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-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-304 for week of 8-4-13: Don’t Bemoan the Demise of Truck Driving – Hasten It

An Access Advertising EconBrief:

Don’t Bemoan the Demise of Truck Driving – Hasten It

Milton Friedman aptly described the profession of economists when he declared that “we are all of us teachers.” An occupational pastime is using economics to overturn popular fallacies and conventions. The other side of that coin is exposing the misuse of economics by those who purport to understand it, but don’t.

The mainstream press has long run rampant with pseudo economics, but the world’s leading financial publication would seem to be the wrong place to look for it. Thus, the July 24, 2013 article by Business Editor Dennis K. Berman, entitled “Daddy, What Was A Truck Driver?” comes as an unpleasant surprise.

The subtitle captures the tone of the piece. “Over the Next Two Decades, the Machines Themselves Will Take Over the Driving” invites the reader to draw two obvious inferences. First, machines will replace people as drivers of trucks. Second, the process of replacement will take a long time.

What should we say about that? The author says quite a bit, cloaking himself in what he thinks is the rhetoric of the economist. Not only does he say it badly and wrongly, he omits what most needs saying – the matter of life and death.

The Implications of the Driverless Motor Vehicle

The WSJ piece trades heavily on the hoary pejorative cliché of technology as relentless destroyer and dehumanizer of work, the subtle message is that machines are inevitably fated to “take over” from human beings. The reader feels that same visceral loss of control most people feel when forced to relinquish the driving to somebody else. Ceding control to a machine they have been repairing and replacing since adolescence does not come easily.

Having set the (poisoned) mood for his audience, editor Berman proceeds to work them into an emotional state using bad economics. Although he feels that “most of the hubbub” created by driverless vehicles “has focused on passenger vehicles, notably Google’s promotional wonder, the Google Car,” we should really be worried about the nation’s 5.6 million licensed truck drivers. “Over the next two decades, the driving will slowly be taken over by the vehicles themselves. Drones. Robots. Autonomous trucks” like the fleet of 45 self-directed mining trucks now working Caterpillar, Inc.’s Australian iron-ore site.

Uh-oh. With the hostile takeover of machines in place, can an emotional appeal for their human victims be far behind? No, indeed. After “watching a half-decade of lagging U.S. employment, it’s hard not to feel a swell of fear for those 5.6 million people, a last bastion of decent blue-collar pay… A world without truck drivers may eventually be a better one. But for whom?” The dispassionate reader is left to account for the rapid decline of print media by its lack of a string section to accompany operatic prose like this.

Berman makes a feeble effort to make an economic case for the driverless car. “Economic theory that such basic changes [as the substitution of machines for labor] will, over time, improve standards of living by making us more productive and less wasteful.” His example of improved productivity is that an “idle truck with a sleeping driver is just a depreciating asset” to be corrected by driverless vehicles.

This is both brainless and half-hearted.  The economics he thinks he is preaching are foolish and he does not know the subject well enough to preach the real thing. Virtually any truck – including driverless ones, when they begin to operate – is a depreciating asset, so depreciation itself is not the wasteful element. An idle truck is a non-productive asset, regardless of its driver’s state of consciousness, which is where the waste lies. Driverless vehicles will indeed operate 24/7, which only scratches the surface of their productive potential.

Driverless vehicles are a wondrous innovation not in spite of the fact that they replace human beings but because of it. The worst thing about people driving cars and trucks is that they get killed doing it. Intrepid editor Berman never explicitly mentions the 30,000-plus annual fatalities lost to auto and truck crashes in the U.S.; the closest he comes is to acknowledge a “payoff” to driverless vehicles of $87 billion in cost savings from the 116,000 injuries and deaths resulting from accidents. This is conclusive proof that the author’s effort to cover his subject has gone off the road and into a ditch, figuratively speaking. What ordinary person could overlook the death of 30,000 people yearly?

A child goes missing for a few hours and the local community switches to full alert. A man dies while jogging and a period of mourning ensues. A plane crash killing three people hogs the headlines for a month. How could it be that an innovation now operational that is virtually certain to save 30,000 lives per year could simmer gently on a developmental back burner while journalists agonize over its labor-market effects? This must be the most half-hearted job of reporting ever done in a profession whose entire raison d’être has morphed into the task of mobilizing emotion.

What went wrong here?

Economics Is All About Value, Not Jobs

For over 40 years after the ascendancy of Keynesian economics in 1936, the economics profession obsessively erected, refined, discussed, researched, picked over and sifted the Keynesian model. Eventually, its major tenets were overturned. But by that time, the Keynesian framework had been established as the lens through which the profession saw the world. Specialties in macroeconomics were available in every major Western university; courses and textbooks were features of the landscape. Although the bases for Keynesian policy recommendations had been discarded, the policies were retained on the ground that macroeconomic stability could be maintained more securely and regained more quickly by activist policies than by laissez-faire.

Worst of all, the economics profession forgot to tell the general public that Keynesian economics, like Freudian psychiatry, was an outmoded relic whose unsound precepts did more harm than good. Consequently, the public – particularly the mainstream news media – continued to follow a crude version of Keynesian economics by embracing the idea that saving was bad, spending was good and certain kinds of spending would trigger multiplier effects that would employ the idle, cure the sick and invigorate the halt.

The extended 20th-century release of economic theory from its sturdy microeconomic moorings to founder on the rocks of macroeconomics has been hard enough on the economics profession. But at least we can hope that professionals will eventually find their way back to sanity. What can be done for a public that long ago forgot the little it knew about sound economics?

The only refuge is the catechism of economic truths. Economics is about value, not jobs. We could achieve “full employment” by conscripting available labor to dig and refill holes or build pyramids, but that would not create value. Driverless vehicles not only use available vehicles more efficiently, they also preserve labor by preventing needless deaths.  This combination of capital goods more fully employed and more labor spared to produce goods and services cannot help but increase the volume of output tremendously. This is the productive value created by driverless vehicles.

But even this does not capture the full measure of value creation. The increase in human happiness resulting from an increase in goods and services cannot compare with the joy of those who are spared decapitation, crushing, fatal bleeding and death from shock in vehicular accidents.

Reporter Berman cites “economic theory” as his authority, but economic theory gives no grounds whatever for putting the displacement of 5.6 million truck drivers ahead of the lives lost to highway deaths – to say nothing of the vast productivity gains that would accrue to driverless vehicles. Just the contrary: economics is all about taking resources like truck-driver labor and putting them where they do the most good, which in this case is somewhere other than driving a truck

 

The fact that reporter Berman is in such agony over the future unemployed truck drivers rather than the present dying traffic-accident victims is implicit testimony to the ineffectiveness of macroeconomics. The very theory that gives such obsessive attention to the problem of unemployment has failed conspicuously to address it. The only valid theory of employment is the microeconomics of value creation, which enlists the price system to re-employ laid-off workers in pursuits suitable to their productivity. History testifies to the efficacy of this system as well as to the failures of macroeconomics.

 

Money Is a Veil; It Is Real Variables, Not Monetary Ones, That We Care About

There is no reason not to express the prospective gains of driverless vehicles in their most vivid form rather than obscuring them inside some enormous, round monetary sum. Alas, the decades of living under Keynesian thrall have convinced people like Berman that economics demands a knack for putting a dollar value on everything. That is why he says absolutely nothing about the real value created by driverless vehicles and contents himself with citing a monetary “payoff” of $87 billion. This bloodless bottom-line total says almost nothing worth saying on the matter.

Berman cites a trucking-company president who predicts that “we will have a driverless truck because there will be money in it.” Berman correctly says that “commercial uses are where the real money and action lie,” but doesn’t trouble to tell his audience why this is so. And this is not a case where the facts speak for themselves.

Every time a truck driver climbs into a cab, there is money on the line. A large number of real variables underlie this monetary relationship. Money rides on the successful completion of the trip, on its speed and on its safety. The driverless vehicle will improve rates of success in each of these areas. A truck is a capital good whose rate of utilization will be dramatically improved by going driverless. Drivers are expensive to acquire, train, pay, medically treat and support in retirement. Driverless vehicles will drastically reduce or even eliminate these costs – of course, these cost reductions will be counterbalanced by increases in maintenance and technical costs.

