DRI-191 for week of 3-15-15: More Ghastly than Beheadings! More Dangerous than Nuclear Proliferation! Its…Cheap Foreign Steel!

An Access Advertising EconBrief:

More Ghastly than Beheadings! More Dangerous than Nuclear Proliferation! Its…Cheap Foreign Steel!

The economic way to view news is as a product called information. Its value is enhanced by adding qualities that make it more desirable. One of these is danger. Humans react to threats and instinctively weigh the threat-potential of any problematic situation. That is why headlines of print newspapers, radio-news updates, TV evening-news broadcasts and Internet websites and blogs all focus disproportionately on dangers.

This obsession with danger does not jibe with the fact that human life expectancy had doubled over the last century and that violence has never been less threatening to mankind than today. Why do we suffer this cognitive dissonance? Our advanced state of knowledge allows us to identify and categorize threats that passed unrecognized for centuries. Today’s degraded journalistic product, more poorly written, edited and produced than formerly, plays on our neuroscientific weaknesses.

Economists are acutely sensitive to this phenomenon. Our profession made its bones by exposing the bogey of “the evil other” – foreign trade, foreign goods, foreign labor and foreign investment as ipso facto evil and threatening. Yet in spite of the best efforts of economists from Adam Smith to Milton Friedman, there is no more dependable pejorative than “foreign” in public discourse. (The word “racist” is a contender for the title, but overuse has triggered a backlash among the public.)

Thus, we shouldn’t be surprised by this headline in The Wall Street Journal: “Ire Rises at China Over Glut of Steel” (03/16/2015, By Biman Mukerji in Hong Kong, John W. Miller in Pittsburgh and Chuin-Wei Yap in Beijing). Surprised, no; outraged, yes.

The Big Scare 

The alleged facts of the article seem deceptively straightforward. “China produces as much steel as the rest of the world combined – more than four times as much as the peak U.S. production in the 1970s.” Well, inasmuch as (a) the purpose of all economic activity is to produce goods for consumption; and (b) steel is a key input in producing countless consumption goods and capital goods, ranging from vehicles to buildings to weapons to cutlery to parts, this would seem to be cause for celebration rather than condemnation. Unfortunately…

“China’s massive steel-making engine, determined to keep humming as growth cools at home, is flooding the world with exports, spurring steel producers around the globe to seek government protection from falling prices. From the European Union to Korea and India, China’s excess metal supply is upending trade patterns and heating up turf battles among local steelmakers. In the U.S., the world’s second-biggest steel consumer, a fresh wave of layoffs is fueling appeals for tariffs. U.S. steel producers such as U.S. Steel Corp. and Nucor Corp. are starting to seek political support for trade action.”

Hmmm. Since this article occupies the place of honor on the world’s foremost financial publication, we expect it to be authoritative. China has a “massive steel-making engine” – well, that stands to reason, since it’s turning out as much steel as everybody else put together. It is “determined to keep humming.” The article’s three (!) authors characterize the Chinese steelmaking establishment as a machine, which seems apropos. They then endow the metaphoric machine with the human quality of determination – bad writing comes naturally to poor journalists.

This determination is linked with “cooling” growth. Well, the only cooling growth that Journal readers can be expected to infer at this point is the slowing of the Chinese government’s official rate of annual GDP growth from 7.5% to 7%. Leaving aside the fact that the rest of the industrialized world is pining for growth of this magnitude, the authors are not only mixing their metaphors but mixing their markets as well. The only growth directly relevant to the points raised here – exports by the Chinese and imports by the rest of the world – is growth in the steel market specifically. The status of the Chinese steel market is hardly common knowledge to the general public. (Later, the authors eventually get around to the steel market itself.)

So the determined machine is reacting to cooling growth by “flooding the world with exports,” throwing said world into turmoil. The authors don’t treat this as any sort of anomaly, so we’re apparently expected to nod our heads grimly at this unfolding danger. But why? What is credible about this story? And what is dangerous about it?

Those of us who remember the 1980s recall that the monster threatening the world economy then was Japan, the unstoppable industrial machine that was “flooding the world” with imports. (Yes, that’s right – the same Japan whose economy has been lying comatose for twenty years.) The term of art was “export-led growth.” Now these authors are telling us that massive exports are a reaction to weakness rather than a symptom of growth.

“Unstoppable” Japan suddenly stopped in its tracks. No country has ever ascended an economic throne based on its ability to subsidize the consumption of other nations. Nor has the world ever died of economic indigestion caused by too many imports produced by one country. The story told at the beginning of this article lacks any vestige of economic sense or credibility. It is pure journalistic scare-mongering. Nowhere do the authors employ the basic tools of international economic analysis. Instead, they employ the basic tools of scarifying yellow journalism.

The Oxymoron of “Dumping” 

The authors have set up their readers with a menacing specter described in threatening language. A menace must have victims. So the authors identify the victims. Victims must be saved, so the authors bring the savior into their story. Naturally, the savior is government.

The victims are “steel producers around the globe.” They are victimized by “falling prices.” The authors are well aware that they have a credibility problem here, since their readers are bound to wonder why they should view falling steel prices as a threat to them. As consumers, they see falling prices as a good thing. As prices fall, their real incomes rise. Falling prices allow consumers to buy more goods and services with their money incomes. Businesses buy steel. Falling steel prices allow businesses to buy more steel. So why are falling steel prices a threat?

Well, it turns out that falling steel prices are a threat to “chief executives of leading American steel producers,” who will “testify later this month at a Congressional Steel Caucus hearing.” This is “the prelude to launching at least one anti-dumping complaint with the International Trade Commission.” And what is “dumping?” “‘Dumping,’ or selling abroad below the cost of production to gain market share, is illegal under World Trade Organization law and is punishable with tariffs.”

After this operatic buildup, it turns out that the foreign threat to America spearheaded by a gigantic, menacing foreign power is… low prices. Really low prices. Visualize buying steel at Costco or Wal Mart.

Oh, no! Not that. Head for the bomb shelters! Break out the bug-out bags! Get ready to live off the grid!

The inherent implication of dumping is oxymoronic because the end-in-view behind all economic activity is consumption. A seller who sells for an abnormally low price is enhancing the buyer’s capability to consume, not damaging it. If anybody is “damaged” here, it is the seller, not the buyer. And that begs the question, why would a seller do something so foolish?

More often than not, proponents of the dumping thesis don’t take their case beyond the point of claiming damage to domestic import-competing firms. (The three Journal reporters make no attempt whatsoever to prove that the Chinese are selling below cost; they rely entirely on the allegation to pull their story’s freight.) Proponents rely on the economic ignorance of their audience. They paint an emotive picture of an economic world that functions like a giant Olympics. Each country is like a great big economic team, with its firms being the players. We are supposed to root for “our” firms, just as we root for our athletes in the Summer and Winter Olympics. After all, don’t those menacing firms threaten the jobs of “our” firms? Aren’t those jobs “ours?” Won’t that threaten “our” incomes, too?

This sports motif is way off base. U.S. producers and foreign producers have one thing in common – they both produce goods and services that we can consume, either now or in the future. And that gives them equal economic status as far as we are concerned. The ones “on our team” are the ones that produce the best products for our needs – period.

Wait a minute – what if the producers facing those low prices happen to be the ones employing us? Doesn’t that change the picture?

Yes, it does. In that case, we would be better off if our particular employer faced no foreign competition. But that doesn’t make a case for restricting or preventing foreign competition in general. Even people who lose their jobs owing to foreign competition faced by their employer may still gain more income from the lower prices brought by foreign competition in general than they lose by having to take another job at a lower income.

There’s another pertinent reason for not treating foreign firms as antagonistic to consumer interests. Foreign firms can, and do, locate in America and employ Americans to produce their products here. Years ago, Toyota was viewed as an interloper for daring to compete successfully with the “Big 3” U.S. automakers. Now the majority of Toyota automobiles sold in the U.S. are assembled on America soil in Toyota plants located here.

Predatory Pricing in International Markets

Dumping proponents have a last-ditch argument that they haul out when pressed with the behavioral contradictions stressed above. Sure, those foreign prices may be low now, import-competing producers warn darkly, but just wait until those devious foreigners succeed in driving all their competitors out of business. Then watch those prices zoom sky-high! The foreigners will have us in their monopoly clutches.

That loud groan you heard from the sidelines came from veteran economists, who would no sooner believe this than ask a zookeeper where to find the unicorns. The thesis summarized in the preceding paragraph is known as the “predatory pricing” hypothesis. The behavior was notoriously ascribed to John D. Rockefeller by the muckraking journalist Ida Tarbell. It was famously disproved by the research of economist John McGee. And ever since, economists have stopped taking the concept seriously even in the limited market context of a single country.

But when propounded in the global context of international trade, the whole idea becomes truly laughable. Steel is a worldwide industry because its uses are so varied and numerous. A firm that employed this strategy would have to sacrifice trillions of dollars in order to reduce all its global rivals to insolvency. This would take years. These staggering losses would be accounted in current outflows. They would be weighed against putative gains that would begin sometime in the uncertain future – a fact that would make any lender blanch at the prospect of financing the venture.

As if the concept weren’t already absurd, what makes it completely ridiculous is the fact that even if it succeeded, it would still fail. The assets of all those firms wouldn’t vaporize; they could be bought up cheaply and held against the day when prices rose again. Firms like the American steel company Nucor have demonstrated the possibility of compact and efficient production, so competition would be sure to emerge whenever monopoly became a real prospect.

The likelihood of any commercial steel firm undertaking a global predatory-pricing scheme is nil. At this point, opponents of foreign trade are, in poker parlance, reduced to “a chip and a chair” in the debate. So they go all in on their last hand of cards.

How Do We Defend Against Government-Subsidized Foreign Trade?

Jiming Zou, analyst at Moody’s Investor Service, is the designated spokesman of last resort in the article. “Many Chinese steelmakers are government-owned or closely linked to local governments [and] major state-owned steelmakers continue to have their loans rolled over or refinanced.”

Ordinary commercial firms might cavil at the prospect of predatory pricing, but a government can’t go broke. After all, it can always print money. Or, in the case of the Chinese government, it can always “manipulate the currency” – another charge leveled against the Chinese with tiresome frequency. “The weakening renminbi was also a factor in encouraging exports,” contributed another Chinese analyst quoted by the Journal.

One would think that a government with the awesome powers attributed to China’s wouldn’t have to retrench in all the ways mentioned in the article – reduce spending, lower interest rates, and cut subsidies to state-owned firms including steel producers. Zou is doubtless correct that “given their important role as employers and providers of tax revenue, the mills are unlikely to close or cut production even if running losses,” but that cuts both ways. How can mills “provide tax revenue” if they’re running huge losses indefinitely?

There is no actual evidence that the Chinese government is behaving in the manner alleged; the evidence is all the other way. Indeed, the only actual recipients of long-term government subsidies to firms operating internationally are creatures of government like Airbus and Boeing – firms that produce most or all of their output for purchase by government and are quasi-public in nature, anyway. But that doesn’t silence the protectionist chorus. Government-subsidized foreign competition is their hole card and they’re playing it for all it’s worth.

The ultimate answer to the question “how do we defend against government-subsidized foreign trade?” is: We don’t. There’s no need to. If a foreign government is dead set on subsidizing American consumption, the only thing to do is let them.

If the Chinese government is enabling below-cost production and sale by its firms, it must be doing it with money. There are only three ways it can get money: taxation, borrowing or money creation. Taxation bleeds Chinese consumers directly; money creation does it indirectly via inflation. Borrowing does it, too, when the bill comes due at repayment time. So foreign exports to America subsidized by the foreign government benefit American consumers at the expense of foreign consumers. No government in the world can subsidize the world’s largest consumer nation for long. But the only thing more foolish than doing it is wasting money trying to prevent it.

What Does “Trade Protection” Accomplish?

Textbooks in international economics spell out in meticulous detail – using either carefully drawn diagrams or differential and integral calculus – the adverse effects of tariffs and quotas on consumers. Generally speaking, tariffs have the same effects on consumers as taxes in general – they drive a wedge between the price paid by the consumer and received by the seller, provide revenue to the government and create a “deadweight loss” of value that accrues to nobody. Quotas are, if anything, even more deleterious. (The relative harm depends on circumstances too complex to enumerate.)

This leads to a painfully obvious question: If tariffs hurt consumers in the import-competing country, why in the world do we penalize alleged misbehavior by exporters by imposing tariffs? This is analogous to imposing a fine on a convicted burglar along with a permanent tax on the victimized homeowner.

