Williamson, a pioneering theorist of the incentives that shape business firms, is one of the world's most cited living economists. Until Monday, Ostrom — a 76-year-old professor of political science at the University of Indiana, and the first woman to win the economics Nobel — was rather less well-known. She is, however, abundantly deserving of both the prize and increased attention. Through an ingenious blend of formal game theory, laboratory experimentation, and down-and-dirty empirical fieldwork, Ostrom has shed light on the ways real people arrive at rules that allow them to live in harmony with each other and their natural environment.

Much of Ostrom's work can be seen as a comprehensive response to a famous paper by the ecologist Garrett Hardin on the so-called "tragedy of the commons."

Imagine a pond considered community property. There's only so many fish in the pond. Each fish taken from the common pool leaves one less for others and everyone knows it. Absent a set of rules governing fishing, the individual's best fish-getting strategy is to race to the pond and take as many fish as possible before the others have taken them all. In the myopic rush to get something now, individuals use up the commons, tragically depriving everyone of its fruits thereafter.

Hardin argued that tragedies of the commons may be avoided only if we turn either to privatization or, more likely, top-down government regulation. Ostrom has proved that this is a false choice. Her trailblazing fieldwork in rural areas of poor countries has shown the users of various common-pool resources can and do develop and enforce rules that make community use of shared natural assets sustainable. "Many policy analysts presume that without major external resources and top down planning by national officials, there can be no provision of public goods and sustainable common-pool resources," Ostrom has written. "This presumption is wrong."

Ostrom is quick to point out attempts to manage common-pool resources outside of formal markets and the regulatory state don't always work. But Ostrom's close inspection of the conditions attending both success and failure helps to clarify many of the challenges of human social life, from the sustainable management of forests to the maintenance of public order by municipal police departments.

If more of us saw the world like Elinor Ostrom, it would be a better world. To see the world more like Elinor Ostrom is to see humans and their communities as a natural part of the natural order, not as invading aliens essentially at odds with their environment or one another. Ostrom has emphasized none of us would be here today had our ancestors failed to work together to find ways to align individual interest with public interest.

Her field work and laboratory experiments both lend credence to the idea that creative, collective problem-solving is a part of human nature. We seem to be "designed" by evolution to negotiate mutually agreeable terms of association, to internalize norms, and to detect and sanction those who flout the rules. But successful solutions to the problems of ecologically embedded common life often depend crucially on the fine-grained details of the problem. That's why top-down, one-size-fits-all solutions so often fail.

According to Ostrom, the terrain of a meadow, shape of a pond, or population of a village can make all the difference. To see the world more like Elinor Ostrom is see the organic, delicately adaptive nature of local rules, and to see the folly of arrogantly assuming our textbooks have taught us a better way.

Where most modern political economy assumes a stark dichotomy between the market and the state, Ostrom makes space for a third sector of voluntary civil association. By insisting on a more realistic account of human behaviour, Ostrom's work not only helps to account for forms of social co-ordination most economists have missed, but it also helps us envision markets and governments as parts of a single tapestry of overlapping and interwoven institutions. Because the devil's in the details, it's hard to say in advance what mix of institutions will work best in a given place.

Ostrom's early work on municipal police departments (with her husband, the decorated political scientist Vincent Ostrom) illustrates the refreshingly pragmatic thrust of her worldview. During the 1960s and '70s the existence of multiple, relatively small police departments in larger metro regions was widely considered wastefully redundant. Many believed that the consolidation and centralization of police authority and administration would both save money and help fight rising crime rates. But the Ostroms found that the opposite was true; people living in small jurisdictions within large metropolitan regions got better policing for less money. Public order is best assured by what may look like a chaotic hodge-podge of overlapping institutions.

To see the world more like Elinor Ostrom is to see each public policy like a real-world experiment. Policies are implemented because they are predicted to have certain beneficial effects. But even experts are fallible. We make mistakes. Multiple, partially redundant jurisdictions make a virtue of inevitability. They allow for simultaneous policy experiments that help us grope toward effective solutions. Successful policy can be easily observed and adapted to other jurisdictions and the damage caused by failed policy is contained.

To see the world more like Elinor Ostrom is to be guided less by ideology and more by the contours of the situation — to use the right institutional tool for the job. "[N]ational governments," Ostrom tells us, "are too small to govern the global commons and too big to handle smaller scale problems." Size matters. We have to understand that we may not have a good tool for our biggest jobs.

But that's okay. To see the world more like Elinor Ostrom is to see that people are creative, that it is possible to get together and work things out. "It is ordinary persons and citizens," she says, "who craft and sustain the workability of the institutions of everyday life."

This is a message we need to hear. In a year that saw some of our central economic institutions collapse, it is good to be reminded that our institutions are our creations, our tools. It's good to be reminded that there is profound social intelligence even in the most modest rural village. It's good to be reminded that even the best and brightest are limited, that failure is inevitable. That we can, and must, learn from our mistakes.

With email grabbing ever more market share from snail mail, USPS's finances are steadily deteriorating. What should federal policymakers do? They can't give USPS the General Motors treatment and nationalize it, because it's already government-owned. And they can't reform postal markets with a "public option" because that's what the USPS already is.

Instead, Congress and President Obama should deregulate postal markets and privatize the USPS. It's true that such pro-market reforms are not in vogue these days, but Obama claims that on economics, he doesn't want to "get bottled up in a lot of ideology … my interest is finding something that works." For postal reform, that means injecting competition by allowing "private options" in the marketplace.

We know that postal deregulation works because it's already in place abroad. Postal services have been opened to competition in Britain, Finland, New Zealand, and Sweden. In those countries, private operators are starting to challenge former monopoly mail providers, particularly on business mail delivery.

In Germany and the Netherlands, the main postal companies (Deutsche Post and TNT Post respectively) have been privatized, allowing them to expand into foreign markets and diversify their services. These two countries haven't yet leveled the playing field for competitor firms, but that reform should be coming soon.

That's because the 27 member nations of the European Union have agreed to end their mail monopolies by either 2011 or 2013. Some countries are dragging their feet, but it appears that the wheels are in motion for the Europeans to soon have a much more dynamic postal sector than the United States.

An analysis by the Consumer Postal Council found that U.S. postal markets are the third most regulated among 19 countries examined. The main regulatory shackle is the USPS's legal monopoly over first-class mail. That restriction makes no sense in today's economy. It simply deprives consumers of the innovations and cost savings that could be brought to the mail business by entrepreneurs.

The good news is that the choke-hold that the USPS has long had over personal and business correspondence has ended. USPS's mail volume peaked in 2006 and will probably never recover. These days, people communicate via email, text messages, and other electronic tools. The share of bills that U.S. households pay online is already 38 percent and rising fast.

The bad news is that we've still got a 700,000-worker behemoth to deal with. We can let entrepreneurs into the market to bring new efficiencies to letter delivery, but we still need to downsize the USPS. In most industries, businesses facing declining markets can radically cut costs and innovate to survive. But the USPS can't do that effectively because it is beholden to members of Congress and their parochial concerns.

Plans to close down some of USPS's 37,000 retail locations across the country are usually met with resistance on Capitol Hill as members defend the facilities in their states. And recently, the USPS floated the idea of cutting mail delivery to five days, but members haven't embraced that cost-cutting idea either.

At the same time, USPS managers try to avoid tough financial decisions. Right now, for example, the USPS is asking Congress to suspend a legal requirement that it pre-fund its huge unfunded health care liability. However, that would just dig a deeper financial hole for the organization down the road.

And then there is USPS's difficulty in cutting its massive labor costs. The average USPS worker earns $83,000 per year in compensation, as union deals have delivered regular wage and benefit increases over the years. The Government Accountability Office recently noted that "compensation and benefits constitute close to 80 percent of USPS's costs — a percentage that has remained similar over the years despite major advances in technology and the automation of postal operations."

A privatized USPS would have the incentive and freedom to tackle such long-standing inefficiencies. At the same time, competitor firms would give households and businesses alternatives to the USPS's regular postal rate increases. It's time to end America's last great monopoly and free the mails.