Safety is the real variable that gets, and deserves, special stress in this account. “Human drivers will often make judgments, most good, but some bad, and those inconsistencies can lead to problems,” reminds Ed McCord, Caterpillar’s safety director. If a truck “is supposed to be in fifth gear coming down a grade, it will be in fifth gear every time” when the truck is driverless. This elimination of driver error is what will cause vehicle accidents to approach zero asymptotically when we go driverless.

On the passenger side, the benefits of driverless vehicles are increased safety and convenience. These are considerable, but they do not approach those on the commercial side either in number or size. They are also somewhat counterbalanced by the driving pleasure and enjoyment of risk experienced by drivers of passenger cars, which have no correlatives on the commercial side. (The principle of risk compensation is why various safety features, particularly coercive seat-belt and anti-texting laws, have failed to meet predictions of improved safety results. The safer vehicles become, the more risky become the habits and behaviors of their drivers.) The incentives to adoption on the passenger side are nowhere nearly as strong as on the commercial side.

Thus, driverless vehicles will be adopted en masse commercially, but much more gradually as passenger vehicles. As the cost comes down, technology improves and public acceptance increases, all vehicles will eventually go driverless.

Why In the World Must We Wait 20 Years For Driverless Vehicles?

Having upbraided editor Berman so severely for his errors, we now honor the practicality of his prediction that it will take two decades for driverless vehicles to become a reality. As we have shown conclusively, this delay will not be salutary. Thousands of human beings will die needlessly in highway crashes; huge amounts of potential output will be lost.

In mid-20th-century America, we resolved to reach the moon and succeeded within a decade. Today, with vastly superior technology and a whopping head start, we won’t forestall hundreds of thousands of deaths. We won’t increase our productivity by leaps and bounds. We will take twice as long to establish our goal of driverless vehicles as it took us to reach the moon.

What is holding up the show?

Berman gives us a broad hint. “It is going to take a long time to prove the case [for driverless vehicles] to government and the public.” It is? Well, it would certainly take Berman a long time, since he persists in ignoring the real value created by driverless vehicles. But we aren’t dependent on his efforts alone. Why should the public prefer to die rather than live, for example? Why should it choose less output rather than more? Left to its own devices and the results of competitive markets, the public would embrace driverless vehicles. No, Berman has identified the roadblock. It is government.

The federal government has an entire cabinet-level department – the Department of Transportation – devoted to regulating the transportation industry. It spends much of its time regulating drivers, particularly truck drivers. The demise of the drivers would leave it with very little to regulate, which would leave it with very little rationale for existence. This means that the federal-government bureaucracy will fight the advent of driverless vehicles tooth and claw. It will find and every possible excuse to delaying their introduction into the market. It will call them unsafe. It will call them introductory and untried. It will call them experimental. It will call them everything but Caucasian and it will require studies, hearings, public meetings, rulemakings and pronouncements by commissioners in order to sanction their use.

The more regulatory dust federal bureaucrats can throw up, the longer will be the delay in implementing driverless vehicles. The longer the delay, the more taxpayer money, agency employment and just plain power federal bureaucrats can wring from the regulatory process. In this case, “use it or lose it” applies just as strongly to regulation as to physical vitality. The opportunity to regulate is a crisis that regulators can’t afford to waste, just as political administrations can’t afford to waste the opportunity to accumulate power that a crisis affords.

The DOT has already telegraphed its intentions by stating that it will not allow private firms to proceed with autonomous vehicle development on their own. DOT will have to develop regulations governing that development. Naturally, that will take time. Public hearings will have to be held. There will be the usual process of rulemakings preceded by public notification and followed by public comment. The whole process will move forward with the speed of an aging glacier. We can’t be too careful, after all. People’s lives are at stake. Why, if we just let private business firms go full speed ahead, at their own pace, something might go wrong. Somebody might get hurt. Better to go slow. That way, nobody can accuse the federal government of responsibility for death or serious injury through carelessness or negligence.

Better safe than sorry, right?

Economists, sticklers for detail, aren’t satisfied by time-honored clichés. They want to know who is safe and who is sorry and how much, in each case. Regulators really mean “better that regulators should be safe than sorry.” But whose welfare are we supposed to be enhancing here, anyway? Regulators may feel safe, but that doesn’t do anything for the people that regulators are supposed to be protecting on the nation’s highways. The problem here is that the regulatory process puts all the emphasis on avoiding one kind of mistake – allowing death or injury that could have been avoided by regulation – and virtually none on avoiding the other kind of mistake – overregulation that prevents businesses from developing new ways of preventing death and injury. That allows regulators in effect to get away with murder under the guise of doing their jobs.

What Was a Truck Driver, Daddy?

Shockingly, editor Berman apparently thinks he has posed a devastating rhetorical question with his “What Was a Truck Driver, Daddy?” In fact, the answer is simple and straightforward.

During the course of 237 years, America has seen hundreds of jobs and dozens of professions come and go. Some of them, such as the cowboy, are still viewed with nostalgic reverence. Many more are now forgotten.

A truck driver was a dedicated professional whose heyday saw him haul some two-thirds of America’s freight. Like the cowboy, he enjoyed an outdoor life suffused in the simple virtues of mobility and independence. The romance of his job overshadowed its monotony and financial limitations – something else he shared with the cowboy. He rode high, wide and handsome for a century, a longer run than his Western predecessor. He had no kick coming and nothing to apologize for – unless he spoiled his final days by whining about his betrayal by fate and the living the world owed him. The many millions who went before him did not receive handouts or exemptions from obsolescence. When their time came, they stepped aside and either retired or changed jobs or careers.

A true Knight of the Highway would never claim a right to hang onto his job at the cost of somebody else’s life.

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-322 for week of 7-21-13: Detroit: Postmortem on a Once-Great American City

An Access Advertising EconBrief:

Detroit: Postmortem on a Once-Great American City

On Thursday, July 18, 2013, Detroit, Michigan’s emergency financial manager Kevyn Orr filed a Chapter 9 bankruptcy petition on the city’s behalf. Detroit became the largest American city ever to declare bankruptcy. Although the handwriting for this action had been on the wall long before it appeared on court documents, it still sent shock waves throughout the country.

The interminable interval between recognition of reality and capitulation to it was partially explained by the ruling issued the following day by Ingham Country Circuit Judge Rosemary Aquillina. She ordered the withdrawal of the bankruptcy petition on the grounds that it would violate the Michigan Constitution to endanger the pension benefits of government employees. And retiree pensions do indeed represent roughly $9.2 billion of the $11.5 billion in unsecured claims listed under the bankruptcy petition. “It’s cheating, sir, and it’s cheating good people who work,” was her reaction to the bankruptcy. “It’s also not honoring the President, who took General Motors out of bankruptcy.” This was the same intractable attitude that had prevented Orr from negotiating any concessions from the city’s creditors, particularly pensioners who refused to relinquish the lucrative defined-benefit contracts that had made them the new aristocracy of Detroit’s organized labor community.

Americans are habituated to viewing Detroit as an economic basket case. Thus, it comes as a shock to realize the relative speed and steepness of the city’s fall from prosperity and prominence. Even more shocking is the similarity between Detroit and most other major American cities.

Various sources, particularly the website “Economic Collapse” and the Rush Limbaugh radio program, have assembled a shocking compendium of facts detailing the decline and fall of Detroit. In just over a half-century, Detroit went from one of the premier American cities to a burnt-out wasteland, comparable to a European city devastated by the effects of World War II.

The Glory Days of Detroit

Detroit was founded during colonial times. It got its name from one of the leading Indian tribes. Its location on the Great Lakes assured its economic prominence, but its development took off in the late 19th century with the invention of the automobile. Detroit became the home of the three leading U.S. automakers – Ford Motor Company, General Motors and Chrysler. Henry Ford developed and perfected the automotive assembly line in Detroit and environs. In the second half of the 20th century, General Motors became the phenomenal success story of the U.S. automotive industry.