Viewed in this light, trade protection seems downright crazy. And in purely economic terms, it is. But in terms of political economy, we have left a crucial factor out of our reckoning. What about the import-competing producers? In the Wall Street Journal article, these are the complainants at the bar of the International Trade Commission. They are also the people economists have been observing ever since the days of Adam Smith in the late 18th century, bellied up at the government-subsidy bar.

In Smith’s day, the economic philosophy of Mercantilism reigned supreme. Specie – that is, gold and silver – was considered the repository of real wealth. By sending more goods abroad via export than returned in the form of imports, a nation could produce a net inflow of specie payments – or so the conventional thinking ran. This philosophy made it natural to favor local producers and inconvenience foreigners.

Today, the raison d’etre of the modern state is to take money from people in general and give it to particular blocs to create voting constituencies. This creates a ready-made case for trade protection. So what if it reduces the real wealth of the country – the goods and services available for consumption? It increases electoral prospects of the politicians responsible and appears to increase the real wealth of the beneficiary blocs, which is sufficient to for legislative purposes.

This is corruption, pure and simple. The authors of the Journal article present this corrupt process with a straight face because their aim is to present cheap Chinese steel as a danger to the American people. Thus, their aims dovetail perfectly with the corrupt aims of government.

And this explains the front-page article on the 03/16/2015 Wall Street Journal. It reflects the news value of posing a danger where none exists – that is, the corruption of journalism – combined with the corruption of the political process.

The “Effective Rate of Protection”

No doubt the more temperate readers will object to the harshness of this language. Surely “corruption” is too harsh a word to apply to the actions of legislators. They have a great big government to run. They must try to be fair to everybody. If everybody is not happy with their efforts, that is only to be expected, isn’t it? That doesn’t mean that legislators aren’t trying to be fair, does it?

Consider the economic concept known as the effective rate of protection. It is unknown to the general public, but is appears in every textbook on international economics. It arises from the conjunction of two facts: first, that a majority of goods and services are composed of raw materials, intermediate goods and final-stage (consumer) goods; and second, that governments have an irresistible impulse to levy taxes on goods that travel across international borders.

To keep things starkly simple and promote basic understanding, take the simplest kind of numerical example. Assume the existence of a fictional textile company. It takes a raw material, cotton, and spin, weaves and processes that cotton into a cloth that it sells commercially to its final consumers. This consumer cloth competes with the product of domestic producers as well as with cotton cloth produced by foreign textile producers. We assume that the prevailing world price of each unit of cloth is $1.00. We assume further that domestic producers obtain one textile unit’s worth of cotton for $.50 and add a further $.50 worth of value to the cloth by spinning, weaving and processing it into the cloth.

We have a basic commodity being produced globally by multiple firms, indicated the presence of competitive conditions. But legislators, perhaps possessing some exalted concept of fairness denied to the rabble, decide to impose a tariff on the importation of cotton. Not wishing to appear excessive or injudicious, the solons set this ad valorem tariff at 15%. Given the competitive nature of the industry, this will soon elevate the domestic price of textiles above the world price by the amount of the tariff; e.g., by $.15, to $1.15. Meanwhile, there is no tariff levied on cotton, the raw material. (Perhaps cotton is grown domestically and not imported into the country or, alternatively, perhaps cotton growers lack the political clout enjoyed by textile producers.)

The insight gained from the effective rate of protection begins with the realization that the net income of producers in general derives from the value they add to any raw materials and/or intermediate products they utilize in the production process. Initially, textile producers added $.50 worth of value for every unit of cotton cloth they produced. Imposition of the tariff allows the domestic textile price to rise from $1.00 to $1.15, which causes textile producers’ value added to rise from $.50 to $.65.

Legislators judiciously and benevolently decided that the proper amount of “protection” to give domestic textile producers from foreign competition was 15%. They announced this finding amid fanfare and solemnity. But it is wrong. The tariff has the explicit purpose of “protecting” the domestic industry, of giving it leeway it would not otherwise get under the supposedly harsh and unrelenting regime of global competition. But this tariff does not give domestic producers 15% worth of protection. $15 divided by $.50 – that is, the increase in value added divided by the original value added – is .30, or 30%. The effective rate of protection is double the size of the “nominal” (statutory) level of protection. In general, think of the statutory tariff rate as the surface appearance and the effective rate as the underlying truth.

Like oh-so-many economic principles, the effective rate of protection is a relatively simple concept that can be illustrated with simple examples, but that rapidly becomes complex in reality. Two complications need mention. When tariffs are also levied on raw materials and/or intermediate products, this affects the relationship between the effective and nominal rate of protection. The rule of thumb is that higher tariff rates on raw materials and intermediate goods relative to tariffs on final goods tend to lower effective rates of protection on the final goods – and vice-versa.

The other complication is the percentage of total value added comprised by the raw materials and intermediate goods prior to, and subsequent to, imposition of the tariff. This is a particularly knotty problem because tariffs affect prices faced by buyers, which in turn affect purchases, which in turn can change that percentage. When tariffs on final products exceed those on raw materials and intermediate goods – and this has usually been the case in American history – an increase in this percentage will increase the effective rate.

But for our immediate purposes, it is sufficient to realize that appearance does not equal reality where tariff rates are concerned. And this is the smoking gun in our indictment of the motives of legislators who promote tariffs and restrictive foreign-trade legislation.

 

Corrupt Legislators and Self-Interested Reporting are the Real Danger to America

In the U.S., the Commercial Code includes thousands of tariffs of widely varying sizes. These not only allow legislators to pose as saviors of numerous business constituent classes. They also allow them to lie about the degree of protection being provided, the real locus of the benefits and the reasons behind them.

Legislators claim that the size of tariff protection being provided is modest, both in absolute and relative terms. This is a lie. Effective rates of protection are higher than they appear for the reasons explained above. They unceasingly claim that foreign competitors behave “unfairly.” This is also a lie, because there is no objective standard by which to judge fairness in this context – there is only the economic standard of efficiency. Legislators deliberately create bogus standards of fairness to give themselves the excuse to provide benefits to constituent blocs – benefits that take money from the rest of us. International trade bodies are created to further the ends of domestic governments in this ongoing deception.

Readers should ask themselves how many times they have read the term “effective rate of protection” in The Wall Street Journal, The Financial Times of London, Barron’s, Forbes or any of the major financial publications. That is an index of the honesty and reputability of financial journalism today. The term was nowhere to be found in the Journal piece of 03/16/2015.

Instead, the three Journal authors busied themselves flacking for a few American steel companies. They showed bar graphs of increasing Chinese steel production and steel exports. They criticized the Chinese because the country’s steel production has “yet to slow in lockstep” with growth in demand for steel. They quoted self-styled experts on China’s supposed “problem [with] hold[ing] down exports” – without every explaining what rule or standard or economic principle of logic would require a nation to withhold exports from willing buyers. They cited year-over-year increases in exports between January, 2013, 2014 and 2015 as evidence of China’s guilt, along with the fact that the Chinese were on pace to export more steel than any other country “in this century.”

The reporters quoted the whining of a U.S. steel vice-president that demonstrating damage from Chinese exports is just “too difficult” to satisfy trade commissioners. Not content with this, they threw in complaints by an Indian steel executive and South Koreans as well. They neglect to tell their readers that Chinese, Indian and South Korean steels tend to be lower grades – a datum that helps to explain their lower prices. U.S. and Japanese steels tend to be higher grade, and that helps to explain why companies like Nucor have been able to keep prices and profit margins high for years. The authors cite one layoff at U.S. steel but forget to cite the recent article in their own Wall Street Journal lauding the history of Nucor, which has never laid off an employee despite the pressure of Chinese competition.

That same article quoted complaints by steel buyers in this country about the “competitive disadvantage” imposed by the higher-priced U.S. steel. Why are the complaints about cheap Chinese exports front-page news while the complaints about high-priced American steel buried in back pages – and not even mentioned by a subsequent banner article boasting input by no fewer than three Journal reporters? Why did the reporters forget to cite the benefits accruing to American steel users from low prices for steel imports? Don’t these reporters read their own newspaper? Or do they report only what comports with their own agenda?

DRI-284 for week of 8-10-14: All Sides Go Off Half-Cocked in the Ferguson, MO Shooting

An Access Advertising EconBrief:

All Sides Go Off Half-Cocked in the Ferguson, MO Shooting

By now most of America must wonder secretly whether the door to race relations is marked “Abandon all hope, ye who enter here.” Blacks – mostly teenagers and young adults, except for those caught in the crossfire – are shot dead every day throughout the country by other blacks in private quarrels, drug deals gone bad and various attempted crimes. Murder is the leading cause of death for young black males in America. We are inured to this. But the relative exception of a black youth killed by a white man causes all hell to break loose – purely on the basis of the racial identities of the principals.

The latest chilling proof of this racial theorem comes from Ferguson, MO, the St. Louis suburb where a policeman shot and killed an unarmed 18-year-old black man on Monday. The fact that the shooter is a policeman reinforces the need for careful investigation and unflinching analysis of the issues involved. The constant intrusion of racial identity is a mountainous obstacle to this process.

The Two Sides to the Story, As Originally Told

The shooting occurred on Saturday afternoon, August 9, 2014, in Ferguson, MO, where 14,000 of the 21,000 inhabitants are black and 50 of 53 assigned St. Louis County Police officers are white. The two sides of the story are summarized in an Associated Press story carrying the byline of Jim Suhr and carried on MSN News 08/13/2014. “Police have said the shooting happened after an [then-unnamed] officer encountered 18-year-old Michael Brown and another man on the street. They say one of the men pushed the officer into his squad car, then physically assaulted him in the vehicle and struggled with the officer over the officer’s weapon. At least one shot was fired inside the car. The struggle then spilled onto the street, where Brown was shot multiple times. In their initial news conference about the shooting, police didn’t specify whether Brown was the person who scuffled with the officer in the car and have refused to clarify their account.”

“Jackson said Wednesday that the officer involved sustained swelling facial injuries.”

“Dorian Johnson, who says he was with Brown when the shooting happened, has told a much different story. He has told media outlets that the officer ordered them out of the street, then tried to open his door so close to the men that it ‘ricocheted’ back, apparently upsetting the officer. Johnson says the officer grabbed his friend’s neck, then tried to pull him into the car before brandishing his weapon and firing. He says Brown started to run and the officer pursued him, firing multiple times. Johnson and another witness both say Brown was on the street with his hands raised when the officer fired at him repeatedly.”

The Reaction by Local Blacks: Protests and Violence

When a white citizen is shot by police under questionable circumstances – an occurrence that is happening with disturbing frequency – the incident is not ignored. But the consequent public alarm is subdued and contained within prescribed channels. Newspapers editorialize. Public figures express concern. Private citizens protest by writing or proclaiming their discontent.

The stylized reaction to a white-on-black incident like the one in Ferguson is quite different. Ever since the civil-rights era that began in the 1950s, these incidents are treated as presumptive civil-rights violations; that is, they are treated as crimes committed because the victim was black. Black “leaders” bemoan the continuing victim status of blacks, viewing the incident as more proof of same – the latest in an ongoing, presumably never-ending, saga of brutalization of blacks by whites. “Some civil-rights leaders have drawn comparisons between Brown’s death and that of 17-year-old Trayvon Martin.”

Rank-and-file blacks gather and march in protest, holding placards and chanting slogans tailored to the occasion. “Some protestors… raised their arms above their heads as they faced the police… The most popular chant has been ‘Hands up! Don’t shoot!'”

Most striking of all is the contrast struck by headlines like “Protests Turn Violent in St. Louis Suburb.” There is no non-black analogue to behavior like this: “Protests in the St. Louis suburb turned violent Wednesday night, with people lobbing Molotov cocktails at police, who responded with smoke bombs and tear gas to disperse the crowd.” This is a repetition of behavior begun in the 1960s, when massive riots set the urban ghettos of Harlem, Philadelphia and Detroit afire.

Joseph Epstein Weighs In

The critic and essayist Joseph Epstein belongs on the short list of the most trenchant thinkers and writers in the English language. His pellucid prose has illumined subjects ranging from American education to gossip political correctness to Fred Astaire. The utter intractability of race in America is demonstrated irrefutably by the fact that the subject reduced Epstein to feeble pastiche.

