Archives: 05/2011

This Week in Government Failure

Over at Downsizing the Federal Government, we focused on the following issues this week:

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Data on Military Compensation

There is an interesting article posted over at the blog Hegemonic Obsessions discussing the need to reform military pay and benefits. One need not agree with the author’s suggestion that the U.S. Army might go the way of General Motors to understand his broader point: personnel expenses are consuming a larger and larger share of the DoD’s budget. Indeed, this has been one of Defense Secretary Robert Gates’ leading complaints for years.

The article provides some of the details:

The Defense Business Board estimates the average cost of a military member at $80,004 per year. Thankfully the military is made up mostly of junior enlisted personnel who leave the service well before they are eligible for a pension. There are, however, 1.9 million military retirees receiving an average of $47,000 per year in pension payments. This does not include their healthcare benefits.

And, just as was true for the pre-bankruptcy auto industry, there are more military retirees than soldiers, sailors, airmen, and marines on active duty. While it may be unpleasant to hear, the system is unsustainable. The military may very well collapse under its own personnel costs. In part, reform has stalled because any voice that questions military pay and benefits is tarred and feathered as unpatriotic.

Americans are understandably proud of the men and women who serve in our military. They endure enormous hardships, including long periods of separation from their families and exposure to all manner of hostile environments. They represent many of the finest attributes of this country. No wonder that the military is regularly cited as the most respected institution in national polls. I’m a little embarrassed to be counted a “veteran” — which is technically true — when many of the men and women with whom I graduated, or served, have stayed in the military for 20 years or more. At least one friend didn’t come home. They are the real heroes.

But while we can and should be proud, we shouldn’t be stupid. The author is right: the system is unsustainable. If we are going to get a handle on rising personnel costs, we must either reform the manner in which pay and benefits are distributed, or reduce the number of personnel. If we are to do the latter (and I think that we should) then we need to rethink roles and missions, and ask less, not more, of the men and women who remain in the service. (See Gen. Raymond Odierno’s recent comments on that score.)

If we succeed in restraining Washington’s interventionist impulses, and draw down the number of active-duty personnel to levels that prevailed in the late 1990s, the end result might be an even more elite force than the one that we have today. The future force would include individuals earning salaries that are competitive with the private sector, which is essential for maintaining the all-volunteer force. And that force would be more than sufficient to protect us from the real but manageable threats of the next few decades.

House Approps Strips TSA of Strip-Search Funds

The fiscal 2012 Department of Homeland Security spending bill is starting to make its way through the process, and the House Appropriations Committee said in a release today that “the bill does not provide $76 million requested by the President for 275 additional advanced inspection technology (AIT) scanners nor the 535 staff requested to operate them.”

If the House committee’s approach carries the day, there won’t be 275 more strip-search machines in our nation’s airports. No word on whether the committee will defund the operations of existing strip-search machines.

Saving money and reducing privacy invasion? Sounds like a win-win.

The National Equalization of Opportunity Board

The National Labor Relations Board filed a complaint last month to stop Boeing from building its new 787 in South Carolina rather than Washington State. As Arthur Laffer and Stephen Moore explain in today’s Wall Street Journal, the Board’s action stems from Boeing’s declaration that it cannot “afford a work stoppage every three years” as has been happening in Washington. The New York Times seems to endorse the NLRB complaint, implying that the federal government must force companies to do business in agency-shop states like Washington, because otherwise they couldn’t compete with more efficient right-to-work states like South Carolina.

Laffer and Moore claim that the NLRB’s move is unprecedented, but it is actually highly reminiscent of the “Equalization of Opportunity Bill.” The EOB forbade entrepreneurs from owning more than one business, in order to allow less efficient, less capable entrepreneurs to compete with them. The EOB is, of course, a measure enacted by the United States Government in Ayn Rand’s Atlas Shrugged.

Yet more evidence that the Obama administration is not only conversant with Rand’s classic, it is using the book as a policy model. It’s just a little confused as to which characters were the heroes and which the bad guys.

The 2011 Social Security Trustees Report — Harbinger of Bad News

The just-released 2011 annual report of the Social Security Trustees shows a significant worsening of the program’s finances.

Last year we were told that we would see payroll tax surpluses over benefit expenditures for a few more years — until 2015. That won’t happen according to the 2011 report; the program will now add to federal deficits in every future year — and increasingly so, which will ramp-up financial pressure to downsize other federal programs, increase taxes, or create yet more debt.

Note that both Republicans and Democrats negotiating over how to reduce federal deficits and the national debt have resolved to leave Social Security untouched for now.  That leaves the program’s finances to fester and worsen — increasing the costs of future adjustments and burdens on future generations.

Many people, especially those who favor early reforms, say that the Social Security trust funds “don’t matter.”  Note, however, that they lock up future federal revenues for Social Security benefit payments — on par with future dedicated payroll taxes.

The lock-up effect of the Social Security trust funds  is demonstrated by the fact that the program’s cash flow deficits today are not forcing any benefit cuts or payroll tax increases.  This can continue until the year 2036 according to the 2011 report.

But if we allow the situation to continue for that long, fixing the program will require a permanent benefit cut of at least 25 percent or a payroll tax increase of at least 40 percent of payrolls in 2036 and beyond.

Most left-leaning politicians and analysts are unwilling to entertain any benefit cuts today.  They favor tax increases today.  But those will fall on today’s and future workers, destroying their incentives to work and ability to save for the future.

Retirees, on the other hand, can continue to enjoy Social Security benefits that are much more generous compared to what they paid in when working.  So to hold all, including well-off, retirees harmless from a “shared sacrifice” approach to fixing Social Security’s finances seems unfair.

