Election at the Crossroads

Daniel Henninger has a good essay in the WSJ on what this "historic election" is really about - whether America will turn towards it's creative, innovative impulses or towards its security and protectionist impulses. He subtitles his essay, "Shifting America's animating idea from creation to protection." [Here, subscription req'd]

He concludes that an Obama presidency would

...transform the animating American idea -- away from creation and toward protection.

Many voters -- progressive Democrats, the asset-safe rich, academics and college students -- regard this as where America should go. They explicitly want America's great natural energies transferred away from unwieldy economic competition and toward social construction. They want the U.S. to reduce its "footprint" in the world. Monies saved by stepping down from superpower status can be reprogrammed into "investments" (a favorite Obama word) in a vast Euro-style hammock of social protection programs.

Economist Alan Reynolds estimates this would cost upwards of $4.3 trillion, and wonders where and how these funds will materialize. In a WSJ Letter to the Editor Nobel economist Vernon Smith provides the answer, which I quote in full here:

I think the answer to Alan Reynolds's excellent question and article ("How's Obama Going to Raise $4.3 Trillion?," op-ed, Oct. 24) is that Barack Obama is not going to raise $4.3 trillion, and he is not going to perform on his rhetoric. He excels as a rhetorician -- common to both the great and the least of past presidents -- but performance cannot run on that fuel. Inevitably, I think his luster will fade even with his most ardent supporters as that reality sets in. We also have seen luster fade time after time with Republican presidents. The rhetoric of a smaller and less invasive government always leads to king-size performance disappointments. This weakness is as central to the reality of our political economy as are its strengths. With all its foibles, its strengths become transparent when you compare it, not with our various idealizations, but with the litter of human experiments in political economy that have delivered far more suffering and murder than human betterment to the citizens of those economies.

Of course it is entirely likely that Mr. Obama will succeed in going for higher business, capital gains and income taxes, but it is an economic illusion to think for a minute that this will benefit the poor. All our wars on poverty have been lost by failing to help the poor help themselves. Higher business taxes, which ultimately can only be paid by individuals anyway, will simply export more economic activity to the world economy. Higher capital gains and income taxes will primarily reduce savings and investment at the expense of greater future productivity, which is at the heart of cross-generational reductions in poverty. A dozen countries, including the third largest economy, already have zero taxes on capital gains, and eight of them score high on the Economic Freedom Index and high in gross domestic product per capita.

I favor making all individual savings and direct investments deductible from income for tax purposes. In that world there would be no need to make any distinction between ordinary income and capital gains. By adding a negative feature to such a net consumption tax, the poor would not only receive redistribution benefit, but have an incentive to save and accumulate capital. Some poor will see this as an opportunity to help themselves.

We swung this way politically from 1965 to 1980. In France, they tried it under Mitterand from 1980 to 1988. Neither experiment worked out very well. It won't this time either. One would hope that it didn't have to be either/or on creation vs. protection, but advocates for either direction choose to ignore the trade-off. In Vernon's last paragraph he signals the way out - which is to help the poor help themselves by becoming integrated into the capitalist accumulation process rather than on the outside looking in, hoping an afterthought of noblesse oblige opens the door a crack.

My own response to Henninger's essay was to note that we are stumbling into making a simple error of risk management, which is rooted in human nature and what all this protection is about. For lack of clearer alternatives, we have convinced ourselves that the best protection against risk is national insurance pooling. Essentially, this says we're all in the same boat and we sink or float together. Yet, the best natural survival strategy against risk in this world is to be proactive, i.e. creative and productive, in the face of change. This strategy depends heavily on the incentive structures we face. Unfortunately, the cradle-to-grave welfare state reinforces all the disincentives to manage our fears and uncertainties effectively. Pray we pull back from that long slow decline into complacency and torpor.

PPP = CAP

A mysterious looking equation perhaps. Economists might mistake PPP to stand for purchasing power parity, but in this case it refers to post-partisan politics. Both our presidential candidates have been struggling to advance themselves as the preferred standard-bearer of post-partisan politics, but what that means is anybody's guess. My own reading of the American electorate from a non-ideological perspective is that citizens are interested in a politics that offers policies and institutions that adhere to three principles. These are choice (C), autonomy (A) and protection (P), hence the acronym, CAP. (I've posted on this before here.)

Americans have grown used to a consumer world of choice - from goods to media to services. This extends to the world of social choice and voters don't expect a one-size-fits-all narrowing of choices from their politics. This appears more like a step backwards for a developed society. This pertains to universal social insurance programs like Social Security, Medicare and possibly health insurance.

