Debt Crisis = A Failed Policy Paradigm

The financial crisis of 2008 paved the way for the employment crisis of 2009, which has now paved the way for the upcoming public finance crisis of 2010. Most federal, state and municipal budgets are strained to the breaking point while the economy still has not found its footing. Meanwhile our national politics is obsessed with expensive overhauls of environmental policy and healthcare reform. Our latest policy strategy is an attempt to borrow and spend our way to prosperity, ala Japan of the past twenty years.

It’s tempting to point to a few simple causes of these economic misfortunes, such as mortgage subsidies, loose credit standards, or excess financial leverage, but the truth is that we are experiencing the fallout of a failed policy paradigm.

This paradigm was rooted in the past century with the creation of the Federal Reserve in 1913, the Employment Act of 1946 and the Humphrey-Hawkins Full Employment and Stabilization Act of 1978. It’s a paradigm dependent on many admittedly useful policy tools, including both Keynesian demand stimulus and the Austrian school’s theory of money and credit, the monetarism of Friedman, as well as the supply-siders of the 1980s.

So, in what ways have these approaches failed?

The policy goals are clearly stated: stable GDP growth and full employment. But the economic results have been decidedly mixed: the growth of real incomes laden with an exploding entitlement state, structural budget crises, widening wealth disparities, a catastrophe-prone banking system, and volatile asset markets. We’ve heard the term “systemic risk” bandied about the recent financial crisis, but this report card captures the true risks of the system we’ve created.

Politically and socially, Americans clearly want a society where a growing middle class thrives, opportunity exists for individual success and advancement, and a prosperous elite accepts the responsibilities of power not to exploit the weak and disadvantaged. Instead, our political economy is hollowing out the middle class, creating more dependency among the poor, and fostering a culture of corruption and irresponsibility among the elites . Elsewhere I’ve characterized this current state of affairs as Casino Capitalism and Crapshoot Politics.

Second question: why has our democratic politics failed to deliver? The short answer: Our government is doing too much of what it shouldn’t be doing and not enough of what it should.

Free market economies are very good at producing wealth by harnessing the incentives of market participants. Market prices are valuable information signals that tell everyone how much of each good to produce. Governments, however, no matter how enlightened, cannot attain this efficiency. But, due to the political imperative to “do something” in response to countless demands, they feel compelled to try. Thus the focus on “growing the economy” and “creating jobs.”

Unfortunately, these goals often demand incompatible policies, highlighting the differences between the private and public sectors. Private firms earn profits (i.e., create wealth) by increasing productivity, often by reducing labor costs. However, the public sector follows no profit criteria, so the government increases employment without attention to productivity. Thus, with more public sector jobs we create more employment while producing less. At the same time, the growth of the public sector empowers a politically powerful public union interest in its continued expansion. This is no way for a nation to grow rich.

When we peal away the logic we find the true goal of public sector job creation: political redistribution of the economy’s wealth-creating capacity in order to mitigate the effects of markets. This is not an unworthy societal goal, but our public policies adopt counterproductive means to achieve it.

To be fair, the political problem arises because private markets are agnostic towards the distributional effects of their success. Inequality, poverty, pollution, environmental degradation, the concentration of economic and political power—all these are unfavorable distributional effects of markets that give rise to political demands. The question is over how government should meet these demands.

The 20th century attempt to tax and redistribute wealth has landed the modern welfare state in a cul-de-sac of exploding budgets, rising costs of living, slower economic growth and structural unemployment. We’re robbing Peter to pay Paul and neither – except for a relative handful of bureaucrats and rent-seeking capitalists - is better off for it. This adds up to less opportunity all around. Again, the problem is with our failed paradigm. We need to align our policies with behavioral incentives without surrendering our policy goals to an agnostic market mechanism.

To construct a new paradigm we might do best to return to first principles of what Americans want: freedom, opportunity and justice. In order to enjoy these principles, citizens need to be empowered with choice, autonomy, and protection from unmanageable risks. Only functioning free and competitive markets can provide the necessary resources.

So, what should be the proper role for government?