The first half of the century belonged to Ford. Henry Ford didn’t invent the automobile, but he might as well have. He produced versions that ordinary Americans embraced wholeheartedly: Models A and T. He perfected the assembly line that revolutionized automobile production. His wage policies were public-relations triumphs in a realm where capitalism has historically taken it on the chin. (Detroit was already a high-wage city and the company was merely competing for labor with its $5-per-day wage offer, not practicing altruism.) Henry Ford presided over the automotive world and American industry from his home in Dearborn, Michigan.

When General Motors shouldered Ford aside as the premier automaker, it established a corporate reputation to rival Ford’s. CEO Charlie Wilson’s famous declaration that “what’s good for General Motors is good for America” may have ruffled feathers, but it certainly dovetailed with the thinking in Detroit. When GM decided to build a brand new auto plant in the venerable neighborhood of Poletown, even the black-separatist municipal administration of mayor Coleman Young hastened to grant the company eminent-domain rights and approve the dispossession of longtime residents. As late as 1971, Economists Roger Miller and Douglass North marveled at GM’s “phenomenal ability to generate profits.”

Led by the “Big Three” automakers, Detroit became the manufacturing center of America. As of 1950, it was home to 276,000 manufacturing jobs. During an era when America’s manufactures led the world, those jobs earned good incomes. As of 1960, Detroit boasted the highest per-capita income in the U.S. This attracted people. As of 1953, Detroit was the 4th-largest city in the U.S., behind New York, Chicago and Los Angeles, with just under 2 million people. In 1966, Look Magazine named Detroit as an All-American city.

Today, Detroit is the Dregs

Today, in 2013, Detroit is the dregs. Its 276,000 manufacturing jobs have shrunk to less than 27,000. This might not be so bad if other jobs had taken their place. They haven’t. It has lost 63% of its former nearly two-million population. Those who remain have a median household income of $26,000 and suffer from unemployment of 16%. Less than half of Detroit residents over 16 years of age are employed. 60% of Detroit’s children live in poverty. Only 7% of 8th-graders are rated “proficient in reading,” which helps explain why 47% of Detroit residents are functionally illiterate.

There are over 78,000 abandoned houses within the city. Many houses are up for sale at prices of $500 or less. One-third of Detroit’s 140 square miles are either vacant or derelict. The city hosts more than 70 Superfund hazardous-waste sites.

City services have declined pari passu with the general decline in incomes and employment. Detroit’s murder rate is eleven times greater than New York City’s. The size of the police force is 40% lower than in 2003. Average response time to a 911 emergency call is 58 minutes. Most police stations are open to the public for only eight hours per day. Police solve fewer than 10% of crimes committed in the city. One-third of Detroit’s ambulances do not run. At least 40 streetlights do not work. Two-thirds of the city’s municipal parks have closed since 2008.

The city earns $11 million of its municipal revenue from… its casinos. Police advise travelers to enter Detroit at their own risk.

In the UK’s Daily Telegraph, MP Daniel Hannan recalls the prescient novel Atlas Shrugged, by Ayn Rand. The book describes the town of Starnesville, home to the fabulously successful Twentieth Century Motor Company. Socialism has reduced both the company and its hometown to ruins. Hannan quotes Rand’s evocative portrait of Starnesville to haunting effect:

“A few houses now stood within the skeleton of what had once been an industrial town. Everything that could move, had been moved away; but some human beings remained. The empty structures were vertical rubble; they had been eaten, not by time, but by men: boards torn out at random, missing patches of roofs, holes left in gutted cellars. It looked as if blind hands had seized whatever fitted the need of the moment, with no concept of remaining in existence the next morning.

“The inhabited houses were scattered at random among the ruins; the smoke of their chimneys was the only movement visible in town. A shell of concrete, which had been a schoolhouse, stood on the outskirts; it looked like a skull, with the empty sockets of glassless windows, with a few strands of hair still clinging to it, in the shape of broken wires.”

Hannan compares Rand’s prose – circa 1957! – with a description of Detroit in the London Observer:

“What isn’t dumped is stolen. Factories and homes have largely been stripped of anything of value, so thieves now target cars’ catalytic converters. Illiteracy now runs at 47%; half the adults in some areas are unemployed. In many neighborhoods, the only sign of activity is a slow trudge to the liquor store.”

Hannan is astounded by the similarity between Rand’s fictional Starnesville and the Detroit of today. Even more astonishing, Rand predicted the effect of socialism on a preeminent auto manufacturer in 1957, when U.S. automakers bestrode the world like colossi and Detroit stood atop the U.S. league tables.

What Happened to Detroit?

In Atlas Shrugged, socialism decimated both the Twentieth Century Motor Co. and Starnesville. The real-world municipal analogue to socialism is liberalism, which features unwieldy bureaucracy spending vast sums on tasks that are none of its business. That describes almost all major U.S. cities, including New York, Chicago, San Francisco, Los Angeles, Boston, Philadelphia, San Diego, Seattle, et al. Liberals are Democrats and all these cities are governed by Democrat majorities, mostly machine-made. Only Houston can fairly be called an exception to the rule of liberalism, though even here Democrats cling to a majority in the city.

Detroit certainly fit this pattern. The last Republican mayor won office in Detroit in 1957, during the city’s glory years. Since 1970, only one Republican has been elected to the City Council. Republicans have occasionally gained statewide office – John Engler’s stint as Governor was a notable recent example – but if anything Detroit’s clout was so formidable that the city’s tail usually ended up wagging the state dog when it came to policy.

When Democrat Jerome Cavanaugh became Mayor of Detroit in 1962, he was one of the brightest lights of the Democrat Party. Cavanaugh was a young New Frontiersman, a JFK-image clone. He was determined to use the city’s prosperity as a tool to eradicate poverty and enact social justice. He raised property and income taxes and increased spending. He inaugurated a utilities tax. The failures of Cavanaugh’s policies were manifest by the 1970s and helped pave the way for the long reign of Coleman Young.

One common denominator behind the serial failure of municipal liberalism is the failure of public education. A handmaiden to educational failure in the 1960s, 70s and 80s is school desegregation and its complement, busing. Cities like Boston, St. Louis and Kansas City lived through historic desegregation sagas, all featuring savage disagreements, shocking expenditure of funds, forced taxation and virtually nothing of educational value to show for it. Detroit was a leader in the field. District-court judge Stephen Roth supervised a massive desegregation plan involving 53 Detroit suburbs and some 780,000 public-school students. Average time spent on daily bus travel hovered at 1.5 hours per day. The effect of the plan was to reinforce the separatist vision of Mayor Coleman Young and drive whites to the outer suburbs, beyond the plan’s reach.

Unions played an important role in Detroit’s downward spiral. Municipal unions do not face the private-sector competition from non-unionized labor that private-sector unions face. This gave them the impetus to negotiate fearlessly with government to increase compensation and defined-benefit pensions while lobbying endlessly for expansion of bureaucracy. The United Autoworkers treated the automakers like piñatas to be cracked open for goodies, heedless of the effects on the company.

Technically, one should acknowledge the role played by the federal government in burdening automakers with safety and mileage standards that vastly increased the companies’ costs with no commensurate offsetting gains to anybody except politicians. (Longstanding research, beyond the scope of this article to reproduce, has reaffirmed the net harm done by these categories of federal legislation.) Still, this was at most a glancing blow felt by Detroit during the reign of liberalism.

“America’s First Third-World City”

In addition to the standard drawbacks of 20th century municipal liberalism, Detroit suffered under its own unique handicap. From 1974 to 1994, it experienced the mayoral reign of Coleman Young. Young was a veteran of World War II who became the North’s first black mayor at the same time as Atlanta’s Maynard Jackson became the South’s first black mayor. Young was elected to five terms before retiring and dying of emphysema in 1997.

