how it's all going wrong

This is a long post, but it functions as something of a capstone to what I've been building up to throughout the year.

A few weeks ago, the Troubled Asset Relief Program, popularly known as the bank bailout, quietly expired. TARP effectively extended a $700 billion line-of-credit to the financial industry, of which just a portion was activated. Bloomberg's post-mortem number crunch attempted to determine how many cents on the dollar US taxpayers recovered on the $309 billion deployed. The answer? 108 cents. In other words, a $25 billion profit.

Addressing this result, President Obama said:

We've managed TARP so well that, in fact, most of the money never even got spent and whatever is remaining will help reduce the deficit. But it doesn't solve our big problem. Solving the big problem will require us making some much more significant adjustments when it comes to big-ticket items. And that's a debate that Republicans really don't want to have....

the big-ticket items are Social Security, Medicare, defense. The entitlements in defense take up about three-quarters of the budget. So you can't cut your way through education or parks programs or the Environmental Protection Agency, because that's not where the money is.

I wouldn't have voted for Obama. In July 2008 I explained why I'm for McCain and took particular exception to Obama's support for rent controls while an Illinois legislator, a disturbing and revealing policy error that got little attention from a MSM that was more interested in what I'd call the bedazzling but policy-irrelevant "Obama narrative." But in his remarks above the President is entirely correct. This year I have directed a lot of "friendly fire" at those who would normally be my political allies, but the basic reason for this is that I'd rather have a liberal who was no talk and no action when it comes to spending than a conservative who was all talk and no action. As I noted a month ago, Republican Senate leader Mitch McConnell loudly advocated the establishment of a deficit commission until Obama called his bluff at which time McConnell bailed. I consider it something of an outrage that the conservative "elite" has just let this slide.

Perhaps I'm just incurably quixotic. At right is a scan from the Edmonton Journal from the last Alberta election campaign. "Reduce government spending" as my #1 priority? This is the sort of platform that gets a candidate 2.7% of the vote. Far more common is the sort of priorities identified by Chuck Farrer, who is looking to unseat Gene Leskiw on Wildrose's behalf in Bonnyville-Cold Lake:

When asked about his top priorities, Farrer said, “Healthcare’s a real big one, the seniors is paramount, and the property rights. ...
Farrer and Sobolewski were asked about the possibility of a provincial sales tax, something both were opposed to.

Healthcare spending soared an utterly unsustainable 16% in the provincial budget announced in February (and in a deficit environment) and this Wildrose candidate STILL isn't happy? Now I understand that Wildrosers will tell me that this isn't fair because the party's view is that when "questions exist about the system’s future financial sustainability, the answer lies in squeezing more inefficiencies from the system," but I do note that I have just quoted a line from Jeffrey Simpson's Friday Globe and Mail column that was written in sarcasm.

As I have noted with some regularity this year, Wildrose policy makers have a rather mixed record with respect to advancing policy that most economists would recognize as efficient. The most important measure would be shifting tax burdens off of businesses and on to consumers, but the party does not have a whole lot to say to business on this front. Prioritizing individual landowners' rights is anti-business, if anything, since businesses - at least the constructive kind - are interested in controlling inputs merely as a means to producing outputs, and giving those who are fortunate enough to begin the game with control over raw inputs more leverage over those inputs makes it more difficult and/or expensive for producers. The one raw input Wildrose seems prepared to make more easily and cheaply available to value-adding business is oil & gas, which happens to be the one input where the externality problem is of least concern (since the economic rent is being captured by a public owner instead of a private one). There are some potential future Wildrose MLAs who may be more sensitive to the needs of business , of course, for example the talented corporate lawyer Shayne Saskiw who will be running in Lac La Biche and Andrew Constantinidis, an internationally experienced C-level executive with a listed company who will be running in the very promising constituency of Calgary West. But the decisive proof that Wildrose hasn't been doing much for business may be the fact that the party has not raised money from the corporate sector like it did during the 2008 campaign when a cut to the corporate tax rate was part of the five point platform. In 2009, corporate donations represented less than a quarter of Wildrose donations received - an even smaller share than for the Alberta Liberals - versus 69% for the PCs.

My favorite modern Presidential candidate for a major US party is not, in fact, Ronald Reagan but Barry Goldwater. In the 1980 Presidential election, independent candidate John Anderson (right) took 7%, running on a platform that included some wonk-friendly measures like a 50 cent per gallon gas tax. During the election debate, Reagan said, "John Anderson tells us that first we've got to reduce spending before we can reduce taxes. Well, if you've got a kid that's extravagant, you can lecture him all you want to about his extravagance. Or you can cut his allowance and achieve the same end much quicker." This may be been the first high level articulation of the pernicious "starve the beast" doctrine. In 2003 Milton Friedman repeated Reagan's contention, writing, "How can we ever cut government down to size? I believe there is one and only one way: the way parents control spendthrift children, cutting their allowance." What this misses, of course, is the fact that a kid can go borrow, and if he can't currently borrow a financial industry will develop that will allow him to shift his consumption from the future to the present. A study by the libertarian Cato Institute gets right to the point: "Starve the beast just does not work."

If deficits finance a significant fraction of government spending, then citizens experience government services as discounted off the full price. The same level of government spending would be less popular were taxpayers charged full fare. By this analysis, in order to build popular support for smaller government the first step ought to be to raise taxes. Indeed, the Cato study found empirical support for the theory that higher revenues constrain spending. In Alberta, of course, the problem is exacerbated because even when not running a deficit, corporate and personal tax revenues pay for only a small fraction of government spending. Other revenues, of which windfall energy revenues are particularly significant, support the bulk of the provincial government's bulk.

