SOTU got me back online...

If there is one thing that excites me about reforming the government, it is not the tax code, senate rules, or commercial and industrial policy. No, what excites me is reforming the bureaucracies that actually implement policy. So I will detail my view of a better and totally possible scheme for the federal government, and then gloss over the enormous gap between my idea and what Obama proposed last night, and declare it a great SOTU because for the first time I actually noticed someone in government taking the first steps towards the inevitable role it must play.

So in a better future, if there is to be one, the federal government must abdicate its largely heavy-handed, hammer-like regulatory efforts to more effective regional governance mechanisms. Leaving aside what the best regional governance regime would be (the breadth of these regimes , and the underlying states composing them will necessarily differ by policy sphere), the purpose for the federal government in this future is to create a common framework for evaluating competing regulatory efforts, preventing beggar-thy-neighbor, race to the bottom schemes, and most importantly spurring innovation efforts within these regional regimes. Having established proof-of-concept in one area, a concept can be expanded to others, and if it is resilient and adaptable enough to suit the objectives of all relevant regions, and data suggest it is a dominant and superior mechanism or policy, the federal government could then anoint the policy as a federal guideline and demand that States toe the line.

This is vastly different from today, where the federal government attempts to balance competing claims, while operating with imperfect data, and being forced to implement broadly and wait and see what happens.

The reason Obama gives my idea a chance of succeeding is that already some of his reforms embrace these ideas. From PPACA's ACO's and the Independent Payment Advisory Board and the Center for Medicare and Medicaid Innovation, to the Race-to-the-top education guidelines, these programs present subordinate operators with a mandate to innovate, demonstrate results, and be leveraged for the benefit of all. Unfortunately, Obama has larger fish to fry, and many areas of policy do not receive the attention they require. Here is a shortlist of critical policy areas that desperately need federal government guidance:

1. State public pension programs
2. State law enforcement
3. State budgeting processes
4. State legal, criminal justice, and rehabilitation systems
5. State transportation spending

I am sure I could go on, but the simple truth is that as a voter for my state reps, I have no idea 1) how well my state compares along any of these issues or 2) how my elected representative's positions have helped or hurt. I'm basically asking for the federal government to develop a report card for our state governments.

One of the most overlooked aspects of the expansion of federal government is that it has been much less a power grab by tyrannical despots, as the right would have you believe, and much more a slow expansion of government prerogatives into a vacuum created by the failure of state governments, who in the counter-narrative are ironically the solution to expanded federal power. In the absence of the federal government, the states had collectively failed to build robust safety nets and implement appropriate financial, environmental, and health/consumer regulations. So we have increasingly turned to the Federal government as the government of last resort. This has become wholly unsustainable, and as many pundits and political scientists have pointed out, has even made the Presidency an un- manageable job.

So Obama is looking for ways to encourage State governments and sub-federal actors to step up and fill the gap. Maybe the appointment of Immelt will be telling in this fashion. GE is much like the future government needs to be from a command and control standpoint - it largely fosters a management culture that encourages its immensely diverse divisions to succeed and innovate, without telling them how to do so.

Fiscal Faux-Conservatives...

In a review of a new study published in the journal Health Affairs, David Leonhardt throws down a pretty rigid gauntlet of fiscal challenges for the country, and particularly republican politicians:

"We are now in a political campaign in which everyone seems to talk about cutting spending without offering many ideas for how to cut spending. When the campaign ends, all that talk won’t balance the budget. Neither will cutting waste, fraud, abuse and foreign aid. Nor will ending the war in Afghanistan and the Bush tax cuts for the rich.

Policies like those can help shrink the deficit, yes. Raising taxes and tweaking Social Security can help even more. But you probably can’t call yourself a fiscal conservative unless you are willing to support changes — that is, cuts — to Medicare"

His link goes back to a recent piece he wrote about how unwilling republicans are to own up to the fact that their campaign promises and rhetoric are completely inconsistent.