The poverty of those years caused many to emigrate from the country, mostly to the U.S. Upper Midwest. Beginning in the 1870s, Sweden created the conditions for developing a high-growth, free-market economy with a slowly growing government sector. As a result, Sweden for many years had the world's fastest-growing economy, ultimately producing the third-highest per capita income, almost equaling that in the United States by the late 1960s. Sweden became a rich country before becoming a welfare state.

Sweden began its movement toward a welfare state in the 1960s, when its government sector was about equal to that in the United States. However, by the late 1980s, government spending grew from 30 percent of gross domestic product to more than 60 percent of GDP.

Most full-time employees faced marginal tax rates of 65 percent to 75 percent, as contrasted with 40 percent in 1960. Labor-market regulations were introduced to make it very difficult to fire workers. Business profits were taxed heavily, and financial markets were regulated heavily. By 1993, the government budget deficit was 13 percent of GDP and total government debt was about 71 percent of GDP, which led to a rapid fall in the value of the currency and a rise in inflation.

These policies and outcomes greatly diminished the incentives to work, save and invest. Economic growth slowed to a crawl. Other countries that avoided the excess spending, taxing and regulation of Sweden grew more rapidly, leaving Sweden in the dust. Sweden is still a prosperous country, but far from the top, and its per capita income has fallen to just about 80 percent of that in the United States.

In the late 1980s and 1990s, Sweden began an economic course correction that continues today. Marginal tax rates were reduced for most of the population, and this trend is expected to continue.

The wealth tax and inheritance tax were abolished. Financial markets, telecommunications, electricity, road transport, taxis and other activities were deregulated. Privatization of industry was begun, and the current government is continuing the process. The generosity of some welfare and other benefits has been reduced, with the goal of making work more economically rewarding relative to government benefits. Also, trade liberalization has been expanded greatly. The result has been a pickup in economic growth, and Sweden is no longer falling further behind other developed countries.

One notable success has been pension reform. Sweden was the first nation to implement a mandatory government retirement system for all its citizens. Sweden, like the United States and most other countries, was faced with an increasing, unfunded social security liability as a result of low birthrates and people living much longer. After studying the problem in the early 1990s, the Swedes approved, in 1998, moving toward a Chilean private pension system, first developed by former Chilean Labor Minister Jose Pinera. (Seventeen countries have adopted variations of the Pinerian system, which has been very successful in Chile.)

The new Swedish pension system has four key features, including partial privatization, individual accounts, a safety net to protect the poor and a transition to protect retirees and older workers. The benefits have been substantial budgetary savings, higher retirement income and faster economic growth.

Those who wish to chase the Swedish model need first to decide which model they seek: The high-growth, pre-1960 model; the low-growth model of the 1970s and 1980s; or the reformist, welfare-state model of recent years. The irony is that the current Democratic Congress and administration are rapidly emulating the parts of the Swedish model that proved disastrous and rejecting those parts that are proving to be successful.

Most Swedes now understand that they still have a good distance to go to further strengthen the market economy to ensure continued growth. Thus, they continue to move toward reducing the size of government rather than increasing it.

If the Obama Democrats were wise enough to learn from the Swedes, they would be moving toward trade liberalization rather than away from it. They would be moving to at least partially privatize Social Security. They would not seek to prevent the abolition of the death tax. They would be reducing rather than increasing regulations. They would be reducing rather than trying to increase marginal tax rates on work, saving and investment. They would be reducing the corporate income tax as was done in Sweden.

Finally, the Obama Democrats would be reducing government spending rather than increasing it and not running deficits as large as those that almost sank the Swedish economy 16 years ago.

In fact, the Washington Metro is a prime example of the failure of our socialized transit model, and why transit systems should be privatized.

In 1964, most of America’s transit systems were private and the industry as a whole was profitable. Then Congress passed the Urban Mass Transit Act, not—as some believe—to help low-income people who couldn’t afford cars, but because railroads threatened to terminate money-losing commuter trains into Manhattan, Boston, Chicago, and Philadelphia.

Congress justified federal support for those trains on the grounds that some of them crossed state lines. Politically, however, supporting transit in those urban areas meant supporting transit throughout the country, whether or not that transit crossed state lines.

Washington, Atlanta and San Francisco then spent billions of dollars building new subway and elevated rail transit lines. These systems completely failed to live up to their promises, costing far more and carrying fewer riders than projected, and they did little to relieve congestion.

Yet transit agencies could not admit they had wasted billions of taxpayer dollars, so they proclaimed these lines to be great successes. Certainly, the people who ride them appreciate the heavy subsidies they receive, but the share of commuters and other travelers riding transit in these regions continued to decline.

For example, the 2000 census revealed that the Washington, D.C. urban area had gained more than 100,000 new jobs since 1990 and that virtually all those commuters drove to work.

Moreover, more than 21,000 commuters who took transit to work in 1990 switched to driving by 2000. You won’t hear that from Washington Metro officials.

Nevertheless, Congress opened the floodgates of federal funding for new rail transit lines, and the number of urban areas with expensive rail transit climbed from 10 in 1980 to nearly 40 today.

To cover the high costs of rail transit, many transit agencies ended up cutting bus service, contributing to declines in per-capita transit ridership.

Nor do transit officials ever mention that the cost of reconstructing rail lines every 30 years is almost as great as the original construction cost. Agencies invariably fail to plan for this cost and hope instead for federal bailouts.

The Chicago Transit Authority is "on the verge of collapse" as it needs $16 billion to rehabilitate its tracks and trains. New York’s Metropolitan Transportation Authority is in serious trouble because it is short $17 billion needed to rehabilitate its rail lines.

Washington’s Metrorail suffers increasing breakdowns because no one has found the $12 billion it needs to keep the system running.

Rail advocates argue that all transportation is subsidized so we should pay no attention to the transit subsidies behind the curtain. Yet transit subsidies are vastly out of proportion to other transportation support and have made transit the most expensive way to travel in the U.S.

Including subsidies, Americans spend 15 cents per passenger mile flying, 24 cents driving, and 80 cents on urban transit. While less than 4 percent of the cost of driving and less than 10 percent of the cost of flying is subsidized, three-fourths of the cost of transit comes from subsidies.

Contrary to conventional wisdom, all transit is not subsidized. Atlantic City, NJ, has a private bus system that runs 24 hours a day without subsidies. San Juan, Puerto Rico residents ride private buses known as públicos that carry more people, without subsidies, than the city’s tax-supported public buses and trains. Yet most American cities and states outlaw private competition to government’s monopoly transit systems.

We won’t fix transit’s woes by throwing money at it, especially not by building new rail transit lines, which will only impose huge obligations on future generations to maintain (or dismantle) those lines.

Instead, we need to return to a private transit model, allowing competing transit companies to provide innovative transit services that people will use at no cost to taxpayers.

Several Cato Institute studies have called for privatization of the public lands, but this idea is strongly resisted by environmentalists, recreationists, and other users of public land. An alternative policy that will both enhance the values sought by environmentalists and improve the fiscal management of the lands is to turn them into fiduciary trusts. Under this proposal, the U.S. would retain title to the lands, but the rules under which they would be governed would be very different.

Fiduciary trusts are based on hundreds of years of British and American common law that ensures that trustees preserve and protect the value of the resources they manage, keep them productive, and disclose the full costs and benefits of their management. For trust law to apply, public land trusts must be based on a law written by Congress that clearly defines the trustees, the beneficiaries, and a specific mission or missions for the trusts.

Congress should create two types of trusts. Market trusts would have a mission of maximizing revenue while preserving the productive capacity of the land. To achieve this mission, Congress should allow them to charge fair market value for all resources. Nonmarket trusts would have a mission of maximizing the preservation and, as appropriate, restoration of natural ecosystems and cultural resources on the public lands.

Each pair of market and nonmarket trusts would jointly manage all federal lands in one of about a hundred ecoregions. Each ecoregion would have about 5 to 10 million acres of federal land that might include forests, parks, refuges, and other public lands. Trustees would be elected by a friends' association that anyone would be welcome to join. Trusts would be funded out of the user fees they collect, with some retained by the market trust and some given to the nonmarket trust. In some cases, excess user fees would be returned to the U.S. Treasury.