In his Wall Street Journal op-ed “What’s Missing in Ferguson, MO.”(The Wall Street Journal, Wednesday, August 13, 2014), Epstein notes the stylized character of the episode: “…the inconsolable mother, the testimony of the dead teenager’s friends to his innocence, the aunts and cousins chiming in, the police chief’s promise of a thorough investigation… The same lawyer who represented the [Trayvon] Martin family, it was announced, is going to take this case.”

But according to Epstein, the big problem is that it isn’t stylized enough. “Missing… was the calming voice of a national civil-rights leader of the kind that was so impressive during the 1950s and ’60s. In those days there was Martin Luther King Jr…. Roy Wilkins… Whitney Young… Bayard Rustin…. – all solid, serious men, each impressive in different ways, who through dignified forbearance and strategic action, brought down a body of unequivocally immoral laws aimed at America’s black population.”

But they are long dead. “None has been replaced by men of anywhere near the same caliber. In their place today there is only Jesse Jackson and Al Sharpton…One of the small accomplishments of President Obama has been to keep both of these men from becoming associated with the White House.” Today, the overriding problem facing blacks is that “no black leader has come forth to set out a program for progress for the substantial part of the black population that has remained for generations in the slough of poverty, crime and despair.”

Wait just a minute here. What about President Obama? He is, after all, a black man himself. That was ostensibly the great, momentous breakthrough of his election – the elevation of a black man to the Presidency of the United States. This was supposed to break the racial logjam once and for all. If a black man occupying the Presidency couldn’t lead the black underclass to the Promised Land, who could?

No, according to Epstein, it turns out that “President Obama, as leader of all the people, is not well positioned for the job of leading the black population that finds itself mired in despond.” Oh. Why not? “Someone is needed who commands the respect of his or her people, and the admiration of that vast – I would argue preponderate [sic] – number of middle-class whites who understand that progress for blacks means progress for the entire country.”

To be sure, Epstein appreciates the surrealism of the status quo. “In Chicago, where I live, much of the murder and crime… is black-on-black, and cannot be chalked up to racism, except secondarily by blaming that old hobgoblin, ‘the system.’ People march with signs reading ‘Stop the Killing,’ but everyone knows that the marching and the signs and the sweet sentiments of local clergy aren’t likely to change anything. Better education… a longer school day… more and better jobs… get the guns off the street… the absence of [black] fathers – … the old dead analyses, the pretty panaceas, are paraded. Yet nothing new is up for discussion… when Bill Cosby, Thomas Sowell or Shelby Steele… have dared to speak up about the pathologies at work… these black figures are castigated.”

The Dead Hand of “Civil Rights Movement” Thinking

When no less an eminence than Joseph Epstein sinks under the waves of cliché and outmoded rhetoric, it is a sign of rhetorical emergency: we need to burn away the deadwood of habitual thinking.

Epstein is caught in a time warp, still living out the decline and fall of Jim Crow. But that system is long gone, the men who destroyed it and those who desperately sought to preserve it alike. The Kings and Youngs and Wilkins’ and Rustins are gone just as the Pattons and Rommels and Ridgeways and MacArthurs and Montgomerys are gone. Leaders suit themselves to their times. Epstein is lamenting the fact that the generals of the last war are not around to fight this one.

Reflexively, Epstein hearkens back to the old days because they were days of triumph and progress. He is thinking about the Civil Rights Movement in exactly the same way that the political left thinks about World War II. What glorious days, when the federal government controlled every aspect of our lives and we had such a wonderful feeling of solidarity! Let’s recreate that feeling in peacetime! But those feelings were unique to wartime, when everybody subordinates their personal goals to the one common goal of winning the war. In peacetime, there is no such unitary goal because we all have our personal goals to fulfill. We may be willing to subordinate those goals temporarily to win a war but nobody wants to live that way perpetually. And the mechanisms of big government – unwieldy agencies, price and wage controls, tight security controls, etc. – may suffice to win a war against other big governments but cannot achieve prosperity and freedom in a normal peacetime environment.

In the days of Civil Rights, blacks were a collective, a clan, a tribe. This made practical, logistical sense because the Jim Crow laws treated blacks as a unit. It was a successful strategic move to close ranks in solidarity and choose leaders to speak for all. In effect, blacks were forming a political cartel to counter the political setbacks they had been dealt. That is to say, they were bargaining with government as a unit and consenting to be assigned rights as a collective (a “minority”) rather than as free individuals. In social science terms, they were what F. A. Hayek called a “social whole,” whose constituent individual parts were obliterated and amalgamated into the opaque unitary aggregate. This dangerous strategy has since come back to haunt them by obscuring the reality of black individualism.

Consider Epstein’s position. Indian tribes once sent their chief – one who earned respect as an elder, religious leader or military captain, what anthropologists called a “big man” – to Washington for meetings with the Great White Father. Now, Epstein wants to restore the Civil Rights days when black leaders analogously spoke out for their tribal flock. Traditionally, the fate of individuals in aboriginal societies is governed largely by the wishes of the “big man” or leader, not by their own independent actions. This would be unthinkable for (say) whites; when was the last time you heard a call for a George Washington, Henry Ford or Bill Gates to lead the white underclass out of its malaise?

In fact, this kind of thinking was already anachronistic in Epstein’s Golden Age, the heyday of Civil Rights. Many blacks recognized the trap they were headed towards, but took the path of least resistance because it seemed the shortest route to killing off Jim Crow. Now we can see the pitiful result of this sort of collective thinking.

An 18-year-old black male is killed by a police officer under highly suspicious circumstances. Is the focus on criminal justice, on the veracity of the police account, on the evidence of a crime? Is the inherent danger of a monopoly bureaucracy investigating itself and exercising military powers over its constituency highlighted? Not at all.

Instead, the same old racial demons are summoned from the closet using the same ritual incantations. Local blacks quickly turn a candlelight protest vigil into a violent riot. Uh oh – it looks like the natives are getting restless; too much firewater at the vigil, probably. Joseph Epstein bemoans the lack of a chieftain who can speak for them. No, wait – the Great Black Father in Washington has come forward to chastise the violent and exalt the meek and the humble. His lieutenant Nixon has sent a black chief to comfort his brothers. (On Thursday, Missouri Governor Jay Nixon sent Missouri Highway Patrol Captain Ron Johnson, a black man, heading a delegation of troopers to take over security duties in Ferguson.) The natives are mollified; the savage breast is soothed. “All the police did was look at us and shoot tear gas. Now we’re being treated with respect,” a native exults happily. “Now it’s up to us to ride that feeling,” another concludes. “The scene [after the Missouri Highway Patrol took over] was almost festive, with people celebrating and honking horns.” The black chief intones majestically: “We’re here to serve and protect… not to instill fear.” All is peaceful again in the village.

Is this the response Joseph Epstein was calling for? No, this is the phony-baloney, feel-good pretense that he decried, the same methods he recognized from his hometown of Chicago and now being deployed there by Obama confidant Rahm Emmanuel. The restless natives got the attention they sought. Meanwhile, lost in the festive party atmosphere was the case of Michael Brown, which wasn’t nearly as important as the rioters’ egos that needed stroking.

But the Highway Patrol will go home and the St. Louis County Police will be back in charge and the Michael Brown case will have to be resolved. Some six days after the event, the police finally got around to revealing pertinent details of the case; namely, that Michael Brown was suspected of robbing a convenience store of $48.99 worth of boxed cigars earlier that day in a “strong-arm robbery.” Six-year veteran policeman Darren Wilson, now finally identified by authorities, was one of several officers dispatched to the scene.

Of course, the blacks in Ferguson, MO, and throughout America aren’t Indian tribesmen or rebellious children – they are nominally free American individuals with natural rights protected by the U.S. Constitution. But if they expect to be treated with respect 365 days a year they will have to stop acting like juvenile delinquents, stop delegating the protection of their rights to self-serving politicians and hustlers and start asserting the individuality they possess.

The irony of this particular case is that it affords them just that opportunity. But it demands that they shed what Epstein calls “the too-comfortable robes of victimhood.” And they will have to step out from behind the shield of the collective. The Michael Brown case is not important because “blacks” are affronted. It is important because Michael Brown was an individual American just like the whites who get shot down by police every year. If Dorian Johnson is telling the truth, Brown’s individual rights were violated just as surely whether he was black, white, yellow or chartreuse.

Policing in America Today – and the Michael Brown Case

For at least two decades, policing in America has followed two clearly discernible trends. The first of these is the deployment of paramilitary equipment, techniques and thinking. The second is a philosophy is placing the police officer’s well-being above all other considerations. Both of these trends place the welfare of police bureaucrats, employees and officers above that of their constituents in the public.

To an economist, this is a striking datum. Owners or managers of competitive firms cannot place their welfare above that of their customers; if they do, the firm will go bankrupt and cease to exist, depriving the owners of an asset (wealth) and real income and the managers of a job and real income. So what allows a police force (more specifically, the Chief of Police and his lieutenants) to do what a competitive firm cannot do? Answer: The police have a monopoly on the use of force to enforce the law. In the words of a well-known lawyer, the response to the generic question “Can the police do that?” is always “Sure they can. They have guns.”

All bureaucracies tend to be inefficient, even corrupt. But corporate bureaucracies must respond to the public and they must earn profits. So they cannot afford to ignore consumer demand. The only factor to which government bureaucracies respond is variations in their budget, which are functions of political rather than economic variables.

All of these truths are on display in this case. The police have chosen to release only a limited, self-serving account of the incident. Their version of the facts is dubious to say the least, although it could conceivably be correct. Their suppression of rioting protestors employed large, tank-like vehicles carrying officers armed with military gear, weapons and tear gas. Dorian Johnson’s account of the incident is redolent of the modern police philosophy of “self-protection first;” at the first hint of trouble, the officer’s focus is on downing anybody who might conceivable offer resistance, armed or not, dangerous or not.

What does all this have to do with the racial identities of the principals? Absolutely nothing. Oh, it’s barely possible that officer Wilson might have harbored some racial animosity toward Brown or blacks in general. But it’s really quite irrelevant because white-on-black, white-on-white and black-on-white police incidents have cropped up from sea to shining sea in recent years. Indeed, this is an issue that should unite the races rather than dividing them since police are not reluctant to dispatch whites (or Hispanics or Asians, for that matter). While some observers claim the apparent increase in frequency of these cases is only because of the prevalence of cell phones and video cameras, this is also irrelevant; the fact that we may be noticing more abuses now would not be a reason to decry the new technology. As always, the pertinent question is whether or not an abuse of power took place. And those interested in the answer to that question, which should be every American, will have to contend with the unpromising prospect of a police department – a monopoly bureaucracy – investigating itself.

That is the very real national problem festering in Ferguson, MO – not a civil-rights problem, but a civil-wrongs problem.

The Battle Lines

Traditionally, ever since the left-wing counterculture demonized police as “pigs” in the 1960s, the right wing has reflexively supported the police and opposed those who criticized them. Indeed, some of this opposition to the police has been politically tendentious. But the right wing’s general stance is wrongheaded for two powerful reasons.

First, support for law enforcement itself has become progressively less equated to support for the Rule of Law. The number and scope of laws has become so large and excessive that support for the Rule of Law would actually require opposition to the existing body of statutory law.

Second, the monopoly status of the police has enabled them to become so abusive that they now threaten everybody, not merely the politically powerless. Considering the general decrease in crime rates driven by demographic factors, it is an open question whether most people are more threatened by criminals or by abusive police.

Even a bastion of neo-conservatism like The Wall Street Journal is becoming restive at the rampant exercise of monopoly power by police. Consider these excerpts from the unsigned editorial, “The Ferguson Exception,” on Friday, August 15, 2014: “One irony of Ferguson is that liberals have discovered an exercise of government power that they don’t support. Plenary police powers are vast, and law enforcement holds a public trust to use them in proportion to the threats. The Ferguson police must prevent rioting and looting and protect their own safety, though it is reasonable to wonder when law enforcement became a paramilitary operation [emphasis added]. The sniper rifles, black armored convoys and waves of tear gas deployed across Ferguson neighborhoods are jarring in a free society…Police contracts also build in bureaucratic privileges that would never be extended to other suspects. The Ferguson police department has refused to… supply basic information about the circumstances and status of the investigation [that], if it hasn’t been botched already, might help cool passions… how is anyone supposed to draw a conclusion one way or the other without any knowledge of what happened that afternoon?”

The Tunnel… and the Crack of Light at the End

The pair of editorial reactions in The Wall Street Journal typifies the alternatives open to those caught in the toils of America’s racial strife. We can play the same loop over and over again in such august company as Joseph Epstein. Or we can dunk ourselves in ice water, wake up and smell the coffee – and find ourselves rubbing shoulders with the Journal editors.