The maldistribution of resources can be mitigated if citizens participate in the wealth creating process as more than an input labor cost. Public policy should cease deficit spending to promote employment and instead look to creating the necessary environment for private risk-taking, saving, investment, and production. This includes insuring market competition and mitigating the effects of economic risk and uncertainty. Tax and regulatory policies should promote the widespread accumulation, diversification, and access to capital to empower individuals and families with the necessary resources to build wealth and insure themselves against uncertainty. Where private insurance markets are incomplete, there is a role for limited social insurance to fill the gap.

Numerous specific policies flow from this general paradigm shift, for example, we can stop penalizing savings through overly loose credit and onerous tax policies on interest and dividend income. There is no reason not to have a tax-free threshold for capital income that reflects the desired savings level of the median annual income household.

Why have we stuck with a failed policy paradigm? Part of the answer is the Kuhnian nature of scientific revolutions, but the pursuit of power and influence by narrow interests is certainly a determinant factor. Economically and socially, we know where we need to go. Getting there politically is another matter. Our present political leadership (of both parties) certainly is not taking us in that direction.

Debt Clock

A YouTube video on our exploding national debt...

Return to Red vs. Blue - With a Vengeance

It's remarkable, though not surprising, how quickly Obama and Rahm Emanuel got back on track with Red vs. Blue politics. (I'm not sure they ever left, as the campaign promises of bipartisanship and compromise were pretty hollow.)

As this blog has argued persistently, red and blue politics is rooted in far more than campaign politics. In addition, the two parties and the media thrive off partisan conflict, so the temptation to carry that battle directly to the media was too powerful to resist for the Obama administration. The attack on Fox and talk radio are attempts to diminish the appeal of these media outlets while heightening the divisions between alternative and mainstream media.

Voters should not be fooled by this and my guess is that most independents are not. I also suspect the media see little to gain by moving the battleground away from politics to their home field. If an administration can de-legitimize one network, why not another? This is so much white noise.

Ideologues Crash and Burn

One has to wonder about the political competence in Washington DC. First the disaster of the Bushies in the second term and now the face plant of the Obamacrats after only six months in office. My guess is that it is less about a lack of intelligence and more due to the insularity of the political class. One wonders if any of these folks know anything about the real America.

Jay Cost of the HorseRaceBlog provides a good critique of the Obama administration's failure to date to understand the country they're trying to lead. I include it here in full:

August 16, 2009
Obama Misread His Mandate

After a rough week for health care reform, Democratic leaders appear to be pulling back on their demand for a public option. It remains to be seen whether liberal Democrats, especially in the House where they are more numerous, will go along with this. But this is still a step in the right direction to get something passed this year.

The public option was an overreach. The White House's erroneous belief that it could get it through the legislature - or at least that it could let four out of five congressional committees push it - was a misinterpretation of last year's election results. It has already made a similar mistake with cap-and-trade, backing a House bill that appears to have no chance of success in the Senate.

Bismarck once commented that politics is the art of the possible. So far, the White House has not exhibited a good understanding of exactly what is possible in this political climate. It has been acting as though the President's election was a major change in the ideological orientation of the country.

A lot of liberals certainly saw it as such. All the strained comparisons of Obama to Franklin Roosevelt were a tipoff that many were talking themselves into the idea that the 2008 election created an opportunity for a substantial, leftward shift in policy. Yet the election of 2008 was not like the 1932 contest. It wasn't like 1952, 1956, 1964, 1972, 1980, 1984, or even 1988, either. Obama's election was narrower than all of these. FDR won 42 of 48 states. Eisenhower won 39, then 41. Johnson won 44 of 50. Nixon won 49. Reagan won 44, then 49. George H.W. Bush won 40. Obama won 28, three fewer than George W. Bush in his narrow 2004 reelection.

This makes a crucial difference when it comes to implementing policy. Our system of government depends not only on how many votes you win, but how broadly distributed those votes are. This prevents one section or faction from railroading another. It is evident in the Electoral College and the House, but above all in the Senate, where 44 senators come from states that voted against Obama last year. That's a consequence of the fact that Obama's election - while historic in many respects, and the largest we have seen in 20 years - was still not as broad-based as many would like to believe. Bully for Obama and the Democrats that they have 60 Senators, but the fact remains that thirteen of them come from McCain states, indicating that the liberals don't get the full run of the show.

