to all tastes.” The word “always confuses and never clarifies;” “pretends to give an answer where no answer exists,” and “is so often used as camouflage for aspirations that have nothing to do with the common interest… .” It has served as a “magical incantation” and used to justify end-runs around traditional morality.

Whew. Can one word that is thrown around so casually and so widely really justify this indictment? Let’s briefly take one example of its usage and try on a few of Hayek’s criticisms for size.

The Example of “Social Justice”
A popular reference source (Wikipedia) has this to say about the concept of “social justice.” “Social justice is justice exercised within a society, particularly as it is applied to and among the various social classes of a society. A socially just society is one based on the principles of equality and solidarity;” it “understands and values human rights as well as recognizing the dignity of every human being.”

The origin of the phrase is ascribed to a Jesuit priest in 1840. It was used to justify the concept of a “living wage” in the late 19th century. The Fascist priest Father Coughlin (curiously, his Fascism goes unremarked by Wikipedia) often employed the term. It became a mainspring of practical Catholic teaching and of the Protestant Social Gospel. Social theorist John Rawls developed a theory of equity intended to give substance to a secular version of social justice.

We can easily locate all of the characteristics identified by Hayek even in this short précis. The definition of “social justice” as “justice exercised within a society” is tautological; this expresses the communal syrup that the word pours over every subject it touches. The “principles of equality and solidarity” sound satisfactorily concrete, but the trouble is that there are no such principles – unless you’re willing to sign off on the notion that everybody is supposed to be equal in all respects. “Solidarity,” of course, is the complementary noun to “social;” each purportedly sanctifies without really saying anything substantial. As such, solidarity became the all-purpose buzzword of the international labor movement. It implies fidelity to an unimpeachable ideal without defining the ideal, just as “social” implies an ideal without defining it.

The reference to “human rights” may well seem obscure to those unfamiliar with the age-old left-wing dichotomy between “property rights” and “human rights” – a false distinction, since all rights are human rights by implication. There may some day be a society that recognizes the dignity of every human being, but the sun has not yet shone on it. Thus, social justice illustrates Hayek’s reference to an underlying lack of agreement masked by a façade of universal accord. The roll call of dubious subscribers to the concept, ranging from Fascists to socialists to left-wing extremists and simplistic activists, dovetails perfectly with a concept of “unlimited elasticity,” which masquerades “in the guise acceptable to all tastes” as a “magical incantation” used to justify dubious means to achieve allegedly noble ends.

The Basic Uses of “Social”
Devotees of the various “social” causes have used the word in certain basic recurring ways. Each of them displays Hayek’s characteristics. We can associate these generic uses with specific “social” causes and government actions.

First, there is the plea for inclusiveness. As originally developed, this had considerable justification. As Hayek admitted, “in the last [19th] century…political discussion and the taking of political decisions were confined to a small upper class.” The appending of “social” was a shorthand way of reminding the upper classes that “they were responsible for the fate of the most numerous and poorest sections of the community.” But the concept “seems somewhat of an anachronism in an age when it is the masses who wield political power.” This is probably the dawn of the well-worn injunction to develop a “social conscience.” We associate the mid-19th century with famous “social” legislation ranging from the end of debtor’s prisons and reform of poor laws to the repeal of the Corn Laws in England.

Second, “social” is a plea to view personal morality abstractly rather than concretely by assigning to it remote consequences as well as immediate ones. For example, traditional ethics implores the businessman to treat his employees and customers fairly by respecting their rights and not hurting them. But “social responsibility” demands that businessmen know, understand and affect the consequences of all their buying decisions as well. They should refuse to buy inputs produced using labor that is paid “too little,” even though this benefits their own customers and workers, because it ostensibly hurts the workers who produce those inputs.

This stands the economic logic of free markets on its head. Businessmen are experts on their own business and the wants of their customers. Free markets allow them to know as little as possible about the input goods they buy because this economizes on information – which is scarce – and on the use of businessmen’s time – which is likewise scarce. But the illogic of “social responsibility” demands that businessmen specialize in learning things it is difficult or impossible for them to know instead of things they normally learn in the course of doing business. This is so absurdly inefficient it is downright crazy; instead of doing what they do best, businessmen are supposed to divert their attention to things they know little about and disregard the value generated by the free market.

The crowning absurdity is that “socially responsibility” expects businessmen to accept on faith the assertions of activists that buying goods produced with low-wage labor hurts the workers who produce those goods. And this is dead wrong, since it does just the opposite – by increasing the demand for the goods labor produces, it increases the marginal product of labor and labor’s wage. The same illogic is sometimes extended even farther to consumers, who are even less well placed to gauge the remote consequences of their personal buying decisions and, thus, are even more at the mercy of the bad economics propounded by “social” theory activists.

Thirdly, “social” theory demands that government also reverse its traditional ethical role by treating individuals concretely rather than abstractly. The traditional Rule of Law requires government to judge individuals by abstract rules of justice – and that the same abstract rules apply to all individuals. But “social justice” requires government to judge individuals according to their respective merits, which requires treating different individuals by different rules; e.g., repealing the traditional Rule of Law. Contemporary examples of this repeal abound: affirmative action, bailouts for firms adjudged “too big to fail,” eminent domain for the benefit of private business, augmented rights granted to certain politically identifiable groups while basic rights are denied to others, and on and on, ad nauseum.

Finally, “social” theory clearly implies the upsetting of traditional morality by the substitution of “social” criteria for traditional moral criteria. Although it seems superficially that traditional moral criteria are without rational foundation, this is misleading. In fact, those criteria evolved over thousands of years because they were conducive to a successful order within humanity. As the Spanish philosopher Ortega y Gasset reminds us, “order is not a pressure imposed on society from without, but an equilibrium which is set up from within.” The word “equilibrium” implies the existence of change which culminates in a new, improved order. Social evolution is thus comparable to economic equilibrium, in which new goods and services are subject to a market test and accepted or rejected. Surviving moral criteria are abstract rules that may not benefit every single individual in every single case but that have demonstrated powerful survival value for humanity over thousands of years. And these rules are subject to a powerful evolutionary test over time.

In contrast, “social” theory substitutes the concrete, ad hoc rules adapted to each situation by self-appointed social theorists. These self-appointed experts reject free competition in both economics and political philosophy; thus, these social theories do not receive the same rigorous evolutionary tests that vetted traditional morality.

Both the impersonal workings of the free economic market and the abstract, impersonal workings of the “market” for morality and social philosophy seem to be harsh because there is no inherent spokesman or advocate to explain their operation to the public. Economists have failed to perform this task for free markets, while the influence of moral arbiters like clergymen and philosophers has waned in recent decades. The plans of “social” theorists appear to be kind because they are designed with appearance in mind rather than to actually attain the results they advertise.

Corollaries to the Uses of “Social”
Certain corollary effects of these uses are implied and have, in fact, emerged. When the appeal to the communal of “social” effects of our actions predominates over our personal actions, our personal responsibility for our own lives and welfare erodes. And sure enough, the widespread reluctance to take responsibility for individual actions is palpable. Why should we take responsibility for saving when the federal government takes our money by force for the ostensible purpose of saving and investing it for our individual retirement uses? Thus does saving decline, asymptotically approaching zero. Why should we accept responsibility for our own errors when we are forced to take responsibility for the errors of others by taxation, criminal justice, economic policy and a host of other coercive actions by government? Hence the growing tendency to claim universal “rights” to goods and services such as food, health care, housing and more.

The irony is that each of us is the world’s leading expert on our self. “Social” policy forces us to shoulder responsibility for people and things we aren’t, and can never be, expert on, while forswearing responsibility for the one person on whom our expertise is preeminent. In economic terms, this cannot possibly be an efficient way to order a society.

