Wednesday, November 26, 2014

Taming Leviathan

STANFORD – A successful society needs effective, affordable government to perform its necessary functions well, and that includes sufficient revenue to fund those functions. But a government that grows too large, centralized, bureaucratic, and expensive substantially impairs the private economy by eroding individual initiative and responsibility; crowding out private investment, consumption, and charity; and damaging incentives with high tax rates. It also risks crowding out necessary government functions such as defense. That is today’s Europe in a nutshell, with America not far behind.

The recent death of James M. Buchanan, the father of public-choice economics, is reason to reflect on his sage warnings. Buchanan was awarded the Nobel Prize in 1986 for bringing to the study of government and the behavior of government officials the same rigorous analysis that economists had long applied to private economic decision-making. Buchanan concluded that politicians’ pursuit of self-interest inevitably leads to poor outcomes.

Buchanan’s analysis stood in marked contrast not only to Adam Smith’s dictum that the pursuit of self-interest leads, as if “by an invisible hand,” to desirable social outcomes, but also to the prevailing approach to policy analysis, which views government as a benevolent planner, implementing textbook “solutions” to market failures.

According to this view, if markets do not fully internalize all of the costs of private action – environmental pollution is a classic example – some “optimal” tax or subsidy supposedly can correct the problem. So, if a monopoly is restricting output and raising prices, regulate firms and industries. When weak demand leads to recession, increase government spending and/or cut taxes by just the right amount, determined by a Keynesian multiplier, and – presto! – the economy rebounds quickly.

Buchanan considered such analysis romantic. He showed that public officials, like everyone else, are driven by self-interest and governed by the rules and constraints operating in their economic environment. Households have a budget constraint. Firms have technological, competitive, and bottom-line constraints. For politicians, the ability to exercise power – for their own interests or those of vested interests – is constrained by the need to get elected.

Buchanan predicted that, by hiding the full costs, the ability to finance public spending through deficits would lead to higher spending and lower taxes at the expense of future generations, whose members were not directly represented in current voting. He predicted ever-larger deficits and debt – and ever-larger government as a result.

On this issue, Buchanan was, unfortunately, prescient – and well before financial crisis and deep recession led to yet another jump in the size and scope of government, accompanied by large deficits and exploding debt in the United States, Europe, and Japan. Buchanan argued tirelessly for lower government spending, balanced budgets (even a balanced-budget amendment to the US Constitution), and streamlined regulation.

Buchanan, along with Milton Friedman and many others, correctly pointed out that government failures are as numerous as market failures. So, even in areas like infrastructure or education, it is necessary to compare the benefits and costs of the imperfect fiscal and regulatory policies likely to be implemented by fallible, self-interested officials with potentially imperfect market outcomes.

These government failures include rent-seeking, pork-barrel spending, social engineering, regulatory capture, and induced dependency. Market failures or claims of unmet need are not sufficient to prescribe government intervention in the private economy, because the cure may be worse than the disease.

There are, of course, important, successful government programs. In America, the post-World War II G.I. Bill financed higher education for demobilized soldiers, and was a highly beneficial public investment in human capital. Social Security has helped reduce poverty among the elderly. The military has kept the US safe and free.

But the gap between textbook solutions drawn up in universities and think tanks and the reality on the ground can be vast. More spending or regulation does not always lead to better outcomes.

Government spending is no less subject to diminishing returns than anything else. Programs become entrenched, develop powerful constituencies, and are hard to shrink. Few programs are targeted carefully enough to real needs – or to the really needy – as politicians buy votes by spreading coverage far beyond what is needed to achieve programs’ stated goals. Hence Buchanan’s disdain for romanticizing government action.

In country after country, one casualty of the ongoing debate over spending, taxes, deficits, and debt has been efforts to make government more effective and efficient. In most areas of government, from defense to entitlements, better outcomes can be achieved at much lower cost, which should please both the left and the right.

