Historical Precedents Reason for Hope

A look back in time will provide not only context but hope for a better economy. Comparisons of the Great Recession with the Great Depression often lead to a concern that it took World War II to end that depression. As Christina D. Romer writes in “The Hope That Flows From History,” (New York Times August 11, 2011), “what is going to save us today?”

Romer answers that while the war speeded the recovery, the economy was “improving long before military spending increased. More fundamentally, the wrenching wartime experience provides a message of hope for our troubled economy today: we have the tools to deal with our problems, if only policy makers will use them.”

“Monetary expansion was very effective in the mid-1930s, even though nominal interest rates were near zero, as they are today,” say Romer. She takes heart that the Federal Reserve may be using its available tools more aggressively in the coming months as a lesson learned. Another lesson “is to beware of withdrawing policy support too soon. A switch to contractionary policy before the economy is fully recovered can cause the economy to decline again.” Romer points out that reducing the deficit more sharply in the near term could be a crucial mistake. She says, “The lesson here is that fiscal stimulus can help a depressed economy recover” as demonstrated in depression.

Looking at mismatch of skills and jobs then and now, Romer notes that “because nearly 10 million men of prime working age were drafted into the military, there was a huge skills gap between the jobs that needed to be done on the home front and the remaining workforce. Yet businesses and workers found a way to get the job done. Here the lesson is that demand is crucial – and that jobs don’t go unfilled for long.”

Romer’s last point is about the national debt. She says, “At the end of WWII, the ratio of debt to GDP hit 109% — one and half times as high as it is now. Yet this had no obvious adverse consequences for growth or our ability to borrow.” She calls for a bolder approach more like that taken in WWII to solve our economic malaise today. Romer says, “Unemployment of roughly 9% for 28 months and counting is a national emergency. We must fight it with the same passion and commitment we have brought to military emergencies in our past.”

The Good, the Bad and the Ugly!

Now that the legislative session is over, business is busy sorting out the good, the bad and the ugly.

The Good:  Governor Brown formalized his Office of Business and Economic Development. GO ED was established in April 2010 via executive order but this action ensures that California now has a permanent and highly visible single point of contact for economic development and job creation efforts. Governor Brown also signed into law a bill that, among other things, requires a standard economic impact analysis for major regulations at the beginning of the regulatory process.

The Bad:  Governor Brown vetoed a requirement that the state begin “performance-based budgeting,” forcing each state agency to provide lawmakers its goals, targeted outcomes and performance data. This bill was strongly supported by the business community.

The Ugly:  California’s revenue for September missed the state’s budget projection by $301.6 million, raising the prospect that spending cuts could be triggered early next year, the state controller said. “For better or worse, the potential for revenue shortfalls is precisely why the governor and Legislature included trigger cuts in this year’s state spending plan,” Controller John Chiang said in a statement. “September’s revenues alone do not guarantee that triggers will be pulled. But as the largest revenue month before December, these numbers do not paint a hopeful picture,” Chiang said. Revenue from the start of the current fiscal year in July through September is trailing budget estimates by $705.5 million, Chiang said. (“California’s September revenue misses target,” Reuters, Oct. 10, 2011)

Starve the Beast?

Is Darwin’s natural selection theory a better framework to understand our Economy? Starve the Beast? by Robert Frank, is an excerpt from his new book, The Darwin Economy: Liberty, Competition, and the Common Good. Frank posits that one day Charles Darwin, not Adam Smith, will be considered the father of economics. Read the article and the book to see if you agree!

By means of three separate Congressional earmarks in 2005, a total of $320 million was proposed for the construction of a bridge linking the town of Ketchikan, Alaska, with its airport on Gravina Island. Dubbed “The Bridge to Nowhere,” the project quickly became a celebrated symbol of waste in government.

This particular bridge was a terrible idea from the beginning. Ketchikan’s population at the time was less than 9,000 and Gravina’s was only fifty. Ferry service provided transportation between the town and the island at a fee of $6, at fifteen- to thirty-minute intervals, depending on the time of day. Having bridge access would have been more convenient, obviously, but nowhere enough so to justify the enormous cost of the project.