This leads to another important point of information theory. The demands of “social” theory imply that certain select individuals possess talents and information denied to the rabble. These are the people who decide which particular distribution of income or wealth is “socially just, which business actions are or aren’t “socially responsible, what linguistic forms are or aren’t “socially aware,” and so forth.

The elevation of some people above others is practiced predominantly by government. In order to reward people according to merit, government must in principle have knowledge about the particular circumstances of individuals that justify the rewards (or deny them, as the case may be). In practice, of course, government is so distant from most individuals that it cannot begin to possess that kind of knowledge. That is why the concept of group rights has emerged, since it is often possible to identify individual membership in a group. Race, gender, religion, political preference and other group affiliations are among the various identifiers used to justify preferential treatment by government.

The blatant shortcomings of this philosophy have now become manifest to all. One need not be a political philosopher steeped in the Rule of Law to appreciate that envy now plays a pivotal role in politics and government. Rather than concentrate on producing goods and services, people now focus on redistributing real income and wealth in their own favor. This is the inevitable by-product of a “social” theory focused on fairness rather than growth. The laws of economics offer a straightforward path toward growth, but there is no comparably unambiguous theory of fairness that will satisfy the competing claimants of “social” causes.

And once again, the shortcomings of “social” theory as magnified by a further irony. For decades, government welfare programs have been recognized as failures by researchers, the general public and welfare recipients themselves. Only “social theorists,” bureaucrats and politicians still support them. This is bad enough. But even worse, the rejection of free markets by “social” theorists has eliminated the only practical means by which individual merit might be used as the basis for compensatory social action. Although you are the world’s leading expert on you and I am the leading authority on me, you will sometimes gain authoritative information about me. By allowing you to keep your own real income and the freedom to utilize it as you see fit, I am also allowing to conduct your own personal policy of “social justice.” This concept of neighborhood or community charity is one form of tribalism that has persisted for thousands of years because it is clearly efficient and has survival value. Yet it is one of the first victims of government-imposed “social justice.” Bureaucrats resent the competition provided by private charity. Even more, they resent watching money used privately when it could have been siphoned off for their own use.

Socialism
What is the relation between the adjective “social” and the noun “socialism?” Socialism had roots traceable at least to the Middle Ages, but its formal beginnings go back to the French philosophers Saint-Simon and Comte in the 18th century. It was Saint-Simon who visualized “society” as one single organic unity and longed to organize a nation’s productive activity as if it were one single unified factory.

It is this pretense that defines the essence of socialism and the appeal of its adjectival handmaiden, “social.” Participation in the sanctifying “social” enterprise at once washes the participant clean of sin and cloaks pursuit of personal gain in the guise of altruism and nobility. It makes the participant automatically virtuous and popular and “one with the universe” – well, part of a subset of like-minded people, anyway.

Socialism sputtered to life in 19th-century revolutionary Europe and enjoyed various incarnations throughout the late 19th and 20th centuries. It has failed uniformly, not just in achieving “the principles of equality and solidarity” but in providing goods and services for citizens. Failure was most complete in those polities where the approach to classical socialism was closest. (In this regard, it should be remembered that the Scandinavian welfare states fell far short of Great Britain on the classic socialist criterion of industrial nationalization.) Yet socialism as an ideal still thrives while capitalism, whose historical preeminence is inarguable, languishes in bad odor.

Hayek’s criticisms of “social” explain this paradox. Socialism’s shortcomings are its virtues. Its language encourages instant belief and acceptance. It smoothes over differences, enveloping them in a fog of good feeling and obscurantism. It promises an easy road to salvation, demanding little of the disciple and offering much. Words are valued for their immediate effects, and the immediate effects of “social” are favorable to the user and the hearer. True, it is an obstacle to clear thinking – but when the immediate products of clear thinking are unpalatable, who wants clear thinking, anyway?

“Social” keeps the ideal of socialism alive while burying its reality. As long as “social” prefaces anything except an “ism,” the listener has license to dissociate the adjective from the noun and luxuriate in the visceral associations of the former while ignoring the gruesome history of the latter.

Just One LIttle, Itsy-Bitsy, Teeny-Weenie Word
F.A. Hayek closed his essay on “social” by saying, “it seems to me that a great deal of what today professes to be social is, in the deeper and truer sense of the word, thoroughly and completely anti-social.” Hayek was right that “such a little word not only throws light upon the process of the evolution of ideas and the story of human error, but … also exercises an irrational power which becomes apparent only when… we lay bare its true meaning.”

Who would have dreamed that one word could say so much?

DRI-312 for week of 8-18-13: Understanding Risk, Benefit and Safety

An Access Advertising EconBrief:

Understanding Risk, Benefit and Safety

The mainstream press has propagated an informal historical narrative of safety in America. Prior to the Progressive era and the advent of muckraking journalism, the public lay at the mercy of rapacious businessmen who knowingly produced unsafe products and unwholesome foods in order to maximize their personal wealth. Thanks to the unselfish labors of investigating journalists and the subsequent creation of government regulatory agencies, products and foods became safe for the first time.

Now regulators and the press fight a never-ending battle for safety against the forces of greedy capitalism. Alas, there are so many industries and goods to regulate and so little time and money in the federal budget with which to do it.

In order to appreciate the full falsity of this doctrine, we must grasp the economic meaning of concepts like risk, benefit and safety. A good route to this goal lies through our own inner sense of the logic of human behavior.

A Reductio Ad Absurdum

To highlight the concepts of risk, benefit and safety, consider the following example. It is a reductio ad absurdum – an example “reduced to absurdity” in order to eliminate extraneous considerations and shine a spotlight on a few insights.

Assume you have only one day left to live – exactly twenty-four hours. You are aware of this. You are also aware that your death will be instantaneous and painless and your vitality, faculties and awareness will remain unimpaired up to your last second of consciousness. How will this affect your behavior?

A little thought should convince you that the effect will be profound. You have only one day left to wring whatever excitement, enjoyment and satisfaction you can from life. Will that day be business as usual, awakening at the normal time and departing to work at your job? Unless you work at one of the world’s most stimulating and fulfilling jobs, the last thing you will want is to spend your final day on Earth at work.

Instead, you will devote your time to the most intense and meaningful pleasures. These may be physical or mental, aesthetic or gastronomic, boisterous or sedate. The word “pleasure” inevitably evokes the notion of hedonism in some people, but this need not apply here. The pleasures you seek during your last day may be sensual but they may just as easily be as cerebral as reading a book or as contemplative as observing a sunset. Your personal selections from the vast menu of choice will be highly subjective, in the sense that my choices might very well differ drastically from yours. In spite of this, though, the example affords highly useful insights about economics – particularly the concepts of risk, benefit and safety.

Economic Benefit

The first conclusion to emerge from our artificial but enlightening example relates to the nature of economic benefit. In recent decades, a Martian studying Earth by scanning its news media transmissions and publications might well conclude that the benefit of human existence derives from work. After all, politicians and commentators yammer endlessly about the glories of, and necessity for, “jobs, jobs, jobs.” Taking this preoccupation at face value implies that work, in and of itself, is what makes life worthwhile. The obiter dicta of the rich and famous, who recklessly profess such heartfelt love for their profession that they would practice it for nothing, reinforce this impression.

Our example, though, shatters this shibboleth. Economic value inheres not in work but rather in the things that work produces, which produce pleasure and satisfaction when consumed. It is certainly possible to love one’s work, but it is not coincidence that the people who love it the most are the ones most highly compensated for it; their earnings can purchase the most satisfaction and pleasure. It is a famous truism that nobody’s deathbed reflections are mostly regrets at not spending more time at the office.