For whatever reason, the Obama administration has acted as if those hagiographical comparisons to FDR were apt. It let its liberal allies from the coasts drive the agenda and write the key bills, and it's played straw man semantic games to marginalize the opposition. For all the President's moaning in The Audacity of Hope about how the Bush administration was railroading the minority into accepting far right proposals - he was prepared to let his Northeastern and Pacific Western liberal allies do exactly the same thing: write bills that excite the left, infuriate the right, and scare the center; insist on speedy passage through the Congress; and use budget reconciliation to ram it through in case the expected super majority did not emerge.

This might have flown during FDR's 100 Days. But this is not 1933 and Barack Obama is no Franklin Roosevelt.

Now that his legislative agenda is stalling, we're seeing the predictable critiques about the outdated United States Senate, which is the real source of the bottleneck: the Connecticut Compromise was meant to protect the interests of small states, but not states that are this small. Rhode Island, yes. Wyoming, no! These arguments will be conveniently tabled whenever the Democrats return to minority status, so I won't bother to address their merits. The bigger question is: what did they think was going to happen? It's one thing to bemoan the fundamental unfairness of the Senate; it's another thing to overlook it when you're formulating your legislative program. The map is what it is: that big swath of red that runs through the middle of the country then swings right through the South should have been a tipoff that the stage was not set for coastal governance.

The President should have realized what was possible and what wasn't, and he should have used his substantial influence to push the House toward the kind of centrist compromise the Senate will ultimately require. That's called building a consensus - something he promised he'd do but has not yet made a serious effort at.

Obamacare Won't Work - These Ideas Will.

The health care system in America needs reform. It works for 85% of the people, but the dysfunctional parts have long ago become the tail that wags the dog. Now the reform is becoming a strident partisan and ideological issue. This is truly unnecessary.

I am amazed how little rationality is applied to the political debate. But I have come across some fruitful ideas that make sense. I include them below. These are culled from WSJ: the first by John Mackey, CEO of Whole Foods and the second by John Cochran, a professor of finance at the U. of Chicago. What's more important is that these reforms are politically feasible because they address the major concerns of the center majority of those people who have health insurance but want to solve the systemic problem for people who don't.

• Remove the legal obstacles that slow the creation of high-deductible health insurance plans and health savings accounts (HSAs). The combination of high-deductible health insurance and HSAs is one solution that could solve many of our health-care problems. For example, Whole Foods Market pays 100% of the premiums for all our team members who work 30 hours or more per week (about 89% of all team members) for our high-deductible health-insurance plan. We also provide up to $1,800 per year in additional health-care dollars through deposits into employees' Personal Wellness Accounts to spend as they choose on their own health and wellness.

Money not spent in one year rolls over to the next and grows over time. Our team members therefore spend their own health-care dollars until the annual deductible is covered (about $2,500) and the insurance plan kicks in. This creates incentives to spend the first $2,500 more carefully. Our plan's costs are much lower than typical health insurance, while providing a very high degree of worker satisfaction.

• Equalize the tax laws so that employer-provided health insurance and individually owned health insurance have the same tax benefits. Now employer health insurance benefits are fully tax deductible, but individual health insurance is not. This is unfair.

• Repeal all state laws which prevent insurance companies from competing across state lines. We should all have the legal right to purchase health insurance from any insurance company in any state and we should be able use that insurance wherever we live. Health insurance should be portable.

• Repeal government mandates regarding what insurance companies must cover. These mandates have increased the cost of health insurance by billions of dollars. What is insured and what is not insured should be determined by individual customer preferences and not through special-interest lobbying.

• Enact tort reform to end the ruinous lawsuits that force doctors to pay insurance costs of hundreds of thousands of dollars per year. These costs are passed back to us through much higher prices for health care.

• Make costs transparent so that consumers understand what health-care treatments cost. How many people know the total cost of their last doctor's visit and how that total breaks down? What other goods or services do we buy without knowing how much they will cost us?

