Archive for February, 2010

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governing America

Saturday, February 20th, 2010

A growing number of political pundits are attracted to the idea that the United States has become “ungovernable” because of legislative gridlock, a result of the requirement of a 60-vote supermajority to pass new legislation in the Senate. The Economist disagrees, arguing that failure to pass laws is the fault of President Barack Obama, not the political system.

America’s political structure was designed to make legislation at the federal level difficult, not easy. Its founders believed that a country the size of America is best governed locally, not nationally. True to this picture, several states have pushed forward with health-care reform. The Senate, much ridiculed for antique practices like the filibuster and the cloture vote, was expressly designed as a “cooling” chamber, where bills might indeed die unless they commanded broad support.

Broad support from the voters is something that both the health bill and the cap-and-trade bill clearly lack. Democrats could have a health bill tomorrow if the House passed the Senate version. Mr Obama could pass a lot of green regulation by executive order. It is not so much that America is ungovernable, as that Mr Obama has done a lousy job of winning over Republicans and independents to the causes he favours. If, instead of handing over health care to his party’s left wing, he had lived up to his promise to be a bipartisan president and courted conservatives by offering, say, reform of the tort system, he might have got health care through; by giving ground on nuclear power, he may now stand a chance of getting a climate bill. Once Mr Clinton learned the advantages of co-operating with the Republicans, the country was governed better.

“Politics in America”, The Economist, 18 February 2010.

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searching for a solution to the Greek crisis

Friday, February 19th, 2010

Financial Times columnist Samuel Brittan has a superb column today on exchange rates, the euro, and the Greek crisis.

I am attracted to Professor Martin Feldstein’s idea (Financial Times, February 17) of a temporary euro exit for Greece followed by re-entry at 20 or 30 per cent below the present level. But if that occurred there might not be a euro to rejoin. So it is a last resort. There is an alternative to try first, which might be called an internal devaluation. When Margaret Thatcher was struggling to wean her colleagues from pay and price controls she at one stage considered a compromise: a temporary wage freeze – in an emergency – after which normal negotiating procedures would be restored. In the case of Greece today it would have to be not just a freeze, but a negotiated reduction in nominal wages. Such a course would cut against Greece’s fiercely independent habits and traditions. But surprises can always occur.

Finally, an offbeat idea which is not an alternative to the others, but can run alongside. Countries in the Middle Ages often operated with two or more currencies: an international one such as the ducat or florin, and local currencies with more restricted use. Could not such a local currency, whether or not called the drachma, emerge in this way with or without the sanction of the Greek government? It would surely be better than being crucified by the international financiers.

Samuel Brittan, “Greek light on an over-hasty project”, Financial Times, 19 February 2010.

It is not necessary to go back to the Middle Ages to find countries with multiple currencies. Until very recently, in much of Latin America ‘strong’ currencies – usually the US dollar – circulated alongside a weak, nonconvertible domestic currency. Zimbabwe is another recent example of this phenomenon.

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double negatives

Thursday, February 18th, 2010

In conventional morality, two wrongs don’t make a right.  Likewise, double negatives don’t always amount to positives; they can make negatives more intense, as in “I can’t get no satisfaction.”  (Actually, languages can be very tricky in this respect.  The eminent linguistic philosopher J. L. Austin of Oxford once gave a lecture in which he asserted that there are many languages in which a double negative makes a positive, but none in which a double positive makes a negative — to which the Columbia philosopher Sidney Morgenbesser, sitting in the audience, sarcastically replied, “Yeah, yeah.”)

Steven Strogatz, “The Enemy of My Enemy”, New York Times Opinionator, 14 February 2010.

In a third post to this series, Cornell mathematician Steven Strogatz first explains why a negative multiplied by a negative is always positive, then searches for parallels in the social and political realms. The most familiar parallel is perhaps the adage “The enemy of my enemy is my friend”. Strogatz devotes a lot of space to this truism, especially as applied to international diplomacy.

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the meaning of facts

Thursday, February 18th, 2010

Facts are meaningless. You could use facts to prove anything that’s even remotely true.

Homer Simpson in “Lisa, the Skeptic”, a 1997 episode of The Simpsons. Quoted in Ian Holdsworth, “Homer Simpson enjoys the pleasures of freefall”, FTdotcomment, 16 February 2010.

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Martin Wolf on Niall Ferguson and the Greek crisis

Wednesday, February 17th, 2010

Harvard historian Niall Ferguson (1964-) claimed last week that a Greek crisis will soon reach the United States.