Risk

Ever since the pathbreaking work of economist Frank Knight some ninety years ago, economists have defined risk as mathematically expressed variance of possible future outcomes. Uncertainty, the first cousin of risk, applies when the future outcomes vary in ways not susceptible to mathematical expression. For our purposes, however, we will view risk colloquially, as the possibility of unfavorable future outcomes.

Again, it should be obvious that the prospect of death in twenty-four hours’ time will radically affect your attitude toward risk and benefit. You are out to grab all the gusto you can get in the day you have left. From experience, we realize that the pursuit of pleasure can involve some element of risk. For example, the most hair-raising rollercoaster ride may well provoke the most pleasurable response. But it may also produce nausea, vertigo and unsteadiness. There is even the risk of injury or death if the mechanism malfunctions or you somehow are thrown from the ride.

If you are the kind of person who enjoys rollercoasters, you will be undeterred by their risk in our special case. You are certainly not going to pass up this big thrill for fear of a one-in-a-hundred-million chance of death – you’re going to be dead tomorrow anyway! On the other hand, you might well refuse to ride the coaster with your safety belt unbuckled for the first twenty-three hours of your last day. You don’t want to take foolish risks and waste most of your last day. But you might well reverse that decision during your final hour, especially if you always wondered what it would be like to take that ride unbuckled. You certainly aren’t risking much for that thrill, are you, with only minutes left to live?

Safety

Safety is best understood as reduction in risk or uncertainty. In colloquial terms, it is time and trouble taken to reduce the likelihood of unfavorable outcomes. Put in those terms, the equivocal nature of safety is clear. It demands the sacrifice of time – and time is just what you have so little left of. Why should you take much trouble reducing the likelihood of an unfavorable outcome when you will experience the most unfavorable outcome of all within twenty-four hours? Every second of time you spend on safety reduces the time you could be spending experiencing pleasure; every bit of trouble you take avoiding risk lowers your potential for happiness during the dwindling time you have left.

Now is the time for you to go hang gliding, even launching off a mountain top if the idea takes your fancy. Bungee jumping is another good candidate. In neither case will you spend an hour or two inspecting your equipment for defects or weakness.

Of course, we know that safety is a significant concern for all of us in our daily lives. That is one of the changes introduced by the reversion to reality in our model. Comparing reality to the polar extreme of our reductio ad absurdum outlines the continuum of risk, benefit and safety.

The Reality of Risk, Benefit and Safety

Reality differs from our artificial example in key respects. Although a relative few of us actually do have only twenty-four hours to live, only a tiny few of that few know (or suspect) the truth. And of those, virtually none have the freedom and vitality accorded our example individual. That clearly affects the central conclusions reached by our model – that the individual would seek out pleasure, eschew work, embrace risk if doing so heightened pleasure significantly and “purchase” little safety at the cost of foregoing pleasure.

We observe, and instinctively realize, that most people must work in order to earn income with which to buy pleasurable consumption goods. They tend to be “risk-averse” within relevant ranges of income and wealth; that is, they will buy a lottery ticket but not play roulette with the rent money. They value safety, but nowhere nearly to the extent implied by the mainstream news media and politicians. In a world of work and production, safety is produced using time and physical resources, which reduces the value of pleasurable goods produced because that time and those resources cannot then be used to produce pleasure. Thus, safety production adds to the money cost and price of consumption goods, which creates a tradeoff between safety and purchasing power. Nobel Laureate George Stigler once colorfully averred that he would rather crash once every 500,000 takeoffs than pay a fortune to fly between major U.S. cities.

In other words, the insights gained from our reductio ad absurdum turn out to be surprisingly useful. We merely have to adjust for the length, variability and unpredictability of actual life spans in order to predict the general character of human behavior in the face of risk. And when we apply these adjustments retroactively, we appreciate how badly astray the mainstream historical view of safety has led us.

Rewriting (Pseudo) History

The mainstream view contains at least a grain of truth in its suggestion that the emphasis on safety is a modern development. But the blame attached to profit-hungry capitalists is wrongheaded. This is not because capitalists aren’t profit-hungry; they most certainly are. But the hunger for profits has always been strong even as the production and consumption of safety have varied. Profit-hunger did not suppress safety for centuries, could not prevent the demand for safety from arising and cannot put it back into the bottle now that it has emerged.

The industrial revolution and the rise of free markets created a tremendous increase in human productivity, thereby increasing real incomes throughout the world. The increases were not uniform; certain countries benefitted much more, and faster, than others. The higher incomes increased the demand for safety and for medical research, which in turn led to tremendous gains in life expectancy.

Longer life spans increased the demand for safety even more. This is our reductio ad absurdum played out in reverse. The longer we expect to live, the more future value we are safeguarding by sacrificing present pleasure with our “purchases” of safety. Prior to the 20th century, with life expectancies at birth not much over 50 years even in the developed industrial nations, it didn’t pay to make great sacrifices in current consumption to safeguard the safety of many people whose longevity was limited anyway. But as life expectancy steadily lengthened – particularly for those in the later stages of life – the terms of the tradeoff changed dramatically.

Risk Compensation

Another factor that greatly affects the balance between risk and safety also emerged in our artificial example. We noted that many of the pleasure-producing human activities carry risk along with their beneficial properties; indeed, therisk itself may even be the source of pleasure. This is true of a wide range of human pursuits, ranging from the rollercoaster rise in our model to auto racing, casino gambling and bungee jumping. Some pastimes such as mountain climbing and hang gliding may produce secondary benefits like physical fitness to supplement their primary purpose of slaking a thirst for risk.

Mainstream society has traditionally viewed risky activities ambivalently. It has tolerated some (mountain-climbing) and frowned on others (gambling, illicit drug-taking) without acknowledging the bedrock similarity common to all. That failure has not only caused much needless death and suffering but has also endangered our freedoms.

Strongly influenced by mid-century muckraker Ralph Nader’s research on the Chevrolet Corvair (later discredited), the U.S. Congress passed legislation beginning in the 1960s requiring American automakers to include safety equipment on all vehicles as standard equipment rather than optional extras. Those safety features included safety belts and, eventually, crash bags. Starting in 1975, University of Chicago economist Sam Peltzman published studies of the results of this legislation. His work showed that any lives that might have been saved among occupants of vehicles tended to be offset by lives lost among pedestrians, cyclists and other non-occupants. That was not to deny the existence of a trend toward fewer highway vehicle deaths. Indeed, that trend had been underway well before the safety legislation was passed owing to factors such as improvements in vehicle design, production and maintenance. Sorting out the effects of this trend from those of the legislation required considerable statistical effort, not to say guesswork.

But the existence of a countervailing force was clear. Peltzman suggested that the safety devices made people feel safer, causing them to drive less carefully. This might be due to increased carelessness or a willingness to embrace a certain level of risk when driving, which caused them to compensate for their increasedlevel of personal protection by taking additional driving risks.

Politicians, regulators and do-gooders of all sorts went ballistic when confronted with Peltzman’s conclusions. How dare he suggest that federal-government safety legislation was anything less than a shining example of nobility and good intentions at work? Rather than ponder the implications of his analysis, they hardened their position. Not only did they force businesses to produce safety, they began forcing consumers to consume safety as well. This campaign began with mandatory seat-belt legislation requiring first drivers, then passengers and eventually children to wear seat belts while vehicles were in operation.

Essentially, the implications of the regulatory position were that markets are dysfunctional. In a competitive market, producers not only produce automobiles that provide transportation services, they also provide various complementary features for those autos. One of those features is safety. (In fact, virtually every safety feature was offered by private auto companies before it was required by the government.) Consumers can patronize auto companies and models that provide the most and best safety features, such as seat belts, air bags, anti-lock brakes and more. They can also reject those that omit safety features. Or consumers can choose to reject safety features by buying autos that lack them. Why would they do that? The obvious reason is that safety features require physical resources and engineering talent to provide, making them costly. Consumers may not wish to pay the cost.