The Democrats of course haven't offered any huge plans to reduce spending - I give them credit for passing comprehensive health care legislation, but that is truly a baby step towards introducing the powerful incentives the system will require if the subsidy is to remain affordable. Instead, they will surely raise taxes if push comes to shove. This is definitely more honest and responsible than cutting taxes and making superficial changes to spending, ultimately bankrupting the country.

Markets for Education

Today in the NYT, Jeremy Dehn, who teaches film and video production at the University of Denver, the Art Institute of Colorado and the University of Colorado at Denver, makes a pretty convincing case that adding a "gainful employment" rule that prevents for-profit colleges from earning revenue without delivering improvements in economic outcomes for students is a good and necessary thing.

He won't find any disagreement here. Instead, I'll expand on some of his commentary to discuss how markets help and hurt in education. I'm sure a knee-jerk reaction to this issue in the "smaller, less, weaker government" circles is that the government is getting what it deserves for meddling in the market for education. This would be the wrong conclusion.

An important thing to realize about education is that it is usually not a component of consumption. In most cases, education is an investment, not different from an upgrade of physical capital that makes a factory more productive. Of course, some people take courses for fun and don't apply their learning in the workplace, but this is surely an exception.

Consumption vs. Investment is an important distinction to make because generally speaking private markets for consumption goods function well - people know what they want, value it appropriately, and private parties are able to profit from serving these needs. Alternatively, markets for investment and risk do not always function well. Short-sightedness and risk-aversion dominate individual preferences in these markets, so the collective outcome that can be expected from private markets is suboptimal.

Fully factoring the costs of education, many individuals would not be willing to take the risk of financing education, and most investors would be reluctant to offer financing on affordable terms. Who, other than a good parent, would be willing to finance the education of a five year old, who wouldn't be able to pay back any loans for at least 10 or 15 years? And even at the age of 18, many students who would benefit from increased education will avoid school because the costs are too high. This is the basis for subsidies at all levels of education.

Now of course if the government subsidizes something, and there are private markets that expand to take advantage of those subsidies, things quickly get out of control. Look at the housing and health care markets for a recent and ongoing example, respectively. All the capital that as been privately directed to expanding schools, building homes, and advancing the medical industry is used for these purposes because the government has signaled quite clearly that it intends to pay for these things for more people. The government platform for decades has been expanded access to health care, home ownership and affordable education. We have completely overstimulated these sectors, because appropriate balancing mechanisms were not put in place, and policies were poorly designed.

The issue with education is actually quite similar to the health care problem in many respects. Our well intentioned and necessary market intervention to expand access is in no way tailored to the purpose we are really seeking. We pay private providers for education and health care services regardless of outcome. So their incentive is simply to maximize revenue and reduce costs. Quality and outcomes are not direct financial motivators, so we rely on altruism on the part of doctors and teachers to achieve the actual effect we are seeking - be it healthier or smarter people. I might even argue that doctors and teachers are some of the most altruistic professionals, but even still, with all individual and structural incentives directed at market expansion, the subsidy overstimulates, drives up costs, and quickly appears unaffordable and not worthwhile.

So I conclude with a fairly banal point - we can and should privately organize to deliver goods and services that are publicly financed and subsidized, but we must reform the subsidies in all cases to direct profit making activities towards the ultimate purposes of our policies.

Can the Government Create Jobs? or Wealth?

This morning at Baseline, a guest blogger, Lawrence Glickman from the University of South Carolina, places a historical context around the state's role in promoting fair markets.

As he highlights, the disconnect between the conservative narrative of the state's minimal role in promoting economic activity and progress, and the historical reality that this role was actually huge and remains so, is of course convenient as a propaganda tool for those who have so far succeeded in claiming a greater share of the national wealth for themselves since anytime since the 1920's.