For example, America’s federal government has 47 separate job-training programs in nine different agencies, costing almost $20 billion a year, most of which the Government Accountability Office reckons are ineffective or poorly run. President Barack Obama added the 47th – for green-energy job training – in 2009. The success rate was so poor (a tiny percentage of participants got targeted jobs) that the Labor Department’s Inspector General recommended shutting it down – and this at a time of massive unemployment, with firms listing millions of job openings but unable to find workers with the required skills.

We have seen what ultimately results when unsustainable spending leads to exploding debt: economic chaos and human tragedy. Somewhere between “romanticized” government solutions to problems and Buchanan’s self-interested government officials, we must find leaders willing to eliminate poorly performing programs; modernize, streamline, and consolidate others; improve services; and limit pressure for ever-higher growth-destroying taxes.

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    1. CommentedParrain Boursorama

      And while the initial Kibbutz movement lost its force and vigor as the country became westernized, the safe and prosperous future of Israel necessitates the return to a similar close, family-like national unity, mutual cooperation and understanding.

    2. CommentedAidan Kelly

      Some great posts on this, Zsolt you are on to the answer, public and private not too cosy but cooperative and with a real commitment to shared value. Economic growth, wise use of capital, private investment, government spending, optimising growth and sharing the benefits: if only it was that easy. Will the system ever be that finely tuned? How to manage debt (societal tooth decay) and unsustainable spending and sub-prime investments in housing and infrastructure. Yes all institutions need to use money wisely and not generate significant impacts (social and environmental) but how do we get to the point where the human machine - is so finely tuned. That is the challenge. Better elected representatives is only part of the answer. Believe it or not the answer lies is moving towards more equitable use of energy. The same amount for each person, give or take some necessary variations. Money as the dominant a unit of currency will not foster equality.

    3. CommentedKen Presting

      Prof. Boskin's argument is typical of his Hoover Institution fellows. It is not just an argument against the possibility of good government, but against the possibility of any fiduciary relationship whatsoever. According to his reasoning, no investor should trust any management nor any board of directors - all of them will be out for themselves alone, interested only in fleecing those with less leverage or less information.

      But the weakest point in his argument is his straw-man suggestion that advocates of good government need to claim that government interventions must be "optimal" in order to be worthwhile. No thoughtful American (and after Churchill, no thoughtful Briton) expects a government to do better than muddle through.

      The real difference between government and private enterprise has been clear since Hobbes: government is specifically in the business of catching and punishing criminals. That applies to private criminals as well as criminals who abuse public office for private gain.

      The relevant economic concept is not optimality but "admissibility" - the property of not being as bad as the other available options. The American constitution deliberately sets each branch of government against the others in the famous "checks and balances." We don't expect administrators to pure pure, we simply expect them to be watching each other.

      Only a fool would expect public decisions to be "optimal," as many well-known theorems in econ attest. At the same time, only a fool would expect a free market to remain efficient in the absence of vigorous, diligent policing.

      Government need not pretend to be a savior to defend its role as a necessary evil. Prof. Boskin and fellows need to show it is unnecessary, which none of them ever attempts.

    4. CommentedAyse Tezcan

      As I was reading some papers on the expansion of large data processing and personalized medicine, I started thinking about this sky falling approach towards borrowing and leaving debt to our future generations, who supposedly have not democratically consented to generating that debt.

      I have come up with two arguments that might warrant considering.

      Firstly, if we look back historical discussions, the same concern has been expressed for centuries despite the fact that US has continued becoming the bedrock of progress. We have always bounced back from financial distress thanks to innovative fabric of this nation, which has been mainly fueled by the public investments. The newly emerging technologies will require financing that private sector will not either have capacity or vision.

      Secondly, we can also argue that the next generation has not participated in the making of the wealth as well as spending of it. Sometimes, as parents we make decisions thinking the best interest of our children at the time, and some of these decisions may turn up to be wrong. The beauty of this nation is that the new generation takes the responsibility and remakes its country with the best opportunities available at the time. Some of these opportunities provided by the govs, such as providing the grounds for internet and space technology. However, free market determines what direction to move according to demands.