By overriding producer decisions and consumer preferences, regulators in effect assert that markets do not work and government commands should replace the voluntary choices made in the marketplace. One obvious problem with this approach is that it creates momentum in the direction of a centrally planned, totalitarian economy and away from a voluntary, free-market one. But for those who believe that the end justifies the means, the loss of freedom may be justified by the greater safety resulting from the regulatory command-and-control approach.

As time went on, however, it became clear that the regulatory approach was not achieving the results claimed for it. Not only were markets being circumvented, but the regulatory nirvana of a risk-free world was no closer to reality. How could this be? What was going wrong?

As far back as 1908, the British equivalent of America’s Auto club urged landowners to cut back their hedges to improve visibility for drivers of the newly invented automobile. A retired Army colonel responded to this appeal by noting that this hedge-trimming had caused unintended consequences: his lawn had been filled with dust caused by zooming motorists who exceeded speed limits and skidded into his yard. When detained by police, the offenders maintained that “it was perfectly safe” to drive so fast because visibility was clear for a long distance. So the colonel changed his mind and let his shrubs grow in order to deter the speeders.

Following Sam Peltzman’s lead, researchers in succeeding decades discovered a myriad of analogous phenomena. The proliferation of wilderness- and mountain-rescue teams induced hikers and climbers to take more and bigger risks, thus assuring that deaths and injuries from hiking and climbing would not decline despite the increase in resources devoted to rescue. Parachute manufacturers built superior rip cords, but chutists pulled the rip cord later because they were more confident of the cord’s resilience. The result was stability of death rates for sky divers. Stronger levees did not reduce the incidence of death, injury and damage from floods because people were induced to remain in floodplain areas rather than move out. Indeed, the desirability of these locations meant that more people moved in when they became more safe, leading to even more deaths, injuries and damage when a flood did occur. Workers who began wearing back supports still suffered injuries from lifting because the safety supports encouraged them to life heavier loads – which overcame the effect of the supports. Research on children who began wearing more protective sports equipment consistently showed that the kids responded by playing more roughly, overriding the benefits of the equipment and continuing the trend toward injuries. Better contraceptives and more effective medical treatments for HIV infection encouraged people to engage in riskier sexual practices, thereby preventing infection rates from declining as much as expected.

The technical term for all these cases is risk compensation. The general public and those with vested interests in government regulation tend to scoff at the concept, but its presence has been confirmed so repeatedly that it is now conventional wisdom. According to the popular purveyor of mainstream science, Smithsonian Magazine, “This counterintuitive idea was introduced in academic circles several years ago and is broadly accepted today…today the issue is not [about] whether it exists but about the degree to which it does.”  We see it “in the workplace, on the playing field, at home, in the air (“Buckle Up Your Seat Belt and Behave,” April 2009, by William Ecenberger).”

The implications of this research for even so widely venerated a government policy as mandatory seat-belt use are startlingly negative. People inclined to use seat belts are unaffected by the laws, but unwilling wearers who are forced to buckle up are presumably risk-loving types. When their seat belts are firmly in place, they will take more driving risks – after all, they must have had a reason for refusing the belt in the first place and risk-preference is the logical explanation. It follows, then, that they must feel safer when buckled in, which implies that they will try to return to their preferred status of risk tolerance. And studies of seat-belt mandates by economists do tend to show this result.

Risk compensation is so widely accepted among scientists outside of government that a Canadian psychologist has carried it to a logical extreme. Gerald J. S. Wilde propounds the philosophy of risk homeostasis, which posits that human beings automatically adjust their behavior to keep their exposure to risk at a constant level, just as the human body regulates its internal temperature at 98.6 degree Fahrenheit despite variations in external conditions.

The Economic View of Risk

We need not carry belief in adjustment to risk this far in order to recognize the futility of government attempts to fit society into a one-size-fits-all risk-free straitjacket. Not only is it a blatant violation of freedom and free markets, it doesn’t even achieve its intended objectives. It is wrong in theory and wrong in practice.

Risk is not an unambiguous bad thing. It is an unavoidable fact of life toward which different people take widely varying attitudes. For some people, risk is a benefit in and of itself. For practically everybody, risk is a by-product of other beneficial products and activities. Free markets give the most scope for the satisfaction of those different attitudes by allowing the risk-averse to avoid risk and the risk-loving to embrace it – and enabling both groups to do so efficiently via the price system.

Those who claim to see a role for government in allowing the risk-averse to avoid risk are practitioners of what Nobel Laureate Ronald Coase calls “blackboard economics.” This is favored by policymakers standing at a figurative blackboard and divorced from the real-world costs and complications of actually putting their government intervention into operation. In practice, risk and safety policies are delegated to regulators who issue orders and run roughshod over markets. The end result benefits regulators by increasing the size and power of government. The rest of us are stuck with obeying the regulations and picking up the tab.

DRI-300 for week of 7-28-13: Was Detroit’s Fall ‘Just One of Those Things That Happens Now and Then’ to ‘An Innocent Victim of Market Forces’?

An Access Advertising EconBrief:

Was Detroit’s Fall ‘Just One of Those Things That Happens Now and Then’ to ‘An Innocent Victim of Market Forces’?

Last week’s EconBrief analyzed Detroit’s precipitous decline from America’s most prosperous city to Chapter 9 bankruptcy. The most popular explanation ascribes the event to 20th-century liberalism, which reigned unchallenged over the city throughout its financial death spiral. When a city is named the most liberal in America, as Detroit was by the BayAreaCenter for Voting Research, political philosophy becomes the prime suspect at its post-mortem.

Still, there have been prominent dissenters. Former Michigan governor Jennifer Granholm called Detroit a victim of “free trade.” Presumably, she refers to the international trade in automobiles that increasingly brought foreign models – especially Japanese cars – to prominence in the U.S. Even more significant were the comments of Nobel laureate Paul Krugman, economist and columnist for the New York Times. In his column of 07/27/2013 entitled “When It Comes to Detroit, Greece Is Not the Word” and subtitled “Victims of Creative Destruction,” Krugman lamented the fact that Detroit’s bankruptcy would occasion comparisons to the financial default of Greece.

Greece’s circumstances were unique and not comparable to those of other countries, Krugman contended. Moreover, Greece’s small economy – “about 1 ½ times as big as metropolitan Detroit” – did not affect the rest of the world much. Consequently, it was wrong to use Greece’s problems as an excuse to cry wolf about government deficit spending. Thus, it must be just as wrong to cite Detroit as a model for municipal excess. For example, U.S. state and local government-employee pensions are only underfunded by about one trillion dollars, Krugman contended. He cited a BostonCollege study as his source for this figure, which is only about one-third the size of conventional estimates.

Having established Greece as an isolated case, Krugman appears poised to do likewise for Detroit – but no. “So was Detroit just uniquely irresponsible? Again, no. Detroit does seem to have had [sic] especially bad governance, but for the most part, the city was just an innocent victim of market forces.” Reading Krugman on Detroit’s political leadership suggests that, had Krugman strolled through Hiroshima the day after the atomic bomb was dropped, his reaction would have been that an especially large bomb seemed to have fallen in the middle of the city.

Krugman plays it coy about just which “market forces” victimized Detroit, but he has no scruples about reminding us that they can be brutal. “…Sometimes whole cities…lose their place in the economic ecosystem…,” he lectures sternly. And when that happens? That is when we pull out the big gun in the liberal arsenal: we need to “have a serious discussion about how cities can best manage the transition when their traditional sources of competitive advantage go away. And let’s also have a serious discussion about our obligations, as a nation, to those of our fellow citizens who have the bad luck of finding themselves living and working in the wrong place at the wrong time.”

