Article I, Section 8 of the U.S. Constitution states that "the Congress shall have Power ... To borrow Money on the credit of the United States." Early in the nation's history, Congress passed a law each time the Treasury Department borrowed. By World War I that had become tedious, so Congress began to authorize Treasury to borrow up to a set limit. (See this source for details.) Ever since, Congress has periodically raised the debt ceiling as needed to finance federal budget deficits -- 69 times since March 1962.
Most of the time, bills increasing the debt ceiling have been politically mundane because the ceiling is usually, and rightly, seen as an EFFECT of federal budget deficits, not their cause. The CAUSE of deficits, of course, is Congressional authorization of expenditures that exceed revenues. Occasionally, however, some lawmakers convince themselves it is a good idea to render the debt ceiling a political football.
The debt ceiling has never caused the Treasury to default on its bonds but it has rendered Treasury operations precarious and uncertain on several occasions, including May-June 2002, February 2003, and October 2004. During those episodes, Treasury resorted to various legal accounting ruses to temporarily stave off default until Congress approved increases. (Essentially, it temporarily replaced bonds held in various intergovernmental accounts with "non-debt instruments," thus allowing it to borrow mo' money. After the ceiling increase, it swapped the non-debt instruments for its bonds once again, restoring the status quo pre factum, so to speak.)
Another debt ceiling crisis is currently brewing and it is shaping up to be a real rumble as Tea Party members and other fiscal conservatives hope to use the approaching ceiling to force large expenditure reductions. Using the debt limit as a political tool, however, is potentially dangerous. It backfired on Republicans in 1995 and could do so again because American swing voters (like yours truly) know full well that fundamental tax reform, even if it leads to higher taxes paid by some, should be on the table too. And most Americans understand that defaulting on the national debt, even if only "technically" and for a short time, is not a trifling matter, especially given the economy's continued weakness and China's positioning of its currency as an alternative reserve currency.
Fiscal conservatives have shot back that failing to decrease the debt limit does not mean that the government will have to default. The Full Faith and Credit Act (S. 163/ H.R. 421) would "require that the Government prioritize all obligations on the debt held by the public in the event the debt limit is reached." In other words, Treasury would be legally required to pay bondholders first. That, however, will look like another Wall Street bailout to many Americans when they learn that the government failed to pay its other creditors, like Social Security recipients and government employees and contractors.
There is, I believe, a compelling argument that it would be UNCONSTITUTIONAL for the government to purposely default on the national debt. I think the argument could be easily extended to its other creditors as well but, as usual, I will defer the point to experts in Con Law (which is not an oxymoron but an abbreviation).
What I will do instead is to submit that it would be highly INEXPEDIENT for the government to fail to raise the debt limit, whether its failure results in a default on its bonds or the non-, late-, or partial payment of its other creditors. Credit is like a tender flower in that it takes only one misstep to crush it forever. Governments interested in borrowing in the future (as all with any pretensions to anything like the preamble of the Constitution must be) should never incur financial obligations of any sort that they do not intend to pay as promised.
Alexander Hamilton, writing as Publius in Federalist No. 30, stated the same idea rhetorically: "Who would lend to a government, that prefaced its overtures for borrowing by an act which demonstrated that no reliance could be placed on the steadiness of its measures for paying? The loans it might be able to procure, would be as limited in their extent, as burthensome in their conditions. They would be made upon the same principles that usurers commonly lend to bankrupt and fraudulent debtors ... with a sparing hand, and at enormous premiums." And in a letter to Hamilton from William Bingham in November 1789: "A Government should therefore pledge every security it can offer, to engage the Confidence of the public Creditors, which, if once impaired, the pernicious Effects can be felt in all its future Dealings. ... The Credit of the Funds must essentially depend on the permanent Nature of the Security; & if that is not to be relied on, they will fall in Value, the disadvantage of which, Government will experience by the payment of an exorbitant Interest, whenever it is compelled to anticipate its revenues. .... Great Attention should be paid to the public Creditors, by making Such Proposals to them, as are consistent with the Principles of Justice & Equity. ... To take Advantage of their Necessities, would be to lose their Confidence." [And on and on and on in Hamilton's public writings and private correspondence.] In other words, failure to raise the debt ceiling could make it much more difficult and much more costly for Treasury to borrow in the future, when America may really need the money to fight a large war or rebuild a region ravaged by a natural catastrophe.
As I have said on this blog and in my books many times before, the federal government DOES need to get its fiscal house in order and the sooner the better. Playing roulette with the debt ceiling, however, is not the way to achieve it. At this crucial juncture America needs economic statesmanship, not financial brinkmanship. It needs policies that will energize entrepreneurs and increase productivity so that the government's debts -- all of them -- can be serviced according to contract more easily. But that would require a lot of thoughtful conversations, a good that again appears to be in short supply in Washington.
Thursday, April 21, 2011
Friday, April 08, 2011
Government Shutdown: Why Should Senators, Reps, and the Prez Still Get Paid?
According to the Washington Post, a growing number of members of Congress will return their pay to the Treasury in the event of a government shutdown. They have to make that pledge because a law mandates that they continue to receive their pay in the event of a shutdown. Why not repeal that law? In fact, why not make members of Congress and the top levels of the executive branch personally liable for any damages caused by the shutdown? America needs statesmanship, not brinkmanship. Think I'll tweet that last bit.
Wednesday, April 06, 2011
The National Debt and What We Can Do About It
About 50 Kentuckiana CFA's were in attendance for the following:
CFA Society of Louisville Lunch Lecture Series
Tuesday, April 5, 2011 at the Pendennis Club
218 West Muhammad Ali Blvd. | Louisville, Kentucky 40202
The National Debt and What We Can Do About It
By Dr. Robert E. Wright
Author and Nef Family Chair of Political Economy at Augustana College
The U.S. federal government now owes its creditors $14.25 trillion dollars, give or take a few hundred billion dollars. That’s a lot of moolah in nominal terms, enough in $1 bills to stretch to Saturn I’m told. If that sounds far-fetched, keep in mind that a trillion is a thousand billion, a one with 12 zeroes after it. But is $14.25 trillion dollars a lot in what economists call real terms, in terms of its purchasing power? That is much less clear. The national debt amounts to about $45,800 per citizen. Maybe that isn’t so bad. But two out of three citizens do not pay taxes, at least not directly. So maybe we should judge the debt by how much each taxpayer owes, currently a little over $128,000 dollar. When we consider that the median household income was a little shy of $50,000 dollars last year that number looms much larger but of course people with seven figure incomes and bad tax accountants will bear the brunt of it.
We also need to consider the fact that the debt need not be repaid in a year. Theoretically, America can spread its burden out over years, decades, centuries even. But in actuality it can do so only by rolling over existing debt. The average maturity on U.S. treasury bonds is about 5 years. That means that we have to repay the $14.25 trillion within that time or borrow that amount at prevailing interest rates. Let’s hope Treasury bond rates stay low because taxpayers are already paying over $200 billion a year in interest on the national debt alone.
While some of that interest goes to domestic bondholders, much of it goes overseas. The governments of China and Japan combined own about $2 trillion dollars of U.S. treasury bonds and the rest of the world about $2 and a half trillion more. That makes a lot of Americans wary but generally for the wrong reasons. Many imagine that our debt makes it easy for China to manipulate U.S. policy. That’s backwards. China doesn’t invade Taiwan because it knows that such a move would cost it, at a minimum, the $1 trillion plus of Treasury debt that it owns. Rather than invade the U.S., China actually has an incentive to protect it from attack. One of Alexander Hamilton’s key insights was that debt ties the interests of the borrower and lender together, except in Sopranos scenarios. But it’s not like China can break our thumbs or kneecaps.
What IS scary about the large foreign holdings of our debt is what will happen if foreigners dump a big batch of Treasuries on the open market or, more likely, simply slow or stop their accumulation of them. If that happens, yields on Treasuries will jump and American taxpayers will have to pony up even more in interest in the years to come.
Thankfully, the U.S. national debt is all currently denominated in dollars, which makes it mighty convenient to service Treasury bonds by firing up the proverbial printing press. But if the government resorts to making lots of new money to pay its debts, the dollar will plummet as inflation soars. The former will help with our huge trade deficit, currently running at over $660 billion dollars, but not enough to offset the many economic distortions that domestic inflation causes. Things don’t have to get as bad as in Zimbabwe a couple years ago to have serious negative economic and social consequences. Anyone remember the Great Inflation of the 1970s? I do, barely, but isn’t pretty. Government price control-induced shortages, rapidly declining real wages, deep trouble for financial institutions like Savings and Loans, and my father fighting with the farmer up the road over the rising cost of bailing hay.
Too much inflation would eventually induce foreigners to stop buying dollar-denominated debt. We glimpsed this in the 1970s, when during the Carter administration the U.S. government actually sold some debt denominated in West German marks. If the U.S. government ever has to borrow large sums in euro or yuan, we will be subject to the same budget constraints as Mexico or Argentina and probably won’t handle it as well.
But that won’t happen, will it? The mighty U.S. dollar can handle any strains, can’t it? Maybe, maybe not. If that 9.0 had hit Cali instead of Honshu we might have learned its limits. The most astute economists argue that the debt to GDP ratio is one important metric to watch. Right now, it is almost 100 percent. That means that the national debt is almost as large as the value of the final goods and services Americans produce in a year. That might sound like an upper limit, but it is not. During World War II the ratio topped out at about 120 percent and has hit several hundred percent in other countries, sometimes with disastrous results, other times not.
If the federal government continues to run budget deficits that exceed the growth rate of the economy, which will average about 3 percent per year at best without reforms like those I’ll discuss later, the national debt will continue to grow vis-à-vis the economy until something gives. I liken the situation to that of a large man in a small boat. If the man grows faster than the boat, the latter is sure to sink at some point. But economics is more black art than physics so economists can’t know for sure when that tipping, or rather sinking point will be reached. Part of the problem is how to precisely measure the debt’s size. That $14.25 trillion dollars I mentioned earlier is just the par value of Treasury securities, the amount the Treasury has promised to repay bondholders. Unfortunately, the U.S. government owes a lot more than that, but how much more is difficult to say.
The government’s Social Security liabilities are estimated at about $15 trillion, the Bush prescription drug benefit at a pill popping $20 trillion, and Medicare at an eye popping $78 trillion. If people work longer than expected, however, the Social Security figure will go down a bit. And if they are healthier than projected the drug and Medicare figures will be lower. But the biggest savings would come from older Americans dropping dead younger than expected and dying more quickly and cheaply than anticipated because that would mean less paid in Social Security, which is after all a life annuity product, and would mean less paid for drugs and other types of healthcare. I’m convinced the people screaming about death panels during the healthcare debate last year intuited – correctly – that the federal government has a vested interest in their sudden death the day after they retire.
On top of all this, Americans have personal debts all their own. I’m less concerned about this as the average citizen owes $178,000 dollars but has assets of almost $250,000. Granted, those averages disguise the fact that a few Americans owe nothing and have assets worth millions while millions of others are underwater on their mortgages. But like Alfred E. Newman, I’m not worried about consumer debt. The claims of numerous historical ignoramuses in the media to the contrary notwithstanding, the average American has been in hock up to his eyeballs since at least the eighteenth century without causing any systemic problems. Let’s not blame the victims in other words. Credit cards and other forms of consumer finance are a big part of America’s social welfare net.
What does concern me is how our nation got into the fiscal, financial, and economic mess that it currently faces. The best escape route out of governmental and personal debt as well as high unemployment is sustained and robust economic growth. At present, achieving genuine economic growth, as opposed to tricking the economy into a temporary prosperity with another asset bubble like the dotcom and real estate bubbles, appears impossible because too many important economic sectors are FUBAR – that’s fouled up beyond all recognition in polite company – and because Thomas Jefferson was right when he predicted that politicians would find it difficult to resist the allure of borrowing and spending.
Jefferson’s view grew out of his public dispute with Alexander Hamilton over the proper way to handle America’s first national debt, the one it racked up fighting for independence from the British. The rebel governments – I mean the ones in Boston and Philadelphia, not Benghazi -- found it too difficult to tax so it resorted to lotteries, currency inflation, and borrowing, some of it voluntary but much of it forced on soldiers and provisions providers. After the war, most states continued to find taxing Americans challenging to say the least. Some threw up their hands and defaulted on their debts, the market price of which dropped to pennies on the dollar. Others, most infamously Massachusetts, pushed taxation until they sparked rebellions in their western hinterlands. The situation was dire but thanks to some invisible elixir the Constitution resulted, Federalist George Washington was elected president, and the Senate confirmed fellow Federalist Alexander Hamilton as his Treasury Secretary.
Hamilton certainly had his faults. Most infamously, he had an affair that would make Bill Clinton blush and did it with a woman who by all descriptions would make Megan Fox look like Monica Lewinsky. No joke, Maria Reynolds was smoking. Hamilton also lost a duel to a Vice President, a species of politician not known for its acumen at anything. But when it came to finance, Hamilton was a freaking genius. Freaking genius. He established a tax that Americans would pay -- a revenue tariff that he let manufacturers believe was a protective tariff -- and used it to service three new types of bonds issued in lieu of the scores of different types of junk certificates the rebels unleashed on their fellow Americans during the war. Because tariff revenues were volatile, Hamilton also established a national bank, the Bank of the United States, charged with lending the Treasury money to pay interest on its new bonds should its revenues fall short. Suddenly rendered safe and liquid, government debt soared from a few cents on the dollar to above par. Bond yields, in other words, dropped from high double digits to under six percent.
You would think that Jefferson and his followers, then called Democratic-Republicans, would have been happy that in a few short years Hamilton transformed the United States from a bankrupt backwater into a nation whose bonds -- which were briefly more valuable than British Consols – cemented the nation together just as Hamilton said they would because they incentivized holders, who were spread wide geographically and occupationally, to back the new regime.
But the Democratic-Republicans were not happy. Some of it was just party politics but some was genuine. They did not like the fact that speculators seemingly made large profits when yields plummeted during implementation of Hamilton’s reforms. As argued then and shown since, speculative profits were not out of line given prevailing interest rates and risk premia but Democratic-Republicans nevertheless argued that the original holders of the governments’ IOUs, the soldiers, farmers, and other patriots to whom they were first issued, should be compensated instead, even though that probably would have delayed the development of our capital market for decades.
Jefferson and his buddies also loathed the Bank of the United States as they harbored a deep distrust of all banks and corporations, except for the ones they owned shares in of course. They also did not believe that the Constitution allowed the federal government to charter any corporation, let alone one so big and extensive. When it was formed in 1791, the Bank of the United States dwarfed all the other banks then in existence – COMBINED. Although headquartered in Philadelphia, it soon began establishing branches – tentacles in the eyes of those who feared this alleged Leviathan – in the nation’s most important cities, a sure sign of its evil designs according to its foes.
Finally, Jefferson and his Democratic-Republican followers disliked the fact that the federal government assumed the state government’s debts even though Hamilton clearly explained that the measure was necessary because the federal government monopolized the best tax then available, the tariff. Hamilton, they believed, was trying to make the national debt as large and long-lasting as possible so it could drain taxpayers in favor of a large national government and a handful of its pampered cronies and rich capitalists.
Hamilton, however, wanted no such thing. He wanted the debt to be widely held so that it would cement the union together and also so the bonds would be liquid, valuable investments. Moreover, Hamilton argued in favor of a vigorous national government not a large one, at least not large by today’s standards. He wanted a tiny national government by today’s standards, Jefferson a teensy-weeny one. Hamilton also did not want the national debt to be perpetual, as his detractors claimed. The new bonds his Treasury issued did not have fixed redemption dates because he did not want to encounter a re-financing problem in the future. The government could still retire its debt and in two ways in fact: First, it could do so at any time by buying its bonds in the open market via an institution called the Sinking Fund. Second, it could retire its bonds slowly via an amortization feature built into some of the bonds that gave the government the option, but not the obligation, of repaying 2 percent of the principal each year.