Goldwater (right) was a true economic conservative and Cold Warrior, who prioritized spending cuts over tax cuts because true conservatives don't run up deficits. Yet Goldwater went on to lose to Lyndon Johnson by one of the largest landslides ever; LBJ's 1964 victory was the only instance between World War II and the present that the Democratic nominee for President has received a majority of the white vote.

Now having said all this, spending per se is not the only problem or even the central problem. In early 2008, the Alberta Liberal leader condemned the overspending and even a NDP MLA said, "with all the spending they've been doing, I don't think the budget is going to be pretty." Since then Ted Morton has taken over as Alberta's Finance Minister, and Doug Griffiths has been made Parliamentary Secretary to Morton (not worth much really but better than nothing). This may provide some restraint or at least reflection going forward. There's also the fact that not all spending is created equal. As the TARP example showed, some spending is investment that may help raise revenues over time. Upgrades to physical infrastructure and government contributions to R&D can potentially serve as a squirreling away of sorts of current revenue, depending on costs.

Spending on civil service salaries and benefits cannot be deemed investments, however. They are privately captured and by economic actors with high marginal propensities to consume to boot. Even worse is the way these expenditures are competitively negotiated, or more precisely uncompetitively negotiated. Unions and consumer advocates are ultimately the biggest enemies of investment.

When politicians sit down to "negotiate" with the civil service unions, immediately there is an agency problem, such that the politicians are not dealing with their own money. More to the point, however, is the fact that the vast majority of politicians are going to be thoroughly outclassed by a union economist like Erin Weir. Weir recently noted that since "2005, business investment in Saskatchewan increased by 55% through 2008. During the same period, investment rose by only 27% in Alberta and 32% in BC." This is used to argue against cutting corporate taxes in Saskatchewan. But would Weir point to these facts in an Alberta context? Highly unlikely, as it doesn't serve the desired narrative; some other statistics would be found.

Contrary to popular perception in Canada, Republican Congressmen from John McCain on down proposed a number of alternatives for US healthcare reform prior to Obamacare. But these proposals went after the fact that the cost of healthcare benefits were exploding as a share of the economy because said benefits were untaxed. The unions blocked/watered down/deferred any removal of the tax exclusion for employer provided healthcare benefits, and they did so because negotiating healthcare benefits like regular wages wouldn't play to their negotiating strengths. Funding for Obamacare - to the extent it was funded - then had to come from taxes on super-high earners instead of high earning union members and this fact more than anything else was the reason GOP support was non-existent.

If provincial and municipal negotiators were to try to bring more of the present value of future benefits to the actual present, the transparency of what public employees are actually getting would be that much clearer to distracted taxpayers and taxpayers wouldn't stand for it. The unions know this and accordingly want benefits deferred so that when reality, and crunch time, arrives, they can say "a contract is a contract," which is a powerful bargaining chip they don't have before something has been signed. As Steven Green has noted while talking about his book, Plunder!: How Public Employee Unions Are Raiding Treasuries, Controlling Our Lives and Bankrupting the Nation, once a deal is granted, it doesn't matter if the union presentations to government are later exposed to have underestimated the present value of the future costs, the benefit has vested and cannot be retracted.

There is a parallel here in the consumer credit bubble. A significant enabler was the sheer complexity of the system that obscured pricing fundamentals, a complexity that the MBAs had no incentive to reduce to the point that MBA-level expertise was not longer required. There is also a parallel in terms of the agency problem, such that mortgage originators lost the incentive to monitor by spinning out their liabilities to relatively disinterested and uninformed external investors (not unlike politicians retaining little incentive to monitor after spinning out liabilities for pension agreements on to relatively disinterested and uninformed taxpayers).

Consider this multi-choice question: who first busted the state of New Jersey for improper and incomplete disclosure of its civil servant pension liabilities?

1) a taxpayers watchdog

2) a conservative politician

3) buyers of the state's debt who could lose their investment in the event of default

4) another government entity

The answer is (4). The SEC ended up prosecuting New Jersey (perhaps to the chagrin of both Tea Partiers south the border who want more sovereignty passed to the states and to Alberta politicians north of the border who oppose a national financial regulator). The fact is that municipal and provincial politicians do not have the expertise to run a net present value analysis on the union benefit packages they negotiate and even if they did, it's their successors who will have to deal with the negative consequences of pushing costs into the future, and even if the costs came due today, it's not their own money. If there is one behaviour that my colleagues in "high finance" engaged in that I found especially objectionable, it was the dog and pony shows that they put on for governance boards in order to get even more money to manage. Complexity increased not because of a real economic demand but because it served as a barrier to entry. In many cases the value of financial wizardry was merely in the appearance of it. Word on the grapevine is that Alberta Investment Management (AIMCo) has pulled the wool over the eyes of its governing board by snowing it with an impressive song and dance about benchmarks that mean bigger bonuses for the investment team on a more or less permanent basis. Don't expect any politicians or taxpayers' associations to do anything about something they would understand even less than the board.

Unions may argue that their influence has been declining, pointing to declining levels of unionization in the private sector. But in fact numbers don't matter. Union membership in France has declined from 20% in 1960 to 8% today, which is even below the US at 12%. Would anyone deny that French unions have significant clout? In large part because taxpayers have been mugged by public employees in state houses and city halls, quite outrageously so in places like Bell, California, cash-strapped cities are switching off streetlights, states are furloughing children from school, and counties are ripping up pavement. It is but the early stages of a civilization in decline; an October 14 Economist article is titled, "Public-sector pensions: Three-trillion-dollar hole" with the byline "American states have promised their employees benefits they can’t afford."

This problem did not "just happen." It is a consequence of a weak governance structure and, ultimately, a weak culture.