Detroit, according to Krugman, isn’t “fundamentally a tale of fiscal irresponsibility and/or greedy public employees…it’s just one of those things that happen now and then in an ever-changing economy.”

It is deeply ironic that, of the two commentators, it was the politician who referred explicitly to international trade. After all, Paul Krugman won his Nobel Prize for work in the field of international trade theory. Yet he referred to that subject only obliquely in his column. That is the clue to the profound intellectual dishonesty of these two commentaries. The politician lied about a subject on which politicians lie reflexively. The economist avoided a subject in which he is supremely qualified because he had no intention of telling the truth and could not bear to trash his reputation by lying outright.

America’s Unfree International Trade in Automobiles
The effects of international trade in automobiles can be seen daily zooming across the roadways of America. The Toyota is one of the most popular automobiles in America. But this is hardly the outcome of free trade in automobiles. Free trade is defined as the absence of such impediments to international trade as tariffs (taxes) and quotas. No sooner did foreign-car makers such as France’s Renault and Sweden’s Volvo enter the U.S. market in the 1960s than they were besieged with tariffs at the behest of Detroit.

When Japanese automakers like Honda, Toyota and Nissan began to loosen the stranglehold of the Big Three on the U.S. market in the 1970s, Congress erected a tariff wall against foreign-car imports. This was even extended to include a quota of one million Japanese-car imports. Amazingly, tariffs remain in force to this day in the form of a 2.25% tariff on Japanese-car imports and a 25% truck tariff.

Doubtless Ms. Granholm was relying on the notoriously poor memories of Americans when she cited free trade as the cause of Detroit’s woes. But it isn’t necessary to be a student of U.S. commercial policy in order to know she is lying. Today, nearly two-thirds of Toyotas sold in America are not shipped to America from Japan. They are assembled right here in the USA in places like Tennessee and Alabama. Why did Japanese automakers take the time and trouble to build auto plants here in the U.S.? In order to escape our import barriers. Direct foreign investment is a classic ploy to overcome tariffs and quotas. Honda was the first Japanese automaker to build a U.S. plant, followed soon by Toyota in the early 1980s.

Not only do domestic manufactures escape the penalties levied on imported goods, they also escape the criticism often leveled at purchases of foreign goods. The same people who scream and holler about American jobs being exported to Japan by “globalization” (today’s pejorative buzzword for free trade) can hardly complain when the Japanese build a U.S. plant that employs U.S. workers. The same chauvinists who demand that we “buy American” can’t very well complain when we buy American-made Toyotas.

It is true that production tends to migrate to its least-cost locus. But transport costs have been falling, not rising, for decades – that is why containerization has become so popular. Before tariffs, the Japanese made cars in Japan and shipped them here. Only after tariffs were imposed did it become efficient to move production to the U.S., where the Japanese had to strain to acclimate U.S. workers to their legendary production methods.

Sharp-eyed readers noticed the word “assembled” used to describe the process by which automobiles are made. Today, the hundreds of parts that comprise an automobile are manufactured throughout the world. They are shipped to automobile plants for final assembly into the finished product. So-called “American” cars like Fords, Chryslers and GM products may well contain fewer American-made parts than do Toyotas and Hondas. To an economist, what matters is that the final product be produced at least cost and that all trade reflects the comparative or “opportunity” costs of producing the products traded. Free trade reflects those costs while tariffs and quotas distort them.

No, it wasn’t free trade that drove General Motors and Chrysler to virtual bankruptcy. It was a combination of factors, one of which was the ability of competitors to overcome the protectionist barriers thrown up by Detroit’s political influence.

Similar logic defeats the comment made by another left-wing onlooker that “capitalism failed Detroit.” The Big Three benefitted from numerous federal-government bailouts even before 2008. Chrysler enjoyed one of the very first federal-government bailouts in 1980, thanks to the charisma and clout of Lee Iacocca. Of course, this was the antithesis of capitalism (but the epitome of “crony capitalism.”) Really, what Ms. Granholm means by “free trade” is freedom itself; e.g., the absence of government coercion and constraint. As we discover below, this is exactly what Detroit did not experience during its painful decline.

Why Krugman Could Not Say What He Implied
Krugman’s comments about “just one of those things” and “an innocent victim of market forces” conjure up images of Detroit buffeted by random shocks from outside the city involving supply, demand and prices of things like oil, raw materials, labor, machinery and technology. Of all the possible “market forces” involved, what could Krugman possibly mean if not the market for automobile production and sale? Surely Detroit and Battle Creek didn’t wage war over breakfast cereal dominance? The Great Lakes weren’t blockaded by Canada at some point, were they?

Krugman’s vague references are intended to allow his readers to believe that he means that the effects of international trade in automobiles are what did Detroit in. But he is not going to come right out and say that. For that would expose him as incompetent in his Nobel-Prize specialty. The problems experienced by the Big Three automakers couldn’t possible have caused Detroit’s bankruptcy and Krugman knows it. There is no alternative to conceding that the right wing is right – liberalism’s bankruptcy caused Detroit’s bankruptcy. And Krugman knows that, too.

Automobile companies located in Detroit certainly suffered losses of sales and profits from (mostly) Japanese competition. But these losses were not felt by “Detroit,” either by the citizenry at large or by municipal government coffers. Corporate profits and losses accrue to shareholders. In this case, that means a few million people who mostly don’t live in Detroit but rather are dispersed throughout the nation. They include private individuals, households, investment-company fund shareholders and pensioners. Some executives lost jobs and income, but they were comparatively few when mingled among the nation’s fourth-largest city. In principle, workers could suffer job and income losses – but in practice the UAW saw to it that they didn’t. The union’s unwillingness to make wage and benefit concessions to management was proverbial. Its legacy-benefit accumulations to retirees were legendary. To this very day, Japanese auto-plant workers continue to assemble cars more productively than do UAW workers in Big Three auto plants. Consequently, the Big Three were bled dry. This even continued during the Obama Administration’s bankruptcy bailout, when General Motors’s shareholders were stiffed in favor of the UAW, which split the spoils with the federal government.

Not only did municipal government not suffer, it was among the vampires. For years, the automakers paid millions to the city for so-called “riot insurance.”

That is not all. The losses suffered by auto-company shareholders must be counterbalanced by the greater gains in real income. After all, international trade produces gains that more-than-offset losses; that is why international trade is just as beneficial as intranational trade. Once again, those gains are dispersed throughout the nation. But there were surely more foreign-car drivers in Detroit than auto-company shareholders – UAW parking lots were often sprinkled with imports! – and the gains of the former were larger than the losses of the latter.

Upon analysis, the notion that foreign-car competition wrecked Detroit is ludicrous on its face. And Paul Krugman’s curiously oblique column now makes sense. He couldn’t endorse Jennifer Granholm’s ridiculous claim, thereby becoming the first Nobel Prize-winning economist to make himself a laughingstock in his own specialized niche. But his liberal credentials, syndicated-column status and unshakable personal arrogance demanded that he not concede even the clearest victory to the enemy. He cannot acknowledge a truth uttered by the right wing even when validated by the logic of his own profession.

Detroit’s Downfall Was Not Random
Krugman’s description of Detroit’s fate as “just one of those things” triggers memories of a popular song from Detroit’s glory days: “Just one of those things; just one of those crazy things; one of those bells that now and then rings; just one of those things.” In short, it implies randomness rather than the result of purposive acts, incompetence, bad judgment or corruption.

That is exactly the opposite of the truth.

Detroit’s political leadership was not a random variable. Its liberal pedigree was impeccable. The city’s last Republican mayor served from 1957 to 1961. His successor, Jerome Cavanaugh, was a young New Frontier Democrat cast in the mold of John F. Kennedy. Cavanaugh was determined to use government to lift up the poor and impoverished. He accomplished half his objective; he used government. But the poor and impoverished did not decline. Instead, a city that boasted America’s highest per-capita income in 1960 went steadily downhill to a household income of $26,000 in 2010. Unemployment stands today at 16%.

