Fixing Broken Government - A Reaction

I just saw a speech given by Philip J. Howard on the topic of Fixing Broken Government.  The LongNow introduces Philip J. Howard as "a conservative who inspires standing ovations from liberal audiences."  They fail to mention that he does this primarily by making fun of Sarah Palin and the Tea Party.

In a very convincing speech, he highlighted how there are many problems that originate from overly complicated rules that are more effective at creating paperwork than in getting the job done. A lot of more of these rules exist today because old laws stay on the books while new ones are added on by a congress who doesn't feel like its job is to fix older laws and regulations.

While he has been involved in attempts to fix regulation on a micro level, Philip has three main reforms that he believes would help solve many of these issues on a systematic level.

1. Laws need to sunset automatically.  This would stop laws from piling up and make the special interests actively fight to protect their favored laws rather than let them target any lawmaker who decides to do anything about their laws.

2. Government officials need to be able to use more discretion in the performance of their jobs.  This would allow for simpler laws and prevent bureaucratic disasters. It will also allow the government to hire more competent employees, the kind who can get the job done without being bogged down by paperwork or always having to follow a poorly planned checklist of procedures.  There also needs to be someone who can green-light a project once a reasonable amount of background research has been done. The interstate highway system was built in 15 years, but today it takes 10 years of feasibility studies and environment assessment before they are even thinking of building windmill off the coast of Massachusetts. 

3. Government officials need to be more accountable for their performance.  This basically means that they need to be able to be fired.  This makes it so the government officials who aren't handling the responsibility they are given can be gotten rid of.

Unfortunately, I became even more pessimistic about fixing broken government after hearing this part of the speech.  The problems that were outlined were much more salient than the solutions that were offered.  When more and more laws sunset automatically, special interests will become more adept at getting them renewed. If a reform that automatically sunsets old laws is ever passed it will hopefully be in conjunction with a congress who is willing to do something about the problem of old laws cluttering the books at the same time. However, once congress grows complacent about this issue and the special interests remain vigilant, it is hard to see how even a large procedural change will do much good in the long term. 

The next two steps go hand in hand. Workers who cannot be fired cannot be given very much leeway in their jobs. In China, local bureaucrats who have discretion with their jobs but are not accountable to anyone but party elders have made millions of dollars selling the land of villagers to large corporations. 

But even if government workers can be fired (by their superiors for lower ranked workers or the higher ranked ones by voters), there are many other problems with giving government workers too much discretion.  In many cases, the government is deciding on whether to award permits that could be worth millions of dollars to businesses who can easily afford to buy the decision maker.  The corruption can happen either directly or indirectly. In Japan, the indirect corruption is subtle: regulators get appointed to the boards of private corporations after they retire. Giving government workers more leeway and accountability might still be better than the status quo, but it will open up a whole new can of worms.

While expanding the three solutions to all of government might take some work, the school system is one area where these types of changes could create an immediate positive impact. One scary statistic is that it cost the Los Angeles School Distract $3.5 million dollars when it tried to fire 7 teachers over the last 10 years. This means that teachers are not by any means accountable once they get their tenure. Another statistic comes from a study which finds that the US would be on top of international math and science educational rankings if we replaced the bottom 5 to 8% of teachers with average teachers.  If the reforms that Philip is pushing were applied only in schools then there could be real progress.

While the chance of a larger fix to the problem of bad governance happening anytime soon doesn't look too likely, it is good to know that there are people identifying and coming up with potential solutions to these types of problems.

Krugman to his commenters

Krugman is a little upset with some of his commenter's insults.

Get your insults right. There is, I believe, a fair bit of evidence against the hypothesis that I’m stupid. What you mean to say is that I’m evil.

I think what his commenters are trying to say is that he often makes stupid arguments because he is evil (which in internet discourse means they have different ideologies) or because he is too obsessed with his clever models that he underestimates the real world consequences of some of his arguments.

The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Time Preferences in Different Countries

 

Garret Jones, via twitter, links to a very interesting paper by the Swiss Finance Institutue. Mei Wang, Marc Oliver Rieger and Thorseten Hens did a study titled How Time Preferences Differ: Evidence from 45 Countries.  In this study, they found that not all countries are equal. Richer countries were more likely to contain more patient citizens*.  Countries with more punctuality and a higher working speed and more innovation also had more patient people.

The chart below measured what percent of the respondents decided to wait for $3800 next month rather than taking $3400 this month. If you look at the top of the chart where more people would wait for a monthly return of over 11%, you will generally find countries with less severe financial crises. At the bottom of the chart are countries who are either undeveloped or particuarly at risk of financial crisis.  While it is possible that the current situation of countries like Greece and Spain make people very short term oriented, the different perspectives that these cultures have on time has been noted previous to the crisis so it is more likely that the shorter term perspective of their population is what helped get them into their current financial mess in the first place.