The trust idea would significantly improve both fiscal and environmental management of the public lands. Congress should begin to implement this idea by testing it on selected national forests, parks, and other federal lands.

While America debates higher government spending on infrastructure, governments on every continent have sold off state-owned assets to private investors in recent decades. Airports, railroads, energy utilities, and many other assets have been privatized. Heathrow airport in London is privately owned and operated. Air-traffic control services are fully private in Canada. In Italy and France, limited access highways are private concessions funded with toll revenue. In many areas, the U.S. is a laggard in the world on private infrastructure provision.

The issue of whether public infrastructure spending encourages economic growth has been studied extensively by economists. In the late 1980s and early 1990s, some research argued that public capital investments had double the effect of private investment on subsequent economic growth. But those findings were challenged, and the statistical techniques were found to be faulty. By the early 2000s the consensus of economists was that the effect of public investment on subsequent economic output was at best extremely low and at worst no effect at all.

The main problem with current government infrastructure spending is not its magnitude but its lack of efficiency. More roads and transit capacity may or may not make sense depending on whether the benefits exceed the costs. One sure way to find out is to have private provision and user charges. If users are not willing to pay the costs of extra or newer capacity, then calls for taxpayer involvement probably imply subsidy of some at the expense of others rather than efficiency.

Privatization of federal and state infrastructure makes sense for many reasons. First, privatization would reduce the responsibilities of the government so that policymakers could better focus on their core responsibilities, such as national security. Second, there is vast foreign privatization experience that could be drawn upon in pursuing U.S. reforms. Third, privatization would spur economic growth by opening new markets to entrepreneurs. For example, repeal of the U.S. postal monopoly could bring major innovation to the mail industry, just as the 1980s' breakup of AT&T brought innovation to the telecommunications industry.

Here are some of the government businesses and infrastructure that could be privatized:

• Postal Services. The mammoth 685,000-person U.S. Postal Service is facing declining mail volume and rising costs. The way ahead is to privatize the USPS and repeal the company's legal monopoly over first-class mail. Reforms in countries such as Germany and New Zealand show that there is no good reason for the current mail monopoly.


• Air Traffic Control. The Federal Aviation Administration has been mismanaged for decades and provides Americans with second-rate air traffic control. The FAA has struggled to expand capacity and modernize its technology. Canada privatized its ATC system in 1996. It set up a private, nonprofit ATC corporation, Nav Canada, which is self-supporting from charges on aviation users. The Canadian system has received high marks for sound finances, solid management, and investment in new technologies.


• Highways. A number of states are moving ahead with privately financed and operated highways. The Dulles Greenway in Northern Virginia is a 14-mile private highway opened in 1995 that was financed by private bond and equity issues. In the same region, Fluor-Transurban is building and mainly funding high-occupancy toll lanes on a 14-mile stretch of the Capital Beltway. Drivers will pay to use the lanes with electronic tolling, which will recoup the company's roughly $1 billion investment.


• Airports. Nearly all major U.S. airports are owned by state and local governments, with the federal government subsidizing airport renovation and expansion. By contrast, airports have been fully or partly privatized in many foreign cities, including Athens, Auckland, Brussels, Copenhagen, Frankfurt, London, Melbourne, Naples, Rome, Sydney, and Vienna.


• Seaports. Nearly all U.S. seaports are owned by state and local governments. Many operate below world standards because of inflexible union work rules and other factors. A Maritime Administration report noted that "American ports lag well behind other international transportation gateways such as Singapore and Rotterdam in terms of productivity." Dozens of countries around the world have privatized their seaports. One Hong Kong company, Hutchinson Whampoa, owns 30 ports in 15 countries. In Britain, 19 ports were privatized in 1983 to form Associated British Ports.

To sum up, some policymakers think that certain activities, such as air traffic control, are "too important" to leave to the private sector. But the reality is just the opposite. The government has shown itself to be a failure at providing efficiency and high quality in services such as air traffic control. Such industries are too important to miss out on the innovations that private entrepreneurs could bring to them.

But the reality has been very different: continuing heavy regulation, with a growing loss of accountability and effectiveness. That’s dysfunctional governance, not laissez-faire.

When it comes to financial regulation, for example, until the crisis of the last few months, the administration did little to alter a regulatory structure that was built over many decades. Banks continue to be governed by a hodgepodge of rules and agencies including the Office of the Comptroller of the Currency, the international Basel accords on capital standards, state authorities, the Federal Reserve and the Federal Deposit Insurance Corporation. Publicly traded banks, like other corporations, are subject to the Sarbanes-Oxley Act.

And legislation that has been on the books for years - like the Home Mortgage Disclosure Act and the Community Reinvestment Act - helped to encourage the proliferation of high-risk mortgage loans. Perhaps the biggest long-term distortion in the housing market came from the tax code: the longstanding deduction for mortgage interest, which encouraged overinvestment in real estate.

In short, there was plenty of regulation - yet much of it made the problem worse. These laws and institutions should have reined in bank risk while encouraging financial transparency, but did not. This deficiency - not a conscientious laissez-faire policy - is where the Bush administration went wrong.

It would be unfair, however, to blame the Republicans alone for these regulatory failures. The Democrats have a long history of uncritically favoring expansion of homeownership, which contributed to the excesses at Fannie Mae and Freddie Mac, the humbled mortgage giants.

The privatization of Fannie Mae dates back to the Johnson administration, which wanted to get the agency’s debt off its books. But now, of course, the government is on the hook for the agency’s debt. As late as this spring, Congressional Democrats were pushing for weaker capital requirements for the mortgage agencies. The regulatory reality was that few politicians were willing to exchange short-term economic gains - namely, higher rates of homeownership - for protection against longer-term financial risks.

Still, the Bush administration’s many critiques of regulation are belied by the numbers, which demonstrate a strong interest in continued and, indeed, expanded regulation. This is the lesson of a recent study, "Regulatory Agency Spending Reaches New Height," by Veronique de Rugy, senior research fellow at the Mercatus Center at George Mason University, and Melinda Warren, director of the Weidenbaum Center Forum at Washington University. (Disclosure: Ms. de Rugy’s participation in this study was under my supervision.) For the proposed 2009 fiscal budget, spending by regulatory agencies is to grow by 6.4 percent, similar to the growth rate for last year, and continuing a long-term expansionary trend.

For the regulatory category of finance and banking, inflation-adjusted expenditures have risen 43.5 percent from 1990 to 2008. It is not unusual for the Federal Register to publish 70,000 or more pages of new regulations each year.

In other words, financial regulation has produced a lot of laws and a lot of spending but poor priorities and little success in using the most important laws to head off a disaster. The pattern is reminiscent of how legislators often seem more interested in building new highways - which are highly visible projects - than in maintaining old ones.

The biggest financial deregulation in recent times has been an implicit one - namely, that hedge funds and many new exotic financial instruments have grown in importance but have remained largely unregulated. To be sure, these institutions contributed to the severity of the Bear Stearns crisis and to the related global credit crisis. But it’s not obvious that the less regulated financial sector performed any worse than the highly regulated housing and bank mortgage lending sectors, including, of course, the government-sponsored mortgage agencies.

In other words, the regulation that we have didn’t work very well.

There are two ways to view this history. First, with the benefit of hindsight, one could argue that we needed only a stronger political will to regulate every corner of finance and avert a crisis.

Under the second view, which I prefer, regulators will never be in a position to accurately evaluate or second-guess many of the most important market transactions. In finance, trillions of dollars change hands, market players are very sophisticated, and much of the activity takes place outside the United States - or easily could.

Under these circumstances, the real issue is setting strong regulatory priorities to prevent outright fraud and to encourage market transparency, given that government scrutiny will never be universal or even close to it. Identifying underregulated sectors in hindsight isn’t a useful guide for what to do the next time.

Both presidential candidates have endorsed regulatory reform, but they have yet to signal that it will become a priority. That isn’t surprising. Fixing these problems may seem a very abstract way of helping the average citizen, and it will certainly require taking on special interests. It’s easier to tell voters that the regulators have taken care of last year’s problem, even if that accomplishes nothing for the future.