Krugman’s description of Detroit as “an innocent victim of market forces” is classic liberal rhetoric. Whereas liberals usually create “social wholes” or collectives from politically malleable blocs and cast them as victims, Krugman has escalated the use of this technique to encompass an entire city. As noted above, his unnamed market forces must refer to international trade. But as explained above, the widely dispersed losses suffered by the Big Three automakers from Japanese competition cannot begin to explain the highly concentrated losses felt by the fourth-largest and most prosperous city in the world’s wealthiest nation. When the gains from that international trade are factored in, Krugman’s implicit case disintegrates.

International trade does not explain the fact that one-third of Detroit’s acreage is either vacant or horribly blighted. Trade cannot account for the fact that houses sometimes sell for $500 or less. International trade did not cause Detroit’s population of nearly 2 million to shrink to roughly 700,000. These things were caused by the 20-year reign of a black-separatist mayor who declared that only white could people could be racist. When whites reacted by fleeing the city for Detroit’s numerous suburbs, Mayor Coleman Young continued to direct imprecations at the “racists in the suburbs.” The more whites left the city, the more politically potent Young’s black base became. This tactic of deliberately encouraging out-migration through ineffective government has been dubbed the “Curley Effect” (after Boston’s notorious Mayor James Curley) by economists Andrei Shleifer and Edward Glaeser.

International trade did not give Detroit the worst crime rate in the nation and a murder rate eleven times greater than New York’s. It was Mayor Young who polarized the police force by laying off white officers to change the racial composition of the department. It was the mayor who refused to treat black and white criminality alike and called rioting “rebellion” when committed by blacks. International trade did not make 47% of Detroit’s citizens functionally illiterate, nor did it set Detroit’s public education system trudging toward the bottom rungs of the national achievement ladder despite an per-student expenditure of over $14,000.

Random market forces did not create a vast municipal bureaucracy, at one time comprising nearly 10% of the city’s working population. Market forces did not arrange for public-employee retirees to have 80-100% of their medical costs paid by their city retirement benefits. International trade did not cause 75% of municipal revenue to be devoted to salaries, benefits and legacy (retirement) obligations of municipal employees. Japanese competition did not force Detroit to burden its citizens with the highest per-capita tax burden in the state while still borrowing and spending lavishly enough to drive the city into bankruptcy.

International trade did not compel two of Mayor Coleman’s closest aides to separately steal over $1 million dollars, crimes for which they served jail terms. Trade did not seduce the “Hip-Hop Mayor,” Kwame Kilpatrick, into violating 24 federal statutes, including racketeering and mail fraud. The Japanese did not make the municipal bureaucracy virtually impervious to all attempts at reform, streamlining or simple day-to-day functional improvement.

International trade did not compel Detroit city government to smother small businesses with regulations such as the licensing requirements that threaten the existence of over 1,000 small businesses that make up some 10% of businesses and serve over two-thirds of Detroit residents. International trade did not dictate a city-imposed minimum wage exceeding $11 per-hour for public employees and businesses contracting with the city.

Krugman’s call for a “serious discussion…as a nation…about our obligations…to our fellow citizens…who have bad luck” is a thinly-veiled call for a bailout. But that was exactly the road Detroit followed under Coleman Young, whose explicit strategy was to “go to war with the city’s major institutions and demand that the federal government save it with subsidies.” Sure enough, up to one-third of Detroit municipal salaries were paid by federal-government salaries, according to researcher and write Tamar Jacoby. As Steven Malanga pointed out in The Wall Street Journal (7/27-28/2013), this strategy acquired the nickname “tin-cup urbanism.” Today, we are all holding tin cups and the federal government is robbing most of them in order to replenish favored cup holders.

No, there is absolutely nothing random about Detroit’s descent into bankruptcy. The forces causing it had virtually nothing to do with international trade. They were the forces of anti-capitalism, not capitalism. It is easy to see why Paul Krugman could only hint that international trade was involved without actually mentioning the subject, and why he had to distract his readers with the non sequitur of Greece. Detroit’s bankruptcy was caused by everything Paul Krugman believes in and continues to advocate today except for free trade. In other words, the fate of Detroit is Krugmanism in action.

DRI-324 for week of 7-14-13: The Short Lives of Truck Drivers and Other Lies Our Government Tells Us

An Access Advertising EconBrief:

The Short Lives of Truck Drivers and Other Lies Our Government Tells Us

Many of us are old enough to remember when the veracity of government was generally taken for granted. This applied particularly to statistics gathered by government or quoted by Presidents, cabinet members and heads of government departments. At worst, we might suspect that statistics were being chosen selectively. Never did we dream that politicians made up numbers out of whole cloth, quoted them in a completely misleading and unjustified way or carefully picked and chose statistics from dubious sources to buttress unjustifiable policies.

Perhaps we were inexcusably complacent. But it is certain that today’s politicians not only lie to us with statistics, but do so with shocking insouciance. The author of the website “Zero Hedge” chided the Bureau of Labor Statistics for failing to correlate two different time series, the monthly release of net new jobs created and the Job Openings and Labor Turnover Survey (JOLTS) series. His point was that when two results that should yield the same result consistently differ by 40% or thereabouts, it becomes all too obvious that one or the other is wrong. This, in turn, suggests that the BLS is cooking the books on its net new job creation numbers to make the Obama administration look good.

Another ongoing whopper has been the government’s straight-faced insistence that the life expectancy of U.S. commercial truck drivers is 61, at least 16years lower than the general population. Not content to strain public credulity, they insisted on hearing it snap when they maintained that this conclusion was the outcome of new research.

The perpetrators of the truck-driver life-expectancy hoax are government regulators. Accordingly, it comes as no surprise that regulatory incentives are behind the hoax.

Ray the Hood Gets Blogged Down in Traffic

On September 2, 2010, Department of Transportation Secretary Ray LaHood made a history-making entry in his blog, “Fast Lane.” LaHood claimed that the average life expectancy of a commercial truck driver is 61 years, some 16 years below the U.S. average. LaHood cited data from the U.S. government’s Centers for Disease Control as the source for his claim. “I think you’ll agree that gap is startling,” LaHood wrote.

“Startling” is certainly the right word for LaHood’s claim about truck-driver life expectancy. Two things happened more or less simultaneously. First, use of the claim that “truck driver life expectancy is 61 years” spread like a contagious virus. Second, industry observers demanded to know the basis for that claim.

The reaction of website findtruckingjobs.com was typical: “According to recent driver health studies, the average lifespan of a professional truck driver is 61 years of age.” LaHood had actually cited no studies, merely referring to CDC as the source of his claim. Notice the weight of authority carried by LaHood’s comments. He was a Cabinet Secretary, an important Government official. He invoked the authority of a prestigious government agency, repository of medical data. Surely there must be studies supporting this statistic. He spoke recently; therefore his information must up-to-the-minute and timely.

Doubtless emboldened by the fact that LaHood seemed to have escaped unscathed, Anne Ferro drew water from the same well the following year. Ms. Ferro, Chief Administrator of the Federal Motor Carrier Safety Administration (FMCSA), delivered a speech in which she repeated LaHood’s claim. “It [the 61-year old life expectancy] is a startling, frightening and frankly untenable figure,” she announced. Virtually everybody agreed with her characterization, but for completely different reasons. Those who took her statement on faith found its content shocking, while those who recognized its utter implausibility found it shocking coming from occupants of high government office.