The trust fund also “matters” because it provides fodder to the argument of left-leaning politicians that the program’s finances are sound, backed by $2.6 trillion in Trust Fund treasury securities.  That $2.6 trillion sounds like a lot of money to the average Joe on the street. But consider that past and current generations, who together contributed an extra $2.6 trillion to Social Security, are now owed much more under the program’s current laws — a whopping $18.8 trillion according to the 2011 report.

The program’s long-term actuarial deficit (over 75 years) is now 2.2 percentage points of payrolls.  That’s 30 basis points larger than was the case in last year’s report, by far the largest increase in recent memory . That’s surely because of poorer prospects today compared to last year of experiencing a rapid recovery of productivity, output, and payroll tax revenues.

Finally, Mark Warshawsky, my friend and colleague on the Social Security Advisory Board, notes that this year’s Trustees’ report has been released on a Friday during the afternoon — the right day to release bad news because policymakers and the public are usually busy planning or traveling for weekend activities.

Topics:

Is Housing Holding Back Inflation?

Today the Bureau of Labor Statistics released the consumer price index (CPI) numbers for April, which generally gives us the best picture of inflation.  The headline number is that between April 2010 and April 2011, consumer prices increased 3.2 percent, as measured by the CPI.  Obviously this is well above 2 percent, the number Ben Bernanke defines as “price stability.”  Setting aside the reasonableness of that definition, there is definitely some mild inflation in the economy.

Also of interest in the April numbers is that if you subtract housing, which makes up over 40% of the weight of the CPI, then prices increased 4.2 percent — twice Bernanke’s measure of stability.  What has always been problematic of the housing component is that its largest piece is an estimate of what owners would pay themselves if they rented their own residence.  This estimate makes up about a fourth of the CPI.  As the chart below demonstrates, for much of 2010, the direction in this number was actually negative, which held down CPI over the last year.  The current annualized figure for owner’s rent is 0.9 from April 2010 to April 2011.  Oddly enough, this is below the actual increase in rents, which was 1.3.  For most homeowners, the real cost of housing — their mortgage payment — has likely been flat, not decreasing.  So whatever benefit there has been to declining housing costs, most consumers are unlikely to feel any benefit from those declines, if they are actually real.

While the primary driver of CPI has been energy costs, food prices have also garnered considerable attention.  Excluding food from the CPI does not change the headline number, although this is due to the fact that the cost of eating out has been rising considerably slower than the cost of eating at home.  So as along as you’ve been eating out every night, you’ve apparently been fine.  This touches upon what is one of the less recognized features of current inflation trends:  the regressive nature of these prices increases.  If you rent, then you’ve seen costs increase more than if you own.  If you mostly eat at home, then you’ve seen prices increase more than if you dine out a lot.  If you have a lot of leisure time, the you’ve gained by the decrease in reaction prices.  While I don’t think one’s position on inflation should be driven purely by distributional concerns, the fact that working middle-income households have been hit harder by recent inflation trends than higher-income households should cut against the claims that inflation is somehow good for the poor or working class.

As a Matter of Fact, the Baltic Nations Are a Success Story

I got a few cranky emails after my post suggesting the United States should copy the Baltic nations and implement genuine spending cuts. These emailers were upset that I favorably commented on the fiscal discipline of Estonia, Lithuania, and Latvia while failing to reveal that these nations were suffering from high unemployment.

From the tone of this correspondence, my new friends obviously think this is a “gotcha” moment. The gist of their messages is that the economic downturn that hit the Baltic nations is proof that the free-market model has failed, and that I somehow was guilty of a cover-up.

That’s certainly a strange interpretation, especially since I specifically noted that the three nations had suffered from an economic downturn. There’s no questioning the fact that unemployment spiked upwards because of the global financial crisis, which was especially damaging to the Baltics since they all had real estate bubbles.

But let’s deal with the bigger issue, which is whether this downturn is proof that the free market failed (and, for the sake of argument, let’s assume that all three Baltic nations are free market even though only Estonia gets high scores in the Economic Freedom of the World rankings).

If you look at the IMF’s World Economic Outlook Database, it does show that the Baltic nations had serious economic downturns. Indeed, if we look at the data from 2008 to the present, the recession was far deeper in those nations than in Western Europe and North America.

So at first glance, it seems my critics have a point.

But what happens if you look at a longer period of data? The IMF has data for all three Baltic nations going back to 1999. And if we look at the entire 12-year period, it turns out that Estonia, Latvia, and Lithuania have enjoyed comparatively strong growth. Indeed, as seen in the chart below the jump, they even surpass Hong Kong.

In other words, the Baltic nations may have suffered larger-than-average economic downturns, but they also enjoyed stronger-than-average booms. And the net effect is that they are now in much better shape than the nations that had smaller recessions but also less-robust growth.

A sophisticated critic may look at the data and say they’re meaningless because convergence theory suggests that middle-income countries almost always will grow faster than rich nations. That’s a fair point, so let’s now compare the three Baltic nations to three other nations that were at the same level of development at the turn of this century.

As you can see, the Baltic nations are doing substantially better than other middle-income nations. By the way, skeptics should feel free to peruse the IMF data to confirm that I didn’t cherry-pick nations to make my point (indeed, I deliberately picked Thailand since it was emerging from the Asian financial crisis and is an example of a nation that enjoyed very good growth in the 2000-2011 period).

The point of this post is not that the Baltic nations are perfect. Estonia is ranked 12th in the Economic Freedom rankings, which is impressive, but Lithuania is 33rd and Latvia is 55th. Those aren’t bad scores considering that these nations are recovering from communist tyranny, to be sure, but Hong Kong isn’t in any danger of being dethroned.

Instead, my argument is that the Baltic nations are making slow but steady progress, and I’m quite confident that the recent decisions by these nations to reduce the burden of government spending will help put them back on an above-average growth path.

That is something the United States should emulate.