Yet if the bridge was such an obvious loser, why was it slated for construction in the first place? The answer to that question reads word-for-word from the dog-eared script of antigovernment crusaders. The politicians who proposed the project hoped to curry favor with the local voters who would directly benefit from it, while foisting the bill on millions of distant and unsuspecting taxpayers, who would never even notice, much less complain about, the eventual small increment in their tax bills. Legislators from other states supported the proposal in the rational expectation of receiving reciprocal support for their own pork projects when the time came.

The encouraging coda to this story is that a firestorm of unfavorable national publicity eventually forced the project’s cancellation. In each congressional budget, however, a host of other proposals survive because they’re too small to make it onto the public’s radar screen.

Antigovernment crusaders are clearly onto something. There is waste in government. But the interesting question is what to do about it. Many libertarians believe that the best strategy is to “starve the beast.” Or, as Grover Norquist, president of the anti-tax advocacy group Americans for Tax Reform, colorfully put it, “I don’t want to abolish government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub.”

Starve-the-beast proponents make a simple point. Since money sent to Washington (or Sacramento or Albany) will inevitably be wasted, the solution is to send as little money as possible to those places. California has been fertile ground for proponents of the starve-the-beast approach because of the state’s unique constitutional provision that permits legislative proposals to be decided directly by voters.

It’s been said that if you want to see where America is headed, you should study California. The state was the first jurisdiction seriously to tackle the problem of air pollution from auto emissions. It led the way in promoting energy-efficient appliances. It was a forerunner in the expansion of rights for women and minorities. It was among the first to confront the issue of secondhand smoke. And it also spawned the anti-tax crusade that has dominated public discourse for the past three decades.

On June 6, 1978, Proposition 13 won the approval of almost 65 percent of Californians who voted in an election with near-record turnout. Officially called the People’s Initiative to Limit Property Taxation, the main provision of this measure was to limit California property taxes to 1 percent of a property’s assessed valuation, which in turn would be prohibited from rising more than 2 percent in any year.

Debate continues about the specific details of Proposition 13’s impact on the state. But no one seriously questions that it significantly dampened what had been a long-run upward trend in tax revenues. Unlike the federal government, state governments are generally not permitted to run persistent budget deficits. There is thus little question that Proposition 13 also prevented much government spending that otherwise would have occurred.

Since at least some of that spending would have been wasteful, the supporters of Proposition 13 can claim, without fear of contradiction, to have eliminated some government waste. But it’s a much harder task to persuade neutral observers that Proposition 13 made California a better place to live. All government programs exist because legislators have constituents who favor them. Some of these programs deliver good value for the money. Others are boondoggles. When revenue shortfalls force government to make budget cuts, the best predictor of which programs get the ax is the power of the particular constituents who support them. As Alaska’s Bridge to Nowhere clearly demonstrates, however, the mere fact that a group supports a project does not mean that it serves the broader public interest. The inescapable conclusion, then, is that Proposition 13 has also caused many worthwhile programs to be cut.

What’s been the net effect? In his 1998 book Paradise Lost, Peter Schrag grappled with that question. Schrag, who had been the editorial page editor of the Sacramento Bee for nineteen years, offered a meticulously researched and studiously nonpartisan account of the state’s economic and social history during the two decades following passage of Proposition 13 and numerous other ballot initiatives aimed at curbing the scope of government.
The portrait that emerges is of a state dramatically different from the one that had been “both model and magnet” for the nation during the generation immediately following World War II. The California government’s fiscal position has continued to deteriorate sharply in the years since Paradise Lost was published, and its overall prosperity relative to other states has fallen spectacularly. In 2009 alone, for example, revenue shortfalls forced the state to make some $20 billion in additional budget cuts. But even the first twenty years of Proposition 13 had left the state a very different place. Thus, Schrag wrote,
California’s schools, which, thirty years ago, had been among the most generously funded in the nation, are now in the bottom quarter among the states in virtually every major indicator—in their physical condition, in public funding, in test scores—closer in most of them to Mississippi than to New York or Connecticut or New Jersey. . . . Its once celebrated freeway system is now rated as among the most dilapidated road networks in the country. Many of its public libraries operate on reduced hours, and some have closed altogether. The state’s social benefits, once among the nation’s most generous, have been cut, and cut again, and then cut again. And what had once been a tuition-free college and university system, while still among the world’s great public educational institutions, struggles for funds and charges as much as every other state university system, and in some cases more.