DRI-303 for week of 5-11-14: The Real ‘Stress Test’ is Still to Come

An Access Advertising EconBrief:

The Real ‘Stress Test’ is Still to Come

Timothy Geithner, former Treasury Secretary and former head of the New York Federal Reserve, is in the news. Like virtually every former policymaker, he has written a book about his experiences. He is currently flogging that book on the publicity circuit. Unlike many other such books, Geithner’s holds uncommon interest – not because he is a skillful writer or a keen analyst. Just the opposite.

Geithner is a man desperate to rationalize his past actions. Those actions have put us on a path to disaster. When that disaster strikes, we will be too stunned and too busy to think clearly about the past. Now is the time to view history coolly and rationally. We must see Geithner’s statements in their true light.

Power and the Need for Self-Justification

In his Wall Street Journal book review of Geithner’s book, Stress Test, James Freeman states that “Geithner makes a persuasive case that he is the man most responsible for the federal bailouts of 2008.” Mr. Freeman finds this claim surprising, but as we will see, it is integral to what Geithner sees as his legacy.

This issue of policy authorship is important to historians, whose job is getting the details right. But it is trivial to us. We want the policies to be right, regardless of their source. That is why we should be worried by Geithner’s need to secure his place in history.

Geithner and his colleagues, Federal Reserve Chairman Ben Bernanke and then-Treasury Secretary Henry Paulson, possessed powers whose exercise would have been unthinkable not that long ago. Nobody seems to have considered how the possession of such vast powers would distort their exercise.

Prior to assumption of the Federal Reserve Chairmanship, Ben Bernanke wrote his dissertation on the causes of the Great Depression. Later, his academic reputation was built on his assessment of mistakes committed by Fed Board members during the 1920s and 30s. When he joined the Board and became Chairman, he vowed not to repeat those mistakes. Thus, we should not have been surprised when he treated a financial crisis on his watch as though it were another Great Depression in the making. Bernanke was the living embodiment of the old saying, “Give a small boy a hammer and he will find that everything he encounters needs pounding.” His academic training had given him a hammer and he proceeded to use it to pound the first crisis he met.

In an interview with “Bloomberg News,” Geithner used the phrase “Great Depression” three times. First, he likened the financial crisis of 2008 to the Great Depression, calling it “classic” and comparing it to the bank runs of the Great Depression. Later, he claimed that we had avoided another Great Depression by following his policies. For Geithner, the Great Depression isn’t so much an actual historical episode or an analytical benchmark as it is an emotional button he presses whenever he needs justification for his actions.

When we give vast power to individuals, we virtually guarantee that they will view events through the lens of their own ego rather than objectively. Bernanke was bound to view his decisions in this light: either apply principles he himself had espoused and built his career upon or run the risk of going down in history as exactly the kind of man he had made his name criticizing – the man who stood by and allowed the Great Depression to happen. Faced with those alternatives, policy activism was the inevitable choice.

Geithner had tremendous power in his advisory capacity as President of the New York Federal Reserve. His choices were: use it or not. Not using it ran the risk of being Hooverized by future generations; that is, being labeled as unwitting, uncaring or worse. Using it at least showed that he cared, even if he failed. The only people who would criticize him would be some far-out, laissez-faire types. Thus, he had everything to gain and little to lose by advising policy activism.

Now, after the fact, the incentive to seek the truth is even weaker than it is in the moment. Now Bernanke, Geithner et al are stuck with their decisions. They cannot change their actions, but they can change anything else – their motivations, those of others, even the truths of history and analysis. If they can achieve by lying or dissembling what they could not achieve with their actions at the time, then dishonesty is a small price to pay. Being honest with yourself can be difficult under the best of circumstances. When somebody is on the borderline between being considered the nation’s savior and its scourge, it is well-nigh impossible.

And a person who begins by lying to himself cannot end up being truthful with the world. No, memoirs like Stress Test are not the place to look for a documentary account of the financial crisis told by an insider. The pressures of power do not shape men like Paulson, Bernanke and Geithner into diamonds, but rather into gargoyles.

We cannot take their words at face value. We must put them under the fluoroscope.

“We Were Three Days Away From Americans Not Being Able to Get Money from ATMs”

Not only are Geithner’s actions under scrutiny, but his timing is also criticized. Many people, perhaps most prominently David Stockman, have insisted that the actual situation faced by the U.S. economy wasn’t nearly dire enough to justify the drastic actions urged by Geithner, et al.

Geithner’s stock reply, found in his book and repeated in numerous interviews, is that the emergency facing the nation left no time for observance of legal niceties or economic precedent. He resuscitates the old quote: “We were three days away from Americans not being able to get money from their ATMs.”

There is an effective reply because its psychological shock value tends to stun the listener into submission. But meek silence is the wrong posture with which to receive a response like this from a self-interested party like Paulson, Bernanke or Geithner. Instead, it demands minute examination.

First, ask ourselves this: Is this a figure of speech or literal truth? That is, what precise significance attaches to the words “three days?”

Recall that Bernanke and Paulson have told us that they realized the magnitude of the emergency facing the country and determined that they must (a) violate protocol by going directly to Congress; and (b) act in secret to prevent public panic. Remember also that Paulson told Congress that if they did not pass bailout legislation by the weekend, Armageddon would ensue. And remember also that, typically, Congress did not act within the deadline specified. It waited  ten days before passing the bailout deal. And the prophesied disaster did not unfold.

In other words, Paulson, Bernanke, et al were exaggerating for effect. How much they were exaggerating can be debated.

That leads to the next logical point. What about the ATM reference itself? Was it specific, meaningful? Or was it just hooey? To paraphrase the line used in courtroom interrogation by litigators (“Are you lying now or were you lying then?”), is Geithner exaggerating now just as Paulson and Bernanke exaggerated then?

Well, Geithner is apparently serious in using this reference. In the same interviews, Geithner calls the financial crisis “a classic financial panic, similar to the bank runs in the Great Depression.” In the 1930s, U.S. banks faced “runs” by depositors who withdrew deposits in cash when they questioned the solvency of banks. Under fractional-reserve banking, banks then (as now) kept only a tiny ratio of deposit liabilities on hand in the form of cash and liquid assets. The runs produced a rash of bank failures, leading to widespread closures and the eventual “bank holiday” proclaimed by newly elected President Franklin Delano Roosevelt. So Geithner’s borrowing of the ATM comment as an index of our distress seems to be clearly intended to suggest an impending crisis of bank liquidity.

There is an obvious problem with this interpretation, the problem being that it is obvious nonsense. Virtually every commentator and reviewer has treated Geithner’s backwards predictions of a “Great Depression” with some throat-clearing version of “well, as we all know, we can’t know what would have happened, we’ll never know, we can’t replay history, history only happens once,” and so forth. But that clearly doesn’t apply to the ATM case. We know – as incontrovertibly as we can know anything in life – what would have happened had bank runs and bank illiquidity a la 1930s so much as threatened in 2008.

Somebody would have stepped to a computer at the Federal Reserve and started creating money. We know this because that’s exactly what did happen in 2010 when the Fed initiated its “Quantitative Easing” program of monetary increase. The overwhelming bulk of the QE money found its way to bank reserve accounts at the Fed where it has been quietly drawing interest ever since. We also know that the usual formalities and intermediaries involving money creation by the Fed could and would have been dispensed with in that sort of emergency. As Fed Chairman, Ben Bernanke was known as “Helicopter Ben” because he was fond of quoting Milton Friedman’s remark that the Fed could get money in public hands by dropping it from helicopters in an emergency, if necessary. Bernanke would not have stood on ceremony in the case of a general bank run; he would have funneled money directly to banks by the speediest means.

In other words, the ATM comment was and is the purest hooey. It has no substantive significance or meaning. It was made, and revived by Geithner, for shock effect only. This is very revealing. It implies a man desperate to achieve his effect, which means his words should be received with utmost caution.

“The Paradox of Financial Crises”

Geithner’s flagship appearance on the promotion circuit was his op-ed in The Wall Street Journal (5/13/2014), “The Paradox of Financial Crises.” The thesis of this op-ed – the “paradox” of the title – is that “the more aggressive the government is in designing a rescue plan, the easier it is to force more restructuring in the financial sector, and the better the chances of leaving the surviving system stronger and less dependent on the taxpayer.” Alas, Geithner complains, “Americans don’t give their presidents much in the way of emergency authority to fight” financial crises. As evidence of the need for this emergency authority, Geithner cites the loss of 16% of U.S. household net worth in 2008, “several times as large as the losses at the start of the Great Depression.”

No doubt eyebrows were raised throughout the U.S. when Geithner bemoaned the lack of emergency authority for a President who has appointed dozens of economic and regulatory “czars,” single-handedly suspended execution of legislation and generally behaved high-handedly. Geithner’s thesis – a generous description of what might reasonably be called a desperate attempt at self-justification – apparently consists of three components: (1) the presumption that financial crises are uniquely powerful and destructive; (2) the claim that, nevertheless, a financial crisis can be counteracted by sufficiently forceful action, taken with sufficient dispatch; and (3) the further claim that he knows what actions to take.

The power of financial crises is a trendy idea given currency by a popular scholarly work by two economists named Rogoff and Reinhart, who surveyed recessions featuring financial panics going back several centuries and ostensibly discovered that their recoveries tended to be slow. How much merit their ideas have is really irrelevant to Geithner’s thesis because Geithner’s interest in financial crises is entirely opportunistic. It began in 2008 with Geithner’s improvisations when faced with the impending failure of Bear Stearns, Lehman Brothers, et al. It perseveres only because Geithner’s legacy is now tied to the success of those machinations – which, unlikely as it might have seemed six years ago, is still in dispute.

Geithner’s theory of financial crises is not the Rogoff/Reinhart theory. It is the Geithner theory, which is: financial crises are uniquely powerful because Geithner needs them to be uniquely powerful in order to justify his unprecedented recommendations for unilateral executive actions. In his book and interviews, Geithner peddles various vague, vacuous generalities about financial crises. In order to these to make sense, they must be based on historical observation and/or statistical regularities. But they cannot jibe with the sentiments expressed above in the Journal. Geithner claims to be enunciating a general theory of financial crisis and rescue. But he is really telling a story of what he did to this particular financial system in the particular financial crisis of 2008.

And no wonder, since the financial system existing in the U.S. in 2008 was and still is like no financial system that existed previously. Instead of “banks” as we previously knew them, the failing financial institutions in 2008 were diversified financial institutions – nominally investment banks, although that activity had by then assumed a minor part of their work – some of whose liabilities would once have been called “near monies.” Meanwhile, the true banks were also diversified into securities and investment banking, and the larger ones controlled the overwhelming bulk of deposit liabilities in the U.S. This historically unprecedented configuration accounted for the determination of Paulson, Bernanke, and Geithner to bail them out at all costs. But they weren’t drawing upon a general theory of crises, because no previous society ever had a financial structure like ours.

Geithner stresses the need to “force more restructuring in the financial sector,” as though every financial crisis was caused by corporate elephantiasis and cured by astute government pruning back of financial firms. This is not only historically wrong but logically deficient, since the past government pruning couldn’t have been very astute if crises kept recurring. Indeed, that is the obvious shortcoming of the second component. There are no precedents – none, zero, nada – for the idea that government policy can either forestall or cure recessions, whether financial or otherwise. This is not for want of trying. If there is one thing governments love to do, it is spend money. If there is another thing governments love to do, it is throw their weight around. Neither has solved the problem of recession so far.

What leads us to believe that Timothy Geithner was and is well qualified to pronounce on the subject of financial crises? Only one thing – his claims that “we did do the essential thing, which was to prevent another Great Depression, with its decade of shantytowns and bread lines. We put out the financial fire…because we wanted to prevent mass unemployment.”

Incredible as it seems now, Timothy Geithner had even fewer economic credentials for his post as Chairman of the New York Federal Reserve than Ben Bernanke had for his as Chairman of the Federal Reserve Board of Governors. Geithner had only one economics course as a Dartmouth undergraduate (he found it “dreary”). His master’s degree at John’s Hopkins was split between international economics and Far Eastern studies. (He speaks Japanese, among other foreign languages.) He put in a three-year stint as a consultant with Henry Kissinger’s consulting firm before graduating to the Treasury, where he spent 13 years before moving to the International Monetary Fund, then becoming Chairman of the New York Fed at age 42. As Freeman observed in his book review, Geithner “never worked in finance or in any type of business” save Kissinger’s consulting firm.