In the meantime, if you hear a call for more regulation, without a clear explanation of why regulation failed in the past, beware. The odds are that we’ll get additional regulation but with even less accountability and even less focus on solving our very real economic problems.

The answer of course is that Fannie and Freddie should get no such privileges and taxpayers should not have to protect them.

Fannie and Freddie are specially privileged "government-sponsored enterprises." They're exempt from state and local taxes. And their required "core capital" (mainly stock) is merely 2.5 percent of assets, compared with a 6 to 8 percent norm for banks. As a result, their $5.3 trillion of debt is piled precariously atop a thin cushion of only $81 billion in core capital. It's risky business. But who bears the risk?

Fannie and Freddie pay an artificially low interest rate on their bonds because everyone assumes that, if it came to it, the U.S. Treasury would bail them out. The artificially fat spread between interest rates earned on mortgages and interest rates paid on bonds amounts to a big subsidy. That thwarts competition. It also undermines market discipline, because creditors have little incentive to monitor the firms' borrowing and investments.

Another unique privilege has been a $2.5 billion line of credit with the U.S. Treasury. Not enough? Treasury Secretary Henry Paulson recently proposed offering Fannie and Freddie unlimited access to the U.S. Treasury for 18 months. He invoked the old "confidence" game, claiming a blank check on the U.S. Treasury "is the best means of increasing market confidence" in Fannie and Freddie. The idea also proved to be an excellent means of decreasing confidence in U.S. Treasury bonds and the dollar, both of which lost value on the news.

Contrary to a common misimpression, Fannie and Freddie provide no mortgages. They just buy bundles of mortgages from lenders and swap them for mortgage-backed securities. They also invest in private mortgage-backed securities, paying for them by getting deeper in debt.

What they own or guarantee amounts to 42 percent of all mortgages, but we know from recent experience that, if Freddie and Fannie bought less, other institutions and investors (including pension funds) would simply get a bigger share. Fannie and Freddie were involved in scandalous accounting fraud in 2003, manipulating earnings to boost their executives' pay. The Office of Federal Housing Enterprise Oversight reacted by raising their capital requirement, greatly limiting their capacity to grow. Yet that certainly didn't make mortgages scarce from 2004 to 2006.

The greater the failure of government regulation, the greater the political urge to give regulators more power and money. But regulators have no magical power to anticipate unforeseen problems, and no incentive to put sound economics ahead of short-term politics.

Secretary Paulson dreams of "a new world-class regulator" for the troubled enterprises. Their current regulator, the Office of Federal Housing Enterprise Oversight is apparently too old at age 16 and not "world class." But regulation of Fannie and Freddie has always been heavily politicized, and there is no reason to expect that to change under a new entity. While Congress controls the oversight office's annual budget, Fannie and Freddie are famously generous with campaign contributions, giving them critical sway over their regulator's regulators.

In a properly critical survey of the economic evidence about Fannie and Freddie, W. Scott Frame of the Atlanta Fed and Lawrence J. White of New York University concluded the best solution would be to end both the special privileges of Fannie and Freddie and the accompanying legal restrictions on the diversity of their investments. Among second-best solutions, they suggested the opposite of Treasury Secretary Paulson's proposal—namely that top officials should explicitly state the government will not guarantee Fannie's and Freddie's debts. They also suggested the opposite of congressional legislation—that the maximum sizes of mortgages the enterprises buy should be frozen rather than increased in order to focus support on less affluent homebuyers.

They are correct, but such good economic advice is too often trumped by politics. A new regulator is unlikely to be any better than the old regulator because the whole notion of a government-sponsored business is thoroughly politicized and inherently corrupt.

Fannie and Freddie may be "too big to fail," but that means they are also too big for taxpayer bailouts.

Potentially massive loans from the Treasury and Fed are no solution to their already excessive debt—the last thing they need is more. These two politically privileged companies pose a "systemic risk" to the economy precisely because they became much too big in the past two decades. Any serious solution must begin by requiring Fannie and Freddie to do what other troubled firms are routinely required to do—sell assets, raise capital, and reduce debt.

Fannie Mae and Freddie Mac need to be downsized and de-leveraged, relieved of special privileges and loan guarantees, and broken into small pieces agile enough to sink or swim on their own, without taxpayer support.

Markets also anticipated the weekend bailout announcement by bidding down the share prices of the two mortgage giants, and also bidding up the prices of their debt (driving down their interest rates). That was a bet that the forthcoming bailout would result in a dilution of shareholder value, and protection for the bondholders.

Yields on Treasuries rose, as the government's balance sheet was expected to expand by whatever the net liabilities of these two companies might be (less, presumably, than their $5.3 trillion gross liabilities). The dollar tumbled in anticipation of more deficits, and more inflation to pay for all this.

The focus must now be on the way forward. This should entail putting both institutions on a sound financial footing, and never again allowing them to become a drain on the taxpayer and a threat to financial stability.

By last week, both corporations were operating at odds with their own charters. Consider Freddie Mac, chartered by Congress in 1970. Its first stated purpose was "to provide stability" in the secondary mortgage market. Its second purpose (of four) was "to respond appropriately to the private capital market." But Freddie and Fannie had both become a source of financial market instability, helping to drag down share prices of other firms exposed to their obligations, and forcing private capital markets to respond to their possible collapse.

Whatever the outlines of what will inevitably be a hastily crafted bailout plan, the result must be true privatization. That means no more government lifeline: no Treasury line of credit, no Fed line of credit.

If the government takes an equity stake in the companies as part of a bailout plan, there needs to be a time line to end government ownership. Freddie and Fannie must cease to be "special," and become quite ordinary.

They must also be downsized, because institutions so dominant in housing cannot be truly private. Additionally, as banking expert Bert Ely has pointed out, Freddie and Fannie have bulked up their balance sheets by taking on excessive interest-rate risk. Like savings and loans in the 1980s, Fannie and Freddie have maturity mismatch — borrowing short and lending long. That risk is a function of their large holdings of mortgage-backed securities. No matter their efforts at hedging that risk (which has previously landed them in trouble), there are no perfect hedges.

Fannie and Freddie must also be reformed because of their role in the culture of corruption in Washington. They have become political ATM machines for campaign contributions. That has to stop.

We must also realize that, whatever the deficiencies of the mortgage market in Depression-era America, that era is over. There is no "market failure" in housing finance today, except the one created by government-backed institutions dominating housing finance. Money flows where it is rewarded. Home mortgages are plain vanilla financial instruments, perhaps partly due to Fannie and Freddie. So by all means, let us thank them for their service as we bid them adieu in their present form.

As nearly every responsible commentator has observed, Fannie and Freddie urgently need more capital. Thus we have an overall diagnosis and treatment plan: downsizing and capital infusions. In the near term, the capital may come from Treasury because of the dire condition of their share prices. Congress could authorize the Treasury to purchase shares of preferred stock convertible into common shares in, say, five years, but it would have a mandatory conversion feature in 10 years. At that point, the Treasury should be required to sell its common stock in an orderly fashion (but within two years). Socialism in housing finance must not be made permanent.

Over the course of the 10-year period, Fannie and Freddie should systematically sell off their security portfolio and raise additional capital. By the end of that period (or sooner, if management desires to get out from under the government's yoke), their capital ratios should be up to the level of a commercial bank: 6%-8% of assets.

Follow these guidelines and at the end of 10 years, perhaps sooner, we could have a truly competitive market in housing finance. No single institution, nor a duopoly, would play a crucial role in housing finance. The idea that a government-sponsored enterprise is needed to provide liquidity is at best obsolete. Global financial markets provide liquidity, except when impeded by the effects of bad, government-directed policies. Credit allocation and easy money created a housing mess that now threatens the viability of even government-sponsored enterprises. Never again.

These recommendations run counter to the prevailing wisdom at the Treasury and the Fed, which is to encourage ever larger institutions, too big to fail, which can be then placed under Fed ministrations. Let us not resolve one crisis by sowing the seeds of the next. We need to empower markets, not embolden central bankers.

Here are the top ten reasons to cut off the taxpayer dollars flowing to National Public Radio and the Public Broadcasting System.