• Enact Medicare reform. We need to face up to the actuarial fact that Medicare is heading towards bankruptcy and enact reforms that create greater patient empowerment, choice and responsibility.

• Finally, revise tax forms to make it easier for individuals to make a voluntary, tax-deductible donation to help the millions of people who have no insurance and aren't covered by Medicare, Medicaid or the State Children's Health Insurance Program.

And this about pre-existing conditions:

What to Do About Pre-existing Conditions
Most Americans worry about health coverage if they lose their job and get sick. There is a market solution.

By JOHN H. COCHRANE

Even if you don't like the massive health-care package being considered in Congress, you have to admit that health insurance and health care in this country are not working well. There are two basic problems:

First, if you get sick and then lose your job or get divorced, you lose your health insurance. With a pre-existing condition, new insurance will be ruinously expensive, if you can get it at all. This, the central defect of American health insurance, explains why most Americans are happy with their current coverage yet also support reform.

Second, health care costs too much. Yes, we get better treatment, but the cost-cutting revolution that has swept through manufacturing, retail, telecommunications and airlines has not touched health care.

The problems are real, but the proposed remedy—even more government intervention—is counterproductive. A market-based, deregulation-focused reform is possible, and it will work.

Health care and insurance are service-oriented, retail businesses. There is only one way to reduce costs in such a business: intense competition for every customer. The idea that the federal government can reduce costs by negotiating harder or telling businesses what to do is a triumph of hope over centuries of experience.

Take the claim that centralized record-keeping can cut costs. In his July 22 press conference, President Barack Obama noted that a new doctor today might run a test again rather than ask for records of a previous result. That seems silly. But maybe it isn't. Maybe the test is cheap, the condition changes, the test can fail, and the cost of setting up an integrated record system between these two doctors isn't worth two tests a year.

The cost-cutting revolutions in other industries didn't settle questions like these with acts of Congress, expert commissions, armies of regulators, or via a "public option"—while leaving in place a system in which consumers have little choice, aren't spending their own money, and suppliers are protected from lower-cost competitors. That approach has never spurred efficiency, and for good reasons. Cost-cutting is painful. Even in Mr. Obama's trivial example, lab technicians and secretaries will lose their jobs to computer programs, and they will complain. Patients might have to get tests at inconvenient times and locations. They will do this when their money is at stake—what people will put up with from airlines for a few dollars is truly amazing—but they will never accept it from the government.

But what about pre-existing conditions?

A truly effective insurance policy would combine coverage for this year's expenses with the right to buy insurance in the future at a set price. Today, employer-based group coverage provides the former but, crucially, not the latter. A "guaranteed renewable" individual insurance contract is the simplest way to deliver both. Once you sign up, you can keep insurance for life, and your premiums do not rise if you get sicker. Term life insurance, for example, is fully guaranteed renewable. Individual health insurance is mostly so. And insurers are getting more creative. UnitedHealth now lets you buy the right to future insurance—insurance against developing a pre-existing condition.

These market solutions can be refined. Insurance policies could separate current insurance and the right to buy future insurance. Then, if you are temporarily covered by an employer, you could keep the pre-existing-condition protection.

Some insurers avoid their guaranteed-renewable obligations by assigning people to pools and raising rates as healthy people leave the pools. Health insurers, like life insurers, could write contracts that treat all of their customers equally.

The right to future insurance could be transferrable to another company, for example, if you move. You could have the right that your company will pay a lump sum, so that a new insurer will take you, with no change in your premiums. Better, this sum could be occasionally placed in a custodial account. If you got sick but had something like a health-savings account to pay high premiums, you could always get new insurance. Insurers would then compete for sick people too.

Innovations like these would catch on quickly in a vibrant, deregulated individual insurance market.

How do we know insurers will honor such contracts? What about the stories of insurers who drop customers when they get sick? A competitive market is the best consumer protection. A car insurer that doesn't pay claims quickly loses customers and goes out of business. And courts do still enforce contracts.