Although Young followed in the wake of the so-called civil-rights movement, he was really a black separatist in the tradition of Malcolm X rather than a reformer a la Martin Luther King, Jr. Young accused the Army of discriminating against him and carried that chip on his shoulder throughout his public career. When he became Mayor of Detroit, he alienated whites by insisting that only white people can be racists. His frequent diatribes induced whites to abandon the city, whereupon Young excoriated them as “racists in the suburbs,” according to Patrick Mallon’s memoir of his formative years in Detroit, entitled “Detroit: Coleman Young’s Triumph of Self-Destruction.” Mallon feels that Young was principally responsible for changing the course of his childhood by [teaching] me, my parents and my friends that we were all in the [racist] class of people.”  Likewise, writer Tamar Jacoby claims that “Detroit was governed by a black demagogue from the moment Coleman Young was elected Mayor.” Rather than take corrective measures to retain white citizens, Young encouraged the concept of black “independence.” This led writer Ze’ev Chafets to label Detroit “America’s first Third-World City.”

The loss of revenue stemming from white flight was partially offset by millions in payments by auto companies for what has been called “riot insurance.” The granddaddy of all riots occurred in July, 1967, when police tried to break up a party at an after-hours nightclub. When they discovered 82 guests celebrating the return of two Vietnam veterans, they tried to haul off all celebrants to jail. The doorman, son of the club owner, hurled a rock through the back window of a squad car, triggering a melee that spread into general rioting. Local and state police could not contain the violence and looting that killed 43 people, injured over a thousand others and caused millions of dollars in property damage. Ironically, although chronic ill will between the police department and blacks was the spark that set off the misbehavior, the first person killed was a white looter. Subsequent violence and looting was perpetrated by and against blacks, particularly harming innocent store and business owners. The riot was classified as America’s third-worst riot, ranking behind the New York Draft Riot during the Civil War and Los Angeles’ Watts riot in 1992. Despite the terrible toll taken by the riot, Young refused to condemn rioting by blacks, calling it “rebellion.”

Whatever psychological benefits blacks may have gained from Young’s posturing, it provided no economic benefits whatever. Detroit gained a reputation as “America’s blackest city,” but this carried little or no economic value. The racial makeup of the 53 Detroit suburbs became lily white, but this did not prevent Michigan from losing roughly half of its manufacturing jobs in the first decade of this century.

What Killed Detroit? “Liberalism,” Sings the Chorus

The response to the bankruptcy announcement has been well-nigh unanimous. Commentators declare that liberalism killed the city. This verdict is easy to understand.

Detroit has been run by liberals for nearly six decades. In approved liberal fashion, municipal government expanded explosively and spent money lavishly, borrowing when necessary. Detroit was not a run-down, underdeveloped community in Appalachia. It was the most prosperous city in America when the liberals took over.

Still, there were poor people – too many, apparently, to suit liberals. The best and brightest of the Kennedy New Frontier generation took a firm grip on the reins of power and set out to lift the poor out of poverty using the levers of government – government programs, welfare, affirmative action and the full-scale liberal agenda.

There were racial problems in Detroit when the liberals took over. A rift existed between the “black community” and the police department. Liberals attacked the problems full bore. They ushered in Detroit’s first black mayor. They gave him his head. He immediately identified whites as the problem. He substituted blacks for whites throughout the city, much as a producer might substitute a more efficient or cheaper input for a less efficient one. In particular, the mayor gave blacks majority status within the police department. The result was that whites fled the city for the suburbs.

In addition to having too many white people, Detroit was also adjudged to have too many rich people. Not only did rich people inhabit the wealthy suburbs like Dearborn, they also lived in enclaves within Detroit proper. One of the first liberal actions taken in the early 60s was to raise existing taxes and create new ones. These were intended to fund the liberal programs, pay the wages and salaries of burgeoning municipal payrolls and to promote social justice by correcting the unfair distribution of income.

If the creed of liberalism is to be believed – if liberalism actually worked – these measures should have enshrined Detroit in prosperity for the indefinite future. Instead, they succeeded only in immizerizing the city. “America’s blackest city” became so crime-ridden and murder-ravaged that police have now declared it unsafe for entry by outsiders. Capital fled Detroit as if it were a banana republic undergoing a revolution. Detroit was dubbed “America’s First Third-World City.”

After a half-century of undiluted, full-throated liberalism, Detroit became the largest American city ever to declare Chapter 9 bankruptcy. Much of the city has the look of a bombed-out, abandoned wasteland.

Michael Barone, author of The Almanac of American Politics, is America’s acknowledged authority on politics. “When people ask me why I moved from liberal to conservative,” he wrote recently, “I have a one-word answer: Detroit. I grew up there…I got a job as an intern in the office of the mayor in the summer of 1967… [Mayor Jerome] Cavanaugh was bright, young, liberal and charming. He had been elected in 1961 at age 33 with virtually unanimous support from blacks and with substantial support from white homeowners – then the majority of Detroit voters – and he was reelected by a wide margin in 1965… He was one of the first mayors to set up an anti-poverty program and believed that city governments could do more than provide routine services; they could lift people, especially black people, out of poverty and into productive lives. Liberal policies promised to produce something like heaven. Instead they produced something more closely resembling hell.”

The First Municipal Domino

While Detroit’s mayoral leadership may have been memorably incapable, other major U.S. cities are following in its wake. Eric Scorsone, economist at Michigan State University, concludes that “it’s the same in Chicago and New York and San Diego and San Jose. It’s a lot of major cities in this country [that] face the same problems.” After all, virtually all major U.S. cities are controlled by Democrats and governed by large, bureaucratic, wasteful administrative mechanisms. They all contain huge unfunded liability time bombs ticking loudly and conspicuously in the form of defined-benefit retirement programs for civic employees. All are spending far beyond their means, often borrowing in order to finance it.

The federal government’s debt, which now exceeds annual gross domestic product, has garnered most of the dire predictions associated with government finance. State and local government finance has a hard time competing in the doom-and-gloom prophecy business when its competitor has the biggest numbers all sewn up. The problem is that the federal government has the advantage of time on its side, as the Detroit bankruptcy shows. The feds wear square-toed financial boots in the form of money-creation powers and interest-rate manipulation powers. These enable them to kick the financial can down the road longer than state and local governments can.

Consequently, we can expect to see more cities stand in the financial dock before the day finally comes when members of Congress have to shape up or get a real job.

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.

DRI-307 for week of 6-30-13: Paving the Road to Hell: A Short History of Bailouts

An Access Advertising EconBrief:

Paving the Road to Hell: A Short History of Bailouts

A versatile sports anecdote of obscure lineage pits a combative baseball manager against a first-base umpire. The manager conducts a prolonged, high-decibel – but utterly unavailing – protest against the umpire’s decision to call a runner out at first base. Upon returning to the dugout, the manager encounters a quizzical coach.

“Why waste all that energy?” the coach inquires. “You know he’s not going to change his call.”

“I’m not arguing about that call,” the manager replies vehemently. “I’m arguing for the next one.”

The story may be apocryphal, but its point is sound. Umpires are known to be influenced by their own nagging suspicions that they have blown a call, so much so that umpire schools teach pupils not to compensate for mistakes in subsequent decisions. The immediate aftermath of the play is the manager’s only window of opportunity to influence the umpire – about future plays, not the one argued about.

From the beginning, economists have argued against “bailouts” – the use of government (e.g., taxpayer) funds to rescue failing business firms. Although the arguments supporting bailouts pretend to be economic, the true motivation is invariably political. This suggests that economists’ opposition is futile. Yet the opposition continues, just as the bailouts themselves do.

Like the proverbial manager, economists are arguing for the next one. They know that the bailout process has a cumulative momentum. A bailout is not an independent, isolated event that stands or falls purely on its own merits. Each bailout establishes the precedent for the succeeding one. Moreover, each new generation requires a fresh introduction to the illogic of the bailout, as well as to the history of the process. Economists direct their arguments against past bailouts, but their true targets are the bailouts to come – the ones whose fate they can influence.

That is why a history of bailouts and the ghastly reasoning that inspired them is far from pointless. It is our only prophylactic against the flood of bailouts to come.

Penn Central (1970)

The Penn Central Railroad was created by the 1968 merger of two venerable American railroad companies: the New York Central Railroad and the Pennsylvania Railroad. A year later, the New York, New Haven and Hartford Railroad joined the party to form Penn Central Transportation Company. These railroads all shared common features, particularly their location in the northeast United States. The Northeast corridor was the most population-dense region of the country. Each of these roads specialized in short hauls of people and freight, in contrast to the mostly long-haul traffic carried by railroads elsewhere in the U.S.