10. We live in a 500-channel world. Back in 1967, when the Public Broadcasting Act was passed, most Americans only had three television channels – ABC, NBC and CBS. But today we have six over-the-air networks and hundreds of cable channels offering everything from news to soap operas to classic movies to history and opera.

9. Sesame Street isn't so special any more. When anyone suggests cutting the budget for the Corporation for Public Broadcasting, its defenders immediately cry "they're trying to kill Sesame Street!" In fact, Sesame Street is big business and would survive in any environment. But also, as Jacob Sullum of Reason notes, "Children's programming that has an audience does not need taxpayer subsidies. Noggin, which is more 'commercial-free' than PBS stations, carries 12 hours of kids' shows (including two different versions of 'Sesame Street') every day, and they are at least as good as the PBS offerings in entertainment and educational value. Parent-acceptable children's programming can also be seen on Nickelodeon, the Disney Channel and ABC Family."

8. Republicans are trying to regulate the way public broadcasting works. A Republican chairman of the CPB, which funds both NPR and the PBS, has appointed a Republican activist as president and CEO. He also commissioned a conservative activist to report to him on PBS's programming.

7. Public broadcasting has a liberal bias. The reason the Republicans are poking around in PBS's business is that they're tired of taxpayer-funded radio and television networks being used to campaign against Republican administrations and their policies. Does public broadcasting have a liberal bias? Is the Pope Catholic? I have the luxury of choosing from two NPR stations. On Wednesday evening, June 29, a Robert Reich commentary came on. I switched to the other station, which was broadcasting a Daniel Schorr commentary. That's not just liberal bias, it's a liberal roadblock.

6. Bias is inevitable. Any reporter or editor has to choose what's important. It's impossible to make such decisions without a framework, a perspective, a view of how the world works. But taxpayers shouldn't have to subsidize any set of biases.

5. You shouldn't use tax money for lobbying. As soon as a congressional subcommittee voted to reduce funding for the CPB, NPR's 800 stations and PBS's 300 stations swung into action. They broadcast 30-second spots urging listeners to call their congressman and "save public broadcasting." Their websites said in bold lettering, "Please call your Senator today to express your support of federal funding for Public Broadcasting" and provided the phone numbers and email addresses. This was a multimillion-dollar ad campaign in a week, paid for with tax dollars. It's just wrong to use our tax dollars to lobby Congress to get more of our tax dollars.

4. Public broadcasting subsidizes the rich. A PBS survey shows that its viewers are 44 percent more likely than the average American to make more than $150,000 a year, 57 percent more likely to own a vacation home, and 177 percent more likely to have investments worth more than $150,000. Why should middle-class taxpayers be subsidizing the news and entertainment of the rich?

3. Public broadcasting gets only 15 percent of its money from the federal government. Businesses and nonprofits deal with 15 percent revenue losses all the time. If NPR and PBS lost all their federal money, they wouldn't disappear. They might eliminate their least popular programs, they might work harder to get local sponsors, or they might have to tighten their belts. But a 15 percent budget cut wouldn't put them out of business.

2. We have a $400 billion deficit. Not to mention total federal liabilities of $72 trillion. It's hard to imagine how we'll ever pay that off. But you start by cutting non-essential spending. Surely, in a 500-channel universe, public broadcasting is non-essential.

And the number one reason to privatize public broadcasting is:

1. The separation of news and state. We wouldn't want the federal government to publish a national newspaper. Why should we have a government television network and a government radio network? If anything should be kept separate from government and politics, it's the news and public affairs programming that Americans watch. When government brings us the news—with all the inevitable bias and spin—the government is putting its thumb on the scales of democracy. It's time for that to stop.]]> Mon, 25 Jul 2005 00:00:00 EDT http://www.cato.org/pub_display.php?pub_id=4002 http://www.cato.org/pub_display.php?pub_id=3968

In a 500-channel world, why do the taxpayers need to subsidize one more channel? Defenders of National Public Radio and the Public Broadcasting System tell us it's because we need "independent journalism." But can we really expect to get truly independent journalism from a government-funded network?

It's time to establish the separation of news and state. Journalists should not work for the government. Taxpayers should not be forced to subsidize news and public-affairs programming.

Tax-funded broadcasters are up in arms these days over what they see as political interference from the Bush administration. Kenneth Y. Tomlinson, the Bush-appointed chairman of the Corporation for Public Broadcasting, has proposed to make a Republican activist president and CEO of the CPB. Like many Republicans, he has also complained about liberal bias at PBS and NPR, both of which receive funding from CPB.

Public opinion polls commissioned by PBS have found that most Americans don't perceive tax-funded radio and television as politically biased. Of course, the most effective bias is bias that the listener doesn't perceive. That can be the subtle use of adjectives or frameworks -- for instance, a report that "Congress has failed to pass a health care bill" clearly leaves the impression that a health care bill is a good thing, and Congress has "failed" a test. Compare that to language like "Congress turned back a Republican effort to cut taxes for the wealthy." There the listener is clearly being told that something bad almost happened, but Congress "turned back" the threat.

A careful listener to NPR would notice a preponderance of reports on racism, sexism, and environmental destruction. David Fanning, executive producer of "Frontline," PBS's documentary series, responds to questions of bias by saying, "We ask hard questions to people in power. That's anathema to some people in Washington these days." But it seems safe to say that there has never been a "Frontline" documentary on the burden of taxes, or the number of people who have died because federal regulations keep drugs off the market, or the way that state governments have abused the law in their pursuit of tobacco companies, or the number of people who use guns to prevent crime. Those "hard questions" just don't occur to liberal journalists.

Anyone who got all his news from NPR would never know that Americans of all races live longer, healthier, and in more comfort than any people in history, or that the environment has been getting steadily cleaner.

One dirty little secret that NPR and PBS don't like to acknowledge in public debate is the wealth of their listeners and viewers. But they're happy to tell advertisers -- oops, I mean sponsors -- about the affluent audience they're reaching. A few years ago NPR enthusiastically told advertisers that its listeners are 66 percent wealthier than the average American, three times as likely to be college graduates, and 150 percent more likely to be professionals or managers. Tax-funded broadcasting, like tax-funded arts, is a giant income transfer upward: the middle class is taxed to pay for news and entertainment for the upper middle class. It's no accident that you hear ads for Remy Martin and "private banking services" on NPR, not for Budweiser and free checking accounts.

Under threat from the House Republicans, NPR and PBS are using their tax-funded airwaves to reach their millions of affluent, influential fans. Local stations are running 30-second ads over and over urging their listeners and viewers to call members of Congress. Their websites offer instructions on how to "call, fax, or e-mail Congress." With some 800 radio and television stations running these ads, this is a multi-million dollar lobbying campaign.

Tax-funded broadcasting has become a vast $2.5 billion enterprise, with more than 350 television stations and 780 radio stations reaching every corner of the country. It's time to cut this "infant industry" loose and let it make its own way in the marketplace, without any more money from the taxpayers.]]> Mon, 27 Jun 2005 00:00:00 EDT http://www.cato.org/pub_display.php?pub_id=3968 http://www.cato.org/pub_display.php?pub_id=2605 Most people understand political disagreement in America through the following prism: One party (the Republicans) believes in free markets and letting the economic chips fall where they may. The other party (the Democrats) believes in taking the rough edges off capitalism and providing insurance against the "creative destruction" of well-functioning national economies.

If that's true, however, how can we explain the recent news story concerning publicly owned dams in the west? The contracts that govern the sale of water from the federal projects in California's Central Valley are up for renewal. A spokesman for the Bureau of Reclamation said that the agency will stand by policies first drafted in the 1940s that give water to farmers at one-eighth the price paid offered to urban consumers.

Democrats rightly charge that the administration is avoiding reform to provide benefits to its political supporters. But while Democrats are on the side of markets and "letting the chips fall where they may" in this particular fight, they are no more inclined to let capitalism ravage their favored constituencies than are the Republicans. Teachers' unions, for example, are important members of the Democratic base, so Democrats resist the introduction of market forces into education through vouchers because it might threaten union jobs.

Both parties, regardless of their rhetorical posturing, want privilege and protection for their political supporters and markets for everyone else.