      PS. oversight of the corrupt politicians has been getting better and better thanks to social media (and thanks to the grounds work laid by public funding), and I believe a good balance of gov and markets is the best policy for a vibrant economic growth as we have in US. I also think that some of the crowding out private investment, consumption, and charity is a result of economic environment not the policy implications in US.

    5. CommentedG. A. Pakela

      There is a real answer, one hinted at by the article, and that is to go back to the "Clinton-Gringrich" game plan. That is to limit future government spending growth to the rate of inflation on a sustained, multi-year basis for enough years for real growth and corresponding tax revenue increases to catch up with government spending.

      The original deficit spending bill negotiated between Clinton and Gingrich called for the elimination of the deficit by 2002. The actual results exceeded the estimates by several years, but the concept remains the same. While President Clinton indeed raised taxes at the beginning of his first term, the Clinton era tax rates were still lower than they were throughout almost the entire Reagan presidency, and much lower than the pre-Reagan post-war era.

        CommentedJohn Brian Shannon

        G.A. Pakela,

        I certainly agree with your comment:

        "...go back to the "Clinton-Gringrich" game plan. That is to limit future government spending growth to the rate of inflation on a sustained, multi-year basis for enough years for real growth and corresponding tax revenue increases to catch up with government spending."

        It worked handsomely before and over the long term, could work very well again.

        An elegant solution to an almost intractable problem.

        Cheers! JBS

    6. CommentedAyse Tezcan

      Even though it presents valid points on predicaments of large governments, the article overlooks some important points as one of the commenters, Mr. Shannon, presented. We cannot forget the history of what the laissez-faire economies did to the humanity. Every free market advocate (btw I am one, too) is quick to cite Adam Smith on his Wealth of the Nation, but never heard anyone supplementing it with the Theory of Moral Sentiments. I don't think Adam Smith, who was a very moral person, expected the fellow citizens' irresponsible behavior to the degree that we observed during industrial revolution and the events of pre-financial collapse.
      Growth can happen without letting the market reign on every inch of people's lives, and our yet unborn children of the future will be thankful to us for leaving them a better planet and life style.
      There is limit to power of markets as well as the government.

        CommentedJohn Brian Shannon

        Thank you for your kind words, Ayse Tezcan.

        I also appreciate your reference to Adam Smith.

        Best regards, JBS

    7. CommentedDan Adams

      All logical but no real answers. The reason for that is the answers are outside the philosophy of the writer. How about this? Get stuff you can pay the bill for. Debt has become a way of surviving for the US and the whole system cannot outrun it.

    8. CommentedFrank O'Callaghan

      The identification of government as a special interest is important. The development and implementation of policy can be explained by the alliance between those with power in the public and private sectors.

      The actions of governments have selectively benefited a relative few while selectively harming a great many during the crisis. This has not been an accident. The benefit to those with power has been the purpose.

      The failure of Democracy to exercise effective control has been fatal. The solution is not "free markets" but a rebirth of Democracy.

    9. CommentedJohn Brian Shannon

      Hi Michael,

      You present a well-argued case and I agree with most of what you say.

      However, in stark contrast to claims made in your first paragraph, I must introduce empirical examples of nations which actually function totally opposite to your projections -- everyday of the year, for decades at a time.

      "...But a government that grows too large, centralized, bureaucratic, and expensive substantially impairs the private economy by eroding individual initiative and responsibility; crowding out private investment, consumption, and charity; and damaging incentives with high tax rates. It also risks crowding out necessary government functions such as defense. That is today’s Europe in a nutshell..." -- Michael Boskin

      Sweden, Switzerland, Norway, Liechtenstein, Germany and others (to name European examples only) do not represent "today's Europe in a nutshell."

      In fact, they couldn't operate more differently than the claims contained within the first paragraph would suggest.

      These countries place well, or very well, on such stats as, Happiness Index, infant mortality, life expectancy, PPP, debt-to-GDP, personal freedoms, health, baseline education, per-capita university education, low crime rate, low murder rate, unemployment rate and other measures of successful governance.