The US comes in slightly less patient than Ireland and more patient than Turkey.  It is distinctly less patient than the German-Nordic countries.  The paper notes that a larger sample done in a previous survey gave the US a score of only 40%, which is below even Greece in this sample.  If the US is anything like Greece, this implies that it that people won't want to suffer through fiscal tightening now to make the future better, so spending without taxing is going to continue until it is stopped by a market crisis. 

*It should be noted that their data was only on university students rather than the population as a whole

Terrorist worries in the US

The FAA is worried about getting data on the owners of planes due to what terrorists might potentially plan with these planes. The TSA is spending 2.4 billion dollars to see people naked or grope those who opt out in the name of stopping terrorists.

This is all ridiculous, of course. If there were a significant amount of dedicated terrorists in this country, we would know. Just ask Israel. Think about what 10 or 20 coordinated people can do.  They don't have to hit the targets they hit before. Two people with a gun and modified car shut down an entire metropolitan area.  Multiple this by 5 or 10 and you have a very large population living in even more of a police state.  The lives lost will be nothing in comparison to the damage done to society during the response to the crisis.  The airport security isn't making anyone safer either, and if there were suicide bombers in the US then they could buy a ticket (or print out a fake ticket) and walk into any packed airline security line and be sure that they are in a crown of people when they go off.  Thankfully, none of these or any other number of simple ideas for terrorists to implement has occurred. When something did happen outside the US in Sweden, the terrorist was apparently so incompetent that they barely manage to kill more than a few people other than themselves in a completely unsuspecting population.

The lack of US terrorist events means that the dedicated terrorists in the US are either planning something really big, have been effectively shutdown by intelligence agents more times than we know or they are in no way organized or motivated enough to give their lives.  Sadly, terrorists don't even have to be organized or even successful to make an impact.  As we've seen, even one or two failed attacks causes billions of dollars of damages by causing money to be sunk into security theater spending that wastes people's time and offends their dignity.  

When we hear that something is being done mainly for our safety, we need to keep Benjamin Franklin's words in mind.

Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.

I would extend this thought to specifically cover those people trying to take away essential liberties. That is the bright side of wikileaks. It may have hurt the US by revealing key people who were helping them, but reminding government workers that their reasons behind their actions might see the light of day sooner than they think will hopefully remove a safety blanket and make them think twice about what they are doing.

The tax cut compromise as a sign of broken politics

So in order to avert a middle class tax hike, Obama agreed to revert tax cuts for everyone and a cut to the payroll tax. In order to give Obama and his party what they wanted, Republicans agreed to extend unemployment benefits.  Everyone wins, just as long as the government can spend money that it doesn't have.

When people worry about inflation or deflation, they are wrong as long as politics are functional. However, events like the recent compromise demonstrate that politics are not really functional.  If more compromises of this nature are expected, then that means that it might take a crisis to fix the deficit.  If the crisis is about dollar confidence, then the crisis will be inflationary. If the government is able to react with austerity to head off the crisis then the crisis will be deflationary.

It is hard to know which way the economy will break, but with each compromise of this nature the probability of a long term goldilocks goes down.

Shorting the VIX

Eric Falkenstein has a post up highlighting another area where there seems to be money on the sidewalk: Shorting the Vix.  He notes that the VXX has underperformed a hypothetical outright short VIX position by a large margin due to the contango in the curve.   

It seems like the people selling lottery tickets are making money, but it is unfortunate that his sample analysis period doesn't go back to the crisis of late 2008.  Any trading strategy that was short volatility over a 10 year period and didn't blow up completely in that time period would probably have made a lot of money overall, but the "not blowing up completely" part is not trivial without utilizing future information.

He links a post from VIX and More where the author of that blog highlights new VIX Exchange Traded Notes (ETNs) and reveals that they are short VXX, one of the front month VIX ETNs.  

One conclusion that can be drawn from this is that if someone wanted to go long volatility to protect their portfolio, front month VIX at this level of contango is one of the most expensive and therefore worst ways to do so.  Now, there are probably good traders who are long the VIX at the short end, but these would be people who are either trading at small enough holding periods that the annual drift doesn't impact them or traders who have found something even better to be short and need to be long the VIX to protect their portfolio.

QE, the deficit and the TSA: Links

1. Scott Sumner Has an open letter to conservatives about monetary policy.  A lot of it is pretty reasonable, but he makes the mistake of thinking that conservatives care about nominal GDP when in reality they care more about real GDP.

2. My solution to the deficit, according to choices offered by the NYT.  It's nice how they let you cap spending on medicare at GDP rates without explaining how this is going to happen.  But it does show how the budget deficit can be balanced without tax increases. I chose to remove the employer tax break on healthcare (which for some reason the NYT doesn't treat as a tax increase), since the connection between employment and healthcare has been one of the reasons the healthcare system costs have gotten out of control.