This isn’t exactly a resume of recommendation for a man taking the tiller during a financial typhoon. Maybe it explains what Freeman called Geithner’s “difficulty in understanding the health of large financial firms.”

When asked by interviewers if he had any regrets about his tenure, Geithner regrets not foreseeing the crisis in time to act sooner. This certainly contradicts his theory of crises and his claim of special knowledge – if he was the man with a plan and the man of the moment, why did he fail to foresee the crisis and have to go begging for emergency authorization for Presidential action at the 11th hour? Why should we now eagerly devour the words of a man who claims responsibility for saving the nation while simultaneously admitting that he “didn’t see the crisis coming and didn’t grasp the severity of the problems when it appeared?” He now boasts a special understanding of financial crises, but “didn’t require the banks he was overseeing to raise more capital” at the time of the crisis. In fact, as Freeman discloses, the minutes of the Federal Reserve show that Geithner denies that the banking system in general was undercapitalized even while other Fed governors were proposing that banks meet a capital call.

Geithner offers no particular reason why we should believe anything he says and ample reasons for doubt.

“The Government and the Central Bank Have to Step In and Take Risks”

Geithner’s book and publicity tour are a public-relations exercise designed to change his image. Ironically, this involves a tradeoff. He had image problems with both the right wing and the left wing, so gains on one side rate to lose him support on the other side. The Wall Street Journal piece shows that he wants to burnish his left profile. He closes by lamenting that “we were not able to do all that was important or desirable.  …Long-term unemployment remains alarmingly high. There are very high levels of poverty and appalling inequality, not just in income and wealth, but in the opportunities Americans have for a quality education or economic mobility.” Having spent the bulk of the op-ed apologizing for not allowing undeserving Wall Street bankers to go broke, he now nods frantically to every left-wing preoccupation. None of this has anything to do with a financial crisis or emergency authorizations or stress tests, of course – it is just Geithner stroking his left-wing critics.

The real sign that Geithner’s allegiance is with the left is his renunciation of the concept of “moral hazard.” Oh, he gives lip service to the fact that when the government bails out business and subsidizes failure, this will encourage subsequent businessmen to take excessive risks on a “heads I win, tails the government bails me out” expectation. But he savagely criticizes the moral hazard approach as “Old Testament” thinking. (The fact that “Old Testament” is now a pejorative is significant in itself; one wonders what significance “New Testament” would have.) “What one has to do in a panic is the opposite of what seems fair and just. In a financial crisis, the natural instinct is to let creditors suffer losses, let firms fail, and protect taxpayers from any risk of loss. But in a financial panic, a strategy based on those instincts will lead to depression-level unemployment. Instead, the government and the central bank have to step in and take risks on a scale that the private sector can’t and won’t… reduce the incentive for investors, lenders and depositors to run…raise the confidence of businesses and individuals… breaking a vicious cycle in which the fear of a financial-system collapse and a deep recession feed on each other and become self-fulfilling.”

This is surely the clearest sign that Geithner is engaging in ex post rationalization and improvisation. For centuries, economists have debated the question of whether recessions are real or monetary in origin and substance. Now Geithner emerges with the secret: they are psychological. Keynes, it seems, was the second-most momentous thinker of the 1930s, behind Sigmund Freud. All we have to do is overcome our “natural instinct” and rid ourselves of those awful “Old Testament” morals and bail out the right people – creditors – instead of the wrong people – taxpayers.

Once again, commentators have glossed over the most striking contradictions in this tale. For five years, we have listened ad nauseum to scathing denunciations of bankers, real-estate brokers, developers, investment bankers, house flippers and plain old home buyers who went wild and crazy, taking risks right and left with reckless abandon. But now Geithner is telling us that the problem is that “the private sector can’t and won’t …take risks on a scale” sufficient to save us from depression! So government and the central bank (!) must gird their loins, step in and do the job.

But this is a tale left unfinished.  Geithner says plainly that his actions saved us from a Great Depression. He also says that salvation occurred because government and the Fed assumed risks on a massive scale. What happened to those risks? Did they vanish somewhere in a puff of smoke or cloud of dust? If not, they must still be borne. And if the risks are still active, that means that we have not, after all, been saved from the Great Depression; it has merely been postponed.

It is not too hard to figure out what Geithner is saying between the lines. He wants to justify massive Federal Reserve purchases of toxic bank assets and the greatest splurge of money creation in U.S. history – without having to mention that these put us all on a hook where we remain to this day.

In this sense, Timothy Geithner’s book was well titled. Unfortunately, he omitted to mention that the most stressful test is yet to come.

DRI-259 for week of 2-2-14: Kristallnacht for the Rich: Not Far-Fetched

An Access Advertising EconBrief:

Kristallnacht for the Rich: Not Far-Fetched

Periodically, the intellectual class aptly termed “the commentariat” by The Wall Street Journal works itself into frenzy. The issue may be a world event, a policy proposal or something somebody wrote or said. The latest cause célèbre is a submission to the Journal’s letters column by a partner in one of the nation’s leading venture-capital firms. The letter ignited a firestorm; the editors subsequently declared that Tom Perkins of Kleiner Perkins Caulfield & Byers “may have written the most-read letter to the editor in the history of The Wall Street Journal.”

What could have inspired the famously reserved editors to break into temporal superlatives? The letter’s rhetoric was both penetrating and provocative. It called up an episode in the 20th century’s most infamous political regime. And the response it triggered was rabid.

“Progressive Kristallnacht Coming?”

“…I would call attention to the parallels of fascist Nazi Germany to its war on its “one percent,” namely its Jews, to the progressive war on the American one percent, namely “the rich.” With this ice breaker, Tom Perkins made himself a rhetorical target for most of the nation’s commentators. Even those who agreed with his thesis felt that Perkins had no business using the Nazis in an analogy. The Wall Street Journal editors said “the comparison was unfortunate, albeit provocative.” They recommended reserving Nazis only for rarefied comparisons to tyrants like Stalin.

On the political Left, the reaction was less measured. The Anti-Defamation League accused Perkins of insensitivity. Bloomberg View characterized his letter as an “unhinged Nazi rant.”

No, this bore no traces of an irrational diatribe. Perkins had a thesis in mind when he drew an analogy between Nazism and Progressivism. “From the Occupy movement to the demonization of the rich, I perceive a rising tide of hatred of the successful one percent.” Perkins cited the abuse heaped on workers traveling Google buses from the cities to the California peninsula. Their high wages allowed them to bid up real-estate prices, thereby earning the resentment of the Left. Perkins’ ex-wife Danielle Steele placed herself in the crosshairs of the class warriors by amassing a fortune writing popular novels. Millions of dollars in charitable contributions did not spare her from criticism for belonging to the one percent.

“This is a very dangerous drift in our American thinking,” Perkins concluded. “Kristallnacht was unthinkable in 1930; is its descendant ‘progressive’ radicalism unthinkable now?” Perkins point is unmistakable; his letter is a cautionary warning, not a comparison of two actual societies. History doesn’t repeat itself, but it does rhyme. Kristallnacht and Nazi Germany belong to history. If we don’t mend our ways, something similar and unpleasant may lie in our future.

A Short Refresher Course in Early Nazi Persecution of the Jews

Since the current debate revolves around the analogy between Nazism and Progressivism, we should refresh our memories about Kristallnacht. The name itself translates loosely into “Night of Broken Glass.” It refers to the shards of broken window glass littering the streets of cities in Germany and Austria on the night and morning of November 9-10, 1938. The windows belonged to houses, hospitals, schools and businesses owned and operated by Jews. These buildings were first looted, then smashed by elements of the German paramilitary SA (the Brownshirts) and SS (security police), led by the Gauleiters (regional leaders).

In 1933, Adolf Hitler was elevated to the German chancellorship after the Nazi Party won a plurality of votes in the national election. Almost immediately, laws placing Jews at a disadvantage were passed and enforced throughout Germany. The laws were the official expression of the philosophy of German anti-Semitism that dated back to the 1870s, the time when German socialism began evolving from the authoritarian roots of Otto von Bismarck’s rule. Nazi officialdom awaited a pretext on which to crack down on Germany’s sizable Jewish population.

The pretext was provided by the assassination of German official Ernst vom Rath on Nov. 7, 1938 by a 17-year-old German boy named Herschel Grynszpan. The boy was apparently upset by German policies expelling his parents from the country. Ironically, vom Rath’s sentiments were anti-Nazi and opposed to the persecution of Jews. Von Rath’s death on Nov. 9 was the signal for release of Nazi paramilitary forces on a reign of terror and abduction against German and Austrian Jews. Police were instructed to stand by and not interfere with the SA and SS as long as only Jews were targeted.

According to official reports, 91 deaths were attributed directly to Kristallnacht. Some 30,000 Jews were spirited off to jails and concentration camps, where they were treated brutally before finally winning release some three months later. In the interim, though, some 2-2,500 Jews died in the camps. Over 7,000 Jewish-owned or operated businesses were damaged. Over 1,000 synagogues in Germany and Austria were burned.

The purpose of Kristallnacht was not only wanton destruction. The assets and property of Jews were seized to enhance the wealth of the paramilitary groups.

Today we regard Kristallnacht as the opening round of Hitler’s Final Solution – the policy that produced the Holocaust. This strategic primacy is doubtless why Tom Perkins invoked it. Yet this furious controversy will just fade away, merely another media preoccupation du jour, unless we retain its enduring significance. Obviously, Tom Perkins was not saying that the Progressive Left’s treatment of the rich is now comparable to Nazi Germany’s treatment of the Jews. The Left is not interning the rich in concentration camps. It is not seizing the assets of the rich outright – at least not on a wholesale basis, anyway. It is not reducing the homes and businesses of the rich to rubble – not here in the U.S., anyway. It is not passing laws to discriminate systematically against the rich – at least, not against the rich as a class.

Tom Perkins was issuing a cautionary warning against the demonization of wealth and success. This is a political strategy closely associated with the philosophy of anti-Semitism; that is why his invocation of Kristallnacht is apropos.

The Rise of Modern Anti-Semitism

Despite the politically correct horror expressed by the Anti-Defamation Society toward Tom Perkins’ letter, reaction to it among Jews has not been uniformly hostile. Ruth Wisse, professor of Yiddish and comparative literature at HarvardUniversity, wrote an op-ed for The Wall Street Journal (02/04/2014) defending Perkins.

Wisse traced the modern philosophy of anti-Semitism to the philosopher Wilhelm Marr, whose heyday was the 1870s. Marr “charged Jews with using their skills ‘to conquer Germany from within.’ Marr was careful to distinguish his philosophy of anti-Semitism from prior philosophies of anti-Judaism. Jews “were taking unfair advantage of the emerging democratic order in Europe with its promise of individual rights and open competition in order to dominate the fields of finance, culture and social ideas.”

Wisse declared that “anti-Semitism channel[ed] grievance and blame against highly visible beneficiaries of freedom and opportunity.” “Are you unemployed? The Jews have your jobs. Is your family mired in poverty? The Rothschilds have your money. Do you feel more secure in the city than you did on the land? The Jews are trapping you in the factories and charging you exorbitant rents.”

The Jews were undermining Christianity. They were subtly perverting the legal system. They were overrunning the arts and monopolizing the press. They spread Communism, yet practiced rapacious capitalism!

This modern German philosophy of anti-Semitism long predated Nazism. It accompanied the growth of the German welfare state and German socialism. The authoritarian political roots of Nazism took hold under Otto von Bismarck’s conservative socialism, and so did Nazism’s anti-Semitic cultural roots as well. The anti-Semitic conspiracy theories ascribing Germany’s every ill to the Jews were not the invention of Hitler, but of Wilhelm Marr over half a century before Hitler took power.

The Link Between the Nazis and the Progressives: the War on Success

As Wisse notes, the key difference between modern anti-Semitism and its ancestor – what Wilhelm Marr called “anti-Judaism” – is that the latter abhorred the religion of the Jews while the former resented the disproportionate success enjoyed by Jews much more than their religious observances. The modern anti-Semitic conspiracy theorist pointed darkly to the predominance of Jews in high finance, in the press, in the arts and running movie studios and asked rhetorically: How do we account for the coincidence of our poverty and their wealth, if not through the medium of conspiracy and malefaction? The case against the Jews is portrayed as prima facie and morphs into per se through repetition.