Maybe that was all too technical for Jefferson, who for all his brilliance in other areas was a financial illiterate and an insolvent debtor most of his adult life. But his Treasury Secretary Albert Gallatin and subsequent Democratic-Republican and Democratic treasury secretaries all understood and used those mechanisms to pay off America’s original national debt, as well as subsequent debts contracted to fight the War of 1812 and several lesser conflicts, and to buy the Louisiana Territory from Napoleon. So score one for Little Hammy.
But Jefferson had the last laugh. As he predicted, politicians would not be able to resist the lure of borrowing and spending. Taxing and spending was of course a political death sentence most election cycles but borrowing and spending could be conducted to great electoral effect because taxpayers received more in benefits from government programs than they paid in taxes and that made them happy, at least in the short term.
Not surprisingly, after completely paying off the national debt in early 1835, the U.S. government had to sell bonds again just a few years later. Tariff receipts fell during a recession, you see, and because Andrew Jackson refused to recharter the second Bank of the United States it was not available to fill the hole in the budget. The federal government’s debt remained small compared to the overall economy but jumped a little during the Mexican war and of course took a huge leap during the Civil War, when it reached 30 percent of GDP for the first time since early in Hamilton’s era.
The government never completely repaid the national debt again but the early pattern established by Hamilton, Gallatin, and other early Treasury Secretaries repeated itself over and over: wars and occasional territorial acquisitions caused the debt to increase but thereafter a combination of expenditure restraint and robust economic growth reduced the debt’s real burden to manageable terms. Even the large run up in the national debt during the Reagan administration fit the pattern: the debt accumulation essentially won the Cold War and was reversed, in percentage of GDP terms anyway, during the 1990s, culminating in small surpluses late in Clinton’s second term.
The pattern, however, now appears to be history, if you can ever forgive that pun. I know I can’t. During the administrations of George W. Bush, the national debt rapidly increased in both nominal and percent of GDP terms, much more rapidly than the relatively minor wars in Iraq and Afghanistan could have caused. Under Obama the debt has continued to soar but due to an unprecedented cause, the bailout of the financial system and massive fiscal stimulus. Various myths to the contrary notwithstanding, the United States got out of the Depression by devaluing the dollar and increasing the money supply, not by large amounts of Keynesian deficit spending. The Depression was over well before World War II began though that fact was clouded by continued high levels of unemployment and the so-called Roosevelt recession of 1937 which was caused, in part, by Roosevelt’s strong desire to balance the federal budget.
The U.S. government certainly engaged in other bailout activity over the years – I’ve recently completed a paper about it that I’m happy to share with you if you wish – but not even the S&L bailout of the early 1990s comes close to the resources thrown at the economy following the Panic of 2008. We’ll never know for sure if the bailouts and fiscal stimulus saved the economy from a steeper or longer downturn than it suffered anyway because we can’t replay those events under a different policy. It’s pretty darn clear, however, that politicians chose to increase the national debt in order to appear to maybe have done some good over allowing the crisis to play out. They will be likely to do so again in the future until, that is, the crisis is about the national debt. Then, some fear, politicians will be flummoxed by hard choices that could potentially tear the nation asunder along its geographical, generational, class, or racial fault lines.
There is, however, an alternative that has not yet garnered the consideration it merits. We need to find ways to become more efficient, plain and simple. Our nation’s economic greatness was built on finding ways to do more with less. It used to take 90 of us to inadequately feed 100 of us. Now it takes only 2 to make 100 of us obese and to feed many abroad as well. We used to need half the workforce to toil 70 to 80 hours a week just to clothe us and provide some basic manufactured goods. Now 20 percent of workers lollygagging about a mere 40 hours a week provide us with more physical stuff than we have ever enjoyed in the past, and that’s not counting imported goods. That’s right, U.S. industry makes more today than it ever has in the past and does so with fewer workers.
Agriculture and manufacturing are our pride and joy but the very efficiency of those sectors threw most farmers and factory operatives out of those occupations and into the service sector, which now accounts for over 75 percent of U.S. GDP. That’s right, three quarters of our economy is service-based. Some service-based activity is low value-added. You know, proverbial burger-flipping. But most of it is higher end activities like construction, consulting, education, entertainment, finance, health-care, legal, and research.
Unfortunately, many of those areas suffer from stagnant productivity growth. We know that is the case in custom construction by directly comparing over time how many inflation-adjusted dollars it takes to complete a structure of fixed size and quality. It’s not an exact science, but the consensus appears to be that construction productivity in 2010 is not statistically significantly different from construction productivity in 1960. In other cases, we can infer productivity stagnation from price trends. When the costs of services like healthcare or education rise faster than inflation for decades on end, there is clearly a problem.
If we are going to jumpstart our economy, we are going to have to figure out how to make construction workers, financiers, healthcare providers, and professors more efficient. Good luck with that you might be thinking and if so, you are right. Reform, meaningful reform anyway, is not easy here as Dodd-Frank and the Mess in Madison attest. But we have to try, even if folks like Will Baumol think it silly.
Will is a friend of mine even though his first journal article appeared the same year my mother was born. We overlapped at New York University’s Stern School of Business a couple of years and worked on several projects together. He’s a brilliant man but that does not mean that he is perfect. He is currently working on entrepreneurship but earlier in his career he made a big impact on economists by describing what has come to be called Baumol’s disease. It’s basically a parable about a string quintet that purports to show how difficult it is to improve productivity among service workers: it still takes five musicians x number of minutes to play a tune composed by Mozart over 200 years ago.
That’s certainly true, but improved musical pedagogy could greatly reduce the amount of time it takes to prepare someone to be able to play a piece of music as sophisticated as that created by Mozart, improved practice techniques could greatly reduce the time spent learning the specific composition, and improved technology could enable a single playing session to be listened to an infinite number of times. When viewed in that light, Baumol’s disease looks more like Baumol’s case of the sniffles.
What actually ails the stagnant parts of the service sector is a bad case of mis-aligned incentives. Fix those mis-alignments and productivity will surge and with it the economy. The national debt probably won’t go away but it’ll look smaller compared with our ability to service it. For more details on this stuff, by the way, see my book Fubarnomics.
Let’s start with custom construction, the creation of quasi-unique houses, office buildings, and other built infrastructure for a specific owner. The root problem here is not ancient building codes, unions, the Davis-Bacon Act, a recalcitrant workforce, ineffective managers and supervisors, or even organized crime because those are all effects of what is effectively a non-competitive industry. Sure, there are millions of construction firms in the U.S. but they range from tiny to infinitesimal and many are highly specialized. In many markets, it is all that somebody can do to get three bids. Not that the bidding process does a dang blasted thing for owners because contractors game bids. In other words, the bid is not an estimate of the actual costs of the job but rather is a way of winning a job. The key is to set the bid low enough to win the contract even if it is unprofitably low. That is because a construction firm on the job is a near monopolist. Contractors use their market power to make so-called change orders stick.
Contractors call them change orders because bill padding is a little too obvious but that is what most change orders are, the means by which contractors who bid too low get their profits. The economic problem here is that contractors don’t so much compete on price, quality, and time as on how good they are at gaming bids and sticking owners with change orders. That is why so many construction firms are small and why so many construction projects come in late, over budget, or, most insidiously of all, under quality.
The fix here is to stop allowing contractors to issue change orders, perhaps through what has been called fixed-price contracts. In such contracts, construction firms face penalties if they do not finish within so many percent of the time and price they promised. The widespread adoption of fixed-price contracts would likely spur a huge consolidation in the industry which, in turn, would result in many fewer but far larger companies run by more professional managers and with far more ability to fight unions and to combat productivity-damaging government policies like antiquated building codes. Some segments of the construction industry are finally beginning to embrace this line of thinking but much work remains to be done.
Financiers can be made more efficient through incentive re-alignment as well. The Panic of 2008 occurred because some individuals profited from offering economically dumb-assed products like 125% LTV loans to NINJA borrowers – individuals with No Income, Job, or Assets – and the various derivatives based upon them. The individuals profited because they made big commissions or bonuses from the sale of the products but did not suffer personally when they all exploded a few years later. There was absolutely no excuse here as the subprime mortgage crisis was the seventh time in U.S. history that a mortgage securitization scheme blew up because of the same set of misaligned incentives. In other words, it was the seventh time that we forgot that brokers should not receive a full commission today for a product that has a 15 or 30 year life. In the nineteenth century, by contrast, life insurers learned and never forgot that they had to spread commissions out over 5 or 7 years or they would soon be inundated with terminally ill policyholders.
The fix for finance today is much the same as it was for the life insurance industry more than a century ago. Don’t pay people for engineering or selling products that haven’t proven their ultimate profitability. I realize that is easier said than done but deferred compensation and bonus-malus systems, where bonuses can be lost back if experience shows that they were too high when awarded, has worked wonders at mutual life insurers like Guardian and at some joint-stock companies as well.
Please do note that the recommendation here is about the structure of compensation and not its extent. As a possible future millionaire I don’t want to mess with market prices. I just want to destroy the ability of executives to pay themselves royally for royally bad behaviors. Not that it is their fault per se. Our corporate governance is really messed up compared to its heyday before the Civil War. We need to again incentivize shareholders to monitor the companies they invest in. But I don’t want to digress further about that complex subject.
Next up are healthcare providers of all stripes, or doctors for short. The solution here is so simple that even Jigsaw, the serial killer from the Saw movie franchise, was able to figure it out. We should pay doctors for curing us, not for merely seeing us. There are several ways of doing that. One developed in the U.S. in the 1920s was called prepaid medical. When you were well, you paid so much per month. When you were ill, you paid nothing until the doctor got you well again. Sure, some people tried to malinger and some doctors tried to stop treating really sick patients but disinterested third parties could generally sort them out and rule accordingly.
Another, not mutually incompatible proposal, is to mandate individual insurance for all, beginning in the womb before any genetic testing has been conducted. That would reduce adverse selection, or the predilection for sicker people to seek health insurance. Moreover, I think that health insurance should be tied to a life insurance policy and structured actuarially so that healthier people get a bigger life insurance payout per dollar of premium paid and sicker people get a smaller one. Combining the two policies into one has the virtue of bonding the insurer to pay for healthcare up to an economic breakeven point. Out of their own self interest, for example, an insurer would easily conclude to pay $500,000 to cure somebody with a $1 million life policy that would otherwise soon fall due. And if it clearly meant less money going to their children and grandchildren, more people would opt out of expensive end of life treatments. As in construction, such reforms would induce doctors to become more efficient, perhaps by tiering service more rationally, ordering fewer tests, embracing new therapies more readily, and so forth. Medical malpractice would still occur but the number and severity of suits would be reduced due to greatly increased emphasis on preventative care.
That brings us to professors and, what the heck, K through 12 teachers too. Unions and tenure are not the problem per se here but rather symptoms of the underlying disease, which is anything but Baumolian. The root problem in education is that professors and teachers are employees instead of professional partners. Like other employees, professors tend to do just enough to keep their jobs while bargaining hard for as much pay and as many perks as they can get, including lifetime tenure. If they have an idea about how to improve pedagogy they are generally mum about it because sharing it won’t get them any more money and might even cost them a teacher of the year award. If somebody suggests a change that personally inconveniences them, they fight it with all their might even if it would help students or cut expenses.
Imagine how differently professors and teachers would behave if their long-term compensation were tied to how well their school did, and how well their school did depended on how well they taught and, in a university setting, how well they completed research projects? That would be the actual case if governments subsidized students instead of schools and if profs and teachers were partners in an LLC instead of mere employees clinging desperately to unions and tenure. In an LLC, professors’ tenure would be priced instead of absolute. They would still have significant job security but could be bought out by the other partners, as in a law firm.
If these reforms are implemented, I think productivity would soar, just as it did when slaves were emancipated from bondage in Egypt and Central Europe. The world looks much different when one can reap the fruits of working harder and smarter. So there you have it. The solution to our macroeconomic woes rests in our willingness and ability to use the microeconomics of incentives to unleash the forces of human creativity.
I fear none of these ideas will ever be adequately tested in the cauldron of real life, at least not in time to do us much good, but stranger things have happened. I think we should try each one on a small scale and then encourage their proliferation should they prove salubrious.
But, you might be wondering, what about Jefferson’s insight? Won’t politicians still have an incentive to borrow and spend no matter how productive the service sector becomes? Perhaps. But recall that until recently American politicians actually did a pretty good job of restraining themselves, increasing the national debt only to fight necessary wars or to acquire vast territories on the cheap, and then working hard afterwards to make sure that the economy grew faster than the debt. Maybe we only need to re-educate voters to return to that relatively happy state of affairs because they will elect politicians committed to committing themselves to reducing the debt, through, say, a balanced budget rule. Some states, including South Dakota, have those and they work fairly well though some effectively circumvent the restrictions, which began in the 1840s when a number of states wrote them into their constitutions in order to avoid going bankrupt like Mississippi and several others did following the financial panics of 1837, 1838, and 1839, aka the good old days.
So voter education might work, but then again it might not. In case you haven’t noticed, candidates for high office have a way of saying one thing and doing another. I once suggested that we force them to post performance bonds that would essentially pauperize them if they ever went back on a formal, solemn promise but for some reason politicians never liked that idea.
If you are with Jefferson and despair of politicians ever again getting a handle on the federal budget, perhaps we should consider emulating Switzerland and have one house of Congress determine revenues, which then binds the other house’s expenditures. If you want to get more radical, how about allowing each taxpayer to determine the precise allocation of his or her taxes? That would reduce tax avoision by empowering the people to set the expenditure side of the budget.
Even more radically, why not adopt a one vote per dollar in taxes paid rule, similar to the one vote per share rule common in corporate elections? That would actually incentivize people to pay more in taxes in order to get more voting power. Most radically of all, why even have elections? No, I’m not advocating dictatorship but rather randomness. Politicians are NOT like the rest of us, that is why they became politicians and why most of them seem to have problems keeping it in their pants. I mean their hands, instead of stretching them out for bribes like that Senator from Alaska, may he rest in peace. If we want to be represented by our peers, we need to turn our legislatures into big juries, except instead of paying them $10 a day the government should pay anyone so drafted their accustomed salary at their regular job, plus 10 percent and reasonable expenses during the entirety of their one and only term. Sure, we will get some dolts in there but that would incentivize us to improve the educational system. Plus I’d rather be led by a group of honest dolts than a gaggle of shady ones.
Gosh, I hope there are no politicians in the audience. Or construction contractors, doctors, or professors! Or financial services professionals. Thank you for your time and attention. I’ll now entertain questions.
CFA Society of Louisville Lunch Lecture Series
Tuesday, April 5, 2011 at the Pendennis Club
218 West Muhammad Ali Blvd. | Louisville, Kentucky 40202
The National Debt and What We Can Do About It
By Dr. Robert E. Wright
Author and Nef Family Chair of Political Economy at Augustana College
The U.S. federal government now owes its creditors $14.25 trillion dollars, give or take a few hundred billion dollars. That’s a lot of moolah in nominal terms, enough in $1 bills to stretch to Saturn I’m told. If that sounds far-fetched, keep in mind that a trillion is a thousand billion, a one with 12 zeroes after it. But is $14.25 trillion dollars a lot in what economists call real terms, in terms of its purchasing power? That is much less clear. The national debt amounts to about $45,800 per citizen. Maybe that isn’t so bad. But two out of three citizens do not pay taxes, at least not directly. So maybe we should judge the debt by how much each taxpayer owes, currently a little over $128,000 dollar. When we consider that the median household income was a little shy of $50,000 dollars last year that number looms much larger but of course people with seven figure incomes and bad tax accountants will bear the brunt of it.
We also need to consider the fact that the debt need not be repaid in a year. Theoretically, America can spread its burden out over years, decades, centuries even. But in actuality it can do so only by rolling over existing debt. The average maturity on U.S. treasury bonds is about 5 years. That means that we have to repay the $14.25 trillion within that time or borrow that amount at prevailing interest rates. Let’s hope Treasury bond rates stay low because taxpayers are already paying over $200 billion a year in interest on the national debt alone.