3. The quantitative easing debate, in video format. Against QEII. For QEII.

4. Orlando is trying to opt out of the TSA, but the TSA points out that their regulation for private screeners requires them to be just as invasive. Ron Paul proposed a law that would remove the immunity of TSA screeners.  Hopefully this issue will get fixed soon, but preventing is people who think the only thing worse than everyone getting seen naked or groped is a little bit of racial profiling.

Mark Cuban against start ups

Mark Cuban has a blog post up where he shows that he thinks the government should encourage people to work at steady 250k a year jobs rather than getting a job in a potentially successful start up where they are often paid via high capital gains.  He tries to justify this by calling it "earned money" vs. "found money" but his definition of "found money" sounds awfully similar to something that would impact early employees in a successful start up.

The disparity in wealth in this country does not come on the backs of people making 250k, or even 500k or 1mm per year FROM THEIR JOBS. The ever increasing delta between the rich and everyone else does not come from EARNED INCOME at all. It comes from found money.

Found money is when an internet bubble hits and the options you got for 1 dollar are sold for 250. It comes from buying a stock for $1 and seeing it turn into a “10 bagger”. It comes from hitting the lottery. It doesn’t matter whether you were smart or lucky, it is money you FOUND based on good fortune.

He seems to assume that everyone making enough income from multi-hundred percent capital gains for it to be called "found money" is in league with him or Steve Jobs. 
When I sold broadcast.com does anyone seriously think I would have cared if the tax on my FOUND money was 10pct or 20pct more ? Hell no. Would I have made any decisions differently, HELL NO.
But he sets the bar to impact people much lower than that level.

For long term capital gains, it would be more difficult, but I would tax it at a gain greater than $1mm or a basis equal to the compounded CPI for every year held, against a 300pct increase and reduce the GOT LUCKY percentage to 20pct..

He'd have to raise the bar much higher if he wants good people to continue focus on building companies. I know a lot of people who have had to choose between the start up world and the corporate consulting/finance world. Passing a law like this would make it much easier for them to decide to avoid start ups.  

But even with a higher bar, that would only incentivize founders of moderately successful companies to focus on generating cash flow for income and dividend payments sooner than they would otherwise chose to because they would be hit hard by high "Found money" gains if they let their capital appreciate by too much. If raising taxes is the goal, raising it from some of the most productive people by calling it "found money" or a "lucky tax" might sound good but it probably won't work out in practice when the second order effects beyond its impact on Steve Jobs and Mark Cuban are considered.

Do people realize that in the next economic downturn the dollar will most likely strengthen?

People talk about a weak economy and weak currency almost like they are the same thing.  Certain commentators like Peter Schiff encourage this view. However, the correlation in the US has actually been the reverse.

When there is growth, a lot of things are pushing down the dollar at the same time the market goes up.

1. Increased demand for commodities weakens the US's terms of trade.

2. Re-leveraging allows people to increase their bets against the dollar.

3. Many other countries (excluding Japan) have interest rates that react more strongly to global growth, so an economic recovery means that the interest rate differential will become less favorable for the US.

4. When the Federal Reserve promises weaker monetary policy than expected the market reacts positively.

Of the variables listed here, numbers one through three will most likely reverse in a downturn not centered around a dollar crisis. People in macro often focus on reason number 2, calling any dollar strengthening during a downturn a "Dollar carry unwind" in reference to the people who have been short the dollar and long a higher yielding currency that have to close out their positions during volatile markets.  This explanation is probably underweighted by people following the markets from day to day, but correlation it describes is still accurate even if the causal reasons behind it are not.

Political Time Preference: A Case Study

Jerry Brown was governor of California in the late 70's and early 80's.  During that time he had an opportunity to try and push government towards defined contribution plans rather then defined benefit plans, but the topic never came up because he was a big supporter of unions*. Defined contribution plans contain the potential for economic volatility, something unions try to avoid at all costs.  

When Jerry Brown was mayor of Oakland some unions received generous pension increases, presumably in lieu of large pay increases. Defined benefit pension promises are currently a major cause behind California's budget problems, some have estimate that California has about $500 billion in unfunded pension liabilities. So 25 years after his governorship when the pension problem is coming home to roost the people of California decide to elect... Jerry Brown**.

And if we wonder why politicians seem to think too short term, it is because voters don't have very good memories. This short sighted point of view is also why the economic environment of election year is much more influential than other years.

*Maybe it is unfair to blame him for not fixing a problem that no one else in the public sector fixed, but 401(k)'s were written into the law around 1980. His first governorship's term coincided with a large shift among private companies towards defined contribution and away from defined benefit plans. 

**The budget was balanced when he was governor, and the stupider pension mistakes have occurred in the last few decades such as SB400 passed in 1999.  If not for Brown's support of union pensions from his position in Oakland and his support of unions more generally things might be looking up.