Today, the Progressive Left operates in exactly the same way. “Corporation” is a pejorative. “Wall Street” is the antonym of “Main Street.” The very presence of wealth and high income is itself damning; “inequality” is the reigning evil and is tacitly assigned a pecuniary connotation. Of course, this tactic runs counter to the longtime left-wing insistence that capitalism is inherently evil because it forces us to adopt a materialistic perspective. Indeed, environmentalism embraces anti-materialism to this day while continuing to bunk in with its progressive bedfellows.

We must interrupt with an ironic correction. Economists – according to conventional thinking the high priests of materialism – know that it is human happiness and not pecuniary gain that is the ultimate desideratum. Yet the constant carping about “inequality” looks no further than money income in its supposed solicitude for our well-being. Thus, the “income-inequality” progressives – seemingly obsessed with economics and materialism – are really anti-economic. Economists, supposedly green-eyeshade devotees of numbers and models, are the ones focusing on human happiness rather than ideological goals.

German socialism metamorphosed into fascism. American Progressivism is morphing from liberalism to socialism and – ever more clearly – honing in on its own version of fascism. Both employed the technique of demonization and conspiracy to transform the mutual benefit of free voluntary exchange into the zero-sum result of plunder and theft. How else could productive effort be made to seem fruitless? How else could success be made over into failure? This is the cautionary warning Perkins was sounding.

The Great Exemplar

The great Cassandra of political economy was F.A. Hayek. Early in 1929, he predicted that Federal Reserve policies earlier in the decade would soon bear poisoned fruit in the form of a reduction in economic activity. (His mentor, Ludwig von Mises, was even more emphatic, foreseeing “a great crash” and refusing a prestigious financial post for fear of association with the coming disaster.) He predicted that the Soviet economy would fail owing to lack of a functional price system; in particular, missing capital markets and interest rates. He predicted that Keynesian policies begun in the 1950s would culminate in accelerating inflation. All these came true, some of them within months and some after a lapse of years.

Hayek’s greatest prediction was really a cautionary warning, in the same vein as Tom Perkins’ letter but much more detailed. The 1945 book The Road to Serfdom made the case that centralized economic planning could operate only at the cost of the free institutions that distinguished democratic capitalism. Socialism was really another form of totalitarianism.

The reaction to Hayek’s book was much the same as reaction to Perkins’ letter. Many commentators who should have known better have accused both of them of fascism. They also accused both men of describing a current state of affairs when both were really trying to avoida dystopia.

The flak Hayek took was especially ironic because his book actually served to prevent the outcome he feared. But instead of winning the acclaim of millions, this earned him the scorn of intellectuals. The intelligentsia insisted that Hayek predicted the inevitable succession of totalitarianism after the imposition of a welfare state. When welfare states in Great Britain, Scandinavia, and South America failed to produce barbed wire, concentration camps and German Shepherd dogs, the Left advertised this as proof of Hayek’s “exaggerations” and “paranoia.”

In actual fact, Great Britain underwent many of the changes Hayek had feared and warned against. The notorious “Rules of Engagements,” for instance, were an attempt by a Labor government to centrally control the English labor market – to specify an individual’s work and wage rather than allowing free choice in an impersonal market to do the job. The attempt failed just a dismally as Hayek and other free-market economists had foreseen it would. In the 1980s, it was Hayek’s arguments, wielded by Prime Minister Margaret Thatcher, which paved the way for the rolling back of British socialism and the taming of inflation. It’s bizarre to charge the prophet of doom with inaccuracy when his prophecy is the savior, but that’s what the Left did to Hayek.

Now they are working the same familiar con on Tom Perkins. They begin by misconstruing the nature of his argument. Later, if his warnings are successful, they will use that against him by claiming that his “predictions” were false.

Enriching Perkins’ Argument

This is not to say that Perkins’ argument is perfect. He has instinctively fingered the source of the threat to our liberties. Perkins himself may be rich, but argument isn’t; it is threadbare and skeletal. It could use some enriching.

The war on the wealthy has been raging for decades. The opening battle is lost to history, but we can recall some early skirmishes and some epic brawls prior to Perkins.

In Europe, the war on wealth used anti-Semitism as its spearhead. In the U.S., however, the popularity of Progressives in academia and government made antitrust policy a more convenient wedge for their populist initiatives against success. Antitrust policy was a crown jewel of the Progressive movement in the early 1900s; Presidents Theodore Roosevelt and William Howard Taft cultivated reputations as “trust busters.”

The history of antitrust policy exhibits two pronounced tendencies: the use of the laws to restrict competition for the benefit of incumbent competitors and the use of the laws by the government to punish successful companies for various political reasons. The sobering research of Dominick Armentano shows that antitrust policy has consistently harmed consumer welfare and economic efficiency. The early antitrust prosecution of Standard Oil, for example, broke up a company that had consistently increased its output and lowered prices to consumers over long time spans. The Orwellian rhetoric accompanying the judgment against ALCOA in the 1940s reinforces the notion that punishment, not efficiency or consumer welfare, was behind the judgment. The famous prosecutions of IBM and AT&T in the 1970s and 80s each spawned book-length investigations showing the perversity of the government’s claims. More recently, Microsoft became the latest successful firm to reap the government’s wrath for having the temerity to revolutionize industry and reward consumers throughout the world.

The rise of the regulatory state in the 1970s gave agencies and federal prosecutors nearly unlimited, unsupervised power to work their will on the public. Progressive ideology combined with self-interest to create a powerful engine for the demonization of success. Prosecutors could not only pursue their personal agenda but also climb the career ladder by making high-profile cases against celebrities. The prosecution of Michael Milken of Drexel Burnham Lambert is a classic case of persecution in the guise of prosecution. Milken virtually created the junk-bonk market, thereby originating an asset class that has enhanced the wealth of investors by untold billions or trillions of dollars. For his pains, Milken was sent to jail.

Martha Stewart is a high-profile celebrity who was, in effect, convicted of the crime of being famous. She was charged and convicted of lying to police about a case in which the only crime could have been the offense of insider-trading. But she was the trader and she was not charged with insider-trading. The utter triviality and absence of any damage to consumers or society at large make it clear that she was targeted because of her celebrity; e.g., her success.

Today, the impetus for pursuing successful individuals and companies today comes primarily from the federal level. Harvey Silverglate (author of Three Felonies Per Day) has shown that virtually nobody is safe from the depredations of prosecutors out to advance their careers by racking up convictions at the expense of justice.

Government is the institution charged with making and enforcing law, yet government has now become the chief threat to law. At the state and local level, governments hand out special favors and tax benefits to favored recipients – typically those unable to attain success on their own efforts – while making up the revenue from the earned income of taxpayers at large. At the federal level, Congress fails in its fundamental duty and ignores the law by refusing to pass budgets. The President appoints czars to make regulatory law, while choosing at discretion to obey the provisions of some laws and disregard others. In this, he fails his fundamental executive duty to execute the laws faithfully. Judges treat the Constitution as a backdrop for the expression of their own views rather than as a subject for textual fidelity. All parties interpret the Constitution to suit their own convenience. The overarching irony here is that the least successful institution in America has united in a common purpose against the successful achievers in society.

The most recent Presidential campaign was conducted largely as a jihad against the rich and successful in business. Mitt Romney was forced to defend himself against the charge of succeeding too well in his chosen profession, as well as the corollary accusation that his success came at the expense of the companies and workers in which his private-equity firm invested. Either his success was undeserved or it was really failure. There was no escape from the double bind against which he struggled.

It is clear, than, that the “progressivism” decried by Tom Perkins dates back over a century and that it has waged a war on wealth and success from the outset. The tide of battle has flowed – during the rampage of the Bull Moose, the Depression and New Deal and the recent Great Recession and financial crisis – and ebbed – under Eisenhower and Reagan. Now the forces of freedom have their backs to the sea.

It is this much-richer context that forms the backdrop for Tom Perkins’ warning. Viewed in this panoramic light, Perkins’ letter looks more and more like the battle cry of a counter-revolution than the crazed rant of an isolated one-percenter.

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-316 for week of 6-23-13: Is It Time to Start Selling The Wall Street Journal at the Grocery Store Checkout?

An Access Advertising EconBrief:

Is It Time to Start Selling The Wall Street Journal at the Grocery Store Checkout?

For three-quarters of a century, The Wall Street Journal has been one of the world’s financial periodicals of record. It has battled London’s Financial Times for supremacy since about the time that the sun set on the British Empire; i.e., the close of World War II. World leadership is a responsibility not lightly assumed or relinquished, and the Journal has taken its role seriously.

The American press has long followed the Journal‘s lead on financial and economic stories, citing it as the primary source of information and analysis. Business schools and economics departments at colleges and universities have offered Journal subscriptions at reduced rates, both to whet student interest and improve the student’s vocabulary and grasp of fundamentals. The need for an intermediary between the public and the professional elite of business, finance and economics is perennial. It has never been greater than today, when the tools of the trade are sophisticated and complex and the threat of economic collapse looms.

The advent of the Internet drove a stake through the heart of the American newspaper business, which had preyed on its public. High advertising rates, particularly for classified ads, were its life’s blood. Its left-leaning editorial stance gradually alienated its readership. Despite declining circulation, the industry obstinately continued to disdain its customers. The Journal and USA Today were lonely exceptions to this trend. Virtually alone, they have maintained circulation and operational scale.

Still, ominous signs are visible. The most disturbing has been the obvious divergence in viewpoint between the editorial page and reporting in the Journal. Technically, reporting is not supposed to reveal a viewpoint; it is supposed to present the “who, what, when, where, why” of the news impartially. Nowadays, though, this is apparently considered passé. And the viewpoint of Journal reporters is left of center, albeit to the right of (say) Mother Jones or The Nation. Meanwhile, Wall Street Journal editors remain a rare bulwark of support for free markets and political conservatism in the print media.

But that disturbing divergence is not stable. The Journal‘s reporting is showing increasing signs of the economic illiteracy and rabid anti-business, anti-market populism that characterizes the popular press. The latest example appeared in the Tuesday, June 25, Wall Street Journal‘s “Marketplace” section. The headline read: “McKesson CEO Due a Pension of $159 Million.”

The $159 Million “Pension”

The article’s byline belongs to one Mark Maremont. The piece opens with the unfavorable characterization of “executive pension plans [that] sometimes grow to a hefty size…as extra retirement cushions for long-serving CEOs.” The curious description of a retirement plan as an extra retirement cushion is advance notice that class warfare is about to break out. After all, the executive pension itself may run to millions of dollars, so it is difficult to justify the pejorative use of these words except as a lubricant for class envy.

That is merely the warm-up for the lead that, contrary to standard journalistic practice, follows in the second paragraph. “Then there’s the record $159 million pension benefit of John Hammergren, the current chairman and CEO of drug distributor McKessonCorp. That’s how much he would have received in a lump-sum benefit had he voluntarily departed on March 31,” according to a company proxy filing.

Mr. Maremont cites unnamed compensation consultants who declare this the largest pension on record for a public-company CEO, and maybe the largest in history. His one named source, James Reda of Gallagher HR Consulting, calls the pension “excessive” because Mr. Hammergren has been very highly paid in recent years. (Mr. Hammergrens annual compensation has averaged over $50 million.) Understandably, Mr. Hammergren refused the opportunity to comment on Mr. Maremont’s findings.

That is understandable because it is difficult to remain both calm and lucid in the face of anything so outrageous. Begin with the obvious; namely, the article’s characterization of the $159 million as a “pension.” To just about everyone in the English-speaking world, the word “pension” connotes a fixed, periodic (classically, annual) payment made according to the terms of a retirement plan. It is essentially synonymous with what insurance calls a “guaranteed life annuity.” Merriam Webster’s Collegiate Dictionary lists “a fixed sum paid regularly to a person” as the first definition of “pension.” According to Wikipedia:

A pension is a contract for a fixed sum to be paid regularly to a person, typically following retirement from service.[1] Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum. The terms retirement plan and superannuation refer to a pension granted upon retirement of the individual.

Given the everyday meaning of the word “pension,” a $159 million pension certainly ought to be a record. The sight of that headline must have set eyes rolling and brows rising throughout the world, because it said that McKesson’s CEO would receive $159 million a year for the rest of his life the equivalent of winning a lottery every year. And it is perfectly obvious that he will get nothing of the kind.