Proponents of Proposition 13 counter that other factors have been important in the state’s long-run relative decline. Undoubtedly so. Yet the fact remains that chronic revenue shortfalls have been at the core of the state’s problems.
Antigovernment activists insist that the best way to deal with revenue shortfalls is to eliminate wasteful government spending. Who, other than the direct beneficiaries of a wasteful program, could possibly object? The difficult question is how to eliminate wasteful spending without inflicting even more costly collateral damage. Experience suggests that the starve-the-beast strategy is not the answer.

Starve-the-beast proponents might be likened to a doctor who treats a patient suffering from intestinal parasites by ordering him to stop eating. The patient’s food intake, he explains, is the very lifeblood of the parasites. Cut that off, and they will eventually die. Well, yes. But the patient himself may die first, or be seriously damaged in the process. That’s why the approved strategies for attacking parasites all take a much more targeted approach. They attempt to inflict damage on the parasites directly, while minimizing collateral damage to their host.

It’s instructive to push the parasite-host analogy a step further, by noting that no complex organism is ever completely free of parasites. Yes, the organism benefits from reducing its parasite load, and that’s why natural selection has always favored organisms with effective immune systems. But natural selection has always favored the most effective parasites, too. The battle against parasites entails costs as well as benefits. The rule of thumb for how to wage such battles is the same as that for battles in other domains: use the most cost-effective weapons first, and use them to attack the most dangerous parasites. But eventually a point comes at which the cost of the next weapon exceeds the costs imposed by the most dangerous remaining parasite. Beyond that point, additional parasite reduction actually leaves the organism worse off.
The same logic applies to the problem of waste in government. The best way to reduce it is surely to reach first for the most cost-effective weapons at our disposal and deploy them against the most important causes of waste directly. To do that, of course, we must ask why waste exists in the first place. Often the answer is that politicians support wasteful programs because of demands from important campaign donors. A good place for opponents of waste to focus might thus be on legislation that could reduce legislators’ dependence on large campaign contributions. (Small donations pose a less serious threat because the individuals who make them are in no position to extract major concessions from legislators.) The cost of enforcing stricter campaign finance laws would be relatively low, and such laws would be likely to curb some of the most important sources of government waste. But the U.S. Supreme Court has shown little inclination to support stricter campaign finance laws in recent years. On the contrary, its controversial ruling in the Citizens United v. Federal Election Commission case appears to signal the court’s intention to roll back even long-standing limits on corporate campaign contributions.

Unless the court reconsiders, opponents of government waste will have to continue working their way down the list of alternative strategies. One lesson of the Bridge to Nowhere episode, for example, was that boondoggles are less likely to survive politically when more voters learn about them. The information revolution has greatly reduced the cost of putting information in front of voters, so we might make some progress there. But the same revolution has also caused explosive growth in the total amount of information that bombards us each day. Thus it may be just as hard as ever to draw voters’ attention to any particular wasteful program.

In short, attacking government waste is a project that will be with us forever. Going forward, new technologies and better institutional design may facilitate significant progress, but they will never eliminate waste entirely.
Government may be imperfect, but there are no countries without one. The territory of any such country would have long since been invaded and claimed by some other country with a government and an army. So our challenge is to come up with the best government possible.

Transparency International, a Berlin-based nonprofit group, conducts periodic surveys to assess the quality of the world’s governments. The organization publishes a Corruption Perceptions Index (CPI), based on its definition of corruption as “the abuse of public office for private gain.” Its surveys ask respondents to report “the degree to which corruption is perceived to exist among a country’s public officials and politicians.” Some countries, such as Myanmar and Somalia, are perennially near the bottom of Transparency International’s CPI. It’s no accident that they and other persistently low scorers on that index—which include Afghanistan, Haiti, Tonga, and Uzbekistan—are among the poorest nations on the planet.

Government may be imperfect, but there are no countries without one. Our challenge is to come up with the best government possible. Notwithstanding the rhetoric of antigovernment crusaders, there seem to be some governments that are relatively free from corruption and do at least a reasonable job of responding to their citizens’ demands for public goods and services. In a three-way tie for the least corrupt government on Transparency International’s 2007 list were Denmark, Finland, and New Zealand. Singapore, Sweden, Iceland, The Netherlands, Switzerland, Canada, and Norway rounded out that year’s top ten in that order. Here, too, it’s surely no accident that most of these countries are among the richest on the planet.