The problem was that, while shorter routes made geographic sense, many competing means of transport had evolved by the late 1960s. Barges carried bulky, low value-to-weight commodities like gravel and sand. Trucks carried retail goods and foodstuffs, including refrigerated perishables. Buses and automobiles carried passenger traffic. This left specialized raw materials like coal and commuting passengers for the railroads.

The roads wanted and needed to lower freight and passenger rates to compete with rival industries. Alas, they were hamstrung by the Interstate Commerce Commission, whose regulations forbade rate changes without regulatory hearings. Ironically, the very regulatory body ostensibly created (in 1887) to prevent railroads from utilizing monopoly power now prevented them from behaving competitively. The erosion of railroad customer base to these competing transportation modes left the railroads with scads of excess capacity and no way to utilize it. This was a recipe for bankruptcy.

The theory behind Penn Central was that merger would allow the single entity to better utilize capacity by selling off abandoning track and rolling stock. Unfortunately, it succeeded only in building a bigger, bulkier and less efficient mousetrap. Penn Central declared bankruptcy in 1970 and was eventually declared unsuitable for reorganization. The federal government took over its passenger business and operated it under the name of Conrail.

Railroads in general and Conrail in particular were saved, not by government bailouts, but by the deregulation of railroads in the Staggers Act of 1980. This gave railroad companies the freedom and flexibility to act quickly and decisively to serve customers by cutting prices and dumping unprofitable lines of business. Unfortunately, the federal government continued to operate a nationalized passenger-rail transport system called Amtrak. Today, a completely deregulated railroad industry would undoubtedly serve the part of the U.S. where passenger-rail service remains viable – the Northeast. Instead, Amtrak continues to serve markets where the demand for passenger service is feeble and the costs of service are astronomically high.

Why in the world was Penn Central bailed out to produce Conrail? What crying necessity demanded it? What calamity would have accompanied an orderly bankruptcy and the demise and liquidation of the company? “None” and “none,” respectively, are the answers to the last two questions. Many upper-middle-class and upper-class Northeasterners traveled the commuter routes served by the roads, and the railroad unions wielded political clout in inverse proportion to the value created by their members for the railroads. (The term “featherbedding” was coined to describe the work practices of railroad-union employees.) The Republican (!) administration in power was powerless to resist the political temptation to “save jobs” and preserve a highly visible service catering to an influential elite.

Today, everybody has forgotten about Conrail. Nobody remembers the first great federal bailout of private business. Of course, it did not end in a huge fiasco. And today the railroad sector is a tremendous transportation success story. But the reason for success is the subsequent deregulation of railroads, and the remaining legacy of the bailout – Amtrak – continues to hemorrhage red ink and suck involuntary transfusions from taxpayers.

Great oafs from little acorns grow.

Lockheed (1971)

The longtime producer of jets had come to derive the bulk of its business from government contracts. This made it a creature of government, even though it technically operated in competition with other airplane manufacturers. The bankruptcy of British firm Rolls Royce – famous for its luxury automobile but also a proficient builder of engines – threatened the completion date for Lockheed’s TriStar L-1011 jet fighter. Default on this U.S. government contract would have put Lockheed under. To tide the company over, the U.S. Congress issued some $250 million in loan guarantees to Lockheed, over the protests of free-marketers.

This time, the rationale was somewhat different. Lockheed’s defense status allowed the company to wrap itself in the cloak of national security, a nuisance that probably destroys more GDP annually than any other economic pest. This required considerable chutzpah on Lockheed’s part, considering that America could still boast firms like Boeing and McDonnell Douglas even if Lockheed had padlocked its doors. But that didn’t stop the company from pointing to the dread specter of its 60,000 jobs that would be lost – gone forever! – if Congress did not ride to its rescue.

Sure enough, the TriStar made it to market. Fittingly, it was deep-sixed by competitors like Boeing’s BA747 and McDonnell Douglas’s DC-10. When the TriStar ceased production in 1983, Lockheed abandoned jet production (so much for our national security) and later merged with Martin Marietta to form Lockheed Martin.

Note, once again, that even though Lockheed did not default on its loans, the bailout was still exposed as a fraud. The pretext of protecting national security proved to be nonsense, the object of the loans proved to be superfluous and as for the jobs – well, the loan guarantees ended up saving a product that deserved to fail but didn’t immunize against an eventual loss of jobs, which went unnoticed anyway.

Chrysler (1980)

In 1979 Chrysler, the smallest of America’s “Big 3” automakers, turned in a then-gigantic $1 billion loss in net income and teetered on the edge of bankruptcy. Dynamic CEO Lee Iacocca heeded the newly evolving American tradition that, when the going gets tough, the tough go begging – to Washington for a bailout. Probably recalling Lockheed’s loan guarantees, Iacocca secured $1.5 billion in guarantees for Chrysler. In addition to the (by now) old chestnut that he was “protecting jobs,” old-hog Iacocca was able to root up a new chestnut – that America’s automotive vanguard had to be protected against the encroachment of foreign competition from Japan. This was a conveniently flexible argument. If there had been no competition from Japan, Iacocca would then have argued that Chrysler needed to be saved to make sure that Americans didn’t run out of cars. Now he could argue that Chrysler needed to be saved to make sure that America “won” the “car war” with Japan. The fact that “winning” by subsidizing an inferior product was the same thing as losing didn’t seem to occur to most people – certainly not to Congress – and Iacocca was hailed as a genius for his lobbying efforts.

President Carter signed the bailout legislation in January, 1980. His administration saved face by requiring Chrysler to raise its own financing for the loans. Iacocca could later brag that the company returned to profitability by 1983 and repaid its loans. No harm, no foul, right? What a triumph for bailouts! At least, that was the general impression conveyed. Yet American consumers paid for Chrysler’s comeback in the form of taxes and quotas levied on imports of Japanese automobiles. That price was very steep.

The biggest price, though, came later. The Chrysler bailout set the stage for the later bailout of General Motors and Ford. The precedent set by Chrysler made it easy – indeed, virtually inevitable – to bail out the “Big 2” when their time came. Not only was it that much harder to reject the same bogus “jobs” rhetoric Iacocca had advanced, but the mere fact that Chrysler had done it and gotten away with it set a psychological minimum standard for treatment of ailing corporate giants. Previous bailees had been either quasi-utilities like Penn Central or quasi-government firms like Lockheed. This was a straightforward case of corporate welfare. It was a line jumped, a Rubicon crossed, a rule broken. Things would never be the same again.

Long Term Capital Management (1998)

In the late 1960s, a group of investors that included Nobel-Prize winning economists formed one of the first hedge funds, named Long Term Capital Management (LTCM). The fund was designed to incorporate asset pricing and portfolio management principles embodied in tools like the Capital Asset Pricing Model developed by William Sharpe. The most striking notions employed by LTCM were those involving portfolio risk.

LTCM designed highly risky portfolios that included long-term fixed-income instruments and currencies. It was precisely the long terms that produced the high risk, since the interest-rate risk of fixed-income securities increases with term to maturity. Currency risk likewise increases with the holding period. The high risk produced very high rates of return. So far, there was nothing remarkable about LTCM’s activities or methods. But the firm was able to offset most of the high risk through a hedge position, whose value was specifically designed to move inversely to that in the risky portfolios. Alternatively put, it was supposed to move directly with interest rates. The general idea behind this hedge investment was simple in concept but hard to achieve in practice: to rise in value when LTCM’s risky portfolios were falling in value, thus offsetting the otherwise-high risk LTCM was running. This made it possible for LTCM to earn spectacularly high profits in good times and break even (more or less) in bad times.

The hedge investment was a short position in U.S. Treasury securities. When worldwide interest rates rose, LTCM’s risky portfolio value would plummet. But LTCM’s managers knew that investors would bid down the prices of Treasury securities and, as a result, their effective yields (interest rates) would rise. Only this higher yield would make Treasury bonds equally satisfactory to investors when world interest rates had risen. The fall in Treasury-bond prices would make big profits on LTCM’s short position to offset the losses on its risky portfolios. And so it went for about 20 years until 1998.