While some of that interest goes to domestic bondholders, much of it goes overseas. The governments of China and Japan combined own about $2 trillion dollars of U.S. treasury bonds and the rest of the world about $2 and a half trillion more. That makes a lot of Americans wary but generally for the wrong reasons. Many imagine that our debt makes it easy for China to manipulate U.S. policy. That’s backwards. China doesn’t invade Taiwan because it knows that such a move would cost it, at a minimum, the $1 trillion plus of Treasury debt that it owns. Rather than invade the U.S., China actually has an incentive to protect it from attack. One of Alexander Hamilton’s key insights was that debt ties the interests of the borrower and lender together, except in Sopranos scenarios. But it’s not like China can break our thumbs or kneecaps.
What IS scary about the large foreign holdings of our debt is what will happen if foreigners dump a big batch of Treasuries on the open market or, more likely, simply slow or stop their accumulation of them. If that happens, yields on Treasuries will jump and American taxpayers will have to pony up even more in interest in the years to come.
Thankfully, the U.S. national debt is all currently denominated in dollars, which makes it mighty convenient to service Treasury bonds by firing up the proverbial printing press. But if the government resorts to making lots of new money to pay its debts, the dollar will plummet as inflation soars. The former will help with our huge trade deficit, currently running at over $660 billion dollars, but not enough to offset the many economic distortions that domestic inflation causes. Things don’t have to get as bad as in Zimbabwe a couple years ago to have serious negative economic and social consequences. Anyone remember the Great Inflation of the 1970s? I do, barely, but isn’t pretty. Government price control-induced shortages, rapidly declining real wages, deep trouble for financial institutions like Savings and Loans, and my father fighting with the farmer up the road over the rising cost of bailing hay.
Too much inflation would eventually induce foreigners to stop buying dollar-denominated debt. We glimpsed this in the 1970s, when during the Carter administration the U.S. government actually sold some debt denominated in West German marks. If the U.S. government ever has to borrow large sums in euro or yuan, we will be subject to the same budget constraints as Mexico or Argentina and probably won’t handle it as well.
But that won’t happen, will it? The mighty U.S. dollar can handle any strains, can’t it? Maybe, maybe not. If that 9.0 had hit Cali instead of Honshu we might have learned its limits. The most astute economists argue that the debt to GDP ratio is one important metric to watch. Right now, it is almost 100 percent. That means that the national debt is almost as large as the value of the final goods and services Americans produce in a year. That might sound like an upper limit, but it is not. During World War II the ratio topped out at about 120 percent and has hit several hundred percent in other countries, sometimes with disastrous results, other times not.
If the federal government continues to run budget deficits that exceed the growth rate of the economy, which will average about 3 percent per year at best without reforms like those I’ll discuss later, the national debt will continue to grow vis-à-vis the economy until something gives. I liken the situation to that of a large man in a small boat. If the man grows faster than the boat, the latter is sure to sink at some point. But economics is more black art than physics so economists can’t know for sure when that tipping, or rather sinking point will be reached. Part of the problem is how to precisely measure the debt’s size. That $14.25 trillion dollars I mentioned earlier is just the par value of Treasury securities, the amount the Treasury has promised to repay bondholders. Unfortunately, the U.S. government owes a lot more than that, but how much more is difficult to say.
The government’s Social Security liabilities are estimated at about $15 trillion, the Bush prescription drug benefit at a pill popping $20 trillion, and Medicare at an eye popping $78 trillion. If people work longer than expected, however, the Social Security figure will go down a bit. And if they are healthier than projected the drug and Medicare figures will be lower. But the biggest savings would come from older Americans dropping dead younger than expected and dying more quickly and cheaply than anticipated because that would mean less paid in Social Security, which is after all a life annuity product, and would mean less paid for drugs and other types of healthcare. I’m convinced the people screaming about death panels during the healthcare debate last year intuited – correctly – that the federal government has a vested interest in their sudden death the day after they retire.
On top of all this, Americans have personal debts all their own. I’m less concerned about this as the average citizen owes $178,000 dollars but has assets of almost $250,000. Granted, those averages disguise the fact that a few Americans owe nothing and have assets worth millions while millions of others are underwater on their mortgages. But like Alfred E. Newman, I’m not worried about consumer debt. The claims of numerous historical ignoramuses in the media to the contrary notwithstanding, the average American has been in hock up to his eyeballs since at least the eighteenth century without causing any systemic problems. Let’s not blame the victims in other words. Credit cards and other forms of consumer finance are a big part of America’s social welfare net.
What does concern me is how our nation got into the fiscal, financial, and economic mess that it currently faces. The best escape route out of governmental and personal debt as well as high unemployment is sustained and robust economic growth. At present, achieving genuine economic growth, as opposed to tricking the economy into a temporary prosperity with another asset bubble like the dotcom and real estate bubbles, appears impossible because too many important economic sectors are FUBAR – that’s fouled up beyond all recognition in polite company – and because Thomas Jefferson was right when he predicted that politicians would find it difficult to resist the allure of borrowing and spending.
Jefferson’s view grew out of his public dispute with Alexander Hamilton over the proper way to handle America’s first national debt, the one it racked up fighting for independence from the British. The rebel governments – I mean the ones in Boston and Philadelphia, not Benghazi -- found it too difficult to tax so it resorted to lotteries, currency inflation, and borrowing, some of it voluntary but much of it forced on soldiers and provisions providers. After the war, most states continued to find taxing Americans challenging to say the least. Some threw up their hands and defaulted on their debts, the market price of which dropped to pennies on the dollar. Others, most infamously Massachusetts, pushed taxation until they sparked rebellions in their western hinterlands. The situation was dire but thanks to some invisible elixir the Constitution resulted, Federalist George Washington was elected president, and the Senate confirmed fellow Federalist Alexander Hamilton as his Treasury Secretary.
Hamilton certainly had his faults. Most infamously, he had an affair that would make Bill Clinton blush and did it with a woman who by all descriptions would make Megan Fox look like Monica Lewinsky. No joke, Maria Reynolds was smoking. Hamilton also lost a duel to a Vice President, a species of politician not known for its acumen at anything. But when it came to finance, Hamilton was a freaking genius. Freaking genius. He established a tax that Americans would pay -- a revenue tariff that he let manufacturers believe was a protective tariff -- and used it to service three new types of bonds issued in lieu of the scores of different types of junk certificates the rebels unleashed on their fellow Americans during the war. Because tariff revenues were volatile, Hamilton also established a national bank, the Bank of the United States, charged with lending the Treasury money to pay interest on its new bonds should its revenues fall short. Suddenly rendered safe and liquid, government debt soared from a few cents on the dollar to above par. Bond yields, in other words, dropped from high double digits to under six percent.
You would think that Jefferson and his followers, then called Democratic-Republicans, would have been happy that in a few short years Hamilton transformed the United States from a bankrupt backwater into a nation whose bonds -- which were briefly more valuable than British Consols – cemented the nation together just as Hamilton said they would because they incentivized holders, who were spread wide geographically and occupationally, to back the new regime.
But the Democratic-Republicans were not happy. Some of it was just party politics but some was genuine. They did not like the fact that speculators seemingly made large profits when yields plummeted during implementation of Hamilton’s reforms. As argued then and shown since, speculative profits were not out of line given prevailing interest rates and risk premia but Democratic-Republicans nevertheless argued that the original holders of the governments’ IOUs, the soldiers, farmers, and other patriots to whom they were first issued, should be compensated instead, even though that probably would have delayed the development of our capital market for decades.
Jefferson and his buddies also loathed the Bank of the United States as they harbored a deep distrust of all banks and corporations, except for the ones they owned shares in of course. They also did not believe that the Constitution allowed the federal government to charter any corporation, let alone one so big and extensive. When it was formed in 1791, the Bank of the United States dwarfed all the other banks then in existence – COMBINED. Although headquartered in Philadelphia, it soon began establishing branches – tentacles in the eyes of those who feared this alleged Leviathan – in the nation’s most important cities, a sure sign of its evil designs according to its foes.
Finally, Jefferson and his Democratic-Republican followers disliked the fact that the federal government assumed the state government’s debts even though Hamilton clearly explained that the measure was necessary because the federal government monopolized the best tax then available, the tariff. Hamilton, they believed, was trying to make the national debt as large and long-lasting as possible so it could drain taxpayers in favor of a large national government and a handful of its pampered cronies and rich capitalists.
Hamilton, however, wanted no such thing. He wanted the debt to be widely held so that it would cement the union together and also so the bonds would be liquid, valuable investments. Moreover, Hamilton argued in favor of a vigorous national government not a large one, at least not large by today’s standards. He wanted a tiny national government by today’s standards, Jefferson a teensy-weeny one. Hamilton also did not want the national debt to be perpetual, as his detractors claimed. The new bonds his Treasury issued did not have fixed redemption dates because he did not want to encounter a re-financing problem in the future. The government could still retire its debt and in two ways in fact: First, it could do so at any time by buying its bonds in the open market via an institution called the Sinking Fund. Second, it could retire its bonds slowly via an amortization feature built into some of the bonds that gave the government the option, but not the obligation, of repaying 2 percent of the principal each year.
Maybe that was all too technical for Jefferson, who for all his brilliance in other areas was a financial illiterate and an insolvent debtor most of his adult life. But his Treasury Secretary Albert Gallatin and subsequent Democratic-Republican and Democratic treasury secretaries all understood and used those mechanisms to pay off America’s original national debt, as well as subsequent debts contracted to fight the War of 1812 and several lesser conflicts, and to buy the Louisiana Territory from Napoleon. So score one for Little Hammy.
But Jefferson had the last laugh. As he predicted, politicians would not be able to resist the lure of borrowing and spending. Taxing and spending was of course a political death sentence most election cycles but borrowing and spending could be conducted to great electoral effect because taxpayers received more in benefits from government programs than they paid in taxes and that made them happy, at least in the short term.
Not surprisingly, after completely paying off the national debt in early 1835, the U.S. government had to sell bonds again just a few years later. Tariff receipts fell during a recession, you see, and because Andrew Jackson refused to recharter the second Bank of the United States it was not available to fill the hole in the budget. The federal government’s debt remained small compared to the overall economy but jumped a little during the Mexican war and of course took a huge leap during the Civil War, when it reached 30 percent of GDP for the first time since early in Hamilton’s era.
The government never completely repaid the national debt again but the early pattern established by Hamilton, Gallatin, and other early Treasury Secretaries repeated itself over and over: wars and occasional territorial acquisitions caused the debt to increase but thereafter a combination of expenditure restraint and robust economic growth reduced the debt’s real burden to manageable terms. Even the large run up in the national debt during the Reagan administration fit the pattern: the debt accumulation essentially won the Cold War and was reversed, in percentage of GDP terms anyway, during the 1990s, culminating in small surpluses late in Clinton’s second term.
The pattern, however, now appears to be history, if you can ever forgive that pun. I know I can’t. During the administrations of George W. Bush, the national debt rapidly increased in both nominal and percent of GDP terms, much more rapidly than the relatively minor wars in Iraq and Afghanistan could have caused. Under Obama the debt has continued to soar but due to an unprecedented cause, the bailout of the financial system and massive fiscal stimulus. Various myths to the contrary notwithstanding, the United States got out of the Depression by devaluing the dollar and increasing the money supply, not by large amounts of Keynesian deficit spending. The Depression was over well before World War II began though that fact was clouded by continued high levels of unemployment and the so-called Roosevelt recession of 1937 which was caused, in part, by Roosevelt’s strong desire to balance the federal budget.
The U.S. government certainly engaged in other bailout activity over the years – I’ve recently completed a paper about it that I’m happy to share with you if you wish – but not even the S&L bailout of the early 1990s comes close to the resources thrown at the economy following the Panic of 2008. We’ll never know for sure if the bailouts and fiscal stimulus saved the economy from a steeper or longer downturn than it suffered anyway because we can’t replay those events under a different policy. It’s pretty darn clear, however, that politicians chose to increase the national debt in order to appear to maybe have done some good over allowing the crisis to play out. They will be likely to do so again in the future until, that is, the crisis is about the national debt. Then, some fear, politicians will be flummoxed by hard choices that could potentially tear the nation asunder along its geographical, generational, class, or racial fault lines.
There is, however, an alternative that has not yet garnered the consideration it merits. We need to find ways to become more efficient, plain and simple. Our nation’s economic greatness was built on finding ways to do more with less. It used to take 90 of us to inadequately feed 100 of us. Now it takes only 2 to make 100 of us obese and to feed many abroad as well. We used to need half the workforce to toil 70 to 80 hours a week just to clothe us and provide some basic manufactured goods. Now 20 percent of workers lollygagging about a mere 40 hours a week provide us with more physical stuff than we have ever enjoyed in the past, and that’s not counting imported goods. That’s right, U.S. industry makes more today than it ever has in the past and does so with fewer workers.
Agriculture and manufacturing are our pride and joy but the very efficiency of those sectors threw most farmers and factory operatives out of those occupations and into the service sector, which now accounts for over 75 percent of U.S. GDP. That’s right, three quarters of our economy is service-based. Some service-based activity is low value-added. You know, proverbial burger-flipping. But most of it is higher end activities like construction, consulting, education, entertainment, finance, health-care, legal, and research.
Unfortunately, many of those areas suffer from stagnant productivity growth. We know that is the case in custom construction by directly comparing over time how many inflation-adjusted dollars it takes to complete a structure of fixed size and quality. It’s not an exact science, but the consensus appears to be that construction productivity in 2010 is not statistically significantly different from construction productivity in 1960. In other cases, we can infer productivity stagnation from price trends. When the costs of services like healthcare or education rise faster than inflation for decades on end, there is clearly a problem.
If we are going to jumpstart our economy, we are going to have to figure out how to make construction workers, financiers, healthcare providers, and professors more efficient. Good luck with that you might be thinking and if so, you are right. Reform, meaningful reform anyway, is not easy here as Dodd-Frank and the Mess in Madison attest. But we have to try, even if folks like Will Baumol think it silly.
Will is a friend of mine even though his first journal article appeared the same year my mother was born. We overlapped at New York University’s Stern School of Business a couple of years and worked on several projects together. He’s a brilliant man but that does not mean that he is perfect. He is currently working on entrepreneurship but earlier in his career he made a big impact on economists by describing what has come to be called Baumol’s disease. It’s basically a parable about a string quintet that purports to show how difficult it is to improve productivity among service workers: it still takes five musicians x number of minutes to play a tune composed by Mozart over 200 years ago.
That’s certainly true, but improved musical pedagogy could greatly reduce the amount of time it takes to prepare someone to be able to play a piece of music as sophisticated as that created by Mozart, improved practice techniques could greatly reduce the time spent learning the specific composition, and improved technology could enable a single playing session to be listened to an infinite number of times. When viewed in that light, Baumol’s disease looks more like Baumol’s case of the sniffles.
What actually ails the stagnant parts of the service sector is a bad case of mis-aligned incentives. Fix those mis-alignments and productivity will surge and with it the economy. The national debt probably won’t go away but it’ll look smaller compared with our ability to service it. For more details on this stuff, by the way, see my book Fubarnomics.
Let’s start with custom construction, the creation of quasi-unique houses, office buildings, and other built infrastructure for a specific owner. The root problem here is not ancient building codes, unions, the Davis-Bacon Act, a recalcitrant workforce, ineffective managers and supervisors, or even organized crime because those are all effects of what is effectively a non-competitive industry. Sure, there are millions of construction firms in the U.S. but they range from tiny to infinitesimal and many are highly specialized. In many markets, it is all that somebody can do to get three bids. Not that the bidding process does a dang blasted thing for owners because contractors game bids. In other words, the bid is not an estimate of the actual costs of the job but rather is a way of winning a job. The key is to set the bid low enough to win the contract even if it is unprofitably low. That is because a construction firm on the job is a near monopolist. Contractors use their market power to make so-called change orders stick.
Contractors call them change orders because bill padding is a little too obvious but that is what most change orders are, the means by which contractors who bid too low get their profits. The economic problem here is that contractors don’t so much compete on price, quality, and time as on how good they are at gaming bids and sticking owners with change orders. That is why so many construction firms are small and why so many construction projects come in late, over budget, or, most insidiously of all, under quality.