The causality undoubtedly runs in both directions. Having a more honest and effective government helps support activities that raise per-capita income. And being richer generally makes citizens more able and willing to support more effective forms of governance. But the correlation between per-capita income and the CPI is far from perfect. For example, the United States, which had higher per-capita income than any of the top ten on the 2007 CPI, ranked only twentieth-best on that list, primarily because of perceptions that our campaign finance system had corrupted Congress.

In countries with honest and effective governments, the view that promoting good government is a worthwhile investment would not strike most observers as absurd. Yet that does not seem to be the position of antigovernment evangelists in the United States, many of whom view government service with thinly veiled contempt. The foundation of honest and effective government is a professional civil service that takes pride in its work. Fostering a climate in which government is viewed with contempt inevitably makes it more difficult to recruit talented and dedicated civil servants.

If we must have a government, it’s surely worth thinking seriously about how to promote good government. What public goods and services do we want? How can we best raise the money to pay for them? And how can we attract the kinds of civil servants we’re willing to install in positions of trust? Going forward, questions like those should be our main focus.

Robert Frank is the Louis Professor of Management in the Johnson School, a New York Times columnist, and the author of such books as Luxury Fever, Falling Behind, and The Economic Naturalist’s Field Guide. He also co-authored the textbook Principles of Economics with Ben Bernanke.

Welcome to the Great Transition!

Stop thinking of recovery and double dips, what’s happening now is far bigger than a business cycle and taking us into uncharted waters. Here are three ways our economy is transitioning and what that means for jobs, growth and America as the world leader.

Shift of Economic Center of Power from West to East
According to Eisuke Sakakibara, former Vice-finance Minister for International Affairs of Japan, speaking at the Business Times Singapore Investment Roundtable on What if there is a double dip? posted by William R. Thomson on September 12, 2011, “The centre of gravity of the world economy is shifting from West to East and we have to cope with it. Such a transition is certain to be very difficult. I would say that the 1930s Depression marked the failure of the transition from the UK to the US and the transition this time is much larger than that of the 1930s. (There could be) some kind of simultaneous, worldwide recession, or even a Depression, sooner or later. Look at what is happening to the US economy and the European economy. China and India are not big enough yet to substitute for these.”

The Economist’s “East or famine,” (February 10, 2010) backs up Sakakibara’s view, “If GDP is instead measured at purchasing-power parity (PPP) to take account of these lower prices, Asia’s share of the world economy has risen more steadily, from 18% in 1980 to 27% in 1995 and 34% in 2009. By this gauge, Asia’s economy will probably exceed the combined sum of America’s and Europe’s within four years. In PPP terms, three of the world’s four biggest economies (China, Japan and India) are already in Asia, and Asia has accounted for half of the world’s GDP growth over the past decade.”

The article points out that “Winston Churchill once said: ‘The longer you can look back, the farther you can look forward.’ The new economic order is in fact a resurgence of a very old one. Asia accounted for over half of world output for 18 of the past 20 centuries. And its importance will only increase in the coming years. Rich countries’ growth rates are likely to be squeezed over the next decade as huge household debts dampen spending, and soaring government debt and higher taxes blunt incentives to work and invest. In contrast, growth in emerging Asia (almost four-fifths of the region’s total output) is likely to remain strong. Robust growth should also give governments in emerging Asian economies the confidence to let their currencies rise, which would further boost the relative size of their economies in dollar terms.”

And the Economist predicts that “By 2020 Asia could well produce half of some big Western multinationals’ sales and profits, up from a typical proportion of 20-25% today. Asian staff eagerly await the day when they can fix the times for international conference calls, so Europeans and Americans have to put up with after-midnight discussions with the Beijing office. That may be the best test of whether economic power has really shifted east.”

Consumer Economy is Gone and Not Coming Back
In “We’re Spent,” David Leonhardt, (New York Times Sunday Review, July 16, 2011) declares the death of the consumer economy. “The notion that the United States needs to begin moving away from its consumer economy — toward more of an investment and production economy, with rising exports, expanding factories and more good-paying service jobs — has become so commonplace that it’s practically a cliché. It’s also true. And the consumer bust shows why. The old consumer economy is gone, and it’s not coming back.”

Leonhardt says, “Sure, house and car sales will eventually surpass their old highs, as the economy slowly recovers and the population continues expanding. But consumer spending will not soon return to the growth rates of the 1980s and ’90s. They depended on income people didn’t have. The choice, then, is between starting to make the transition to a different economy and enduring years of stop-and-start economic malaise.”