      My tax rate in Sweden was an astounding 52% in the early 1980's, but among other benefits, I had free and excellent health care which included everything from emergency care, to doctor visits, to full dental and prescription medicines (a small deductible in each case applied) and much more.

      Basically, apart from cosmetic surgery and the deductible amount, my health care was fully covered and it was, and remains to this day, world-class health care in every respect.

      I saw real value for my high tax rate.

      Had I become unemployed, unemployment benefits would have immediately kicked-in and after some amount of time had passed, I would have been offered a mandatory job-sharing program while still collecting some amount of unemployment insurance. However, this was not required in my case.

      In fact, in the so-called 'welfare state' of Sweden (where there is no such thing as 'welfare' by the way) people there fall into four broad categories:
      1) Students or pre-school individuals
      2) Employed people
      3) People on unemployment insurance/job sharing
      4) Retired, homemakers, or other people who have decided to not work and are self or family income supported.

      See, no 'welfare' category.

      And, bonus for all employers in the country -- very few employee sick days, when compared to the U.S. or Canada.

      Productivity levels in any nation are enhanced when workers have full health care benefits and do not have to choose between paying for a doctor visit/medication/therapy and their car insurance or rent.

      Not to mention the peace of mind that full and universal health care brings to citizens.

      I have read that America's productivity would increase by up to 18 points if all citizens were covered by full and universal health care (including dental, which also accounts for a large number of costly sick days for corporations and small businesses) and that the country's GDP would be positively and noticeably affected.

      Although I arrived in Sweden a right-winger, I became convinced over time that staying loyal to that ideology was less important than embracing an ideology which, in every respect, worked better for citizens, corporations and society in general.

      I argued, I made examples, I tried to catch the Swedes off guard, I looked for loopholes and exceptions the entire time I was there to prove my ideology was better. It wasn't.

      What matters at the end of every day, is what works. Sweden 'works', the other European countries I mentioned above 'work'.

      Nothing beats success -- no, not even right-wing ideology.

      My take on this is that it is time to embrace what actually works in other nations and to forget about our preconceived ideological views.

      I sincerely enjoyed reading your fine article Michael.

      Very best regards, JBS

    10. CommentedZsolt Hermann

      As the article itself shows at the moment we are turmoil, trying to find balance, the best possible way of adjusting the socio-economic system in order to navigate ourselves out of the multi faceted crisis we are continually sinking into.
      So far all through human history, including today we cannot find a perfect system, because whatever system we use, in it almost all participants feel restricted, pulled back, inhibited.
      Everybody feels they could soar much higher without undue taxes, without government control, without needing to take into consideration parts of society that are seemingly only producing ballast and so on.
      And all of the previous social experiments, revolutions failed, because regardless of how they started, what their goals were all arrived to the same or even worse conclusions.
      All we need is a simple psychological shift.
      At the moment all individual human beings, and all smaller or bigger circles, nations look at the world in a subjective manner, as individual pieces that are grudgingly associated with others because alone they would not be able to survive, but if they could they would cut themselves off others to be able to do whatever they wish, believing that such a state can indeed exist.
      With the maximum evolution of our ego today we arrived to such a point when even the most basic human association, the family has become obsolete and people want to remain completely independent, without any commitment, obligatory connection to others.
      But such an attitude, behavior cannot work, cannot produce a sustainable future in a global system, where all the elements are so interconnected and interdependent as individual cells in a living body.
      Thus we first of all need to understand that we cannot simply only work or make calculations for ourselves, we cannot exist independently.
      Moreover in today's interconnected system an individual can only prosper, or even exist if the whole system is in an optimal state.
      If through a global education program, explaining our natural, global, interconnected system to everybody, we can accept and embrace this idea, we could start creating, building totally new socio-economic models reflecting the actual, natural, already existing relationships in between us, and between humanity and the vast natural system around.
      If people understand reality around them, and are properly motivated (that their interest parallels the interest of the whole), such a system could exist without coercion and trickery, without the violent or false safeguards we have been employing through thousands of years.