The fix here is to stop allowing contractors to issue change orders, perhaps through what has been called fixed-price contracts. In such contracts, construction firms face penalties if they do not finish within so many percent of the time and price they promised. The widespread adoption of fixed-price contracts would likely spur a huge consolidation in the industry which, in turn, would result in many fewer but far larger companies run by more professional managers and with far more ability to fight unions and to combat productivity-damaging government policies like antiquated building codes. Some segments of the construction industry are finally beginning to embrace this line of thinking but much work remains to be done.
Financiers can be made more efficient through incentive re-alignment as well. The Panic of 2008 occurred because some individuals profited from offering economically dumb-assed products like 125% LTV loans to NINJA borrowers – individuals with No Income, Job, or Assets – and the various derivatives based upon them. The individuals profited because they made big commissions or bonuses from the sale of the products but did not suffer personally when they all exploded a few years later. There was absolutely no excuse here as the subprime mortgage crisis was the seventh time in U.S. history that a mortgage securitization scheme blew up because of the same set of misaligned incentives. In other words, it was the seventh time that we forgot that brokers should not receive a full commission today for a product that has a 15 or 30 year life. In the nineteenth century, by contrast, life insurers learned and never forgot that they had to spread commissions out over 5 or 7 years or they would soon be inundated with terminally ill policyholders.
The fix for finance today is much the same as it was for the life insurance industry more than a century ago. Don’t pay people for engineering or selling products that haven’t proven their ultimate profitability. I realize that is easier said than done but deferred compensation and bonus-malus systems, where bonuses can be lost back if experience shows that they were too high when awarded, has worked wonders at mutual life insurers like Guardian and at some joint-stock companies as well.
Please do note that the recommendation here is about the structure of compensation and not its extent. As a possible future millionaire I don’t want to mess with market prices. I just want to destroy the ability of executives to pay themselves royally for royally bad behaviors. Not that it is their fault per se. Our corporate governance is really messed up compared to its heyday before the Civil War. We need to again incentivize shareholders to monitor the companies they invest in. But I don’t want to digress further about that complex subject.
Next up are healthcare providers of all stripes, or doctors for short. The solution here is so simple that even Jigsaw, the serial killer from the Saw movie franchise, was able to figure it out. We should pay doctors for curing us, not for merely seeing us. There are several ways of doing that. One developed in the U.S. in the 1920s was called prepaid medical. When you were well, you paid so much per month. When you were ill, you paid nothing until the doctor got you well again. Sure, some people tried to malinger and some doctors tried to stop treating really sick patients but disinterested third parties could generally sort them out and rule accordingly.
Another, not mutually incompatible proposal, is to mandate individual insurance for all, beginning in the womb before any genetic testing has been conducted. That would reduce adverse selection, or the predilection for sicker people to seek health insurance. Moreover, I think that health insurance should be tied to a life insurance policy and structured actuarially so that healthier people get a bigger life insurance payout per dollar of premium paid and sicker people get a smaller one. Combining the two policies into one has the virtue of bonding the insurer to pay for healthcare up to an economic breakeven point. Out of their own self interest, for example, an insurer would easily conclude to pay $500,000 to cure somebody with a $1 million life policy that would otherwise soon fall due. And if it clearly meant less money going to their children and grandchildren, more people would opt out of expensive end of life treatments. As in construction, such reforms would induce doctors to become more efficient, perhaps by tiering service more rationally, ordering fewer tests, embracing new therapies more readily, and so forth. Medical malpractice would still occur but the number and severity of suits would be reduced due to greatly increased emphasis on preventative care.
That brings us to professors and, what the heck, K through 12 teachers too. Unions and tenure are not the problem per se here but rather symptoms of the underlying disease, which is anything but Baumolian. The root problem in education is that professors and teachers are employees instead of professional partners. Like other employees, professors tend to do just enough to keep their jobs while bargaining hard for as much pay and as many perks as they can get, including lifetime tenure. If they have an idea about how to improve pedagogy they are generally mum about it because sharing it won’t get them any more money and might even cost them a teacher of the year award. If somebody suggests a change that personally inconveniences them, they fight it with all their might even if it would help students or cut expenses.
Imagine how differently professors and teachers would behave if their long-term compensation were tied to how well their school did, and how well their school did depended on how well they taught and, in a university setting, how well they completed research projects? That would be the actual case if governments subsidized students instead of schools and if profs and teachers were partners in an LLC instead of mere employees clinging desperately to unions and tenure. In an LLC, professors’ tenure would be priced instead of absolute. They would still have significant job security but could be bought out by the other partners, as in a law firm.
If these reforms are implemented, I think productivity would soar, just as it did when slaves were emancipated from bondage in Egypt and Central Europe. The world looks much different when one can reap the fruits of working harder and smarter. So there you have it. The solution to our macroeconomic woes rests in our willingness and ability to use the microeconomics of incentives to unleash the forces of human creativity.
I fear none of these ideas will ever be adequately tested in the cauldron of real life, at least not in time to do us much good, but stranger things have happened. I think we should try each one on a small scale and then encourage their proliferation should they prove salubrious.
But, you might be wondering, what about Jefferson’s insight? Won’t politicians still have an incentive to borrow and spend no matter how productive the service sector becomes? Perhaps. But recall that until recently American politicians actually did a pretty good job of restraining themselves, increasing the national debt only to fight necessary wars or to acquire vast territories on the cheap, and then working hard afterwards to make sure that the economy grew faster than the debt. Maybe we only need to re-educate voters to return to that relatively happy state of affairs because they will elect politicians committed to committing themselves to reducing the debt, through, say, a balanced budget rule. Some states, including South Dakota, have those and they work fairly well though some effectively circumvent the restrictions, which began in the 1840s when a number of states wrote them into their constitutions in order to avoid going bankrupt like Mississippi and several others did following the financial panics of 1837, 1838, and 1839, aka the good old days.
So voter education might work, but then again it might not. In case you haven’t noticed, candidates for high office have a way of saying one thing and doing another. I once suggested that we force them to post performance bonds that would essentially pauperize them if they ever went back on a formal, solemn promise but for some reason politicians never liked that idea.
If you are with Jefferson and despair of politicians ever again getting a handle on the federal budget, perhaps we should consider emulating Switzerland and have one house of Congress determine revenues, which then binds the other house’s expenditures. If you want to get more radical, how about allowing each taxpayer to determine the precise allocation of his or her taxes? That would reduce tax avoision by empowering the people to set the expenditure side of the budget.
Even more radically, why not adopt a one vote per dollar in taxes paid rule, similar to the one vote per share rule common in corporate elections? That would actually incentivize people to pay more in taxes in order to get more voting power. Most radically of all, why even have elections? No, I’m not advocating dictatorship but rather randomness. Politicians are NOT like the rest of us, that is why they became politicians and why most of them seem to have problems keeping it in their pants. I mean their hands, instead of stretching them out for bribes like that Senator from Alaska, may he rest in peace. If we want to be represented by our peers, we need to turn our legislatures into big juries, except instead of paying them $10 a day the government should pay anyone so drafted their accustomed salary at their regular job, plus 10 percent and reasonable expenses during the entirety of their one and only term. Sure, we will get some dolts in there but that would incentivize us to improve the educational system. Plus I’d rather be led by a group of honest dolts than a gaggle of shady ones.
Gosh, I hope there are no politicians in the audience. Or construction contractors, doctors, or professors! Or financial services professionals. Thank you for your time and attention. I’ll now entertain questions.
Tuesday, March 22, 2011
Recent One Nation Under Debt Review
The book that launched this blog, One Nation Under Debt (McGraw Hill 2008) is still getting reviewed, usually favorably. This one, republished with permission, recently appeared from the keyboard of Scott Paradis:
Scott F. Paradis
Scott F. Paradis, author of 'Promise and Potential: A Life of Wisdom, Courage, Strength and Will' http://www.promiseandpotential.com publishes 'Insights' available for free at http://www.c-achieve.com
One Nation Under Debt
Author:Scott F. Paradis
Copyright (c) 2011 Scott F Paradis
In light of our burgeoning national debt and impending financial catastrophe, Robert E. Wright points out that without 'the debt', what we know as the United States would likely not exist. During and after the revolution the states united as much under a financial obligation as they did under a banner and a constitution. The debt the population of rebels, transplants, and immigrants assumed from the nation\'s founding served as seed corn for economic growth and prosperity.
Wright offers two golden nuggets in his book 'One Nation Under Debt' making the, at times tedious, historical exploration of the establishment of the national debt most telling and fruitful: the debt brought and held the nation together at its most crucial hour; and the 'development diamond' is a viable tool to gage past achievements and to leverage for future success.
One thing everyone agreed on during the struggle for independence was that victory would require resources: men, equipment, arms - money. From the beginning, promises were made, some kept, others dismissed, that ultimately carried the day. Two prominent figures offered prescient views over the means of securing the resources to birth a nation. Thomas Jefferson lamented long-term debt amounted to, 'swindling futurity on a large scale'; while Alexander Hamilton claimed a national debt, of manageable size, was a 'national blessing.' Both views proved correct, but it was Hamilton who secured the first four score years.
Motivated by the desire to be free the founding fathers debated the three major options for raising funds: tax, sell assets, issue debt. Understanding the multiplying effect of debt Hamilton invoked the maxim, 'The more you borrow, the more friends you make.' The rebellious colonies, the confederation, and ultimately the United States were able to secure credit abroad and raise capital through debt issued to citizens. The diversity and liquidity of the government debt bond markets, coupled with a strong political commitment to repay the debt bolstered government credit and bound the nation together.
'The public debt served as the bridge between the nation\'s nonpredatory government and its emerging financial system.' A land of dreamers, risk takers, and entrepreneurs fueled by additional funds made available through debt accelerated economic growth. The system was so prosperous that during Andrew Jackson\'s presidency the people retired the debt. Within months of paying off the debt however, for a host of reasons, not the least of which was government mismanagement, the United States went into hock and has never looked back.
In modern times, 'The people, not as enlightened as they once were...Their leaders, now mere politicians instead of statesmen, began to accumulate massive new debts to ensure their popularity rather than to fend off encroachments upon liberty. As foretold, the blessings of debt became a great curse...' Wright has no illusions about the predicament the United States is in now, as he calls on none other than Adam Smith to define the requisites for state prosperity: peace, easy taxes and a tolerable administration of justice.
While we tend to look for easy solutions and simple direct relationships we erringly believe national wealth is a function of cash aid, Western culture, greater democracy, more education, less imperialism, more natural resources and greater stability - our modern democratic, free-market ideal. But these are not the factors that foster economic prosperity. Wright demonstrates only two things create wealth: trade and increases in efficiency. He introduces the 'development diamond' as a model to measure a country\'s propensity for economic prosperity.
To succeed economically a nation must have: good (nonpredatory) governance; a sound financial system; a creative / industrious bent; and effective managerial acumen. Good governance is the basis for the other three components of the 'development diamond', and at a minimum protects the lives, liberty and property of its citizens. Progressive, prosperous countries do not seek to secure more of the pie - they enlarge the pie. Failings in government lead to circumstances that serve to enrich the few at the expense of the many. A reality increasingly evident in the United States today.
Debt was a necessity uniting disparate interests into one nation. The debt, as a tool of good governance served to foster economic prosperity the likes of which had never been seen before. But, like with most human failings, discipline and moderation gave way to excess. The United States abandoned a viable model of development and sought instead to invoke easy, convenient solutions to complex, persistent challenges. Well, times have changed, and we must now change, more than ever, to keep from being overwhelmed by a blessing turned to curse - debt.
Article Source: http://www.articlesbase.com/politics-articles/one-nation-under-debt-4443694.html
About the AuthorScott F. Paradis, author of 'Promise and Potential: A Life of Wisdom, Courage, Strength and Will' http://www.promiseandpotential.com publishes 'Insights' available for free at http://www.c-achieve.com
Monday, March 14, 2011
Price discrimination = yahoo!
Whenever I talk about the concept of price discrimination, students and other audience members often get uncomfortable. It's probably because they are trained to think "discrimination = bad." What they don't realize is that price discrimination (PD) is ubiquitous and helps them when they most need it, when they are young, old, or down on their luck. PD is simply any mechanism by which sellers try to figure out how much to charge an individual consumer for a good. The most common example is probably the coupon. Sellers assume that anyone who takes the time to seek out a coupon and clip it must really want the price to be 15 cents (or 15%, etc.) lower to induce them to buy. Those who could care less about the five their blowing (that's from an old rap song btw) don't bother and pay full sticker.
Other forms of PD apply to enter groups, like people willing to eat dinner at 4 p.m. or, which often amounts to the same thing, senior citizens. Students can also leverage PD in their favor and to help them do that Onlinecollegesanduniversities.net has published "100 Niche Deal Sites Every College Student Should Know" that obviously goes beyond Groupon. Using such sites and inducing your professors to adopt open source textbooks like mine can help keep that student debt load down.
Other forms of PD apply to enter groups, like people willing to eat dinner at 4 p.m. or, which often amounts to the same thing, senior citizens. Students can also leverage PD in their favor and to help them do that Onlinecollegesanduniversities.net has published "100 Niche Deal Sites Every College Student Should Know" that obviously goes beyond Groupon. Using such sites and inducing your professors to adopt open source textbooks like mine can help keep that student debt load down.
Friday, February 25, 2011
Net Outrageous!
There was a fella whose name escapes me on the Colbert Report a few back complaining that many companies were paying later than usual. Like Net 60 or 90 instead of Net 30 or 15. In other words, corporations are getting forced loans from their suppliers and contractors. One way to fight this is to insist that the company pay interest on any balances still due after 15 or 30 days of invoicing. And the interest rate should be what YOU lose by not having the money, not the Fed Funds rate, the prime rate, etc. So more like 10% than 1%. Most corporations can of course get loans at a lower rate than a small business person can so they will likely pay up in a reasonable time. Of course they might not do any more business with you too in which case you might let them play their Net Outrageous game but increase your fee at the first opportunity. If they ask why your fee went up, dispassionately explain that your costs have increased because your clients pay so slowly these days but then offer them a discount (back to your usual fee) if they pay promptly, as you define it. Technology these days is such that Net 5 should be the norm, but that is another topic.
Sunday, February 20, 2011
Federal Government Partial Shutdown? Huzzah! Huzzah!
Due to the budget impasse, the federal government may experience a partial shutdown like that of 1995-96.
I think a partial shutdown is a good idea. No, a GREAT idea, but only if the parts that stop operating are shuttered permanently pending positive proof that they were providing goods (as opposed to bads) and that the government itself has to provide those goods. Such a shutdown would allow private enterprise and charity to step into the void and show that we don't need the federal government for much beyond homeland defense and federal courts. Leasing of national infrastructure and parks would allow the national government to run a surplus next year and soon after to implement a large, permanent tax decrease that will spark the greatest economic expansion since ratification of the Constitution.
I think a partial shutdown is a good idea. No, a GREAT idea, but only if the parts that stop operating are shuttered permanently pending positive proof that they were providing goods (as opposed to bads) and that the government itself has to provide those goods. Such a shutdown would allow private enterprise and charity to step into the void and show that we don't need the federal government for much beyond homeland defense and federal courts. Leasing of national infrastructure and parks would allow the national government to run a surplus next year and soon after to implement a large, permanent tax decrease that will spark the greatest economic expansion since ratification of the Constitution.
Tuesday, February 15, 2011
On dentists and dentistry
In Fubarnomics and Broken Buildings, Busted Budgets, I* show how we need to move toward fixed cost contracts if we ever want productivity in construction to improve. No more of this "I bid $3 [thousand, million, billion] but because of X, Y, Z [usually total b.s.] I need you to pay me $6 [thousand ...]" crap!
So when a local dentist advertised a price guarantee, I decided to check it out. That's when I confronted another problem, one of asymmetric information. The dentist said that I needed a filling in one of my molars. That's plausible -- I only brush, floss, and use mouthwash 4x a day, have missed only 1 cleaning in the last decade, and had only 3 small cavities as a child -- but the diagnosis rather took me by surprise. As advertised, the dentist gave me a firm quotation on the proposed work but while driving home from the appointment I heard another local commercial, this one by an auto mechanic who was making fun of mechanics who screw customers by coming up with screwy car ailments. Pretty funny: something about a muffler belt and a flux capacitor, the latter of which I am pretty sure is found only in certain time traveling cars. In any event, I thought what a nice racket this could be: appear to be a "good guy" by offering a firm quotation but do it on unnecessary work! Then an RDH friend of mine confirmed the validity (though of course not the veracity) of my fears.