Politics is the provision of exemptions from market forces. Such policies are wonderful for beneficiaries -- who are few in number -- and not too great a burden on the rest of us. Costs are diffuse and nearly invisible to those of us paying the higher taxes and consumer prices necessary to keep beneficiaries happy.

This makes policy reform difficult. Recipients of market privileges are well organized, give lots of money to their political champions, and vote en masse against any politician who proposes change. Prospective winners from reform are rarely aware that they would indeed benefit from changing many of these arcane government interventions and, thus, are unlikely to go out of their way to reward politicians looking out for their interest.

We would all be better off if none of us organized politically to gain market privileges. But once one group gets subsidies, preferences, or other forms of exemption from competition, the incentives are for others to organize to do likewise. Refusing to sit at the table of government help simply clears a spot for someone else to eat from the government trough at our expense. In the end, most citizens get something from the political system, but we are all worse off because of the economic inefficiencies that result.

Unfortunately, once everyone is organized and getting market privileges from the government, true reform is almost impossible because it requires everyone to cooperate to give up their privileges at the same time. This requires extraordinary leadership to organize and political trust to keep it from falling apart.

The great tax reform of 1986 is a rare example of success. Lower marginal rates for everyone in return for the elimination of loopholes and exemptions was exemplary public policy. But since then the tax code has again become filled with privileges and exemptions; it seems in retrospect to have been hardly worth the trouble.

The essence of politics is the use of the coercive power of government to take from the general population and give to your supporters in return for votes. So we can concede that Republicans like to give subsidized water to farmers in California's Central Valley and no amount of effort is likely to dissuade them from doing so. But why not let farmers resell the water at market rates and, perhaps, even stop farming altogether? Granted, the farmers will still receive the wealth transfer from the political system and, in turn, give incumbents their political support -- all bad things in an ideal world but tough to change in the real world. But by allowing farmers to sell their water rights (from which they stand to profit more than they would by using that subsidized water to grow rice in the desert), society saves all the wasted resources that would have otherwise gone into farming.

Such creative reform would allow farmers to continue getting something while improving the lot of conservationists and taxpayers. There's good, creative work to be done for politicians interested in something other than simply rewarding their supporters.

Saddam's grip on oil has dangerous security repercussions for the United States and its allies. According to the U.S. General Accounting Office, oil smuggling and illegal surcharges of 25 cents to 50 cents on a barrel of legal oil are providing the funds to bolster Saddam's regime. Saddam's unaccounted revenues are at least $6.6 billion-revenues available to develop WMD and support terrorism in spite of economic sanctions imposed by the United Nations on Iraq after the Persian Gulf War.¹ (This in spite of the fact that the United Nations intended to lift the sanctions in exchange for Saddam giving up his program to develop WMD.)

Saddam's regime has succeeded in bankrupting the country, even though it boasts the world's second largest oil reserves after Saudi Arabia. The oil sector provides more than 60 percent of the country's gross domestic product (GDP) and 95 percent of its hard currency earnings. Yet GDP for 2001, at the market exchange rate, is estimated to be only about one-third its 1989 level. Iraq also is hobbled by its $140 billion foreign debt. This devastation was wrought by such policies as the nationalization of the country's chief export commodity, oil; extensive central planning of industry and trade; the 1982-1988 war against Iran; and the invasion of Kuwait, which precipitated the 1991 Gulf War. Iraq's economy has been grossly mismanaged. Sound economics are needed to help the Iraqi people rebuild their lives and their country after two decades of wars and four decades of repression under the current regime.

A postwar economic strategy is necessary, which will be beneficial for the industrial world, the countries of the Middle East and the developing world. The full reintegration of Iraq's oil industry into the global marketplace would allow a more abundant and stable energy supply and a greater revenue flow for the Iraqi budget, foster a higher living standard for the Iraqi people, and provide numerous business opportunities for the region and the world.

The way out of the economic morass for the Iraqi economy lies through privatization of its abundant oil assets, not bureaucratic mismanagement, as some have advocated. If successful, Iraq's privatization of its oil sector, refining capacity, and pipeline infrastructure, could serve as a model for privatizations by other OPEC members, thereby weakening the cartel's domination of the energy markets.

The road to economic prosperity in Iraq will not be easily paved, but the Bush Administration can help the future Iraqi government achieve fundamental structural reform with massive, orderly, and transparent privatization of various sectors of the economy, including the oil industry. The United States should offer its guidance on establishing sound economic and trade policies to stimulate growth and recovery. Privatization efforts in other countries demonstrate that privately held infrastructure, oil, and oil service companies attract modern technology and management expertise, produce greater efficiencies, improve production standards, and generate higher revenues than do centrally planned and state-owned industries. The same can be achieved in Iraq, whose oil industry cannot thrive without access to global capital markets.

In particular, the Administration should work with opposition leaders in Iraq to convince them now that a future Iraqi federal government must develop mechanisms for privatizing these industries and taxing oil sales, and for sharing the proceeds equitably with the three major ethnic regions: Kurds in the North, Shi'a Arabs in the South, and Sunni Arabs in the central region. (In our opinion, the best model for postwar Iraq is a federal system that incorporates the various factions and regional leaders.)

Obviously, the immediate priorities of the postwar administration will be the restoration of order and the full dismantling of the Ba'athi dictatorship. However, economic reform cannot be neglected. In the months following the removal of Saddam Hussein from power, the United States and its allies (as well as relevant international organizations) must provide the necessary technical and financial assistance that enables the Iraqis to create modern legal environment that recognizes property rights and is conducive to privatization. A key role here can be played by the large and successful Iraqi expatriate community (as well as other Western-educated Iraqis) to provide the personnel, expertise and entrepreneurial know-how that can ensure a successful privatization reform. Contrary to the advice proffered by some in the international NGO community, prices will need to be deregulated, including in the utilities and the energy sector. Finally, it should be a top priority to liberalize Iraq's trade, with an eye to eventual Iraqi membership in the World Trade Organization. Restoring Iraq quickly to the global economic mainstream is critical to end the damage caused by decades of isolation and to lift the living standard.

Economic growth will be an important contribution to the stabilization of Iraq, allowing the United States and other forces stationed there to depart after assuring that Iraq's WMD threat and repressive regime have ended. Structural reform and comprehensive privatization is a winning strategy for the people of Iraq, its future government, the region, and the United States.

1. A point tellingly made by Richard Perle. Cf.

Saddam's regime has succeeded in bankrupting the country even though it boasts the world's second-largest oil reserves after Saudi Arabia. The oil sector provides more than 60 percent of the country's gross domestic product (GDP) and 95 percent of its hard-currency earnings. Yet GDP for 2001, at the market-exchange rate, is estimated to be only about one-third what it was in 1989. Iraq also is hobbled by its $140 billion foreign debt. This devastation was wrought by such policies as the nationalization of the country's chief export commodity, oil; extensive central planning of industry and trade; the 1982-1988 war against Iran; and the invasion of Kuwait, which precipitated the 1991 Gulf War.

According to the U.S. General Accounting Office and British intelligence sources, oil smuggling and illegal surcharges of 25 to 50 cents on a barrel of legal oil are providing the funds to bolster Saddam's regime. Saddam's unaccounted revenues are between $6.6 billion and $10 billion - money that he has been free to spend to develop WMD and support terrorism in spite of economic sanctions imposed by the United Nations on Iraq after the Persian Gulf War to force him to give up his WMD.

The road to economic prosperity in Iraq will not be easily paved, but the Bush administration can help the new Iraqi government achieve fundamental structural reform with massive, orderly, and transparent privatization of various sectors of the economy, including the oil industry. The U.S. should offer its guidance on establishing sound economic and trade policies to stimulate growth and recovery.

After Saddam's brutal and repressive regime is ended, the new government established by the people of Iraq should represent all the major sub-national groups - the Shiite Arabs, the Sunni Arabs, and the Kurds. To succeed, Iraqi opposition leaders will need a political commitment from the United States and international organizations to furnishing the necessary expertise and technical assistance. To gain that commitment, Iraq will need to abandon statist policies of the past and become fully committed to the principles of a market economy.