That was the year of the Russian government default. Suddenly the world’s investors abandoned risky investments altogether. They embarked on a “flight to safety.” At that point, the U.S. government’s Treasury bond was still the prototypical riskless asset. So investors bought Treasury bonds, driving up their price and driving down their effective yields (interest rates).

Whoops! Now LTCM was losing boatloads of money on both sides of its trades. In no time it was going down for the third time, financially speaking. And its owners, having kept their eyes open for the preceding 20 years, did what any red-blooded American financier or CEO would do. They ran to the federal government for a bailout.

LTCM was not a railroad. It was not a defense contractor. It was not a car company. It wasn’t even a bank. It was just an investment company whose investment strategy had blown up in its face. Now its investors and owners were suddenly staring insolvency in the face. Except, in this case, they decided to stare Fed Chairman Alan Greenspan in the face instead. And Greenspan blinked. Acting through its New York branch, the Fed passed the plate around Wall Street and collected $3.8 billion in funds with which to salvage the firm’s investments while delivering the firm into the hands of its rescuers.

And what was the rationale for this unprecedented act? Basically, to prevent turmoil in the markets. LTCM was so big that the Fed was afraid that its failure would scare investors to death. Note that there was now no pretense of saving jobs, defending national security, preserving the sanctity of motherhood or the recipe for Mom’s apple pie.

LTCM was a hedge fund whose investors were people of considerable means. The whole idea behind the tight regulation of the investment business is to make sure that investors and investments are suitable for each other and risks are borne by willing individuals who can afford to lose the money. And now… the Fed said we couldn’t afford to let them lose the money! Why? Because the knowledge that one firm had failed would drive this group of rational investors to collectively commit irrational acts. The Fed intervened massively in capital markets to reverse the outcomes of legitimate trades because their subjective reading of collective psychology told them it was the thing to do. And they arbitrarily commandeered private resources to do so, without statutory or judicial warrant.

The Bailouts of the Great Recession and the Financial Crisis (2007-2010)

For most people, the steps taken by the federal government during the Great Recession and the Financial Crisis of 2008 seemed unique and precipitous. But our history of bailouts shows their roots extending far back in history.

The nationalizations of General Motors, Fannie Mae and Freddie Mac were preceded by the nationalization of Conrail. The bailout of GM came after the bailout of Chrysler. The bailout of a financial firm like LTCM paved the way for future bailouts of AIG, Goldman Sachs Hedge Fund and others. The numerous bank and near-bank bailouts in the Financial Crisis were the grandchildren of the Continental Illinois bailout.

The ostensible legacy of the Great Depression was that particular markets needed tight regulation. Financial markets needed it to insure that all parties had the information needed to make rational voluntary exchange possible. Banking needed it because the principle of fractional-reserve banking allowed banks in the aggregate to exert an undue influence over the supply of money through credit creation. In good times, this could facilitate inflation and the creation of bubbles. In bad times, this could cause disaster when bank runs and bank failures have a downwardly cascading effect on the money supply.

Our history of bailouts, however, indicates that bailouts began forfirms in specialized sectors like railroads, defense and banking, but gradually spread to mundane sectors like manufacturing and investment. It comes as no surprise, therefore, that today programs like TARP offers bailouts to a substantial sector of the American population. Homeowners make up a majority of U.S. households and it is not hard to envision a day when a mortgage will come with a guarantee against foreclosure.

The ultimate guarantors of a bailout are taxpayers. The government can obtain funds to bail out a business firm from only three sources: tax receipts, borrowing and money creation. Taxes reduce the real income of taxpayers. Borrowing requires the repayment of principal and interest; thus, it reduces taxpayer real incomes unless it funds the creation of a productive asset. Money creation reduces the value of taxpayers’ money holdings, which is tantamount to a tax.

When everybody bails out everybody else, the process is self-defeating. It becomes impossible and purposeless to sort out gainers and losers. Only the brokers, politicians and bureaucrats, are net gainers. Since the expenditure of resources necessary to produce the bailouts far exceeds the gains enjoyed by these groups, economists frown on the whole process. Far better to allow market to allocate resources and pass judgment on how well or how badly business firms use them to satisfy consumers. Of course, anybody who wants to voluntarily contribute their own resources to compensate losers in the competitive process is welcome to do so. When people act voluntarily, we can presume they gain more than they lose from their actions.

But when government meddling takes the form of bailouts, there is no such presumption.

DRI-332 for week of 6-16-13: What Lies Ahead for Us?

An Access Advertising EconBrief:

What Lies Ahead for Us?

Last month, Federal Reserve Chairman Ben Bernanke announced that the Fed Open Market Committee is contemplating an end to the $85 billion program of bond purchases that has been dubbed “Quantitative Easing (QE).” The announcement was hedged over with assurances that the denouement would come only gradually, when the Fed was satisfied that general economic conditions had improved sufficiently to make QE unnecessary. Nonetheless, the announcement produced a flurry of speculation about the eventual date and timing of the Fed’s exit.

The Fed’s monetary policy since the financial crisis of 2008 and the stimulus package of 2009 is unique in U.S. economic history. Indeed, its repercussions have resounded throughout the world. Its motives and means are both poorly understood and hotly debated. Shedding light on these matters will help us face the future. A question-and-answer format seems appropriate to reflect the mood of uncertainty, anxiety and fear that pervades today’s climate.

What was the motivation for QE, anyway?

The stated motivation was to provide economic stimulus. The nature of the stimulus was ambiguously defined. Sometimes it was to increase the rate of inflation, which was supposedly too low. Sometimes it was to stimulate investment by holding interest rates low. The idea here was that, since the Fed was buying bonds issued by the Treasury, the Fed could take advantage of the inverse relationship between a bond’s price and its yield to maturity by bidding up T-bond prices, which automatically has the effect of bidding down their yields. Because $85 billion worth of Treasury bonds comprise such a large quarterly chunk of the overall bond market, this will depress bond yields for quite a while after the T-bond auction. Finally, the last stimulative feature of the policy was ostensibly to indirectly stimulate purchase of stocks by driving down the yields on fixed-income assets like bonds. With nowhere to go except stocks, investors would bid up stock prices, thus increasing the net worth of equity investors, who comprise some 40-50% of the population.

How was driving up stock prices supposed to stimulate the economy?

The ostensible idea was to make a large segment of Americans feel wealthier. This should cause them to spend more money. This sizable increase in overall expenditures should cause secondary increases in income and employment through the economic process known as the “multiplier effect.” This would end the recession by reducing unemployment and luring Americans back into the labor force.

How did the plan work out?

Inflation didn’t increase much, if at all. Neither did investment, particularly when viewed in net terms that exclude investments to replace deteriorated capital stock. Stock prices certainly rose, although the consumption increases that followed have remained modest.

So the plan was a failure?

That would be a reasonable assessment if, and only if, the stated goal(s) of QE was (were) the real goal(s). But that wasn’t true; the real goal QE was to reinforce and magnify the Fed’s overall “zero interest-rate policy,” called ZIRP for short. As long as it accomplished that goal, any economic stimulus produced was a bonus. And on that score, QE succeeded very well indeed. That is why it was extended and why the Fed is stretching it out as long as it can.

Wait a minute – I thought you just said that even though interest rates have remained low, investment has not increased. Why, then, is the Fed so hot to keep interest rates low? I always heard that the whole idea behind Fed policies to peg interest rates at low levels was to stimulate investment. Why is the Fed busting our chops to follow this policy when it isn’t working?

You heard right. That was, and still is, the simple Keynesian model taught to freshman and sophomore economics students in college. The problem is that it never did work particularly well and now works worse than ever. In fact, that policy is actually the proximate cause of the business cycle as we have traditionally known it.

But even though the Fed gives lip service to this outdated textbook concept, the real reason it wants to keep interest rates low is financial. If the Fed allowed interest rates to rise – as they would certainly do if allowed to find their own level in a free capital market – the rise in market interest rates would force the federal government to finance its gargantuan current and future budget deficits by selling bonds that paid much higher interest rates to bondholders. And that would drive the percentage of the federal government budget devoted to interest payments through the roof. Little would be left for the other spending that funds big government as we know it – the many cabinet departments and myriad regulatory and welfare agencies.