So I've been musing about how to fix this problem and came to the following solution: instead of relying on "trust," as the dentist and the auto mechanic in question claimed I should, couldn't we devise a system where dentists, auto mechanics, and any other line of business where asymmetric information is heavy anonymously check each other's work? Say all dentists, or at least the ones that want to signal their quality, agree to review each others' diagnoses. (One for every patient of theirs reviewed by someone else in the group.) Upload the X-rays (c'mon, you should all be digital by now ... and if not, buy a scanner!) to a system that would randomly send them to another dentist in the region (or time zone) for review. Lacking any incentive to lie, the provider of the second opinion would be much more "trustworthy" than the first. The ADA or other association could spot check the diagnoses to keep everyone on the up and up and provide a third opinion in cases where the first two disagree.
The same could be done for automobile repair, I suspect, by creating short videos of the car experiencing problems when running, taking pics of the part(s) in doubt, etc. (And then give a firm price quotation, of course.)
Yes, these procedures would consume resources but they would probably pay for themselves with an increased volume of overall business as people learned that even though they can't trust their local service provider they can trust the second opinion system of which they are a part. For now, I'm leaving my tooth untreated and leaving the "check engine" light in my Saturn on for at least another month.
*And my co-authors on BBBB of course.
So when a local dentist advertised a price guarantee, I decided to check it out. That's when I confronted another problem, one of asymmetric information. The dentist said that I needed a filling in one of my molars. That's plausible -- I only brush, floss, and use mouthwash 4x a day, have missed only 1 cleaning in the last decade, and had only 3 small cavities as a child -- but the diagnosis rather took me by surprise. As advertised, the dentist gave me a firm quotation on the proposed work but while driving home from the appointment I heard another local commercial, this one by an auto mechanic who was making fun of mechanics who screw customers by coming up with screwy car ailments. Pretty funny: something about a muffler belt and a flux capacitor, the latter of which I am pretty sure is found only in certain time traveling cars. In any event, I thought what a nice racket this could be: appear to be a "good guy" by offering a firm quotation but do it on unnecessary work! Then an RDH friend of mine confirmed the validity (though of course not the veracity) of my fears.
So I've been musing about how to fix this problem and came to the following solution: instead of relying on "trust," as the dentist and the auto mechanic in question claimed I should, couldn't we devise a system where dentists, auto mechanics, and any other line of business where asymmetric information is heavy anonymously check each other's work? Say all dentists, or at least the ones that want to signal their quality, agree to review each others' diagnoses. (One for every patient of theirs reviewed by someone else in the group.) Upload the X-rays (c'mon, you should all be digital by now ... and if not, buy a scanner!) to a system that would randomly send them to another dentist in the region (or time zone) for review. Lacking any incentive to lie, the provider of the second opinion would be much more "trustworthy" than the first. The ADA or other association could spot check the diagnoses to keep everyone on the up and up and provide a third opinion in cases where the first two disagree.
The same could be done for automobile repair, I suspect, by creating short videos of the car experiencing problems when running, taking pics of the part(s) in doubt, etc. (And then give a firm price quotation, of course.)
Yes, these procedures would consume resources but they would probably pay for themselves with an increased volume of overall business as people learned that even though they can't trust their local service provider they can trust the second opinion system of which they are a part. For now, I'm leaving my tooth untreated and leaving the "check engine" light in my Saturn on for at least another month.
*And my co-authors on BBBB of course.
My Twitter "career"
I haven't been blogging much of late because I've been too busy working on a massive project (that might be going bust soon). :-(
I have been doing a little tweeting though. Here they are to date. Feel free to "follow" if you like but I'm much less committed to it than to this blog, which finally generated some income for me last month! Tweeting is a little like a "quickie": it's better than nothing sometimes but not as satisfying as a good, long blogging. Ya know?
Wrighticism #19: If the measure of a man is earning more money than his wife can spend then I am surely a failure! Happy Valentine Day yall!
robertewright Robert E. Wright
Wrighticism #18: "skippy" = the way to pronounce Skype when the video isn't functioning well. "skyp" = skip; e = y (ee). Get it?
robertewright Robert E. Wright
Wrighticism #17: caveat erus = let the owner (investor) beware
robertewright Robert E. Wright
My textbook publisher is growing http://www.bloomberg.com/news/2011-01-20/bertelsmann-puts-cash-into-college-textbook-publisher-ft-says.html
robertewright Robert E. Wright
Wrighticism #16: homo ereptor = man the thief, in "honor" of the ways that we steal from each other, sometimes openly, sometimes in darkness
robertewright Robert E. Wright
Wrighticism #15: twittersated = to have written and/or read enough tweets for the day/month/year/decade. As in I am twittersated for today.
robertewright Robert E. Wright
Wrighticism #14: twittertwit = ppl hu rite in twitter in such s-hand tht it is freakin impossible to understd what the heck they mean.
robertewright Robert E. Wright
Wrighticism #13: triskaidekaphonia = fake fear of the number 13, not be confused with triskaidekaphiladephia = fear of 13 Phillies/Flyers.
robertewright Robert E. Wright
Wrighticism #12: trannycock = that's not a dead hen pheasant you just shot, that's a rooster that likes to dress up in hen feathers!!
robertewright Robert E. Wright
Wrighticism #11: fourclosure = when not one but four houses on your block are being sold at sheriff's sale in the same week.
robertewright Robert E. Wright
Wrighticism #10: antler (fur, feather, scale) "porn" = those hunting and fishing TV shows w/ only the biggest and best deer, ducks, fish etc
robertewright Robert E. Wright
Wrighticism #9: znorexia = when chubby people see themselves as skinny in the mirror and have another helping of chocolate-covered cumquats
robertewright Robert E. Wright
Wrighticism #8: crybaby capitalism = redistribution to private enterprises that complain loudest rather than create the most economic value
robertewright Robert E. Wright
Wrighticism #7: bailout nation = a country that instead of creating wealth redistributes it to special interests during supposed crises
29 Dec Favorite Reply Delete
robertewright Robert E. Wright
Wrighticism #6: bailoutnomics = the study of the economic effects of government bailouts of private enterprises and other governments
robertewright Robert E. Wright
Wrighticism #5: bailout incidence = the ultimate recipient of bailout funds; analogous to "tax incidence."
robertewright Robert E. Wright
Wrighticism #4: wheatful = fruitful, but in a non-gluten free format
robertewright Robert E. Wright
Wrighticism #3: cornful = fruitful, but in a corny way
robertewright Robert E. Wright
Wrighticism #2: megapocrisy = a grossly large or blatant hypocrisy; a mega-hypocrisy; the lifeblood of most DC politicians
robertewright Robert E. Wright
Wrighticism #1: Wrighticism = a neologism or witticism by Robert E. Wright
robertewright Robert E. Wright
Secession and America's Looming Fiscal Crisis, Daily Caller, http://dailycaller.com/2010/12/21/secession-and-americas-looming-fiscal-crisis/
I have been doing a little tweeting though. Here they are to date. Feel free to "follow" if you like but I'm much less committed to it than to this blog, which finally generated some income for me last month! Tweeting is a little like a "quickie": it's better than nothing sometimes but not as satisfying as a good, long blogging. Ya know?
Wrighticism #19: If the measure of a man is earning more money than his wife can spend then I am surely a failure! Happy Valentine Day yall!
robertewright Robert E. Wright
Wrighticism #18: "skippy" = the way to pronounce Skype when the video isn't functioning well. "skyp" = skip; e = y (ee). Get it?
robertewright Robert E. Wright
Wrighticism #17: caveat erus = let the owner (investor) beware
robertewright Robert E. Wright
My textbook publisher is growing http://www.bloomberg.com/news/2011-01-20/bertelsmann-puts-cash-into-college-textbook-publisher-ft-says.html
robertewright Robert E. Wright
Wrighticism #16: homo ereptor = man the thief, in "honor" of the ways that we steal from each other, sometimes openly, sometimes in darkness
robertewright Robert E. Wright
Wrighticism #15: twittersated = to have written and/or read enough tweets for the day/month/year/decade. As in I am twittersated for today.
robertewright Robert E. Wright
Wrighticism #14: twittertwit = ppl hu rite in twitter in such s-hand tht it is freakin impossible to understd what the heck they mean.
robertewright Robert E. Wright
Wrighticism #13: triskaidekaphonia = fake fear of the number 13, not be confused with triskaidekaphiladephia = fear of 13 Phillies/Flyers.
robertewright Robert E. Wright
Wrighticism #12: trannycock = that's not a dead hen pheasant you just shot, that's a rooster that likes to dress up in hen feathers!!
robertewright Robert E. Wright
Wrighticism #11: fourclosure = when not one but four houses on your block are being sold at sheriff's sale in the same week.
robertewright Robert E. Wright
Wrighticism #10: antler (fur, feather, scale) "porn" = those hunting and fishing TV shows w/ only the biggest and best deer, ducks, fish etc
robertewright Robert E. Wright
Wrighticism #9: znorexia = when chubby people see themselves as skinny in the mirror and have another helping of chocolate-covered cumquats
robertewright Robert E. Wright
Wrighticism #8: crybaby capitalism = redistribution to private enterprises that complain loudest rather than create the most economic value
robertewright Robert E. Wright
Wrighticism #7: bailout nation = a country that instead of creating wealth redistributes it to special interests during supposed crises
29 Dec Favorite Reply Delete
robertewright Robert E. Wright
Wrighticism #6: bailoutnomics = the study of the economic effects of government bailouts of private enterprises and other governments
robertewright Robert E. Wright
Wrighticism #5: bailout incidence = the ultimate recipient of bailout funds; analogous to "tax incidence."
robertewright Robert E. Wright
Wrighticism #4: wheatful = fruitful, but in a non-gluten free format
robertewright Robert E. Wright
Wrighticism #3: cornful = fruitful, but in a corny way
robertewright Robert E. Wright
Wrighticism #2: megapocrisy = a grossly large or blatant hypocrisy; a mega-hypocrisy; the lifeblood of most DC politicians
robertewright Robert E. Wright
Wrighticism #1: Wrighticism = a neologism or witticism by Robert E. Wright
robertewright Robert E. Wright
Secession and America's Looming Fiscal Crisis, Daily Caller, http://dailycaller.com/2010/12/21/secession-and-americas-looming-fiscal-crisis/
Wednesday, December 08, 2010
Dying by Degrees: The Economics of FUBAR
This is the text of a speech that I delivered at Augustana College's Center for Western Studies yesterday (12/01/10).
Dying by Degrees: The Economics of FUBAR
By Robert E. Wright, Nef Family Chair, Augustana College
FUBAR is an acronym that stands for Fouled (ahem!) Up Beyond All Recognition. Many military veterans know it as one of a family of acronyms, like SNAFU, TARFU, and SUSFU, that express anger for, and cynicism and distrust of, the status quo and the powers that be. Movie buffs learned the term FUBAR from films like Saving Private Ryan and Tango and Cash. I used it in the title of my book about the hyper-dysfunctional parts of the American economy because saying FUBAR isn’t cursing according to the word police but it definitely carries the connotation of the f-bomb. Like most folks, I’m a sinner … yep, yep, it’s true … and so I do curse when I’m angry or hurt. And the state of the U.S. economy has me feeling both of those powerful emotions.
But please don’t get me wrong – I’m not trying to cash in on the recent financial crisis … at least not in this book. The subprime debacle and subsequent financial system meltdown wasn’t the cause of America’s current economic plight but rather was a symptom of a much deeper illness, one that is slowly killing our economy. Hence the title of this talk, “Dying by Degrees.”
Given the events of the past couple of years, few people dispute that the financial system is totally FUBAR. Ditto with slavery, another melancholy subject covered in the book. Sometimes, however, people wonder if construction, higher education, healthcare, and Social Security are as economically dysfunctional as I claim. They certainly are if one accepts a simple objective criteria: quality and the price level constant, the costs of built infrastructure, college degrees, healthcare services, and retirement savings have been rising for decades and show no signs of abating. Dollar for dollar, our buildings, transportation infrastructure, and college graduates are no better now than a generation ago, Social Security continues to offer a substandard basket of disability and life insurance and retirement annuities, and our healthcare outcomes, as measured by mortality and morbidity rates and patient satisfaction, have improved relatively little, especially compared with those same outcomes in some other rich nations, like Switzerland. Yet all four services cost a lot more in inflation-adjusted terms than they once did – Social Security tax rates have risen over a dozen times, for example, and everyone knows about the soaring costs of tuition, health insurance, and construction services. As a consequence, those sectors swallow ever larger percentages of our GDP or total national income. Healthcare expenditures, for example, continue to soar towards 20 percent of GDP, or approximately the economy’s arm and leg.
The economy is littered with other trouble spots as well -- like military defense contracting, 401K administration, and automobile manufacturing and repair -- that I just don’t know enough about to discuss at present. But I heartily encourage others to do so using my theory of FUBAR-nomics, or the causes of economic hyper-dysfunction.
The core cause of the economy’s plight, I believe, is our society’s collective inability to first identify and then ameliorate what I call hybrid failures. No, not a Prius that won’t start but rather complex combinations of market failures and government failures that fester for decades until the infected sector or industry functions so poorly that vaguely obscene military acronyms become apropos. To understand my thesis, one must of course know a little bit about both market and government failures. After quickly reviewing some examples of each, I’ll then describe how they combine to suck the life out of some of the most important parts of our economy.
Market failure is the term that economists use to describe 5 situations in which markets do not function in the neat ways described by Adam Smith.
One: market power, or the ability of some sellers -- monopolies and cartels for example -- to make prices, generally by imposing their will on supply, rather than to take prices from the market as competitive firms must.
Two: public goods, or goods -- which is to say merchandize or services with a positive value -- that no seller could profit from by providing. National defense is the classic example but I like to expand the concept beyond the military to the Lockean trinity of protection of life, liberty, and property, the end all of all good governments.
Three: externalities, or situations where some of the costs or benefits of a good are not included in its price. Pollution is the classic example of a negative externality, one where some of the costs of production are not internalized by the polluter, who responds rationally by producing more goods and hence more pollution, than it would have if it had to bear the costs created by the pollution. Education is the classic example of a positive externality because some the benefits of education do not accrue to the student. More on that one later.
The fourth type of market failure is asymmetric information, or disparities in the quality or quantity of information possessed by the buyers and sellers of a good. There are three main varieties, adverse selection, moral hazard, and agency problems. The classic example of adverse selection is the lemons problem, the high probability that the purchaser of a used automobile in the person-to-person market who doesn’t know much about cars will pay too much. The most famous example of moral hazard is burning down the barn or shop for the insurance money. Agency problems are perhaps best exemplified by the shiftless fast food chain employee that we’ve all encountered or, in my case, was, albeit for a brief period.
The fifth and final type of market failure are asset bubbles, or periods when investors pay more for specific assets – sometimes land, sometimes equities, sometimes gold, sometimes Merino sheep, sugar beets, or other agricultural goods – than fundamental variables like interest rates suggest that they should. Some economists dispute the existence of bubbles, or at least definitions of them that assert the irrationality of bubble participants. That reminds me of a joke: “When an economist says the evidence is mixed, she means that theory says one thing and data says the opposite.” Whether they are rational or not, bubbles have certainly existed in the past and there is no indication that they are extinct.
Almost all economists agree that market failures exist but more libertarian slash Republican leaning ones tend to downplay their importance while more socialist slash Democratic ones seem to think that all markets are deeply infected with one or more failures. The opposite reaction occurs with government failures – libertarian-style Republicans see government failures everywhere and uphold them as the key problems to solve while liberal Democrats ignore or at least minimize them.