Those two words, “lump-sum benefit,” in paragraph two of Mr. Maremont’s article, are the tipoff to the charade he is staging. Diehard readers who inspect all 24 paragraphs of the article and its accompanying 13-paragraph sidebar detailing the calculation of Mr. Hammergren’s “pension,” eventually learn the truth; namely, that what Mr. Maremont calls a pension is closer to what Wikipedia calls a “severance.”

In journalism as it was formerly practiced – that is to say, reputable journalism – accuracy and clarity were the watchwords. Style and viewpoint were never issues. And political issues such as the fairness of CEO compensation belonged on the editorial page, not the front page of the “Marketplace” section. Ambiguity about the meaning of the word “pension” would never, ever have been allowed to mar the meaning of a story.

If It Doesn’t Waddle Like a Duck, Quack Like a Duck or Have Feathers…

One has the paralyzing suspicion that, when pressed to account for his conduct, Mr. Maremont would reply with a shrug, “But McKesson calls it a pension. I just accepted their terminology. It wasn’t my place to question or interpret it.”

If the Journal received a fisherman’s report touting a “world-record sardine” weighing a ton, possessing a pointed dorsal fin, skin instead of scales, double rows of sharp teeth and two unblinking eyes, would it unquestioningly print this account unedited and unqualified? Would it put “world-record sardine” in the headline, burying the likelihood that the sardine was really a shark somewhere in the fine print of the article?

Presumably not. But that is what the Journal has done here. We know this because Mr. Maremont himself grudgingly discloses it over the course of the article. After having spent the first 17 paragraphs implicitly flogging McKesson (and, by implication, Mr. Hammergren) for trying to put something over on shareholders and the public, Mr. Maremont comes clean about what is really going on. In paragraph 18, he discloses that in 2006 federal regulators changed the rules of disclosure for executive pensions. Under the new rules, companies were required to calculate a present discounted value for the pension each year under the hypothetical assumption that the executive retired that year.

Like many regulations, this initially seems weird and pointlessly complicated but actually has a logical purpose behind it. One obvious way to enable shareholders and analysts to understand how much executives are being compensated by boards of directors is to compare their compensation with that of executives at other firms. But coming up with a valid comparison for executives in different circumstances – different ages, different health profiles, etc. – is impossible without finding a format in which relevant values can be expressed in a common denominator. Thus, regulatory requirements have demanded that companies express compensation in just that common-denominator form – the present discounted value of the future pension payments. This is evaluated in various termination contexts, one of which is current termination of service.

And that is that Mr. Hammergren’s reported McKesson “pension” represents – not a pension in the generally understood sense, but in this special regulatory sense. There is no way under heaven that this pension – a lump sum representing the present discounted value of all future pension payments – belongs in the same comparative category as an ordinary “annual pension,” which is only one of those payments that gets discounted in computing the lump-sum payment. The lump sum can be compared to other executive pensions that are expressed identically – and this is the only comparison in which it should figure. Presumably, this is the comparison Mr. Maremont really refers to when he claims “record” status for it. Or rather, that is presumably what he would say if called upon to defend his article.

It is impossible to believe that a bylined reporter on the world’s leading financial daily could or would innocently mislead readers by suggesting one thing, then reluctantly and inferentially removing the suggestion through information supplied later. There is no innocent explanation; Mr. Maremont is either too incompetent to realize that he has confused his readers or he intended to profit from the confusion. That is, he is either a fool or a knave. There is no third possibility.

Either way, the episode indicates that The Wall Street Journal should take its place alongside The National Inquirer and News of the World on the tabloid rack at the grocery-store checkout.

Never Ascribe to Venality That Which Can be Explained by Mere Stupidity

Was Mr. Maremont devious or merely stupid? That remains to be determined. There is evidence on both sides.

Go back to the beginning of the article, where Mr. Maremont cites James Reda’s denunciation of McKesson’s lump-sum pension benefit as “excessive” because Mr. Hammergren is already making so much money. This is bizarre, to say the least. Every compensation specialist knows that the foundation of the pension calculation is the employee’s salary or wage. Mr. Hammergren is making lots of money, so of course his lump-sum benefit will be relatively large; that is how the system works.

But that’s not all. For years, the political left has complained about benefits that are not tied to performance. Here, Mr. Hammergren’s benefit is tied to his performance, which is a key factor in Mr. Hammergren’s high pay. “Under his leadership, the company’s stock price has more than tripled, significantly outperforming the overall market.” This came after his ascension to co-CEO in 1999 “after an accounting scandal decimated the company’s top ranks and led its stock to tank.”

Next, consider Mr. Maremont’s handling of the discount rate, which is usually the most contentious issue whenever the matter of present discounted value arises. In order to value benefits scheduled to occur in the future, a means to reduce the future value to its current equivalent must be found. The theoretically correct way is by “discounting” them; that is, dividing the benefit by a discount factor that embodies the relevant opportunity cost of generating the benefit. In the special case of a perpetuity – a fixed sum available forever – the perpetual benefit is divided by 1 + i, where i represents the interest rate or discount rate that reflects the opportunity cost. The general principle applies in slightly more complicated form to non-perpetual future benefits, which are discounted and summed to yield the present discounted value.

Mr. Maremont implies that the discount rate used by McKesson inflates the value of Mr. Hammergren’s pension; e.g., that it would give him too much money if he retired this year. Moreover, this point is anything but academic since he also says that “McKesson pays its executive pensions as a lump sum rather than annually.” Apparently, the company computes the pension in the conventional manner, using a formula based primarily on the executive’s final salary, years of service and performance. Then, using actuarial age to derive the length of the future payments, they calculate the present discounted value of the pension and pay it.

Mr. Maremont claims, quite correctly, that the selection of the discount rate can influence the outcome of the calculation. In general, the lower the discount rate, the higher will be the present discounted value. Mr. Maremont claims that “most firms” use “a rate set by the Internal Revenue Service of about 3.7% for a similar-age person [to Mr. Hammergren].” Thus, according to Mr. Maremont, McKesson’s chosen rate of 1% results in a windfall of some $52.4 million to Mr. Hammergren, compared to the IRS rate.

A good way to start a fistfight in a roomful of economists is to pose a problem involving selection of a discount rate. No problem is more contentious among forensic economists, the occupational niche that specializes in hiring out their services for legal testimony on valuation, regulation and antitrust. There is an excellent a priori case for assuming that “most firms” accept the IRS valuation simply because they don’t want to start a beef with the IRS, not because the government is a better economic evaluator of discount rates than private firms.

But rather than debate that point at length, ponder the implications of another admission by Mr. Maremont. “Mr. Hammergren will be eligible for full retirement benefits next year, when he turns 55. If interest rates rise, his lump-sum pension could decline [my emphasis].” Mr. Maremont’s conditional prediction clearly suggests that McKesson chooses the discount rate by linking it to current market rates, perhaps by pegging it to an interest-rate index. Indeed, this is just the sort of discount-rate-choice mechanism that appeals to economists generally. And this is tremendously important, not only to Mr. Hammergren but to our analysis, since it means that the CEO’s pension is running interest-rate risk. This would be important under any circumstances, but in today’s world it makes Mr. Maremont’s casual remark that “his lump-sum pension could decline” just about the biggest understatement since Noah said it looks like rain. If the difference between 3.7% and 1% is worth a $52 million gain to Mr. Hammergren, how big do you suppose the loss would be if interest rates rose from the (indexed) 1% up to 7%, or 10%, or 15% or 20%?

The Fed has just announced its anxiety to end the QE process. The market reaction has fallen just short of complete hysteria. Interest rates have already risen markedly. An interest-rate rise that could cost Mr. Hammergren tens of millions of dollars between now and next year is entirely plausible. This loss of value would occur within his retirement account, on the putative eve of his retirement. Elsewhere in the article, Mr. Maremont bemoans the special privilege ostensibly given to executives by these pensions and the detriment suffered by “rank-and-file employees” who have been stuck with defined-contribution plans instead defined-benefit (e.g., pension) plans. Yet now, in the face of his own admission of the special risk Mr. Hammergren is running, Mr. Maremont suddenly becomes analytically mute.

This is clear evidence of bad faith on his part – venality rather than mere stupidity.

Come to think of it, wouldn’t it have made much sense to run a piece on the phenomenon of companies paying executive pensions in lump-sum form rather than in standard life-annuity form? This would have alerted the general public to the existence of this new form of “pension” while simultaneously providing a valid forum in which to compare executive pensions in a truly valid way. For example, Mr. Maremont’s chart shows two line items – “added years of service” and “boosting bonus in formula” – that account for $50 million worth of the $159 million. We cannot evaluate them because he does not give us any information about them, but a genuine news article might have had the time and space to remedy that omission. This would have been The Wall Street Journal operating in traditional fashion; reporting the news and the facts, educating the public while informing them. But Mr. Maremont couldn’t very well have profited from the ambiguity attached to a “pension” by dispelling that ambiguity. That would have nixed the class-envy angle that apparently motivated him, and these days it’s the angle that drives the story.

Just about the time that the triumph of venality seems complete, the reader’s eye is caught by Mr. Maremont’s assertion that McKesson’s 1% discount rate “increased the size of its chief’s lump-sum pension benefit 52%, according to Bolton Partners Inc.” Wait a minute – Mr. Maremont’s chart shows a gain of $52 million (actually, $52.4 million), but now the gain is instead 52%? Confusing dollars with percentages is just plain stupid.

It’s beginning to be clear were our aphorism came from. It may derive from the fact that stupidity and venality are not independent of each other but positively correlated. Consequently, when they arise it becomes difficult to sort out their effects.

It isn’t difficult, alas, to associate their incidence with the decline of a great newspaper.

DRI-312 for week of 5-19-13: Our IRS Relationship: Business/Customer or Ruler/Subject?

An Access Advertising EconBrief:

Our IRS Relationship: Business/Customer or Ruler/Subject?

Last week, it was revealed that, over the course of roughly two years between 2010 and 2012, the Internal Revenue Service (IRS) sorted applications for tax-exempt status by right-wing organizations and designated them for special treatment. Special bad treatment, that is; it delayed processing of these applications by an average of more than twice as long as other applications. The organizations complained about the delay and even voiced their surmise that political sabotage by a Democrat administration might have been responsible for the delay. The complaints got them nowhere until last week, when the truth began seeping out.

The first reports gave little hint of a major scandal. According to the mainstream news media, a few crackpot right-wing outfits with the words “patriot,” “tea party” and “9-12” in their names had to cool their heels until their tax designations came through. It was all the work of a few “rogue IRS operatives” in the Cincinnati office. The New York Times buried the story on page 11. The Washington Post, though, apparently remembered that back in 1973 it ran an obscure item about a President named Nixon using the IRS to investigate his political enemies. It ran the story on page one.

The agency harrumphed and allowed as how mistakes had been made, but no serious damage had been done. President Obama assumed his by-now-familiar pose of innocent bystander loitering in the vicinity of a crime scene, remarking breezily that the IRS was “an independent agency.” This was too much for The Wall Street Journal, which ran an editorial titled “The ‘Independent’ Revenue Service,” pointing out sharply that the IRS is a key agency in the Executive Branch of the federal government, with a chief appointed by the President.

Within the next two days, further revelations emerged. The manner of their revelation was as revealing as the revelations themselves. An internal report by the Treasury Inspector General, soon to be released, confirmed the IRS targeting and the fact that IRS officials had known about it for at least two years. The targeting was not confined to one office; it was nationwide. The basis for the “special attention” devoted by the IRS was not merely the names of the groups – it went much further than that. The issues addressed by the groups were also targeted; they included “government spending,” government debt” and “taxes.” Targeted groups included those that “criticized how the country is being run” and sought to “make America a better place to live.” Questionnaires were sent requesting voluminous information; some of the more intrusive questions demanded to know future political plans of employees and the nature of religious beliefs of groups requesting religious exemptions.

President Obama abruptly reversed his previous indifference to the brewing scandal by declaring that if the “allegations” were true, they were “outrageous.” As the Journal noted, the President was referring in the conditional tense to events that his IRS subordinates had already admitted to be true. Equally significant was the fact that both of these admissions came in the form of response to questions rather than at news conferences called to discuss the specific events, as would ordinarily have been expected. The obvious inference was drawn that, had the questions not been asked, the statements made by the IRS and the President would have gone unsaid. Subsequently, it transpired that the IRS question and response had been a preplanned strategy designed to minimize the impact of the eventual Inspector General report.

In general terms, what is the significance of the scandal? In particular, what does it tell us about the relationship between the IRS and American citizens?