It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. For this is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the western world.

Niall Ferguson, “A Greek crisis is coming to America”, Financial Times, 11 December 2010.

Martin Wolf “promptly dismissed this as hysteria”. I had the same reaction, so ignored Ferguson’s column. Not everyone responded this way: fiscal conservatives were frightened. The always-sensible Martin Wolf today rebuts Ferguson in a column that should be required reading (antidote) for anyone attracted to Professor Ferguson’s ravings.

The high-income countries that have experienced the biggest jumps in deficits and debts have, inevitably, been Ireland, Spain, the UK and US …. These are the countries that had the biggest credit booms and asset bubbles. ….

If these governments had decided to balance their budgets, as many conservatives demand, two possible outcomes can be envisaged: the plausible one is that we would now be in the Great Depression redux; the fanciful one is that, despite huge increases in taxation or vast cuts in spending, the private sector would have borrowed and spent as if no crisis at all had happened. In other words, a massive fiscal tightening would actually expand the economy. This is to believe in magic.

So, yes, high-income countries face huge fiscal challenges. And yes, the crisis-hit countries start from grossly unsustainable fiscal positions. But the US is not Greece. Moreover, a massive fiscal tightening today would be a grave error. There is a huge risk – in my view, a certainty – that this would tip much of the world back into recession. The private sector must heal. That, not fiscal retrenchment, is the priority.

Martin Wolf, “How to walk the fiscal tightrope that lies before us”, Financial Times, 17 February 2010.

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Europe dare not rescue Greece

Monday, February 15th, 2010

German economist Otmar Issing, in an op-ed published in tomorrow’s Financial Times, argues convincingly that a bail-out of Greece would threaten the very foundations of European monetary union.

By joining Emu, a country accepts its rules. Greece, moreover, also knew that adopting a stable currency that was not controlled by its own central bank implied a total break with the past. Devaluation of the national currency and an inflationary monetary policy were no longer options. A single monetary policy is implemented by the European Central Bank and it is the responsibility of each country to adjust its economic policies so that this one size fits all.

…. Thanks to the euro, Greece has enjoyed long-term interest rates at a record low. But instead of delivering on its commitment at the time of entry to reduce public debt levels, the country has wasted potential savings in a spending frenzy. ….  Bailing out Greece would reward such behaviour and create moral hazard of a dimension hardly seen before.

In this context, one conclusion becomes obvious: financial assistance for countries that violated the terms of their participation in Emu would be a major blow for the credibility of the whole framework. By its construction, Emu is a “no transfers” community of sovereign states. Transferring taxpayers’ money from countries that obeyed the rules to those that violated them would create hostility towards Brussels and between euro area countries.

Otmar Issing, “Europe cannot afford to rescue Greece”, Financial Times, 16 February 2010.

Otmar Issing (1936-), president of the Centre for Financial Studies in Frankfurt, is a former member of the board of the Deutsche Bundesbank (1990-1998) and of the Executive Board of the European Central Bank (1998-2006). His latest book, Der Euro – Geburt, Erfolg, Zukunft (Franz Vahlen, 2008) was published in English translation as The Birth of the Euro (Cambridge University Press, 2008).

Elsewhere, Simon Johnson, who is an MIT professor and former IMF chief economist, complains that the Financial Times does not disclose the fact that Mr Issing is adviser to Goldman Sachs – the Wall Street bank that helped Greece violate Emu rules by providing it with loans disguised as currency trades. This story gets more complicated by the hour!

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monetary union and political union

Sunday, February 14th, 2010

Princeton economist Paul Krugman thinks that, even though political union should ideally have preceded monetary union in the eurozone, “Europe is now stuck with this creation, and needs to move as quickly as possible toward the kind of fiscal and labor market integration that would make it more workable”.

‘Charlemagne’, author of a weekly column on the European Union for The Economist, disagrees.