A month after Ferro’s speech, Bloomberg website reporter Jeff Plungis referred to both LaHood’s and Ferro’s comments in an article on the government’s resolution of the long-simmering debate over the hours-of-service (HOS) regulation. In support of the statistic, Plungis reminded his readers that “trucking is the most dangerous profession in on-the-job fatalities and the eighth-most dangerous in deaths per worker, according to the Bureau of Labor Statistics.” It apparently didn’t occur to him to wonder whether there could be seven other professions with even lower life expectancies than 61 years.

Stewart Levy of corporatewellnessmagazine.com apparently brought the epidemic of imitative citation to an end in his February, 2012 piece entitled “America Crisis: Health of Our Nation’s Truck Drivers.” Levy not only cited both LaHood and Ferro, but also speculated at length on the dietary, nutritional and behavioral shortcomings of the average truck driver. He offered gratuitous advice on improvement – not surprising in view of his professional status as a wellness consultant. The unique datum here, though, was the source he cited for the 61-year life expectancy – not CDC, but a 2005 study by the well-known consulting firm Global Insight.

Pushback

Sources friendly to truck drivers, including Truckinginfo.com (the website of Heavy Duty Trucking Magazine) and Land Line Magazine, the organ of the Owner Operator Independent Drivers’ Association, were openly skeptical of the LaHood/Ferro life expectancy claim. They wanted to see an actual study that reported a 61-year life expectancy for truckers. After long and diligent search, they found one – sort of.

A document called the Roemer Report quoted a scientist named Charles Moore-Ede, described as a “Toronto researcher,” who supposedly performed a “new study” showing “that truck drivers have a 10-15 year lower life expectancy than the average American male, who lives to age 76.” (The quotation is from an article by Land Line editor Sandi Soendker.) The word “supposedly” is the tipoff; when located, Mr. Moore-Ede identified this information as an online hoax. He is not even from Toronto.

The closest thing investigators could find to a study actually reaching a conclusion involving a 61-year age was a study published in 2007 in Environmental Health Perspectives. But the study followed 54,000 employees of four national trucking companies during the years 1985-2000. The employees were hired at varying points going back to the 1960s. Not surprisingly, the study calculated the mean and median age of death of the subjects, not their life expectancy. Surprisingly, drivers had longer longevity (61.9 years) than non-driver employees (59.9 years).

Apparently, one or more studies of commercial truck-driver mortality are now underway. Pending these results, the best chance to learn something cogent on the subject is probably insurance-company actuarial tables, which should seemingly yield useful occupational data on this subject.

We can safely rest content, then, that the 61-year-old life expectancy claimed for commercial truck drivers has no credible support and is wildly unlikely on its face.

How Do We Know That the 61-Year Life Expectancy Claim Was Not Merely An Honest Mistake?

Anybody can make a mistake. How do we know that LaHood, Ferro, et al were cynically trying playing politics rather than honestly trying to improve the health and well-being of American truck drivers, as well as safeguarding the safety of the nation’s highways?

We can tell. There are ways.

An honest mistake is made up of two components – error and good faith. Honesty implies the absence of deliberate prevarication and incompetence. Alas, both are evident in the composition of LaHood’s original statement.

The incompetence arises from the use of the term “life expectancy.” The word “expectancy” invokes the notion of relative frequency probability and an expected-value or mean outcome – what an ordinary person would call an “average.” A “life” denotes an entire lifespan, from birth to death. Sometimes the concept is modified by starting the clock later in life; “life expectancy at age x” is a common modification. But the elements of the concept always include numerical starting and ending points, whether birth- and death-year or otherwise.

It is easy to see that the term “life expectancy” does not adapt to professional or occupation categories, where there is no common start date corresponding with “birth (0)” or (say) “age 65 (retirement).” That is why professional and occupational studies usually substitute terms like “mean (or median) age at death” for life expectancy.

There may be a very superficial resemblance between the two terms, but concentrated thought demonstrates the unbridgeable gulf between them. Life expectancy deliberately incorporates all influences on longevity over the course of a lifetime – those operating at birth, in infancy, childhood, adulthood and old age. When we investigate “life expectancy of a commercial truck driver,” we are still incorporating all those influences in our study – but we almost certainly have no interest in anything that happened before our subjects began their professional careers as commercial drivers. Do we care that a truck driver smoked cocaine in high school, thereby damaging his heart and shortening his lifespan? No, not unless truck drivers are occupationally prone to have done this – and they aren’t.

The category of “life expectancy” is crucially affected by deaths at birth and in childhood; indeed, one of the major components of the increase in 20th-century life expectancy is the reduction in stillbirths and childhood mortality. These factors will affect a true “life expectancy” calculation for truck drivers (or any other profession or occupation), despite the fact that they are not what we want to get at when we probe the matter. What we really want to know is how commercial truck-driving per se affects longevity. What happened before the driver’s career is almost completely irrelevant, although post-career events are relevant since they are affected by the driver’s behavior and environment during his career.

It is now clear why the B.S. detector of every thoughtful and numerate person within earshot should have redlined the moment Ray LaHood opened his mouth on truck-driver “life expectancy.” He compared the alleged truck-driver life expectancy of 61 years with the 77-year life expectancy of the general population. But the category called “general population” counts everybody, including a fair number of people who died in childbirth, youth and adolescence. Because the United States encourages heroic measures to preserve the life of premature babies, deaths of “preemies” artificially lower our life expectancy number (and raise our infant mortality number) compared to that of other countries. This insures that, ceteris paribus (all other things equal), all professional and occupational categories will tend to reflect higher longevities than the general population. After all, a profession includes zero people who died at birth, in childhood and in adolescence – otherwise how could they have attained professional status? Yet Ray LaHood expects us to believe that truck drivers’ lives average 16 years shorter than those of the general population?

To be sure, all other things are decidedly not equal for truck drivers, who suffer relatively high rates of accidental death. (Similarly, taxi-cab drivers fall prey to the bullets of armed robbers and coal miners succumb to black-lung disease.) And this tends to offset the bias introduced in comparisons with the general population. As a first approximation, whether commercial truck drivers actually live shorter or longer lives than ordinary people will depend on the relative strength of these two effects on the truck-driver result – the average-shortening effect of accidental deaths vs. the average-lengthening caused by removing early deaths from the calculation. When we examine the paucity of genuine research on the subject, we will see that the issue remains an open one.

Recall also that LaHood cited the CDC as his source. Medical professionals for whom statistical data and analysis are life’s blood would never commit the amateur blunder of applying life expectancy to professional or occupational longevity. And they would not compare truck-driver longevity to that of the general population without qualifying the comparison as was done above.

No, Ray LaHood has carelessly let his mask slip, revealing Ray the Hood, dedicated to untruth, injustice and the un-American way. What were the ulterior motives that underlay this crude deception? Before proceeding to the answer, we must glance in the rear-view mirror at the original truck-driver health scare ginned up by Obama Administration regulators: sleep apnea.

The First Truck-Driver Health Deception: Sleep Apnea

Since 2009, the Obama Administration has consistently supported mandatory sleep studies for truck drivers to test for the presence of sleep apnea. Based on one study of fewer than 1,400 truck drivers located within a 50-mile radius of the University of Pennsylvania, the Administration claimed that 28% of truck drivers have sleep apnea. Not only was the study extremely narrow in design and scope, the government had to distort the study’s procedures in order to obtain the vaunted 28% figure.

The website askthetrucker.com (written by Allen and Donna Smith) examined the Pennsylvania study in some detail. While the study drew upon 1,391 truck drivers located close to the university, the actual sleep apnea examinations were conducted upon a smaller subset of this population. The original sample was screened to determine the most promising candidates for sleep apnea diagnosis. The sub-sample of 406 candidates was then tested. In and of itself, this procedure is unexceptional, because testing the original sample would have tripled the cost of the study.