“The Power to Tax:” A History of Abuse

Supreme Court Chief Justice John Marshall coined the phrase: “The power to tax involves the power to destroy.” The IRS was created with the birth of the federal income tax in 1913. A centenary is traditionally a time for recapitulation and stocktaking. A good place to begin is by recalling the IRS’s history of political abuses, which reinforces Marshall’s maxim.

President Franklin Roosevelt inaugurated the practice of using the IRS as an all-purpose tool of revenge and intimidation against his political opponents, particularly his bête noire, Col. Robert McCormick, Republican owner/published of the Chicago Tribune. One of the Kennedy administration’s many well-closeted skeletons was an Ideological Organizations Audit Project, devoted to auditing tax returns of administration opponents. Lyndon Johnson was among the beneficiaries of FDR’s influence with the agency, which derailed an IRS audit that might have ended his political career by exposing an early financial peccadillo. Richard Nixon’s famous “enemies list” was a handy source of potential names for IRS scrutiny. The Clinton administration apparently launched hundreds of IRS audits of individuals and organizations that opposed the administration politically.

Now the Obama administration has taken its place on this historical roster of infamy. Its one distinctive talent seems to be one for extreme actions – spending, debt, regulation, exceeding its authority, et al. Now it has become the first administration whose IRS scandal has matured during its time in office.

Collusion Between the President and the IRS

Much of the furor surrounding the IRS scandal has raged over President Obama’s degree of involvement. Considering the history previously recounted, this is not surprising. It is hard to believe that such consummate politicians as Franklin Delano Roosevelt and Richard Nixon should have left an incriminating paper (or audio tape) trail. To date, the President’s defenders have focused on the absence of any such “smoking gun” directly linking him with the agency’s actions.

But critics such as Kimberly Strassel of The Wall Street Journal have denied the need for any such link. President Obama’s public utterances – speeches in the 2010 and 2012 election campaigns, public addresses and his remarks during press conferences – drew a road map for regulators and officials to follow. Sounding uncannily like Henry II, he lamented the burden placed on him, his administration and the country by the actions of his right-wing opponents. The only thing missing was a frustrated, whining cry a la T.S. Eliot’s Henry: “Will no one rid me of these meddlesome right wingers?”

The notion that President Obama could tell the IRS to harass the right-wing groups, not by making direct statements but purely by hinting, is embodied by the term tacit collusion. This concept is well-known to economists who specialize in the field of Industrial Organization. Ironically, academic economists tried for decades to pin the term on certain private markets – which didn’t deserve it – rather than applying to government and regulatory interactions – where it did apply.

In the 1930s, economists such as Edward Chamberlain, Joan Robinson and Paul Sweezy developed theories of “imperfect competition” – markets whose structural characteristics fell in between those of pure monopoly and ideal or “perfect” competition. One popular conjecture was that markets containing a small number of relatively large firms would feature sluggish price competition. The thinking was that each firm would be conscious of the effects of its own pricing and output decisions on the market outcome, as well as the reactions of rivals to its decisions. Instead of lowering price to compete with each other, firms would recognize their mutual interest in pricing and output restraint. Moreover, this recognition would come intuitively, without explicit cooperation on their part. Thus, they would collude tacitly to attain the same result otherwise obtained by formation of an illegal cartel.

In practice, this seldom if ever happened; it was just too difficult to achieve. The reasons for this were the same ones that made successful cartels so rare. Each party to the cartel agreement has an incentive to violate the agreement by cheating – lowering its price to steal customers while its fellow members keep their prices high. The incentive exists automatically whenever price is elevated substantially above marginal cost – which is what accounts for the profit potential of the cartel in the first place. But when all or most cartel members succumb to this temptation to cheat, the cartel falls apart because the large increase in output drives down the price and kills off the profits. This has been the fate of most cartels throughout history. And it is much harder to sustain a tacit cartel, where the terms are merely understood intuitively rather than agreed verbally or in writing, than an explicit cartel.

But collusion between government or regulatory agencies is much easier to achieve and maintain. It involves general actions rather than the specific, quantitative price and quantity decisions faced by private businesses. Instead of puzzling over “how much should we raise price, and how much should that change when our costs change by a certain magnitude?,” an agency like the IRS knows instinctively that its mandate is simply “hurt those right-wingers.” Bureaucrats and regulators do not have the same clear, strong incentives to cheat on the agreement that are present in a business cartel. When a business-cartel member cheats by lowering its price to steal customers from its fellow cartel members, its reward is increased profits. But government bureaus and regulatory agencies do not earn profits, so there is no profit motive to violate their (tacitly) collusive agreement.

Thus, collusive arrangements like the IRS policy can persist for years until and unless they are discovered. It is publicity and fear of prosecution that gives government employees their one and only motive to squeal, thereby upsetting the applecart. But the beauty of this type of collusion – from a Presidential standpoint – is that its strictly tacit character leaves the President untouched. Here, for example, there is no legal evidence – no signed document, no incriminating tape recording, no e-mail – that he instigated the IRS behavior, even though the world knows that he did.

“Was the White House involved in the IRS’s targeting of conservatives?” the Journal’sKimberly Strassel asked (5/17/2013) rhetorically. “Of course it was.” Mr. Obama’s collusive communication with his executive branch underlings began no later than his 2010 State of the Union address, when he “cast aspersions on the Supreme Court’s Citizens United ruling, claiming that it ‘reversed a century of law to open the floodgates for special interests’ (read conservative groups).” He “derided ‘tea-baggers,'” whom his Vice-President “compared to ‘terrorists.'” Then, “in more than a dozen speeches Mr. Obama raised the specter that these groups represented nefarious interests that were perverting elections. ‘Nobody knows who’s paying for these ads,’ he warned. ‘We don’t know where this money is coming from.’…In case the IRS missed his point, he raised the threat of illegality: ‘All around this country there are groups with harmless-sounding names like Americans for Prosperity, who are running millions of dollars of ads against Democratic candidates…And they don’t have to say who exactly the Americans for Prosperity are. You don’t know if it’s a foreign-controlled corporation.’ Short of directly asking federal agencies to investigate these groups, this is as close as it gets.” Strassel noted that the President’s efforts were reinforced by Democratic representatives who publicly called on the IRS to validate the credentials of right-wing groups.

The President didn’t stop at corporate intimidation. His 2012 campaign website listed eight Mitt Romney donors by name and tarred each one with various slurs, the most outrageous being that they were “on the wrong side of the law.” The most prominent was Frank VanderSloot, an Idaho businessman and longtime donor to right-wing causes. This earned him mention by the Obama campaign as a “wealthy individual” with a “less-than-reputable record.”

In April 2012, shortly after the website mention, Democratic activists sought Mr. VanderSloot’s divorce records. In June, he and his wife were audited for two tax years. In July, the Department of Labor audited records pertaining to the guest workers on his cattle ranch. In September, the IRS audited another of his businesses. That was three audits in four months following the tacit signal sent out by the Obama campaign.

The Motivation for the Crime

Although President Obama and IRS officials initially pretended that the IRS targeting of right-wing groups was merely a wayward impulse that struck a few rogue IRS functionaries, it was really a serious crime. The key distinction separating felonious criminal acts from civil torts is mens rea, or criminal intent. This makes the issue of motivation highly relevant.

When the President speaks, the IRS listens. Not only does the President appoint the head of the IRS, he also submits an annual budget – or is legally supposed to, anyway. In this case, the IRS is the agency ramrodding ObamaCare, which means that the President has made it the most important agency in the federal government. Congress votes on budget appropriations for the IRS, so IRS ears are constantly attuned to the Congressional frequency as well. Leading IRS officials recently received annual bonuses worth over six figures. These had to be approved by the President. Recently it was revealed that the President’s counsel was notified in 2012 of the findings of the Inspector General’s report revealing the targeting of conservative groups by the IRS.

What inferences can reasonably be drawn from the above set of facts? That the President and the IRS tacitly concluded in a campaign to harass, intimidate and suppress right-wing political activist groups; that the President knew of its ongoing nature and its success and rewarded IRS officials for it.

Government officials do not commit crimes randomly or capriciously. Like all criminals, they respond to incentives, both positive and negative. In this case, the specific positive incentives were the bonuses received by top IRS officials and the increase in responsibility, size and budget conferred by the award of ObamaCare responsibility. The annual appropriations process left open the potential for additional future rewards in the form of increased appropriations. Because the IRS is a command-and-control, top-down bureaucracy, top officials could give orders to subordinates to commit and support these criminal acts. The negative incentives were the potential discipline of budget cuts administered by the President and/or Congress for failing to collude.

The latest development in Congressional hearings is the refusal by IRS official Lois Lerner to answer questions and her invocation of the Fifth Amendment against self-incrimination, following an opening statement in which she denied wrongdoing.

“Just Bad Customer Service”

Not surprisingly, the IRS from the outset has employed a typical criminal strategy: minimize the crime or redefine it away altogether. In May 17, 2013 testimony before the House of Representatives’ Ways and Means Committee, outgoing Acting IRS Director Steven Miller called the IRS actions “obnoxious” but “not illegal” – in fact, he did “not believe that partisanship motivated” the agency. What was responsible, then? “Foolish mistakes,” suggested Mr. Miller with a straight face – a case of “horrible customer service.”

Fewer recent public comments by a government official have drawn more hilarity. The Wall Street Journal editorially marveled at his equating of “the coercive power of taxation” to “rude service at a Best Buy.” But the full meaning of Mr. Miller’s comparison seems to have eluded observers.

The difference between the IRS and Best Buy is not a joke. It accounts for the existence and magnitude of the abuse itself. When private citizens approach the IRS, they do so with hat in hand, virtually begging not to be destroyed. Alternatively, they arrive in the company of a lawyer who does all the talking. But when Americans walk into a Best Buy, they are in control. They may complain about prices or service, but they hold the whip hand. They can always take their business elsewhere. And, in the particular case of Best Buy, they have done just that – its stock price has been decimated in the last few years. The company has been the one to go hat in hand to the public and capital markets in order to hang on by its fingernails.

The difference between the two cases is that we are not “customers” of the IRS because the IRS faces no competition. Our relationship to them is not “business/customer” but rather “ruler/subject.” They dictate and we obey – or go to jail. Under those circumstances, any demands we make for better customer service ring hollow indeed.

That is the key to the IRS scandal. To the degree that commentators have offered solutions, they have been the usual thin gruel of reform – politicians should behave better, the press should be more vigilant, the public gets the government it deserves, ad infinitum, ad nauseum. But the only way to get better customer service from the IRS is to provide it with competition. Since that is impossible, the only solution is the removal of the IRS. And that requires the replacement of taxation as a basis for funding the federal government.

End the Power to Destroy

Several of the agencies scrutinized by the IRS are supporters of the Fair Tax, a measure designed to replace the federal income tax with a national sales tax. An ancillary result would be the elimination of the IRS. No wonder the IRS tried to harass and intimidate these groups!

Leaving taxation in place, however, would provide government with an ongoing weapon to hold at the public’s head. In order to make sure that we didn’t end up with the worst of both worlds – a national sales tax and a federal income tax still in place – we would have to amend the Constitution to end income taxation so as to eliminate the IRS. Since we have to go to this much trouble anyway, it would be far preferable to end taxation itself. That would allow us to solve the overriding crisis of our time by ending the welfare state and its mortal threat to our freedom and financial lives.

Taxation is a continual source of inefficiency and a serious hindrance to productivity. The true solution to the threat to freedom and productivity represented by taxation and the IRS is to fund government by user fees. Government would charge a price for each service it provides. Any private business could compete with government in the provision of any service.

This would allow the public to scrutinize government activities at the margin, comparing the price paid for each one with the value received. It would provide an automatic check on overspending. Coming at a moment when the civilized world is drowning in sovereign debt, it would provide an Alexandrian solution to the Gordian knot of big-government welfare-statism – a solution that probably will otherwise elude us.

Vested interests, starting with the executive and regulatory branches of government, would oppose this reform to their last breath. That and its inherent logic are two of the strongest arguments in its favor.

The chief difficulty in moving to a system of user fees lies in funding a big-ticket item like national defense, where the product must be funded and produced in advance of its “consumption” – that is, before citizens have an opportunity to gauge the value of what they are buying. Defenders of the status quo will insist that we cannot live with such a system and must put up with the bureaucratic behemoth of a defense establishment that we have now.

Increasingly, though, it is becoming clear that we cannot live with the system we have, which is now proceeding down F.A. Hayek’s famous “road to serfdom” at a breakneck pace.