How do we get to a competitive market? The tax deduction for employer-provided group insurance, which has nearly destroyed the individual insurance market, is a central culprit. If we don't have the will to remove it, the deduction could be structured to enhance competition and the right to future insurance. We could restrict the tax deduction to individual, portable, long-term insurance and to the high-deductible plans that people choose with their own money.

More importantly, health care and insurance are overly protected and regulated businesses. We need to allow the same innovation, entry, and competition that has slashed costs elsewhere in our economy. For example, we need to remove regulations such as the ban on cross-state insurance. Think about it. What else aren't we allowed to purchase in another state?

The bills being considered in Congress address the pre-existing condition problem by forcing insurers to take everybody at the same price. It won't work. Insurers will still avoid sick people and treat them poorly once they come. Regulators will then detail exactly how every disease must be treated. Healthy people will pay too much, so we will need a stern mandate to keep them insured. And this step further reduces competition.

Private, competitive insurance markets are a superior way to solve the pre-existing-conditions problem, and the only hope to lower costs.

Red vs. Blue States

Froma Harrop writes this article ("No, Red States Are Not Better Than Blue States") about the fallacies of the red state vs. blue state narrative. Of course, we already know red vs. blue politics is not about state borders, but about population density. The narrative of red and blue states is a myth promoted by the media and the parties...

The End of Red and Blue?

...Yeah, right. I reprint below an article by Andrew Wilson from the WSJ about ideology and politics around the family dinner table. As predicted, a Democratic Obama presidency has done little to bridge the divide.

Politics for Dinner
Debate at home has turned ugly since November.

When it comes to waging battle over the stimulus bill, health care and cap and trade, the folks on Capitol Hill have nothing on my family.

Before escalating to stronger language, my older brother Harry sometimes calls me a “mental defective” in conversations about politics. He thinks that I have been Bush-whacked. I think that he has been L’Obamatized. That is the highly scientific condition of having half of your brain removed and the other half turned into jelly with no off/on switch to control veneration of the 44th president.

Harry and I grew up as the second and third kids in a family of seven children. Loud and heated political argument at the dinner table was a family tradition. That’s continued and become an extended family tradition at gatherings over Thanksgiving and Christmas that often number up to 32 people—including siblings, spouses, children, and grandchildren.

But never before have our debates been more likely to stray into acrimony and ugliness. And never before have the differences of opinion between family members been so striking.

We used to take great pride as a family in having freewheeling, no-holds-barred discussions about politics and world events. Now it’s come to the point that all of us must exercise some self-censorship in order to maintain an amicable level of discourse.

The most outspoken among us, my younger sister Dodie, has been urged by her own kids to tone down her libertarian, anti-Obama rhetoric. Though her children agree with her sentiments, it embarrasses them in front of their friends. (This is especially so for the two children now at a prestigious college where public criticism of the current occupant of the White House is almost verboten).

One could liken the situation inside my extended family to a second War of the Roses, with Lancastrian Obamaites on one side and Yorkist Bushites on the other. Harry, the leading Lancastrian, and a lawyer by trade, inveighs against the negativity of those supposedly afflicted with “Obama derangement syndrome.”

But what of the “George W. Bush derangement syndrome”— the notion that Mr. Obama must be Superman to make up for the colossal blunders of his predecessor? The president certainly never misses a chance to belittle the former president. Following Obama’s cue, the Obamaites in my family heap every kind of blame on George W., and then pin the Bushite label on the rest of us who disagree.

In fact, this is a false label. None of us could be described as an avid and devoted follower of George W. I, for one, believe that he made an awful mess of things in the closing months of his presidency when he endorsed the idea of bailing out big banks and auto companies.

So it goes in the extended Wilson family. We squabble. Or, for the sake of family harmony, we muzzle our old instinct to engage in honest debate.

In the midst of the so-called Great Recession, there are some in my family who see Barack Obama as hero and savior. Others tremble at the massive extension of government power and the winnowing down of freedom, personal responsibility and belief in private enterprise as the one true engine of economic growth and progress.

Harry and I will go on being brothers and good friends. But like the American people as a whole, we are politically estranged in a way that marks a real departure from the past.