Government failures come in many different flavors but are most easily understood with reference to competition and incentives. No organization – government, non-profit, or for-profit – is likely to meet its goals in an effective way if it is cloistered from competition AND if the incentives of its employees are not clearly aligned with the organization’s goals. That is because a dearth of competition allows an organization to wax fat and inefficient and employees tend to do precisely what they are rewarded for doing.
Governments rarely face much competition, which is often legislated away. No bank, for example, can compete with the Federal Reserve’s monetary policy or regulatory powers; the Post Office has a legal monopoly on first class mail, which used to be important; in many municipalities it is illegal for anyone but local government employees to collect homeowners’ trash. And so on and so forth. Due to the government’s monopoly or quasi-monopoly power, customers need the government but the government doesn’t need the customers. Agencies like the DMV – those of every state are about equally notorious – are the result.
Compounding the lack of competition is the fact that most government employees are paid a salary based on the number of years that they have been employed. That incentivizes them to do the bare minimum, which they understandably negotiate to the lowest possible level, and also persuades them to NOT innovate because introducing new ideas might be seen as “rocking the boat” and lead to dismissal or undesirable assignments.
Thankfully, we live in the worst form of government except all the others, a democracy. So the public sometimes gets so irate at government inefficiencies that vote-hungry politicians take notice and implement some reforms. Were it not for that, and the occasional public-spirited do gooder, I suspect many government clerks would still be using quill pens. … I’m only half joking.
If you perceive from these comments that I lean toward libertarianism … kudos! … you’re paying attention and are an astute student of the subtleties of language and rhetoric. But I’m far from the anarchic end of libertarianism and in fact embrace so-called “pragmatic libertarianism,” a term applied to my thinking in a review of Fubarnomics that appeared in the Los Angeles Times early in the fall term. I’m not trying to score ideological points but rather am attempting to move public discussion out of the steep partisan ravine into which it has fallen. Instead of blaming market failures for our economic ills as Democrats tend to do, or government failures as Republicans tend to do, I argue that the FUBAR parts of our economy stem from combinations of the two. What that means in practical terms is that both sides hate me. …
Examples taken from the book are the easiest way to proceed next. The recent financial crisis -- you know the one that caused a worldwide recession and that injured the livelihood or savings of almost all Americans -- was caused by both market and government failures. The latter included all the artificial props to home ownership that various parts of the government implemented over the years as well as said government’s inability to see the Frankenstein it was unwittingly building in time to stop it from burning down the neighborhood if not the entire town. The mortgage interest deduction combined with the retirement savings tax structure rewarded people for staying mortgaged to the hilt and using their savings to speculate in the stock market, albeit via favored intermediaries rather than directly. Ironically, that led to LESS homeownership, as measured by the total equity invested in homes rather than the government’s preferred metric, the percentage of households who owned nominal amounts of equity in a house. That, in turn, led to an Alanis Morrissette-sized irony: homeownership was supposed to give people a stake in their communities and governments but the bass ackwards way that home ownership was encouraged actually decreased people’s commitment because they had so little of their own money invested. Instead of paying off their mortgages and owning their homes outright as in the pre-Depression period, most Americans today are essentially renting from the bank in exchange for an equity put option sweetener.
The most obvious market failure in the recent financial crisis was an asset bubble, or rather several of them. Homeowners paid too much for houses and lenders and appraisers were complicit. Please bear in mind that the conclusion that people were paying too much isn’t hindsight: every housing affordability metric, including the Price-Rent Ratio, was setting off more alarms than a high rise fire. Investors, goaded on by paid cheerleaders like the ratings agencies, also paid far too much for fancy securitized mortgage products like mortgage backed securities and collateralized mortgage obligations. Again here, some observers correctly perceived the bubble, arguing that no financial alchemy could turn a bundle of 125 percent LTV loans made to major credit risks into a golden opportunity.
Another major market failure contributing to the financial crisis was the principal-agent problem, though certainly asymmetric information and negative externalities were also present to some degree. In a nutshell, investment banks morphed from private partnerships into publicly traded joint stock corporations in the 1970s, 80s, and 90s but the new owners, mostly institutional stockholders, did not take effective control of the new companies, employees did. Exploiting our greatly weakened system of corporate governance, itself a hybrid failure, those employees compensated themselves both liberally and in a dangerous way. Basically, they created a game of “tails I win, heads you lose” that rewarded them for taking large, short-term bets. If a gamble paid off, they made literally millions of dollars in bonuses. If a gamble failed, they personally didn’t lose anything except maybe a job, one that after several years of large bonuses they no longer needed because they had already made enough to live out their days not just in the lap of luxury but in its very loins.
Sure there were some boneheads on Wall Street who didn’t understand what they were doing or who were fooled by the smoke and mirrors of fancy equations and theories. But most knew that it was not a good long-term business strategy to make adjustable rate loans to so-called NINJAs – borrowers with No Income, No Job or Assets. But Wall Street bigwigs didn’t care because they were not paid to care about next year, let alone next decade, they were paid to create short-term accounting quote unquote profits.
Custom construction contractors, by contrast, are paid to complete homes, office buildings, roads, and other types of built infrastructure. Its close connection to concrete reality, however, does not make custom construction immune to the hybrid failure disease. As you may know, most construction projects are over-budget, late, and/or under-quality. Unsurprisingly, productivity in the sector has been flat for decades, meaning that each inflation-adjusted dollar put into a construction project creates no more building, bridge, or tunnel than it did when I was born in 1969. So far over my lifetime, however, productivity in the manufacturing part of the economy has increased several fold.
The main market failures in custom construction are asymmetric information and market power. Owners and their minions cannot see everything that a general contractor does, or doesn’t do, and the general contractor cannot monitor all of his sub-contractors 24/7. The reasonableness of change orders, essentially increases in project costs, cannot therefore be accurately assessed and even if they could a construction company already on the job can be replaced only at considerable cost. Once a bid is won and a company is on the job, it is a near monopolist. Bids are therefore not an offer of a fair price but rather a strategic game, the sole goal of which is to win the job so that profitable change orders can be submitted. If an owner refuses to comply, profits can be extracted in other ways, by slowing down production or using inferior techniques or materials.
Yes, government officials inspect most buildings during construction but only to ascertain if they are up to code, the local minimum standard in other words. They do not verify that the materials or techniques specified in the contract have been actually utilized. Building inspections and codes are one of the government failures in the construction sector. They tend to be outdated and cause needless delays and their idiosyncrasies from municipality to municipality also help to keep construction firms smaller and less efficient than they would otherwise be. Governments also interfere with construction wages and labor conditions and help to perpetuate the flawed bidding system just described.
Before somebody in a hard hat takes a pot shot at me, I should describe the hybrid failure at the heart of ever rising college tuitions. As mentioned previously, the market failure in education is a positive externality. Specifically, if left to their own devices individuals would acquire less education than is socially optimal. Highly educated people, the standard argument goes, make better citizens and dinner party guests and are also more creative and innovative in ways that often enrich our culture and economy without necessarily enriching educated individuals. Ergo, the government needs to subsidize higher education. As a professor at a college that receives sundry government grants currently speaking at said college, I wholeheartedly endorse the standard argument.
Where I part ways with the status quo, however, is with the payment of educational subsidies to schools rather than to students. By supplying a large portion of higher education themselves, governments actually fail us. By and large government schools are not as efficient as private ones. Instead of investing in undergraduate education, most state schools invest in research, often of the most careerist, least socially remunerative types, and in lobbying legislators for more funds. Like other government entities, in other words, state university systems tend to bloat bigger than South Dakota roadkill … in July!! Private colleges often suffer the same fate, but generally to a lesser degree because they are less assured of receiving subsidies.
One major problem with colleges and universities of all types is that -- from the richly endowed private Harvard University to the public University of Virginia to the for-profit, stockholder-owned University of Phoenix – they all consider professors to be mere employees. That, I sincerely believe, is a major mistake because professors are professionals, the heart and soul of their institutions. Treating professionals as mere employees exacerbates agency problems, leading to bizarre institutions like the current system of lifelong tenure. Many tenured professors continue to work hard but enough don’t to serve collectively as a rather weighty millstone around the necks of their institutions and hence taxpayers and students and their families.
Slavery was – or rather I should say is because it persists in many places in the world – another hybrid failure. The government failure was allowing one person to own another, a clear violation of the enslaved’s natural right to liberty. Had the government failure ended there, slavery in the antebellum U.S. South probably would have petered out, as it did in the North, because slaves were not very efficient workers. Slaveholders didn’t have to pay them a wage but they had to pay a purchase price for them and feed and clothe them, even when they were sick or there was no work for them to do. Even more costly, slaves resisted bondage in a wide variety of ways, ranging from outright rebellion to working soft and dumb instead of hard and smart. As a result, slavery was generally unprofitable unless slaveowners could cajole the government into assuming some of the control costs of their peculiar chattels, which of course they did up until the Civil War. Slavery, then, was in a sense a negative externality, a form of pollution that planter-controlled governments not only countenanced but abetted far too long.
Rapidly rising healthcare costs are also caused by a hybrid failure, one almost completely unaddressed by so-called Obamacare. Health insurers suffer from adverse selection and moral hazard. More specifically, sick and sickly people are more eager to purchase insurance than healthy ones are and people who have insurance are more likely to seek medical attention, and more expensive varieties of medical attention, than uninsured people are.
The health insurance industry was well on its way to ameliorating those problems when the Great Depression struck and mucked things up. Then the government interceded in very damaging ways. First, the government literally regulated an entire genre of small mutual health insurers, fraternal benefit societies, out of business. That was damaging because small mutual insurers were very good at limiting adverse selection and moral hazard by carefully screening insurance applicants and monitoring claimants. Next, the government used the tax code to encourage employers to offer health insurance as a fringe benefit. That was damaging because employer-provided health insurance essentially de-coupled the cost of insurance premiums from the cost of healthcare by encouraging people to seek the best doctors rather than the most cost-effective ones. It also abetted pre-existing condition clauses and, given our extremely flexible labor markets, swelled the number of uninsured individuals. The government also became a little too friendly with the American Medical Association, which restricts the supply of doctors. Because of their artificially limited numbers, doctors have the market power to insist on being paid for seeing patients rather than returning them to health, another major flaw in our post-Depression system of which more a little later.
The government also responded in damaging ways to the retirement savings crisis created by the Great Depression. Social Security, in short, was a permanent solution to a temporary problem. The concept of retirement was more or less unknown until the late nineteenth century. Before then, numerous well-to-do Americans stopped working before they died but there was no widespread expectation that most people’s final years would be spent outside the labor force, except in cases of disability or dementia. As increasing numbers of people began to outlive their ability or willingness to work, families began to save for what came to be known as retirement by purchasing real estate outright and by investing in savings bank accounts, life insurance policies and annuities, and stocks and bonds. As a result, there was no epidemic of impoverished old folks leading up to the Depression. Some of the aged were indigent but most, in fact, were able to live off their savings, inherited wealth, and/or contributions from their children.
The Depression pinched those resources, however, by decreasing the value of real estate, stocks, and riskier corporate bonds, by throwing older people out of work sooner than expected, and by decreasing the ability of their children, many of whom were unemployed as well, to aid them. If the government had simply provided indigent seniors with direct monetary aid and not created Social Security, prudent Americans today would save for retirement at much higher levels than they currently do and would be much more astute about matters of personal finance. Instead, the government took a very different path that threatens to cause tremendous economic and possibly political instability. It strikes me as more than a little un-democratic that long-dead politicians, now accountable only to God or, more likely, Satan, should be allowed to burden posterity with such unnecessary legislation.
In case any of you are wondering, the Great Depression itself was a prime example of a hybrid failure. It began due to a real estate bubble and was exacerbated by the stock market crash of 1929, two clear market failures. But the numerous bank failures that followed were actually government failures caused by regulations that prohibited branch banking in most states. That left most banks small and hence vulnerable to local and national shocks that a wing of the government, the Federal Reserve, did not adequately address even though macroeconomic stability was its stated mission. A single policy, Roosevelt’s devaluation of the dollar, was sufficient to bring the economy out of the Depression. The rest of the New Deal was a mixed bag comprised mostly of government failures like the Agricultural Adjustment Act and the National Industrial Recovery Act. Even the Federal Deposit Insurance Corporation, which stabilized the deeply flawed Depression-era banking system by guaranteeing retail bank deposits, helped to cause subsequent financial crises, most notably the Savings and Loan crisis, by rewarding bankers for taking on excessive risks. The bastard offspring of the S&L crisis, the infamous Too Big To Fail Policy, played a major role in the most recent crisis.
Additional details on the financial crisis and all of the other topics touched on here today can of course be found in Fubarnomics but now I would like to sketch out the book’s recommendations. It is important to note that I do not think that any of these solutions are possible in today’s political climate, although the results of the recent election may have brought us closer to some of them. I offer them in the hopes that they will be discussed, critiqued, and revised so that they may be implemented when politicians get serious about fixing the economy and make the policy changes that will unleash the entrepreneurial energies under girding each recommendation. I should make clear at the outset that all of my recommendations essentially entail reversing or untangling the hybrid failures that cause the economic dysfunctions just discussed.
If we don’t want another gut wrenching financial panic and economic downturn, the government should:
1) abolish GSEs, or government-sponsored enterprises, including Fannie Mae and Freddie Mac. Andy Jackson called the GSE of his era, the Second Bank of the United States, a hydra-headed monster and he was right. Figuratively speaking of course. If an enterprise is profitable, the government doesn’t need to subsidize it. If it isn’t, and we’re sure it involves a public good as previously defined, then the government itself should provide the good.
2) reform credit rating agencies so that they actually assess credit risks again instead of merely pandering to issuers as they have the last few decades. That will entail returning to a subscription-based revenue model and eschewing payments from issuers, a business model that turned into a form of ratings-for-payment bribe.
3) expunge Too Big to Fail Policy from businesses’ expectation set by making it clear that if any company runs into difficulty it will be allowed to fail. Streamline bankruptcy reorganization procedures, especially for financial institutions, so that the threat is credible.
4) learn to learn from past mistakes. The subprime debacle of 2007 was not the first time that a mortgage securitization scheme in America blew up. It was the seventh. No kidding. Fool me once, shame on you. Fool me twice, shame on me. Fool me seven times and … that is, as they say in Boston, “wicked retawded.”
5) reward regulators for regulating intelligently, for discouraging bubbles, and for acting before matters get out of hand. The status quo is to reward regulators for preparing to fight the last crisis rather than the next one, a flaw that also pervades the TSA’s so-called thinking. But that is another conversation.
6) improve corporate governance by mandating deferred compensation or bonus-malus systems where ever and whenever appropriate, which would include at least some positions in most financial services firms.
All of those proposals have been made by others, but no one else, to my knowledge, has recommended all six.
The construction industry can be fixed by moving away from the current system, where numerous small firms compete based on their strategic bidding and change order skills rather than on their efficiency. Governments and private firms should choose the best bidder, not the lowest one. The best bidder could be ascertained more easily if someone had the incentive to track construction company and individual performance over time. Eliminating the bidding system altogether could work as well, as in new construction systems where architects, designers, and contractors are compensated to develop change order proof plans, or in other words are paid by owners to dramatically reduce both asymmetric information and post-contractual monopoly power. A recent book, the Commercial Real Estate Revolution by Rex Miller and others, essentially calls for the same reform, though for a less compelling reason.
Higher education would be vastly improved if professors were allowed to own their own colleges in professional partnership. Instead of being mere employees, they would be professionals akin to attorneys or business consultants and would have long-term incentives to provide students with the most inexpensive, highest quality undergraduate and graduate educations possible. Under such a system tenure would dissolve of its own weight but academic freedom, the right of tenured professors to say pretty much anything they want to without fear of being fired, would be priced in the market. A professor who is a partner in a college organized as a professional services firm could not be dismissed, he or she would have to be bought out by the other partners, essentially pricing tenure and academic freedom.
Other salubrious reforms would include the government allowing more competition in higher education, the creation of a system of standardized exit exams, the payment of subsidies only to students and not to schools, and passage of a GI-like bill expanded to include a wide variety of public service, not just military duties. Again, almost all of these ideas have been proffered by others, but never as a complete package designed to eliminate the hybrid failures at the heart of rising tuition costs.