Though Prof Krugman is a very clever economist, I also have a hunch he may be falling into the trap that has caught so many American observers of the European Union, namely they are rather casual about other people’s sovereignty. I appreciate that from the other side of the Atlantic, it may seem quaint for the different tribes of Lilliput to insist on their differences. But from this side, economic logic alone is not enough to persuade German politicians, say, that they should be sending their taxpayers’ money to Greece, say. This is precisely because Europe is not a political union. In a monetary union that is also a political union, like America or Britain, a central government is able to transfer wealth from one part of the union to another because it is democratically accountable to voters in both places. Indeed, central governments may need votes in both rich and poor regions to secure re-election, which gives them a strong incentive to set up mechanisms for fiscal transfers. But the German government cannot win votes in Greece by sending Greece money. German governments are made and unmade by German voters. So they need to make a case to German voters, in terms of German self-interest (or higher interests, if you are an optimist), before the transfers can be made.

Charlemagne, “Rescuing Greece. Economic union. Two different things”, Charlemagne’s notebook (The Economist), 12 February 2010.

Charlemagne’s point is well-taken, but I would go further. Even with full political union, taxpayers may have no stomach for the bail-out of prolific (or unlucky) members. It does not look like the US federal government will be bailing out California, for example, just as there was no bailout a few years ago of New York City or of Orange County, California. Local governments in the US can default on bonds, with little or no impact on the value of the common currency of the American union. The value of the euro will not fall if Greece defaults on its sovereign debt. It might fall if Germany (or Brussels, or the European Central Bank) rescues Greece, because investors will expect the same to happen with Spain and other EU countries that have severe fiscal imbalances.

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Oskari Juurikkala on universal pensions

Sunday, February 14th, 2010

Oskari Juurikkala is deeply religious. He was raised in Finland as a Lutheran, converted to the Roman Catholic faith and joined Opus Dei, so his conservative credentials are not in question. He supports  non-contributory, universal pensions because means-tested benefits discourage work and saving.

I promised yesterday to post a thought of Mr Juurikkala to this blog, but discovered that I already did so last October. Nonetheless, I would like to repeat one short sentence from October’s post:

Targeting the poor with benefits has the paradoxical effect of creating more poor people.

Oskari Juurikkala, “Punishing The Poor: A Critique of Means-Tested Retirement Benefits”, Economic Affairs 28:1 (March 2008), pp. 11-16.

Words of wisdom. I would add that targeted benefits everywhere miss large numbers of the intended beneficiaries – around 30% in the US, and 40% in the UK. Universal benefits paradoxically are the best way to reach the poor.

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Andrew Biggs on universal pensions

Saturday, February 13th, 2010

I have never understood why universal age pensions typically are supported only by scholars on the political left, since they actually reduce the power of the state and its capacity to intrude in the lives of citizens. Andrew Biggs is an exception to this generalisation. No one would accuse Andrew of leftist tendencies. His political philosophy is very libertarian; nonetheless he supports universal pensions. Another exception is conservative scholar Oskari Juurikkala, who also favours state provision of universal pensions.

Today I am recycling a 6 May 2009 Thought du Jour that highlights the work of Andrew Biggs. Soon I will post a Thought du Jour of Oskari Juurikkala that I circulated by email two years ago (27 February 2008).

Although the Social Security program is progressive—meaning that the replacement rate of preretirement earnings offered by Social Security tends to rise as lifetime earnings decline—this relationship is erratic. While individuals with lower lifetime earnings receive better treatment on average, lifetime earnings are only a weak predictor of how any one person will be treated by the Social Security program. Many high-earning households receive high replacement rates, and many low-earning households fail to receive them. …

I propose … an alternative. The proposal … combines a first-tier flat dollar benefit paid to each worker—regardless of prior earnings— with a second-tier benefit that is based entirely on earnings. The first-tier benefit resembles the “universal pension” concept that has been adopted in a number of countries, including New Zealand. It would pay a flat dollar benefit to each individual of retirement age, regardless of prior earnings or labor force participation. The first tier would focus on redistribution to low earners, fulfilling the traditional “adequacy” goal of Social Security benefits. The flat dollar benefit would overlap functions of both Social Security and the means-tested Supplemental Security Income (SSI) program.

The second tier benefit would be entirely earnings related, fulfilling the “equity” role of Social Security in paying benefits correlated to contributions. The earningsrelated benefit could be based upon contributions to a personal account. In practice, this account could be funded either out of the existing payroll tax or from additional funds, or it could be a notional personal account financed on a pay-as-you-go basis.

Andrew G. Biggs, “Will Your Social Insurance Pay Off? Making Social Security Progressivity Work for Low-Income Retirees”, American Enterprise Institute for Public Policy Research, No. 1, January 2009.