Even if you don’t find this argument compelling – and you can bet it compels anybody who gets a paycheck from the federal government – it should be obvious to everybody that the Fed isn’t really trying that hard to apply traditional stimulative monetary policy. After all, stimulative monetary policy works by putting money in public hands – allowing banks to make loans and consumer spending to magnify the multiplier effects of the loan expenditures. But Bernanke lobbied for a change in the law that allowed the Fed to pay interest to banks on their excess reserves.  When the Fed enforces ZIRP by buying bonds in the secondary market, it pays banks for them by crediting the banks’ reserve accounts at the Fed. The interest payments mean that the banks don’t have to risk making loans with that money; they can just hold it in excess reserves and earn easy profits. This is the reason why the Fed’s money creation has not caused runaway inflation, as government money creation always did in the past. You can’t have all or most prices rising at once unless the newly created money is actually chasing goods and services, which is not happening here.

But the mere fact that hyperinflation hasn’t struck doesn’t mean that the all-clear has been sounded. And it doesn’t mean that we’re not being gored by the horns of a debt dilemma. We certainly are.

Being gored in the bowels of a storm cellar is a pretty uncomfortable metaphor. You make it sound as though we have reached a critical economic crisis point.

We have. Every well-known civilizational collapse and revolution, from ancient Rome to the present day, has experienced a financial crisis resembling ours. The formula is familiar. The government has overspent and resorted to money creation as a desperate expedient to finance itself. This has papered over the problem but ended up making things even worse. For example, the French support for the American colonies against Great Britain was the straw that broke the bank of their monarchy, fomenting the French Revolution. The Romanovs downfall occurred despite Russia’s increasing rate of economic growth in the late 1800s and because of financial profligacy and war – two causes that should be familiar to us.

It sounds as though government can no longer use the tools of fiscal and monetary policy to stimulate the economy.

It never could. After all, the advent of Keynesian economics after 1950 did not usher in unprecedented, uninterrupted world prosperity. We had recessions and depressions before Keynes wrote his General Theory in 1936 and have had them since then, too. And Keynes’s conclusions were anticipated by other economists, such as the American economists Foster and Catchings in the late 1920s. F.A. Hayek wrote a lengthy article refuting their arguments in 1927 and he later opposed Keynes throughout the 1930s and thereafter. The principles of his business-cycle theory were never better illustrated than by real-world events during the run-up to the recession and financial crisis in 2007-2008 and the later stimulus, ZIRP and QE.

It seems amazing, but Keynesian economists today justify government policies by claiming that the alternative would have been worse and by claiming responsibility for anything good that happens. Actually, the real force at work was described by the Chairman of Great Britain’s Bank of England, Mervyn King, in the central bank’s February Inflation Report:

“We must recognize [sic], however, that there are limits to what can be achieved via general monetary stimulus – in any form – on its own. Monetary policy works, at least in part, by providing incentives to households and businesses to bring forward spending from the future to the present. But that reduces spending plans tomorrow. And when tomorrow arrives, an even larger stimulus is required to bring forward yet more spending from the future. As time passes, larger and larger doses of stimulus are required.”

King’s characterization of transferring spending or borrowing from the future accurately describes the effects of textbook Keynesian economics and the new variant spawned by the Bernanke Fed. Keynesians themselves advertised the advantage of fiscal policy as the fact that government spending spends 100% of every available dollar, while private consumers allow part of the same dollar to leak into savings. This dovetails exactly with King’s account. The artificially low interest rates created by monetary policy have the same effect of turning saving into current consumption.

Today, we are experiencing a grotesque, nightmarish version of Keynesian economics. Ordinarily, artificially low interest rates would stimulate excessive investment – or rather, would drive investment capital into longer-maturing projects that later prove unprofitable, like the flood of money directed toward housing and real-estate investment in the first decade of this century. But our current interest rates are so absurdly low, so palpably phony, that businesses are not about to be suckered by them. After all, nobody can predict when rates might shoot up and squelch the profitability of their investment. So corporations have pulled up their financial drawbridges behind balance sheets heavy with cash. Consumers have pulled consumption forward from the future, since that is the only attractive alternative to the stock investments that only recently wrecked their net worth. This, too, validates King’s conclusions. Whether “successful” or not, Keynesian economics cannot last because the policy of borrowing from the future is self-limiting and self-defeating.

Didn’t I just read that our budget deficit is headed lower? Doesn’t this mean that we’ve turned the corner of both our budget crisis and our flagging recovery?

If you read carefully, you discovered that the improvement in the federal government’s fiscal posture is temporary, mostly an accounting artifact that occurs every April. Another contributing factor is the income corporations distributed at year-end 2012 to avoid taxation at this year’s higher rates, which is now being taxed at the individual level. Most of this constitutes a one-time increase in revenue that will not carry over into subsequent quarters. Even though the real economic benefits of this are illusory, it does serve to explain why Fed Chairman Bernanke has picked this moment to announce an impending “tapering off” of the QE program of Fed bond purchases.

How so?

The fact that federal deficits will be temporarily lower means that the federal government will be selling fewer bonds to finance its deficit. This, in turn, means that the Fed will perforce be buying fewer bonds whether it wants to or not. Even if there might technically be enough bonds sold for the Fed to continue buying at its current $85 billion level, it would be inadvisable for the federal government to buy all, or virtually all, of an entire issue while leaving nothing for private investors. After all, U.S. government bonds are still the world’s leading fixed-income financial instrument.

Since the Fed is going to be forced to reduce QE anyway, this gives Bernanke and company the chance to gauge public reaction to their announcement and to the actual reduction. Eventually, the Fed is going to have to end QE, and the more accurately they can predict the reaction to this, the better they can judge when to do that. So the Fed is simply making a virtue out of necessity.

You said something awhile back that I can’t forget. You referred to the Keynesian policy of artificially lowering interest rates to stimulate investment as the “proximate” cause of the business cycle. Why is that true and what is the qualifier doing there?

To illustrate the meaning, consider the Great Recession that began in 2007. There were many “causes,” if one defines a cause as an event or sequence of events that initiated, reinforced or accelerated the course of the recession. The housing bubble and ensuing collapse in housing prices was prominent among these. That bubble itself had various causes, including the adoption of restrictive land-use policies by many state and local jurisdictions across America, imprudent federal-government policies promoting home-ownership by relaxing credit standards, bank-regulation standards that positioned mortgage-related securities as essentially riskless and the creation and subsidy of government-sponsored agencies like Fannie Mae and Freddie Mac that implemented unwise policies and distorted longstanding principles of home purchase and finance. Another contributor to recession was the decline in the exchange-value of the U.S. dollar that led to a sharp upward spike in (dollar-denominated) crude oil prices.

But the reign of artificially low interest rates that allowed widespread access to housing-related capital and distorted investment incentives on both the demand and production side of the market were the proximate cause of both the housing bubble and the recession. The interest rates were the most closely linked causal agent to the bubble and the recession would not have happened without the bubble. Not only that, the artificially low interest rates would have triggered a recession even without the other independent influences – albeit a much milder one. Another way to characterize the link between interest rates and the recession would be to say that the artificially low interest rates were both necessary and sufficient to produce the recession. The question is: Why?

For several centuries, an artificial lowering of interest rates accompanied an increase in the supply of money and/or credit. Prior to the 20th century, this was usually owing to increases in stocks of mined gold and/or silver, coupled with the metallic monetary standards then in use. Modern central banks have created credit while severing its linkage with government holdings of stocks of precious metals, thus imposing a regime of fiat money operating under the principles of fractional-reserve banking.

In both these institutional settings, the immediate reaction to the monetary change was lower interest rates. The effect was the same as if consumers had decided to save more money in order to consume less today and more in the future. The lower interest rates had complex effects on the total volume of investment because they affect investment through three different channels. The lower rate of discount and increased value of future investment flows greatly increase the attractiveness of some investments – namely, those in long-lived production processes where cash flows are realized in the relatively distant future. Housing is a classic example of one such process. Thus, a boom is created in the sector(s) to which resources are drawn by the low interest rates, like the one the U.S. enjoyed in the early 2000s.