The cure for slavery is economic development. Ironically, economists have a very poor track record at creating economic growth in poor countries. That is why vast swathes of Latin America, Africa, and Central Asia continue to suffer with per capita incomes not far above the subsistence level. A growing consensus among an interdisciplinary group of scholars who study the wealth question, however, suggests that national wealth is largely a function of institutional quality, particularly whether the government adequately protects life, liberty, and property or not. Where it does not, poverty is certain, even if oil or diamonds are present. Where it does, wealth is certain, even in barren, windswept places like Iceland … and South Dakota.
Of course dictators control most poor nations and most do not behave as enlightened despots and protect life, liberty, and property of their own accord. I suggest in Fubarnomics that dictators can be rewarded for providing such protections through the judicious use of aid and carefully designed long-term compensation schemes. It’s a long-term fix that won’t alleviate the suffering of all people enslaved today but will help to prevent the enslavement of future generations because slavery is highly unprofitable where governments are against it and where wage laborers are abundant and efficient, as they are in developed economies.
Speaking of enslaving future generations, it is now time for the big two, Social Security and healthcare. Seriously, the former might survive intact if the economy grows really robustly. If growth is anemic, as some fear, Social Security could be extended indefinitely by some combination of tax increases and benefit cuts, including raising the retirement age. My recommendation, however, is to simply eliminate it for myself and every younger than me and to pay the promised benefits to everyone older than me out of general revenues. My rationale here is that younger people still have time to save for retirement but older Americans don’t. Moreover, Social Security payroll taxes are highly regressive and the payout structure is distorted towards preferred groups. As a whole, the system redistributes wealth from poor minority men to middle class white women, a rather cruel and ironic outcome especially after, say, 1970. The structure of the system and demographics virtually ensure that poorer Americans, especially those from disadvantaged minority groups, almost never receive even modest inheritances, a leading spoke in the wheel that perpetuates the cycle of poverty. Due to the payroll tax, the poor can’t afford much whole life insurance or other asset building financial products.
I wouldn’t replace Social Security with anything other than the government’s solemn promise that when people my age and younger get old we will be on our own so we had better start saving now. And don’t worry about silly claims emanating from mass media outlets about the negative effects of higher savings rates on consumption. Via the financial system, one person’s savings becomes another’s consumption. We also need a much better, longer, and more comprehensive system of personal finance education, ideally supplied by teachers and professors in professional partnerships of course. I don’t want to hear any of this bull puckey about “privatizing Social Security” or “investing in the stock market.” Proper investing starts with rainy day savings, preferably in low-cost depository institutions like credit unions, then moves on to insurance, and only then moves on to well diversified portfolios of financial securities, derivatives, and commodities, portfolios that become less risky as the investor’s target retirement age approaches.
Finally, we also need much less but much better financial system regulation. The topic is too detailed to delve into during this talk but suffice it to say that pre-Depression historical precedents suggest that intelligently regulated financial markets and intermediaries can provide Americans with solid private security in a much fairer way and at a much lower overall cost than Social Security has done. Recent and current problems with pensions, 401Ks, life and disability insurance, and other private security products are due to relatively minor hybrid failures that could be fixed in fairly short order if desired.
That leaves us with health insurance. As hinted at previously, healthcare costs would stabilize and perhaps even decline if doctors were rewarded for healing people rather than merely treating them. That may sound like a radical idea but the U.S. healthcare system was moving in that direction when the Depression struck and the government sent us down a very different path. They were called prepaid plans. People paid monthly fees when they were healthy and stopped paying when they were sick. Healthcare providers therefore had strong incentives to keep people from getting sick in the first place and to fix them up quickly if they did fall ill. Today, doctors in most parts of the United States have incentives to keep patients sick. And don’t even get me started on pharmaceutical company incentives.
Another salubrious change would entail the creation of large mutual health insurers, under a general agent sales system, that offer joint life and health insurance policies that I call “health for life.” Mutuals are for-profit corporations owned by their customers, in this case their policyholders. Their profits accrue to the policyholders and to their general agents, which like large blockholders in joint-stock corporations serve to keep the companies’ executives on task. The joint policies would commit insurers to providing large sums for healthcare by promising a life insurance payment as well as health insurance. A rational company would pay healthcare costs up to the discounted present value of the life insurance due multiplied by the probability of treatment success. It’s called incentive alignment and it works much better than government mandates likely to spur premium increases or, if that avenue is blocked, exit from that line of business.
In addition, for a given premium level the life insurance benefit would decline as more healthcare was used and increase if relatively little was utilized. That would help to reduce the adverse selection problem by inducing healthy people to buy more health insurance. “Health for life” policies would also force insured persons, especially those near the end of their lives, to decide between living a few extra months and leaving an estate for their heirs, a vast improvement over the current system which more or less rewards people for receiving as many final treatments as they can get insurers or the government to pay for, no matter how expensive or futile. By leaving the final choice to the individual, “health for life” policies would be far preferable to any sort of non-price rationing system, fictional or factual.
Again, most of these ideas are not entirely original but no one else has offered them all and no one else to my knowledge has a set forth such a clear theory of the causes of such a wide range of economic hyper-dysfunction. I therefore encourage you to buy Fubarnomics, read it, and post 5-star reviews of it on Amazon. … But I also encourage you to critique any aspect of it that you think does violence to reality because, again, my goal is to have policies ready if and when politicians are prepared to save our economy from dying by degrees.
Thank you! I’ll now entertain a few questions.
Dying by Degrees: The Economics of FUBAR
By Robert E. Wright, Nef Family Chair, Augustana College
FUBAR is an acronym that stands for Fouled (ahem!) Up Beyond All Recognition. Many military veterans know it as one of a family of acronyms, like SNAFU, TARFU, and SUSFU, that express anger for, and cynicism and distrust of, the status quo and the powers that be. Movie buffs learned the term FUBAR from films like Saving Private Ryan and Tango and Cash. I used it in the title of my book about the hyper-dysfunctional parts of the American economy because saying FUBAR isn’t cursing according to the word police but it definitely carries the connotation of the f-bomb. Like most folks, I’m a sinner … yep, yep, it’s true … and so I do curse when I’m angry or hurt. And the state of the U.S. economy has me feeling both of those powerful emotions.
But please don’t get me wrong – I’m not trying to cash in on the recent financial crisis … at least not in this book. The subprime debacle and subsequent financial system meltdown wasn’t the cause of America’s current economic plight but rather was a symptom of a much deeper illness, one that is slowly killing our economy. Hence the title of this talk, “Dying by Degrees.”
Given the events of the past couple of years, few people dispute that the financial system is totally FUBAR. Ditto with slavery, another melancholy subject covered in the book. Sometimes, however, people wonder if construction, higher education, healthcare, and Social Security are as economically dysfunctional as I claim. They certainly are if one accepts a simple objective criteria: quality and the price level constant, the costs of built infrastructure, college degrees, healthcare services, and retirement savings have been rising for decades and show no signs of abating. Dollar for dollar, our buildings, transportation infrastructure, and college graduates are no better now than a generation ago, Social Security continues to offer a substandard basket of disability and life insurance and retirement annuities, and our healthcare outcomes, as measured by mortality and morbidity rates and patient satisfaction, have improved relatively little, especially compared with those same outcomes in some other rich nations, like Switzerland. Yet all four services cost a lot more in inflation-adjusted terms than they once did – Social Security tax rates have risen over a dozen times, for example, and everyone knows about the soaring costs of tuition, health insurance, and construction services. As a consequence, those sectors swallow ever larger percentages of our GDP or total national income. Healthcare expenditures, for example, continue to soar towards 20 percent of GDP, or approximately the economy’s arm and leg.
The economy is littered with other trouble spots as well -- like military defense contracting, 401K administration, and automobile manufacturing and repair -- that I just don’t know enough about to discuss at present. But I heartily encourage others to do so using my theory of FUBAR-nomics, or the causes of economic hyper-dysfunction.
The core cause of the economy’s plight, I believe, is our society’s collective inability to first identify and then ameliorate what I call hybrid failures. No, not a Prius that won’t start but rather complex combinations of market failures and government failures that fester for decades until the infected sector or industry functions so poorly that vaguely obscene military acronyms become apropos. To understand my thesis, one must of course know a little bit about both market and government failures. After quickly reviewing some examples of each, I’ll then describe how they combine to suck the life out of some of the most important parts of our economy.
Market failure is the term that economists use to describe 5 situations in which markets do not function in the neat ways described by Adam Smith.
One: market power, or the ability of some sellers -- monopolies and cartels for example -- to make prices, generally by imposing their will on supply, rather than to take prices from the market as competitive firms must.
Two: public goods, or goods -- which is to say merchandize or services with a positive value -- that no seller could profit from by providing. National defense is the classic example but I like to expand the concept beyond the military to the Lockean trinity of protection of life, liberty, and property, the end all of all good governments.
Three: externalities, or situations where some of the costs or benefits of a good are not included in its price. Pollution is the classic example of a negative externality, one where some of the costs of production are not internalized by the polluter, who responds rationally by producing more goods and hence more pollution, than it would have if it had to bear the costs created by the pollution. Education is the classic example of a positive externality because some the benefits of education do not accrue to the student. More on that one later.
The fourth type of market failure is asymmetric information, or disparities in the quality or quantity of information possessed by the buyers and sellers of a good. There are three main varieties, adverse selection, moral hazard, and agency problems. The classic example of adverse selection is the lemons problem, the high probability that the purchaser of a used automobile in the person-to-person market who doesn’t know much about cars will pay too much. The most famous example of moral hazard is burning down the barn or shop for the insurance money. Agency problems are perhaps best exemplified by the shiftless fast food chain employee that we’ve all encountered or, in my case, was, albeit for a brief period.
The fifth and final type of market failure are asset bubbles, or periods when investors pay more for specific assets – sometimes land, sometimes equities, sometimes gold, sometimes Merino sheep, sugar beets, or other agricultural goods – than fundamental variables like interest rates suggest that they should. Some economists dispute the existence of bubbles, or at least definitions of them that assert the irrationality of bubble participants. That reminds me of a joke: “When an economist says the evidence is mixed, she means that theory says one thing and data says the opposite.” Whether they are rational or not, bubbles have certainly existed in the past and there is no indication that they are extinct.
Almost all economists agree that market failures exist but more libertarian slash Republican leaning ones tend to downplay their importance while more socialist slash Democratic ones seem to think that all markets are deeply infected with one or more failures. The opposite reaction occurs with government failures – libertarian-style Republicans see government failures everywhere and uphold them as the key problems to solve while liberal Democrats ignore or at least minimize them.
Government failures come in many different flavors but are most easily understood with reference to competition and incentives. No organization – government, non-profit, or for-profit – is likely to meet its goals in an effective way if it is cloistered from competition AND if the incentives of its employees are not clearly aligned with the organization’s goals. That is because a dearth of competition allows an organization to wax fat and inefficient and employees tend to do precisely what they are rewarded for doing.
Governments rarely face much competition, which is often legislated away. No bank, for example, can compete with the Federal Reserve’s monetary policy or regulatory powers; the Post Office has a legal monopoly on first class mail, which used to be important; in many municipalities it is illegal for anyone but local government employees to collect homeowners’ trash. And so on and so forth. Due to the government’s monopoly or quasi-monopoly power, customers need the government but the government doesn’t need the customers. Agencies like the DMV – those of every state are about equally notorious – are the result.
Compounding the lack of competition is the fact that most government employees are paid a salary based on the number of years that they have been employed. That incentivizes them to do the bare minimum, which they understandably negotiate to the lowest possible level, and also persuades them to NOT innovate because introducing new ideas might be seen as “rocking the boat” and lead to dismissal or undesirable assignments.
Thankfully, we live in the worst form of government except all the others, a democracy. So the public sometimes gets so irate at government inefficiencies that vote-hungry politicians take notice and implement some reforms. Were it not for that, and the occasional public-spirited do gooder, I suspect many government clerks would still be using quill pens. … I’m only half joking.
If you perceive from these comments that I lean toward libertarianism … kudos! … you’re paying attention and are an astute student of the subtleties of language and rhetoric. But I’m far from the anarchic end of libertarianism and in fact embrace so-called “pragmatic libertarianism,” a term applied to my thinking in a review of Fubarnomics that appeared in the Los Angeles Times early in the fall term. I’m not trying to score ideological points but rather am attempting to move public discussion out of the steep partisan ravine into which it has fallen. Instead of blaming market failures for our economic ills as Democrats tend to do, or government failures as Republicans tend to do, I argue that the FUBAR parts of our economy stem from combinations of the two. What that means in practical terms is that both sides hate me. …
Examples taken from the book are the easiest way to proceed next. The recent financial crisis -- you know the one that caused a worldwide recession and that injured the livelihood or savings of almost all Americans -- was caused by both market and government failures. The latter included all the artificial props to home ownership that various parts of the government implemented over the years as well as said government’s inability to see the Frankenstein it was unwittingly building in time to stop it from burning down the neighborhood if not the entire town. The mortgage interest deduction combined with the retirement savings tax structure rewarded people for staying mortgaged to the hilt and using their savings to speculate in the stock market, albeit via favored intermediaries rather than directly. Ironically, that led to LESS homeownership, as measured by the total equity invested in homes rather than the government’s preferred metric, the percentage of households who owned nominal amounts of equity in a house. That, in turn, led to an Alanis Morrissette-sized irony: homeownership was supposed to give people a stake in their communities and governments but the bass ackwards way that home ownership was encouraged actually decreased people’s commitment because they had so little of their own money invested. Instead of paying off their mortgages and owning their homes outright as in the pre-Depression period, most Americans today are essentially renting from the bank in exchange for an equity put option sweetener.
The most obvious market failure in the recent financial crisis was an asset bubble, or rather several of them. Homeowners paid too much for houses and lenders and appraisers were complicit. Please bear in mind that the conclusion that people were paying too much isn’t hindsight: every housing affordability metric, including the Price-Rent Ratio, was setting off more alarms than a high rise fire. Investors, goaded on by paid cheerleaders like the ratings agencies, also paid far too much for fancy securitized mortgage products like mortgage backed securities and collateralized mortgage obligations. Again here, some observers correctly perceived the bubble, arguing that no financial alchemy could turn a bundle of 125 percent LTV loans made to major credit risks into a golden opportunity.
Another major market failure contributing to the financial crisis was the principal-agent problem, though certainly asymmetric information and negative externalities were also present to some degree. In a nutshell, investment banks morphed from private partnerships into publicly traded joint stock corporations in the 1970s, 80s, and 90s but the new owners, mostly institutional stockholders, did not take effective control of the new companies, employees did. Exploiting our greatly weakened system of corporate governance, itself a hybrid failure, those employees compensated themselves both liberally and in a dangerous way. Basically, they created a game of “tails I win, heads you lose” that rewarded them for taking large, short-term bets. If a gamble paid off, they made literally millions of dollars in bonuses. If a gamble failed, they personally didn’t lose anything except maybe a job, one that after several years of large bonuses they no longer needed because they had already made enough to live out their days not just in the lap of luxury but in its very loins.
Sure there were some boneheads on Wall Street who didn’t understand what they were doing or who were fooled by the smoke and mirrors of fancy equations and theories. But most knew that it was not a good long-term business strategy to make adjustable rate loans to so-called NINJAs – borrowers with No Income, No Job or Assets. But Wall Street bigwigs didn’t care because they were not paid to care about next year, let alone next decade, they were paid to create short-term accounting quote unquote profits.
Custom construction contractors, by contrast, are paid to complete homes, office buildings, roads, and other types of built infrastructure. Its close connection to concrete reality, however, does not make custom construction immune to the hybrid failure disease. As you may know, most construction projects are over-budget, late, and/or under-quality. Unsurprisingly, productivity in the sector has been flat for decades, meaning that each inflation-adjusted dollar put into a construction project creates no more building, bridge, or tunnel than it did when I was born in 1969. So far over my lifetime, however, productivity in the manufacturing part of the economy has increased several fold.