Second, the strain of independence and autonomy runs deep in American culture. Capitalism and democracy are both meant to empower autonomy and policies that encourage dependency on public institutions run counter to this. (Yes, there are exceptions, covered in the next paragraph.) The recent financial crises have reinforced this suspicion of dependence and lack of trust in unresponsive public or private institutions. The ground for an FDR-style New Deal has shifted.

Lastly, a counter-balance to this desire for freedom and autonomy is a strong demand for protection from contingencies (like 9/11, Katrina or the credit and housing meltdowns) over which individuals have little or no control over their own fate. In most cases, contingency risks are managed by private insurance pools, but in cases where private markets are incomplete we rely on social insurance. This is where the demand for working social institutions comes in, where legal constraints and regulatory oversight play an important role. But, this demand for protection is predicated on the conditions of the previous two principles of choice and autonomy. The idea is to maximize choice and autonomy subject to the constraints of protection and security.

So, to sum up a simple rule on government policy and legislation, we would be wise to remember: PPP = CAP.

Left vs. Right + Rural vs. Urban = Red vs. Blue

Dennis Prager published an essay I found today on RealClearPolitics titled "There Are Two Irreconcilable Americas." He writes:

It is time to confront the unhappy fact about our country: There are now two Americas. Not a rich one and a poor one; economic status plays little role in this division.

There is a red one and a blue one.

He identifies these along ideological lines:

Right and the left do not want the same America.

The left wants America to look as much like Western European countries as possible. The left wants Europe's quasi-pacifism, cradle-to-grave socialism, egalitarianism and secularism in America. The right wants none of those values to dominate America.

This is the ideological component of our political divide - the explanation for the tight polarization of the country into a 50-50 nation. I estimate it explains about one-third or slightly more of our recent electoral outcomes. This ideological component has been dominated by the center-right ever since the Reagan years and it seems to prevail still, though it can be trumped by other factors. We see this in the tension over this election. Neither Obama nor McCain has transcended this divide, but the Bush years and the financial crisis has changed the playing field.

If we look at the politics of the last 40+ years we can see how ideology and party platforms have coincided with geography, which explains the pattern of red vs. blue across the nation. These patterns reflect real differences in lifestyle preferences and values. This is nothing unique to America or our times. For example, Thailand seems to be experiencing the same division in its politics:
"In Thai Protests, a Divide Between Urban and Rural."

The challenge for our politics is to reconcile these divisions and I have to say I'm a bit more optimistic than Prager, who believes one or the other ideological world must win out. America is not like Europe and never will be; trying to make it thus only invites a backlash. Besides, in practical matters European societies have been moving away from state socialism toward markets for years. The developing world is moving that way even more deliberately.

But there are important aspects of a developed society that the traditional right needs to acknowledge - things like a competitive market in health care and spreading the benefits of capitalism by promoting equity participation and defending the rights of ownership. The corporate scandals and moral hazard of the financial sector have dealt a terrible blow to these preconditions.

October Surprise?

It seems like the credit meltdown and financial crisis has delivered the October surprise that caught both campaigns unawares. The public reaction among independents has strongly favored Obama and with the McCain campaign's political bumbling it might be enough to award Obama the election.

However, neither McCain nor Obama has adequately addressed the financial crisis and what policies they will advocate to correct. It seems a bit ironic that free market capitalism is being blamed for what has predominantly been a government-induced mortgage bubble and House members seem to be ducking under the radar. But it falls to market advocates to explain how and why and so far political conservatives have been quite disoriented.

Daniel Henninger of the Wall Street Journal wrote a decent article on Oct 2 about the larger political context of moral hazard (link here - subscription may be req'd). He writes:

This subject -- risk and political moral hazard -- should be at the center of our derailed presidential campaign and its debates. Liberals don't like to hear moral-hazard arguments raised against social-policy goals. The current mortgage nightmare, however, grew primarily from Congress's insistence on increasing home ownership by reducing its risks.

Barack Obama's core proposals on health insurance, trade policy and tax credits all seek to reduce an array of economic risks. John McCain's ideas on health, education and the tax code tilt toward "choice," or letting individuals make judgments about economic risk-taking.

Most of the time, moral hazard is simply academic. Not after this week. Our presidential candidates should have a talk about it.

This is what this election should be about, but it doesn't seem like the political establishment is able to focus.

The result may give us the only purely liberal US president of the post-60s modern age. This combined with a House and Senate that is far more liberal than the population. It will be interesting to see how a center-right polity reacts to future policy proposals that reflect a left-leaning ideology. A bunch of counties on the border between CA and OR want to secede and form their own state. Good luck with that.