The increase in employment and income in those sectors causes an increase in the demand for current consumption goods. This bids up prices of labor and raw materials, provided either that full employment has been reached or that those resources are specialized to their particular sectors. This tends to reduce investment in shorter-term production processes, including those that produce goods and services for current consumption. Moreover, the original investments are starting to run into trouble for three reasons: first, because their costs are unexpectedly increasing; second, because the consumer demand that would ordinarily have accompanied an increase in saving is absent because it was monetary expansion, not saving, that produced the fall in interest rates; and third, because interest rates return to their (higher) natural level, making it difficult to complete or support the original investments.

Only an increase in the rate of monetary expansion will allow original investments to be refinanced or validated by an artificial shot of consumer demand. That is what often happened throughout the 20th century – central banks frantically doubled down on their original monetary policy when its results started to go sour. Of course, this merely repeated the whole process over again and increased the size and number of failed investments. The eventual outcome was widespread unemployment and recession. That is the story of the recent housing bubble. This mushrooming disaster couldn’t happen without central banking, which explains why 19th century business cycles were less severe than many modern ones.

I don’t recall reading this rather complicated explanation before or hearing it discussed on television or radio. Why not?

The preceding theory of business cycles was developed by F. A. Hayek in the late 1920s, based on monetary theory developed by his mentor, Ludwig von Mises, and the interest-rate theory of the Swedish economist, Knut Wicksell. Hayek used it to predict the onset of what became the Great Depression in 1929. (Von Mises was even more emphatic, foreseeing a “great crash” in a letter to his wife and refusing a prestigious appointment in his native Vienna to avoid being tarred by exposure to events.) Hayek’s theory earned him an appointment to the London School of Economics in 1931. It was cited by the Nobel committee that awarded him the prize for economic science in 1974.

But after 1931, Hayek engaged several theoretical controversies with his fellow economists. The most famous of these was his long-running debate with John Maynard Keynes. One long-term consequence of that debate was the economics profession’s exile of capital theory from macroeconomics. They refused to contemplate the distinction between long-term and short-term production processes and capital goods. They treated capital as a homogeneous lump or mass rather than a delicate fabric of heterogeneous goods valued by an intricate structure of interest rates.

That is why Keynesian macroeconomics textbooks pretend that government can increase investment by creating money that lowers “the” interest rate. If government could really do this, of course, our lives would all be radically different than they actually are. We would not experience recessions and depressions.

Public-service radio and television advertisements warn consumers to beware of investment scams that promise returns that are “too good to be true.” “If it sounds too good to be true,” the ad declares sententiously, “it probably is.” What we really need is a commercial warning us to apply this principle to the claims of government and government policymakers – and, for that matter, university professors who are dependent upon government for their livelihood.

It turns out to be surprisingly difficult to refute the claims of Keynesian economics without resorting to the annoyingly complicated precepts of capital theory. Ten years before Keynes published his theory, the American economists Foster and Catchings developed a theory of government intervention that embodied most of Keynes’ ideas. They published their ideas in two books and challenged the world to refute them, even offering a sizable cash prize to any successful challenger. Many prominent economists tried and failed to win the prize. What is more, as Hayek himself acknowledged, their failure was deserved, for their analysis did not reveal the fallacies inherent in the authors’ work.

Hayek wrote a lengthy refutation that was later published under the title of “The ‘Paradox’ of Saving.” Today, over 80 years later, it remains probably the most meticulous explanation of why government cannot artificially create and preserve prosperity merely by manipulating monetary variables like the quantity of money and interest rates.

There is nothing wrong with Hayek’s analysis. The main problem with his work is that it is not fashionable. The public has been lied to so long and so convincingly that it can hardly grasp the truth. The idea that government can and should create wealth out of thin air is so alluring and so reassuring – and the idea of its impossibility so painful and troubling – that fantasy seems preferable to reality. Besides, large numbers of people now make their living by pretending that government can do the impossible. Nothing short of social collapse will force them to believe otherwise.

The economics profession obsessively studied and research Keynesian economics for over 40 years, so it has less excuse for its behavior nowadays. Keynes’ main contentions were refuted. Keynesianism was rejected by macroeconomists throughout the world. Even the head of the British Labor Party, James Callaghan, bitter denounced it in a famous speech in 1976. The Labor Party had used Keynesian economics as its key economic-policy tool during its installation of post-World War II socialism and nationalization in Great Britain, so Callaghan’s words should have driven a stake through Keynes’ heart forevermore.

Yet economists still found excuses to keep his doctrines alive. Instead of embracing Hayek, they developed “New Keynesian Economics” – which has nothing to do with the policies of Bernanke and Obama today. The advent of the financial crisis and the Great Recession brought the “return of the Master” (e.g., Keynes). This was apparently a default response by the economics profession. The Recession was not caused by free markets nor was it solved by Keynesian economics. Keynesian economics hadn’t got any better or wiser since its demise. so there was no reason for it to reemerge like a zombie in a George Romero movie. Apparently, economists were reacting viscerally in “we can’t just sit here doing nothing” mode – even though that’s exactly what they should have done.

If QE and ZIRP are not the answer to our current economic malaise, what is?

In order to solve a problem, you first have to stop making it worse. That means ending the monetary madness embodied in QE and ZIRP. Don’t try to keep interest rates as low as possible; let them find their natural level. This means allowing interest rates to be determined by the savings supplied by the private sector and the investment demand generated by private businesses.

In turn, this means that housing prices will be determined by markets, not by the artificial actions of the Fed. This will undoubtedly reverse recent price increases recorded in some markets. As the example of Japan shows only too well, there is no substitute for free-market prices in housing. Keeping a massive economy in a state of suspended animation for two decades is no substitute for a functioning price system.

The course taken by U.S. economic history in the 20th century shows that there is no living with a central bank. Sooner or later, even a central bank that starts out small and innocuous turns into a raging tiger with taxpayers riding its back and looking for a way to get off. (The Wall Street Journal‘s recent editorial “Bernanke Rides the Bull” seems to have misdirected the metaphor, since we are the ones riding the bull.) Instead of a Fed, we need free-market banks incapable of wangling bailouts from the government and a free market for money in which there are no compulsory requirements to accept government money and no barriers to entry by private firms anxious to supply reliable forms of money. Bit Coin is a promising development in this area.

What does all the talk about the Fed “unwinding” its actions refer to?

It refers to undoing previous actions; more specifically, to sales that cancel out previous purchases of U.S. Treasury bonds. The Fed has been buying government bonds in both primary and secondary bond markets pursuant to their QE and ZIRP policies, respectively. It now has massive quantities of those bonds on its balance sheet. Technically, that makes the Fed the world’s largest creditor of the U.S. government. (Since the Fed is owned by its member banks, the banks are really the owner/creditors.) That means that the Federal Reserve has monetized vast quantities of U.S. government debt.

There are two courses open to the Fed. One of them is hyperinflation, which is what will happen when the Fed stops buying, interest rates rise to normal levels and banks have no alternative but to use their reserves for normal, profit-oriented purposes that put money into circulation for spending. This has never before happened in peacetime in the U.S. The other is for the Fed to sell the bonds to the public, which will consist mostly of commercial banks. This will withdraw the money from circulation and end the threat of hyperinflation (assuming the Fed sterilizes it). But it will also drive bond prices into the ground, which means that interest rates will shoot skyward. This will create the aforementioned government budget/debt crisis of industrial strength – and the high interest rates won’t do much for the general business climate for awhile, either.

Since it is considered a public-relations sin for government to do anything that makes the general public uncomfortable and which can be directly traced to it, it is easy to see why the Fed doesn’t want to take any action at all. But doing nothing is not an option, either. Eventually, one of the two aforementioned scenarios will unfold, anyway, in spite of efforts to forestall them.

Uhhhh… That doesn’t sound good.

No spit, Spurlock. Yet, paradoxical as it might seem at first, either of these two scenarios will probably make people more receptive to solutions like free banking and free-market money – solutions that most people consider much too radical right now. There are times in life when things have to get worse before they can get better. Regrettably, this looks like one of those times.