The main market failures in custom construction are asymmetric information and market power. Owners and their minions cannot see everything that a general contractor does, or doesn’t do, and the general contractor cannot monitor all of his sub-contractors 24/7. The reasonableness of change orders, essentially increases in project costs, cannot therefore be accurately assessed and even if they could a construction company already on the job can be replaced only at considerable cost. Once a bid is won and a company is on the job, it is a near monopolist. Bids are therefore not an offer of a fair price but rather a strategic game, the sole goal of which is to win the job so that profitable change orders can be submitted. If an owner refuses to comply, profits can be extracted in other ways, by slowing down production or using inferior techniques or materials.
Yes, government officials inspect most buildings during construction but only to ascertain if they are up to code, the local minimum standard in other words. They do not verify that the materials or techniques specified in the contract have been actually utilized. Building inspections and codes are one of the government failures in the construction sector. They tend to be outdated and cause needless delays and their idiosyncrasies from municipality to municipality also help to keep construction firms smaller and less efficient than they would otherwise be. Governments also interfere with construction wages and labor conditions and help to perpetuate the flawed bidding system just described.
Before somebody in a hard hat takes a pot shot at me, I should describe the hybrid failure at the heart of ever rising college tuitions. As mentioned previously, the market failure in education is a positive externality. Specifically, if left to their own devices individuals would acquire less education than is socially optimal. Highly educated people, the standard argument goes, make better citizens and dinner party guests and are also more creative and innovative in ways that often enrich our culture and economy without necessarily enriching educated individuals. Ergo, the government needs to subsidize higher education. As a professor at a college that receives sundry government grants currently speaking at said college, I wholeheartedly endorse the standard argument.
Where I part ways with the status quo, however, is with the payment of educational subsidies to schools rather than to students. By supplying a large portion of higher education themselves, governments actually fail us. By and large government schools are not as efficient as private ones. Instead of investing in undergraduate education, most state schools invest in research, often of the most careerist, least socially remunerative types, and in lobbying legislators for more funds. Like other government entities, in other words, state university systems tend to bloat bigger than South Dakota roadkill … in July!! Private colleges often suffer the same fate, but generally to a lesser degree because they are less assured of receiving subsidies.
One major problem with colleges and universities of all types is that -- from the richly endowed private Harvard University to the public University of Virginia to the for-profit, stockholder-owned University of Phoenix – they all consider professors to be mere employees. That, I sincerely believe, is a major mistake because professors are professionals, the heart and soul of their institutions. Treating professionals as mere employees exacerbates agency problems, leading to bizarre institutions like the current system of lifelong tenure. Many tenured professors continue to work hard but enough don’t to serve collectively as a rather weighty millstone around the necks of their institutions and hence taxpayers and students and their families.
Slavery was – or rather I should say is because it persists in many places in the world – another hybrid failure. The government failure was allowing one person to own another, a clear violation of the enslaved’s natural right to liberty. Had the government failure ended there, slavery in the antebellum U.S. South probably would have petered out, as it did in the North, because slaves were not very efficient workers. Slaveholders didn’t have to pay them a wage but they had to pay a purchase price for them and feed and clothe them, even when they were sick or there was no work for them to do. Even more costly, slaves resisted bondage in a wide variety of ways, ranging from outright rebellion to working soft and dumb instead of hard and smart. As a result, slavery was generally unprofitable unless slaveowners could cajole the government into assuming some of the control costs of their peculiar chattels, which of course they did up until the Civil War. Slavery, then, was in a sense a negative externality, a form of pollution that planter-controlled governments not only countenanced but abetted far too long.
Rapidly rising healthcare costs are also caused by a hybrid failure, one almost completely unaddressed by so-called Obamacare. Health insurers suffer from adverse selection and moral hazard. More specifically, sick and sickly people are more eager to purchase insurance than healthy ones are and people who have insurance are more likely to seek medical attention, and more expensive varieties of medical attention, than uninsured people are.
The health insurance industry was well on its way to ameliorating those problems when the Great Depression struck and mucked things up. Then the government interceded in very damaging ways. First, the government literally regulated an entire genre of small mutual health insurers, fraternal benefit societies, out of business. That was damaging because small mutual insurers were very good at limiting adverse selection and moral hazard by carefully screening insurance applicants and monitoring claimants. Next, the government used the tax code to encourage employers to offer health insurance as a fringe benefit. That was damaging because employer-provided health insurance essentially de-coupled the cost of insurance premiums from the cost of healthcare by encouraging people to seek the best doctors rather than the most cost-effective ones. It also abetted pre-existing condition clauses and, given our extremely flexible labor markets, swelled the number of uninsured individuals. The government also became a little too friendly with the American Medical Association, which restricts the supply of doctors. Because of their artificially limited numbers, doctors have the market power to insist on being paid for seeing patients rather than returning them to health, another major flaw in our post-Depression system of which more a little later.
The government also responded in damaging ways to the retirement savings crisis created by the Great Depression. Social Security, in short, was a permanent solution to a temporary problem. The concept of retirement was more or less unknown until the late nineteenth century. Before then, numerous well-to-do Americans stopped working before they died but there was no widespread expectation that most people’s final years would be spent outside the labor force, except in cases of disability or dementia. As increasing numbers of people began to outlive their ability or willingness to work, families began to save for what came to be known as retirement by purchasing real estate outright and by investing in savings bank accounts, life insurance policies and annuities, and stocks and bonds. As a result, there was no epidemic of impoverished old folks leading up to the Depression. Some of the aged were indigent but most, in fact, were able to live off their savings, inherited wealth, and/or contributions from their children.
The Depression pinched those resources, however, by decreasing the value of real estate, stocks, and riskier corporate bonds, by throwing older people out of work sooner than expected, and by decreasing the ability of their children, many of whom were unemployed as well, to aid them. If the government had simply provided indigent seniors with direct monetary aid and not created Social Security, prudent Americans today would save for retirement at much higher levels than they currently do and would be much more astute about matters of personal finance. Instead, the government took a very different path that threatens to cause tremendous economic and possibly political instability. It strikes me as more than a little un-democratic that long-dead politicians, now accountable only to God or, more likely, Satan, should be allowed to burden posterity with such unnecessary legislation.
In case any of you are wondering, the Great Depression itself was a prime example of a hybrid failure. It began due to a real estate bubble and was exacerbated by the stock market crash of 1929, two clear market failures. But the numerous bank failures that followed were actually government failures caused by regulations that prohibited branch banking in most states. That left most banks small and hence vulnerable to local and national shocks that a wing of the government, the Federal Reserve, did not adequately address even though macroeconomic stability was its stated mission. A single policy, Roosevelt’s devaluation of the dollar, was sufficient to bring the economy out of the Depression. The rest of the New Deal was a mixed bag comprised mostly of government failures like the Agricultural Adjustment Act and the National Industrial Recovery Act. Even the Federal Deposit Insurance Corporation, which stabilized the deeply flawed Depression-era banking system by guaranteeing retail bank deposits, helped to cause subsequent financial crises, most notably the Savings and Loan crisis, by rewarding bankers for taking on excessive risks. The bastard offspring of the S&L crisis, the infamous Too Big To Fail Policy, played a major role in the most recent crisis.
Additional details on the financial crisis and all of the other topics touched on here today can of course be found in Fubarnomics but now I would like to sketch out the book’s recommendations. It is important to note that I do not think that any of these solutions are possible in today’s political climate, although the results of the recent election may have brought us closer to some of them. I offer them in the hopes that they will be discussed, critiqued, and revised so that they may be implemented when politicians get serious about fixing the economy and make the policy changes that will unleash the entrepreneurial energies under girding each recommendation. I should make clear at the outset that all of my recommendations essentially entail reversing or untangling the hybrid failures that cause the economic dysfunctions just discussed.
If we don’t want another gut wrenching financial panic and economic downturn, the government should:
1) abolish GSEs, or government-sponsored enterprises, including Fannie Mae and Freddie Mac. Andy Jackson called the GSE of his era, the Second Bank of the United States, a hydra-headed monster and he was right. Figuratively speaking of course. If an enterprise is profitable, the government doesn’t need to subsidize it. If it isn’t, and we’re sure it involves a public good as previously defined, then the government itself should provide the good.
2) reform credit rating agencies so that they actually assess credit risks again instead of merely pandering to issuers as they have the last few decades. That will entail returning to a subscription-based revenue model and eschewing payments from issuers, a business model that turned into a form of ratings-for-payment bribe.
3) expunge Too Big to Fail Policy from businesses’ expectation set by making it clear that if any company runs into difficulty it will be allowed to fail. Streamline bankruptcy reorganization procedures, especially for financial institutions, so that the threat is credible.
4) learn to learn from past mistakes. The subprime debacle of 2007 was not the first time that a mortgage securitization scheme in America blew up. It was the seventh. No kidding. Fool me once, shame on you. Fool me twice, shame on me. Fool me seven times and … that is, as they say in Boston, “wicked retawded.”
5) reward regulators for regulating intelligently, for discouraging bubbles, and for acting before matters get out of hand. The status quo is to reward regulators for preparing to fight the last crisis rather than the next one, a flaw that also pervades the TSA’s so-called thinking. But that is another conversation.
6) improve corporate governance by mandating deferred compensation or bonus-malus systems where ever and whenever appropriate, which would include at least some positions in most financial services firms.
All of those proposals have been made by others, but no one else, to my knowledge, has recommended all six.
The construction industry can be fixed by moving away from the current system, where numerous small firms compete based on their strategic bidding and change order skills rather than on their efficiency. Governments and private firms should choose the best bidder, not the lowest one. The best bidder could be ascertained more easily if someone had the incentive to track construction company and individual performance over time. Eliminating the bidding system altogether could work as well, as in new construction systems where architects, designers, and contractors are compensated to develop change order proof plans, or in other words are paid by owners to dramatically reduce both asymmetric information and post-contractual monopoly power. A recent book, the Commercial Real Estate Revolution by Rex Miller and others, essentially calls for the same reform, though for a less compelling reason.
Higher education would be vastly improved if professors were allowed to own their own colleges in professional partnership. Instead of being mere employees, they would be professionals akin to attorneys or business consultants and would have long-term incentives to provide students with the most inexpensive, highest quality undergraduate and graduate educations possible. Under such a system tenure would dissolve of its own weight but academic freedom, the right of tenured professors to say pretty much anything they want to without fear of being fired, would be priced in the market. A professor who is a partner in a college organized as a professional services firm could not be dismissed, he or she would have to be bought out by the other partners, essentially pricing tenure and academic freedom.
Other salubrious reforms would include the government allowing more competition in higher education, the creation of a system of standardized exit exams, the payment of subsidies only to students and not to schools, and passage of a GI-like bill expanded to include a wide variety of public service, not just military duties. Again, almost all of these ideas have been proffered by others, but never as a complete package designed to eliminate the hybrid failures at the heart of rising tuition costs.
The cure for slavery is economic development. Ironically, economists have a very poor track record at creating economic growth in poor countries. That is why vast swathes of Latin America, Africa, and Central Asia continue to suffer with per capita incomes not far above the subsistence level. A growing consensus among an interdisciplinary group of scholars who study the wealth question, however, suggests that national wealth is largely a function of institutional quality, particularly whether the government adequately protects life, liberty, and property or not. Where it does not, poverty is certain, even if oil or diamonds are present. Where it does, wealth is certain, even in barren, windswept places like Iceland … and South Dakota.
Of course dictators control most poor nations and most do not behave as enlightened despots and protect life, liberty, and property of their own accord. I suggest in Fubarnomics that dictators can be rewarded for providing such protections through the judicious use of aid and carefully designed long-term compensation schemes. It’s a long-term fix that won’t alleviate the suffering of all people enslaved today but will help to prevent the enslavement of future generations because slavery is highly unprofitable where governments are against it and where wage laborers are abundant and efficient, as they are in developed economies.
Speaking of enslaving future generations, it is now time for the big two, Social Security and healthcare. Seriously, the former might survive intact if the economy grows really robustly. If growth is anemic, as some fear, Social Security could be extended indefinitely by some combination of tax increases and benefit cuts, including raising the retirement age. My recommendation, however, is to simply eliminate it for myself and every younger than me and to pay the promised benefits to everyone older than me out of general revenues. My rationale here is that younger people still have time to save for retirement but older Americans don’t. Moreover, Social Security payroll taxes are highly regressive and the payout structure is distorted towards preferred groups. As a whole, the system redistributes wealth from poor minority men to middle class white women, a rather cruel and ironic outcome especially after, say, 1970. The structure of the system and demographics virtually ensure that poorer Americans, especially those from disadvantaged minority groups, almost never receive even modest inheritances, a leading spoke in the wheel that perpetuates the cycle of poverty. Due to the payroll tax, the poor can’t afford much whole life insurance or other asset building financial products.
I wouldn’t replace Social Security with anything other than the government’s solemn promise that when people my age and younger get old we will be on our own so we had better start saving now. And don’t worry about silly claims emanating from mass media outlets about the negative effects of higher savings rates on consumption. Via the financial system, one person’s savings becomes another’s consumption. We also need a much better, longer, and more comprehensive system of personal finance education, ideally supplied by teachers and professors in professional partnerships of course. I don’t want to hear any of this bull puckey about “privatizing Social Security” or “investing in the stock market.” Proper investing starts with rainy day savings, preferably in low-cost depository institutions like credit unions, then moves on to insurance, and only then moves on to well diversified portfolios of financial securities, derivatives, and commodities, portfolios that become less risky as the investor’s target retirement age approaches.
Finally, we also need much less but much better financial system regulation. The topic is too detailed to delve into during this talk but suffice it to say that pre-Depression historical precedents suggest that intelligently regulated financial markets and intermediaries can provide Americans with solid private security in a much fairer way and at a much lower overall cost than Social Security has done. Recent and current problems with pensions, 401Ks, life and disability insurance, and other private security products are due to relatively minor hybrid failures that could be fixed in fairly short order if desired.
That leaves us with health insurance. As hinted at previously, healthcare costs would stabilize and perhaps even decline if doctors were rewarded for healing people rather than merely treating them. That may sound like a radical idea but the U.S. healthcare system was moving in that direction when the Depression struck and the government sent us down a very different path. They were called prepaid plans. People paid monthly fees when they were healthy and stopped paying when they were sick. Healthcare providers therefore had strong incentives to keep people from getting sick in the first place and to fix them up quickly if they did fall ill. Today, doctors in most parts of the United States have incentives to keep patients sick. And don’t even get me started on pharmaceutical company incentives.
Another salubrious change would entail the creation of large mutual health insurers, under a general agent sales system, that offer joint life and health insurance policies that I call “health for life.” Mutuals are for-profit corporations owned by their customers, in this case their policyholders. Their profits accrue to the policyholders and to their general agents, which like large blockholders in joint-stock corporations serve to keep the companies’ executives on task. The joint policies would commit insurers to providing large sums for healthcare by promising a life insurance payment as well as health insurance. A rational company would pay healthcare costs up to the discounted present value of the life insurance due multiplied by the probability of treatment success. It’s called incentive alignment and it works much better than government mandates likely to spur premium increases or, if that avenue is blocked, exit from that line of business.
In addition, for a given premium level the life insurance benefit would decline as more healthcare was used and increase if relatively little was utilized. That would help to reduce the adverse selection problem by inducing healthy people to buy more health insurance. “Health for life” policies would also force insured persons, especially those near the end of their lives, to decide between living a few extra months and leaving an estate for their heirs, a vast improvement over the current system which more or less rewards people for receiving as many final treatments as they can get insurers or the government to pay for, no matter how expensive or futile. By leaving the final choice to the individual, “health for life” policies would be far preferable to any sort of non-price rationing system, fictional or factual.
Again, most of these ideas are not entirely original but no one else has offered them all and no one else to my knowledge has a set forth such a clear theory of the causes of such a wide range of economic hyper-dysfunction. I therefore encourage you to buy Fubarnomics, read it, and post 5-star reviews of it on Amazon. … But I also encourage you to critique any aspect of it that you think does violence to reality because, again, my goal is to have policies ready if and when politicians are prepared to save our economy from dying by degrees.
Thank you! I’ll now entertain a few questions.
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