The problems of interpretation came from what happened next. Some 36% of this sample was diagnosed with sleep apnea. Most of these drivers had mile or moderate disease; only a tiny fraction was considered to be severe sufferers. Another sample of 778 was developed from a second screening, of which 28% were diagnosed as apnea-positive. Once again, the overwhelming bulk of these were mild or moderate sufferers, not severely afflicted.

The Smiths rightly questioned the propriety of calculating the percentage of apnea sufferers using the screened sample as the base rather than the original sample of 1,391 drivers, in which case the calculated percentages would have been much lower. Really, no national extrapolation of the incidence of sleep apnea should have been made on the basis of this single, highly flawed study. At least one other study has found no difference between the incidence of sleep apnea among truck drivers and the general population.

Even more pertinent is the fact that no studies have found a correlation, let alone causation, between sleep apnea incidence and automobile crash incidence. And it is highway safety, after all, that is the supposed pretext justifying truck-driver regulation.

Businessmen Maximize Profit; Regulators Maximize Regulation

For far too long, government regulation has gotten a free pass from academic economists and the general public. The inherent regulating forces of free markets have gone unnoticed and unstressed. Meanwhile, the practice of regulation has been presumed to be benign at worst and highly beneficial at best.

One of the culprits in this litany of oversight has been the practice of what Nobel laureate Ronald Coase has called “blackboard economics.” When drawing diagrams on the classroom blackboard, academic economists have anointed themselves omniscient philosopher kings, with infallible knowledge of business costs and consumer benefits and unlimited power to enact regulatory changes that fine-tune away market failure and deliver optimal outcomes.

In real life, it is regulators who administer the programs ostensibly charged with achieving these blackboard results. The regulators know little or nothing about the actual costs and benefits and lack the power to make the changes necessary to produce the outcomes called for. Since the costs and benefits are not known anyway – by regulators or economists – we can’t even be sure that the blackboard results would work the way they do on the blackboard.

The blackboard only serves to provide cover for what regulators are really up to – which is achieving their own aims and those of their political sponsors. The academic economics is what justifies setting up the regulatory apparatus in the first place. Once securely in place, the regulatory agencies then proceed to get markets in a stranglehold by forcing businesses to comply with an unending regime of rules.

Economists have rightfully emphasized the deregulation of price and entry in trucking starting in 1978. But safety regulation has remained in place, allowing the Department of Transportation and its subsidiary agencies like FMCSA to hold trucking companies and drivers under the regulatory thumb.

Readers may object to such a pejorative take on the regulatory function. How do we know that regulation isn’t exactly what it purports to be – the diversion of selfish private actions toward the public interest? How do we know that regulators aren’t what they seem to be – noble public servants sacrificing their incomes and egos to the greater glory of social welfare and social justice?

When the goals of regulation are defined in terms of grandiloquent holisms like social welfare and social justice, it becomes impossibly nebulous. There is no “social” welfare apart from the individual welfares that comprise a nation; any specification simply substitutes the designer’s own concept for the welfare of “society.” Society is not an organic unity with its own independent existence, the protestations of socialists down through the centuries notwithstanding.

When the definition becomes specific – regulators should keep businessmen from raising prices “too high;” keep profits from growing “too large;” keep product quality from growing “too poor,” “too coarse” or “too fine;” keep technology improving steadily or stop it from going too fast – it turns out that people want regulators to do what only markets can do and, for the most part, already do.

And if it should turn out that markets aren’t doing such a good job of those things, after all? Anybody who thinks a regulator heading up a government agency can run an industry from the outside better than businessmen can from the inside is smoking illicit substances. Markets process a staggering flow of information about prices, costs, inputs and technology. Regulators have no way to obtain all that information and no incentive to pass it along to society even if they could get it.

Indeed, incentives are another glaring difference between marketplace competition and regulated industrial life. Competition provides the incentives for consumers to shop carefully to maximize their own well-being and for producers to minimize cost in producing products and adopt technological innovations at a suitable pace. There is no incentive for regulators to improve on the results obtained through unhampered markets even if they knew what they were doing.

Instead, regulators have every incentive to serve the interests of their political patrons, the politicians who appointed them. Regulators are paid according to the size of their agency and its staff, so they have every incentive to grow the size of government. Is it any wonder that government agencies have multiplied in number beyond our power to enumerate them?

Regulators’ Attitude Toward Trucking Regulation: Use It Before They Lose It

From Inauguration Day to date, the Obama Administration has used trucking regulation as a tool for achieving its political aims. For example, industry figures have predicted reductions in capacity and higher freight rates as outcomes of regulatory actions ostensibly intended to improve highway safety and information available to shippers. These would be rewards for political support and contributions.

But the purpose behind the wildly unlikely claims about truck-driver health and longevity made by regulators almost certainly trace to the other category of incentives faced by regulators. Regulation itself constitutes an income-earning, wealth-building asset to regulators. It is the source of their income, wealth and prestige. If that asset is faced with depletion in the future, regulators have an incentive to use it now, before its value vanishes.

That is the case with truck-driver regulation. Today, federal transportation regulators spend a vast amount of time, energy and money regulating truck drivers. But the profession of truck driver is an endangered species. Self-driving vehicles are now a reality. Innovations like this usually come to fruition first in their highest-valued use. Because trucks carry two-thirds of the nation’s freight, including many highly valued cargos, trucking will be the vanguard of self-driving vehicle adoption. While humans may accompany the vehicles, particularly in the early stages of adoption, the profession of truck driver as we know it is in its last years. The only remaining question is how long this period of obsolescence will last.

When human truck driving comes to an end, so will the period of truck-driver regulation as we have known it. Of course, regulation will still exist for the vehicles – regulators have seen to that by preemptively staking their claim and demanding control over the adoption of self-driving vehicles. But vehicles will not present the bonanza for health and safety regulation that now exists.

Meanwhile, regulators must milk the possibilities of truck-driver regulation for all it is worth. The aging population of truck drivers presents intriguing possibilities. Truck drivers smoke more than average. They eat on the go, guaranteeing that their diet will be nutritionally incorrect. They spend long periods sitting down in truck cabs, suggesting that their level of exercise may be less than optimal. All this allows regulators to accuse them of being health scofflaws.

Why isn’t this exclusively the business of truck drivers themselves? What makes it the business of transportation regulators? Regulators must make a connection between poor truck-driver health and public safety. If they do, this will provide the needed pretext for the blizzard of rulemakings, mandates and dictates that are the raison d’être of regulation and the bane of the regulated.

That is the purpose of the manufactured campaign designed to persuade the public – or at least create the necessary breath of suspicion – that truckers disproportionately suffer from sleep apnea. Sleep apnea makes truckers sleepy – so the regulators’ argument goes – which causes them so fall asleep on the road, which leads to accidents.

The more recent round of trash talk about truck-drive life expectancy caters to the popularity of paternalistic government. If we can have ordinances limiting the size of soft drinks sold in restaurants, it’s not much of a stretch to say that we can regulate the health of truck drivers. After all, not only would these regulations protect truck drivers from themselves, they would also protect the motoring public. Fewer truck drivers would suffer heart attacks and strokes on the job, making it safer for other drivers.

Where truck-driver regulation is concerned, the operative maxim among regulators is “use it before you lose it.” Regulators have little to lose from exaggerating their case for regulation, since their regulatory mandate is eventually going away anyway. They might as well grab for all the regulatory gusto they can while the grabbing is good.

Of course, all this desperate striving is inconsistent with scientific objectivity. It is unseemly for high-level government officials to lie and distort statistics like tabloid newspapers or snake-oil salesmen. Then again, government regulation never really had much to do with science or objectivity. The urgency created by the impending demise of truck driving has led to the destruction of regulation’s façade of respectability.