I completely agree with him, but would challenge him to go further. The minimalist state narrative, false and absurd as it is, actually gives far more credit to the government compared to the prevailing doctrine espoused by the faux-populist Tea Partiers and recast Republicans.

Last night on Lawrence O'Donnell's new MSNBC show, The Last Word, Michael Steele, a traitor to his race and a sycophantic cheerleader, while embarrassing himself by not knowing what the federal minimum wage was, stood by a previous statement he made that "Government has never created a single job."

While demonstrably false - the government created the internet for example, which I hear has created a few jobs - there is a deeper problem with this sort of anti-government rhetoric. In the original exchange, which dates to Jan 31 2009, Stephanopoulos admits he doesn't understand the distinction between a government and a private job. Steele, fool that he is, obviously doesn't either, because he basically claims private jobs last longer. Absurd. I will try to explain for Steele the argument he is unable to make, and then debunk it.

The underlying corollary to the idea that government can't create jobs is that socially organized economic models are incapable of creating wealth. No one would deny that government can spend money and put people to work. What Steele is really suggesting is that in any circumstance where this happens, it is a waste of money and a drain on the nations wealth/utility/happiness etc. Following from this, one must argue that police, firemen, teachers, garbage collectors and the whole host of services provided by the government actually destroy wealth, and generate less benefit for society than their cost.

To be clear, I firmly believe competitive markets, with the right structures and conditions, do a better job channeling labor and capital to achieve desired ends. But as noted in the previous post citing Kaletsky, "markets investors are often short-sighted, fail to reflect widely held social objectives and sometimes make catastrophic mistakes." In these instances, the desired outcome may simply not be independently achievable under current market structures, and an active role for government can certainly create wealth.

Now there are plenty of government programs that are wasting money, or are at best on the margin in terms of wealth creation, and these are in need of reform. However, if you believe that fundamentally the government cannot create wealth, then there is no case for reform, instead one must call for abolishing those enterprises, including the government itself. Maybe Steele believes so much in the power of the market that he thinks it would trump the anarchy which would result from following his assertion to its logical conclusion , but I sincerely doubt he is intelligent enough to realize the consequence of his position. I mean, he can't even make his own argument. He thinks the difference is that private sector jobs last longer and come back.

The Markets New Role

Anatole Kaletsky, in an Op-ed for the NYT, predicts the decline of "free-market thinking in international economic management," as well as the rise of greater state intervention in domestic economic management. In a passage highly reminiscent of Daniel Yergin's Commanding Heights, Kaletsky discusses the state prerogative for economic management:

"If market forces cannot do something as simple as financing home mortgages, can markets be trusted to restore and maintain full employment, reduce global imbalances or prevent the destruction of the environment and prepare for a future without fossil fuels?"

His answer to this question is nuanced - "yes and no" - an justifiably so. This article better articulates the options for economic development facing countries today than any that I have recently read. This passage summarizes the balance that must be struck between free markets and government management:

"Yes, because markets are the best mechanism for allocating scarce resources. No, because market investors are often short-sighted, fail to reflect widely held social objectives and sometimes make catastrophic mistakes. There are times, therefore, when governments must deliberately shape market incentives to achieve objectives that are determined by politics and not by the markets themselves, including financial stability, environmental protection, energy independence and poverty relief"

Kaletsky then explains the mechanism for effecting these policies without subsuming the power and benefits of the market, "This doesn’t necessarily mean that governments get bigger. The new model of capitalism evolving in Asia and parts of Europe generally requires government to be smaller, but more effective."

I couldn't have said it better myself. The Fair Market Movement is all about finding market based solutions to social, public and economic problems, without weighing the government with increased responsibility for outcomes. Kaletsky may be giving other countries more credit than is due in terms of the size of their shift from the "Washington Consensus" economic model, but he is spot on in describing America as embodying some of the worst Fair Market principles.