Privatization efforts in other countries demonstrate that privately held infrastructure, oil, and oil service companies generate greater efficiency, improved production, and higher revenues than do centrally planned and state-owned industries. The same can be achieved in Iraq, whose oil industry cannot thrive without access to global capital markets.

In particular, the administration should work with opposition leaders in Iraq to convince them now that a future Iraqi federal government must develop mechanisms for privatizing these industries and taxing oil sales, and for sharing the proceeds equitably with the three major ethnic regions - the Shiite Arabs in the South, the Kurds in the North, and the Sunni Arabs in the central region.

The Bush administration, its allies, and international organizations should prepare, encourage, and support the future leaders of a post-Saddam Iraqi government in developing a comprehensive economic reform package. Specifically, the next Iraqi government must take steps to create a modern legal environment that recognizes property rights and is conducive to privatization. Furthermore, it should educate and prepare the Iraqi people for structural economic reform and privatization through a public-information campaign.

To bring modern economic expertise and management skills to Iraq, the government will have to hire Iraqi expatriates as well as other Western-educated Arabic speakers with financial, legal, and business backgrounds to fill key government positions on economic reform and privatization. To improve fuel efficiency of the Iraqi economy, the future regime will have to deregulate prices internally, including in the utilities and energy sector. Most importantly, it will have to prepare state assets, including industries, utilities, transportation, ports and airports, pipelines, and the energy sector, for privatization. It will have to keep the budget balanced and inflation, taxes, and tariffs low. Finally, it should liberalize and expand trade and launch an effort for Iraq to join the WTO.

Economic growth will be an important contribution to the stabilization of Iraq, allowing the United States and other forces stationed there to depart after assuring that Iraq's WMD threat and repressive regime have ended. Structural reform and comprehensive privatization is a winning strategy for the people of Iraq, its future government, the region, and the United States.

Furthermore, such a strategy will prove beneficial for the industrial world, the countries of the Middle East, and the developing world. Iraq's return to the global markets would allow a more abundant and stable energy supply and a greater revenue flow for the Iraqi economy, foster a higher living standard for the Iraqi people, and provide numerous business opportunities for the region and the world. If successful, Iraq's privatizations of its oil sector, refining capacity, and pipeline infrastructure could serve as a model for privatizations by other OPEC members, thereby weakening the cartel's domination of the energy markets.

In addition to opening the A-share market to selected foreign investors, Beijing will allow foreign investors to buy previously non-tradable shares of state-owned enterprises. Non-tradable shares include "state-owned shares" and "legal person shares," with the former owned by government and the latter by SOEs. Initial sales will take place outside the official stock exchanges; foreign investors will have to hold their shares at least one year; and resale will apparently take place through the government not the market. The tight restrictions on salability mean that foreigners' appetite for the shares of SOEs will be quite limited.

If China is to create real capital markets and maximize the value of invested capital, individuals must be allowed full tradability of their shares, and all shares must be tradable. China has reneged on earlier promises to allow the sale of non-tradable shares to domestic investors because of a concern for diluting market values of existing shares. The new measure will apply only to foreign investors and will not directly affect share prices on the Shanghai or Shenzhen exchanges. This policy option may be a politically feasible way for the state to begin exiting the share market. The ultimate goal, however, should be to have a unified private share market with prices that reflect the true values of the listed companies. Until that happens, China's capital markets will be more socialistic than capitalistic.

Privatization is the key

The dominance of SOEs on the stock exchanges and the fact that 70 percent of state-owned shares are non-tradable mean there are no real capital markets in China. Moreover, the government fixes interest rates on savings accounts in state-owned banks at artificially low levels and prohibits capital outflows. The lack of investment alternatives means domestic investors are more reckless in picking stocks than if they had deeper and broader capital markets. The high price-earnings ratios, of 40 or more, in the A-share market reflect this speculative fever.

The lack of capital freedom also means that government officials, not private investors, are the controllers of capital assets. So long as that is the case, investment decisions will be politicized, and the threat of bankruptcy will be a hollow one. Socialist managers will continue to lack strong incentives to be efficient. Consequently, until the institutional incompatibility that characterizes China's socialist market economy is resolved, the nonperforming loans of state-owned banks will continue to mount.

China needs to transform its financial architecture and give security to private property rights—that is, there must be a legal system that safeguards private owners. Individuals must have the effective right to buy and sell shares, to freely invest abroad and to transact at market-determined interest rates. When individuals are allowed the freedom to specialize in ownership and risk bearing and face market-determined interest rates, capital will flow to its highest-valued uses, and the market value of firms will be maximized for the benefit of both shareholders and consumers. The government will also be rewarded as tax revenues increase.

China needs to allow its institutional infrastructure to evolve; private property rights must enjoy equal protection under the law. Consumers, not government officials, will then determine what firms remain in business. At present, the lack of fully transferable shares in SOEs means that share prices are distorted and do not reflect the true value of state assets. Only by allowing individuals to freely exchange all shares of SOEs can their true value be discovered.

So long as the state holds the majority of shares and SOEs dominate the stock market, the Chinese people will be denied the opportunity to specialize further in ownership and risk taking. Those who are most skilled as entrepreneurs will be denied the opportunity to acquire SOEs and privatize them. As such, resources will be prevented from moving to higher-valued uses.

Maintaining the dominance of state ownership will protect the power of the Chinese Communist Party, at least temporarily, but will reduce China's potential wealth. Allowing widespread privatization, or what can be called "marketization" since markets are impossible to develop without private property rights, would create new wealth as inefficient SOEs disappear and workers move to jobs that consumers value more highly. That process has been occurring in the special economic zones, as witnessed by the rapid growth of the private sector.

The challenge is to bring about political liberalization that is consistent with economic liberalization. President Jiang Zemin's endorsement of greater protection for private property rights at the 16th Party Congress in November is a signal that China is moving in the right direction. According to Jiang, "We need to respect and protect all work that is good for the people and society and improve the legal system for protecting private property."

Depoliticizing investment decisions

To depoliticize investment decisions in China, there must be constitutional protection for private property rights, and private owners must be given access to both domestic and foreign capital. The renminbi must be made fully convertible as soon as possible, and interest rates must fully reflect market forces. Discriminating against the private sector has led to overinvestment in the state sector and a low rate of return. Meanwhile, growth in the private sector has been hampered.

Artificially supporting share prices of SOEs is a recipe for disaster. Government support of the market only compounds the difficulty of trying to evaluate socialist firms. Without real owners with fully transferable shares, there can be no way to know the capitalized values of the listed companies and no way to discipline socialist managers for failing to maximize profits. Restructuring SOEs is not sufficient; they must be fully subjected to market forces, which means they must be privatized along with state-owned banks. Only then will China transform its socialist capital market into a true capital market.

Chen Mingxing, senior researcher with the State Information Center, has recommended more rapid ownership reform: "The government should leave the adjustment of share prices to market forces, but put more effort into establishing a marketplace that is 'just, fair and transparent,' and reforming the ownership systems at the listed companies." China's accession to the World Trade Organization will put pressure on SOEs to "jump into the sea of private enterprise." It will take political courage, however, to do so.

The nonstate sector now accounts for more than 70 percent of the gross value of industrial output, yet private firms are being starved of capital. Peking University economist Fan Gang has pointed out, "The most serious policy mistake in the past 20 years of reform has been the lack of development of nonstate financial institutions that could adequately provide for the growth of the nonstate sector. … Experience shows that the longer the state sector exists, the worse its financial situation and the lower its profitability."

Safeguarding economic freedom: A winning strategy

The benefits to China and to foreigners from liberalizing the financial sector are great: China would achieve a more efficient use of its capital by reallocating funds from the state to the nonstate sector; new funds would flow into China as foreigners became more certain about the security of property rights; the Chinese people would have an important part of their human rights, the right to own property, protected by law; and foreigners would be able to deal with private firms and offer a greater choice of investments to China's savers.

The more secure rights to future income streams are, the more confidence individuals will have in the future, the more breadth and depth capital markets will have, and the more liquidity will be created. Likewise, any attenuation or weakening of private property rights—including the rights to use, to sell and to partition property—will mean less trust, less liquidity and less wealth.