This radical proposal for reform of the US public pension system would be even more radical if the full New Zealand model were embraced, by abolishing the second tier altogether. New Zealand provides a flat, non-contributory pension to everyone over the age of 65, financed from general government revenue. Saving to top up this basic pension is regarded as a private matter, so is left to the discretion of each citizen. No-one in New Zealand is forced to contribute to a retirement savings or pension scheme. See Larry Willmore, “Three Pillars of Pensions? A Proposal to End Mandatory Contributions”, United Nations DESA Discussion Paper No. 13, June 2000.

Andrew Biggs is a resident scholar at the American Enterprise Institute. He blogs here.

To understand just how exceptional Andrew is, look at the views of a typical libertarian, such as George Mason University economist Bryan Caplan. Like most libertarians, Caplan would prefer to “just abolish the welfare state”. So long as the welfare state exists, however, he favours subjecting all transfers to a means test as a way to keep spending under control. Caplan is not concerned with disincentives because

the lower deciles don’t contribute that much to the economy, anyway.  Suppose means-testing led half of the second decile to stop working.  That destroys a lot less value than higher overall taxes that lead to 5% less work effort across the entire income distribution.

Bryan Caplan, “Means-Testing Really Is Relatively Awesome”, EconLog, 10 February 2010.

Caplan agrees that means tests are equivalent to taxation, but does not see this as a problem, since for him the ideal tax system is one with low rates of taxation on the wealthy, even if this requires high rates of taxation on incomes of the poor.

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automatic retirement saving

Friday, February 12th, 2010

Financial executive Robert Pozen is concerned that “75m American workers (one half of the labour force) do not have the opportunity to participate in a retirement plan at their place of employment”. Most – though not all – of these workers are employed by farmers, small contractors and small retail establishments. He thinks Obama’s proposed Automatic Individual Retirement Account would be an effective way to encourage this group of workers to save.

In his recent State of the Union speech, President Barack Obama asked the US Congress to establish the Automatic Individual Retirement Account. If enacted, this legislation would be the single most effective vehicle to increase retirement savings in the US. ….

When workers are not offered a retirement plan by their employer, they are allowed to open an Individual Retirement Account (IRA) at a qualified financial institution. However, this requires a worker actively to seek out a financial institution, fill out an application and choose an investment. For most workers in this situation, inertia overcomes their desire to save.

By contrast, the Automatic IRA harnesses the power of inertia. It would require every employer, with certain exceptions, to enrol all its workers in a retirement plan at a qualified financial institution – unless a particular worker opts out. Empirical studies show that inertia prevents most workers from opting out of an Automatic IRA.

Robert Pozen, ” How to get Americans saving for retirement”, Financial Times, 10 February 2010.

Pozen, in his column, discusses “arguments against the Automatic IRA”, but limits himself to the burden on employers and to the need for an adequate “default” option for the savings. To reduce the burden on small employers, he recommends that the legislation exempt “employers with fewer than a specified number of permanent workers such as 15 or 25″ and that all employers be exempted from mandatory employer contributions. As for the default option, Pozen insists that this should be chosen by the financial instruction administering the accounts, not by the employer, “who may have little investment expertise”.

Pozen has extraordinary faith in financial institutions, possibly because he runs one. He does not discuss the plight of workers who might escape the automatic IRA by working for exempt employers.

A serious problem in the US is that the current pension system discourages low-income workers from saving for their own retirement. Non-contributory pensions – known as Supplemental Security Income (SSI) – are denied to those with assets greater than $2,000, and reduced – dollar for dollar – for all “unearned” income, such as another pension, or interest on savings. SSI pensions are reduced also for “earned” income, but at the lower rate of 50 cents per dollar of wage income. This disincentive could be removed by providing all elderly with a universal age pension, so that entitlements would not be affected by their current income, employment history or past savings. Andrew G. Biggs of the American Enterprise Institute, following this line of reasoning, recommends a universal, non-contributory pension as replacement for the means-tested SSI. Pozen does not mention the problem of disincentives for saving, much less provide a solution.

Robert Pozen (1946-) is chairman of MFS Investment Management, a Boston-based company that specializes in mutual funds. He currently lectures at Harvard Business School and taught previously at Georgetown Law School, NYU Law School and MIT’s Sloan School of Management. His latest book is Too Big to Save? How to Fix the U.S. Financial System (John Wiley. 2009).

Technical note: I was unable to locate a non-gated version of this column, but non-subscribers are allowed to download ten articles a month at ft.com (free registration required).

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