Pension Reform - Half-Baked Proposal

In an Op-ed at Nytimes.com, Richard Riordan and Alexander Rubalcava propose a "Race to the Top" initiative aimed at State and Municipal Pension fund reforms.

The proposal makes sense - have the federal government offer a way to reduce interest payments and guarantee the funds in exchange for much needed reforms aimed at increasing transparency and solvency. Their point that the federal government is already going to be holding the bag on the $1T+ in unfunded liabilities of all the TBTF pensions, so we might as well compel the funds to act more in our interests, is eminently true, and largely unappreciated in the public discourse.

The only issue I take is that they position their proposals to shore up government pensions as a solution to the situation of underfunding. The problem as I see it is that there are pensions at all. The truth is, a pension is by definition underfunded. Pensions have always been a device used by spineless managers and politicans to defer current operating costs by converting them into future liabilities - someone else's problem. Why would someone employ a pension (defined benefit plans) if they didn't intend to underfund it? It would be much less risky for workers to accept the pension contributions (defined contribution plans) and establish themselves an independent investment vehicle, but that would mean employers would have to pay every worker all the money they earned for that time period. Instead former managers, government and private, vastly preferred writing I.O.U.s with an accounting cost of capital of zero (I believe this to be the case, but am not a pension accounting expert).

GM kicked this can down the road for decades, and we all know how that story ended. The State and Muni pensions are next, though they are likely to get funded 100 cents on the dollar. While the taxpayer, local, state and federal, may not be able to dodge this bullet, I think any serious reform proposal for pensions must prevent the politicians and public unions from reloading the gun to our heads.

Private companies already eschew the pension , with most companies trying to wind them down and offering 401K type plans instead. If pension reform is going to be a "race to the top", I certainly hope the finish line is considered pension abolition. I realize it may take years, but we should at least be heading in that direction.

Reinhardt's Panglossian Vision of Policy

In an Economix article today,

http://economix.blogs.nytimes.com/2010/08/27/when-value-judgments-masquerade-as-science/?hp#preview

Professor Reinhardt basically says economists shouldn't weigh in with policy preferences, and should leave this to politicians. Here is my comment on the site, hope it get posted.

Professor, I appreciate the historical context you provide here, but I'm surprised and disappointed that you would prefer economists abdicate any preferences for policy. Your objective model of policy development requires that politicians judge the facts economists provide and make decisions that affect our social welfare. I don't think this is a good idea for a variety of reasons, all of which should be obvious, but I'll just point out that politicians need all the help they can get as far as I can tell.

I understand the fear of Ivory Tower liberal economists master-minding the economy, but I'd prefer that to over-lobbied, partisan, popularity contest winning politicians any day. Do you think if economists had gotten their way for the last 30 years we would have plundered social security, spawned an unaffordable health care industrial complex, underfunded state/muni pensions by trillions, subsidized housing finance cabals, and ran up operating deficits that approach Grecian levels? Its actually hard to imagine things having gone worse, short of losing the cold war, so I'm not sure you have a leg to stand on when you ask experts to stand back at this point.

In fact, the media's favorite poster child for effective economic policies is China, which engages in just the type of tough, undemocratic decision making that you say won't deliver the goods. I'm no fan of that model of getting things done, but it provides an important foil for your proposed model.

Yours is an argument that assumes politicians can be effective leaders, and economists would come up short. I assure you, the former is innocent of the charge, and I'd say the jury is still out on the latter....

To bring this into fair market context, I agree with his point that redistribution of goods through policies should not be a focus of policy. But that doesn't mean that a policy that redistributes welath is bad. Lets imagine, and it won't be hard, that a small group of financial institutions have managed to capture 40%+ of corporate profits, and simultaneously rely on taxpayer guarantees for risk-free financing. now clearly any policy that disrupts this scheme will redistribute wealth from bankers to other businesses and ultimately reduce taxpayers' unforeseen liabilities. Nevertheless this policy would be good - it would make the market more competitive.