Cautioning that now is not the time for the government to stop spending, too, Leonhardt says, “The prospect of that cycle is one reason an impasse on the debt ceiling, and a government default, could do so much damage. But the debt-ceiling debate doesn’t have to be yet another problem for the economy. The right kind of agreement could help soften the consumer bust and also speed the transition to a different kind of economy.”

According to Leonhardt, “The biggest flaw with the past stimulus was that it imagined that the old consumer economy might return. Households received large tax rebates, usually with little incentive to spend the money (the cash-for-clunkers program being the exception that proves the rule). People did spend some of these across-the-board rebates, and kept economic growth and unemployment from being even worse, but also saved a sizable portion.”

Leonhardt wants tax cuts to businesses, “but only to those expanding their payrolls and, in the process, helping to solve the jobs crisis. Along similar lines, a budget deal could increase funding for medical research and clean energy by even more than President Obama has suggested. These are the kinds of investments that have brought huge returns in the past — think of the Internet, a Defense Department creation — and whose price tags are tiny compared to, say, Medicare or the Bush tax cuts.” Sadly, he doubts that the political climate will allow this to happen but observes that a protracted process in Congress will mesh with a consumer bust that will last for a very long time.

Freelance Workforce is the Industrial Revolution of Our Time
Sara Horowitz writes in “Freelance Workforce is the Industrial Revolution of Our Time,” (The Atlantic Monthly, September, 2011) that the U.S. workforce is experiencing a dramatic transition. She says, “It’s been called the Gig Economy, Freelance Nation, the Rise of the Creative Class, and the e-conomy, with the “e” standing for electronic, entrepreneurial, or perhaps eclectic. Everywhere we look, we can see the U.S. workforce undergoing a massive change. No longer do we work at the same company for 25 years, waiting for the gold watch, expecting the benefits and security that come with full-time employment. Today, careers consist of piecing together various types of work, juggling multiple clients, learning to be marketing and accounting experts, and creating offices in bedrooms/coffee shops/coworking spaces. Independent workers abound. We call them freelancers, contractors, sole proprietors, consultants, temps, and the self-employed.”

Horowitz says, “This transition is nothing less than a revolution. We haven’t seen a shift in the workforce this significant in almost 100 years when we transitioned from an agricultural to an industrial economy. Now, employees are leaving the traditional workplace and opting to piece together a professional life on their own. As of 2005, one-third of our workforce participated in this “freelance economy.” Data show that number has only increased over the past six years. Entrepreneurial activity in 2009 was at its highest level in 14 years, online freelance job postings skyrocketed in 2010, and companies are increasingly outsourcing work. While the economy has unwillingly pushed some people into independent work, many have chosen it because of greater flexibility that lets them skip the dreary office environment and focus on more personally fulfilling projects.”

Identifying three major trends that will have an enormous impact on our economy and our society, Horowitz says:

1. We don’t actually know the true composition of the new workforce. After 2005, the government stopped counting independent workers in a meaningful and accurate way. Studies have shown that the independent workforce has grown and changed significantly since then but Washington can’t fix what it can’t count. Since policies and budget decisions are based on data, freelancers are not being taken into account as a viable, critical component of the U.S. workforce.

2. Jobs no longer provide the protections and security that workers used to expect. The basics ¬ such as health insurance, protection from unpaid wages, a retirement plan, and unemployment insurance ¬ are out of reach for one-third of working Americans. Our current support system is based on a traditional employment model, where one worker must be tethered to one employer to receive those benefits. Given that fewer and fewer of us are working this way, it’s time to build a new support system that allows for the flexible and mobile way that people are working.

3. This new, changing workforce needs to build economic security in profoundly new ways. When it was passed in the 1930s, the New Deal provided workers with important protections and benefits ¬ but those securities were built for a traditional employer-employee relationship. The New Deal has not evolved to include independent workers: no unemployment during lean times; no protections from age, race, and gender discrimination; no enforcement from the Department of Labor when employers don’t pay; and the list goes on.

Horowitz concludes, “The solution will rest with our ability to form networks for exchange and to create political power. I call this “new mutualism.” I believe that new mutualism will be at the core of the new social support system that we need to build for the new workforce.”