Mounting evidence shows that private property rights, protected by the rule of law, are a key ingredient in the recipe for economic development. In a study of 150 countries, Lee Hoskins and Ana Eiras found that those countries in which private property rights are secure and transparent have created more wealth, as measured by real GDP per capita, than countries in which private property rights are insecure and corruption is high.

China has done an excellent job of alleviating poverty since the economic reform began in 1978, but the main engine of the reform process has been the nonstate sector. Now is the time to cement and extend those gains by giving greater constitutional protection to the private sector. Increasing economic freedom is a win-win strategy—both China and her trading partners will gain. Free trade and privatization can help normalize China and transform it into a modern economy and a civil society under the rule of law. China's accession to the WTO will help move China in that direction.]]> Fri, 06 Dec 2002 00:00:00 EST http://www.cato.org/pub_display.php?pub_id=4109 http://www.cato.org/pub_display.php?pub_id=4082

To make it work better, Daniels has announced plans to open up 425,000 jobs to competitive outsourcing. That means allowing private firms to compete with federal workers in jobs that are commercial in nature, such as the 10,000 cafeteria jobs and 18,000 health technician jobs in the Department of Veterans Affairs.

Despite immediate howls from the federal labor unions that the plan "emasculates" worker rights, state and local governments have pursued such reforms for a decade. Former Philadelphia Mayor Ed Rendell faced similar union protests in 1992 when he launched his program to contract out dozens of city services, such as maintenance, security, and custodian services. The reforms have saved the city hundreds of millions of dollars - partly from city agencies cutting waste to ward off the threat of outsourcing. Rendell's success has been replicated across the country, and the Government Contracting Institute says that the value of state outsourcing soared 65 percent in the past five years.

Now it is the federal government's turn. Daniels is putting into high gear a procedure to open up bidding for in-house activities that private firms may be able to do better. The administration says that it currently takes 20 months to contract out such simple tasks as lawn mowing. With streamlined rules, the administration wants to see as many as 15 percent of federal jobs that are commercial in nature be opened to competition by the end of 2003.

A primary goal is to save taxpayer money. The Pentagon figures it has cuts costs by 20 percent in the areas it has contracted out, such as logistics, training, and computer services. The administration thinks savings of 20 percent are widely achievable, which could really add up in a $2.1 trillion federal budget. Aside from saving money, outsourcing would improve government performance by allowing federal managers to focus on their core missions. That's the strategy many large corporations are taking. For example, General Motors outsources its payroll and accounts receivables, and Microsoft outsources many finance, manufacturing, distribution, and customer support functions.

Competitive sourcing can also give the government access to fresh ideas. That is sorely needed because federal workers have a habit of staying in their jobs too long, making them out of touch with advances in private industry. Department of Labor data show that federal worker layoffs and firing occur at just one-fourth the rate of the private sector. Indeed, the government only fires 1 in 5,000 nondefense workers each year for poor performance.

Given that excessive job security, it's clear why the federal unions are fighting change. They point to horror stories of federal contractors who performed poorly or raised prices. Yet the advantage of contracting is that federal managers can fire service providers that haven't met clear goals. Nonetheless, there are legitimate concerns about federal contracting. In particular, contracting opens up opportunities for favoritism, or outright corruption, which happens when the public sector is tightly engaged with the private sector.

An even better strategy is to move federal activities fully into the private sector when possible. Consider air traffic control (ATC), which is a $6 billion industry that happens to be run by the federal government. ATC services could be contracted out, but why not fully privatize them? ATC companies supported by airline fees could run different airports and compete to reduce congestion and increase safety.

Canada's privatization of its ATC system in 1996 has received rave reviews. The administration needs to expand its initiative to consider not just which activities can be contracted out, but whether activities need to be within the federal realm at all.]]> Sun, 24 Nov 2002 00:00:00 EST http://www.cato.org/pub_display.php?pub_id=4082 http://www.cato.org/pub_display.php?pub_id=3507 These are dark days for Edison Schools, the nation's largest private management company for public schools. In recent weeks Edison has been fired by one of its original charter schools, the nationally recognized Boston Renaissance School. It has undercut expectations by receiving a contract to run 20 of Philadelphia's troubled schools -- after predicting a contract for twice as many. And it has settled an SEC investigation into its accounting practices by accepting unfavorable adjustments to its revenue numbers for the past several quarters.

In response to all this, Edison's stock price has plummeted to less than 10 percent of its previous value. Due to its low stock price Edison has had to heap insult upon injury, warning of its possible delisting by Nasdaq, and of its potential inability to secure sufficient funds to open promised new schools in Philadelphia.

Detractors of privatization are eagerly piling on, publishing story after op-ed about Edison's woes. Edison's failure would prove, they maintain, that private contracting has been a failed fad -- that private companies cannot do more with less, and that the stability of politically driven school management is preferable to the uncertainty of private management.

Edison's skewering by the press has been so energetic that one Merrill Lynch analyst commented, "We have never seen a company attract so much negative publicity, especially when [the company's business objective] is such a noble one." The analyst concluded, "It will be difficult [for Edison] to get out of the way of the news flow."

After all, both friends and enemies have long regarded Edison as the acid test for contract school management. Defenders of the public school status quo, motivated either by an immovable belief in the goodness of government or by the more banal desire to protect teachers from accountability, have elevated Edison to the status of Leviathan in pitched battle against public institutional culture.

School reformers, by contrast, have tended to ideologically over-invest in Edison. Founder Chris Whittle typically characterized Edison as "the vanguard of an important movement." Privatizers have unwisely allowed a single company to become emblematic of their cause.

In terms of educational performance, Edison's record is mixed, but fairly good. It can point to rising scores in most of its schools, though some of these increases may be attributable to other factors. While a few cities such as Boston and Dallas have reconsidered their contracts due to lagging scores, most of Edison's 100-plus schools apparently remain well satisfied.

More troubling is Edison's financial management. Administrative costs continue to outpace revenues in an equity market considerably less tolerant of operating losses than that which Edison enjoyed in its early years. Also of concern are several unprofitable business acquisitions, and large personal loans from the company to its executives.

The jury is still out on Edison's management performance, as to both its public schools and its private finances. But those awaiting the verdict on Edison's future should not misconstrue the lesson of failure or success. Edison's crisis is not a referendum on private contract management of public schools. Edison's failure would not demonstrate that private contract management is a bad idea.

Rather, Edison's failure -- if indeed it does fail -- would illustrate the advantage of private management. Private companies that do not do their jobs well are allowed to fail. School districts that do their jobs poorly may operate indefinitely. Those who doubt the staying power of miserable public management should ask Cleveland City Counsel member Fannie Lewis, who supported school choice there after having tried to improve the city's notorious public system since 1951. "Any other business that would have lost [so many children] would have gone under by now," she said.

Edison is aware that its survival depends on its ability to satisfy both investors and school boards. "It is certainly unusual for a school system to go through the scrutiny we go through," an Edison spokesman Adam Tucker observed. "We have to deliver great services to our schools."

Edison may fall victim to the vagaries of the equity markets and bad press, but these are dangers we expect private companies to guard against while serving their clients. Hopefully Edison will succeed in doing its job well and on budget. But, if not, the company can be discarded in favor of a more effective alternative. That, after all, is the great virtue of privatization.

Bush is not the first observer to note that regulations often are not well targeted, cost more than they should, and may have costs that outweigh benefits.

Health, safety and environmental regulations cost up to $229 billion annually, according to OMB. An outside estimate by professors Thomas Hopkins of the Rochester Institute of Technology and Mark Crain of George Mason University that also includes economic regulations and paperwork costs pegs regulatory costs at about $840 billion.

But better analysis aimed at assuring "net benefits" has its limits.

The cure for excessive regulation, along with the measures like those proposed by the administration, is to end "regulation without representation."

Congress delegates immense legislative power to agencies despite the fact that the Constitution grants legislative powers solely to Congress. That severs the voters' connection to those who regulate them, and allows Congress to take credit for popular regulatory initiatives while blaming agencies for costs.

Rational regulatory policy -- not to mention Constitutional government -- demands that every elected representative be on record for significantly costly regulations that are imposed on citizens. That would force legislators to demand the science and analysis that Bush can only encourage.

One proposal, the Congressional Responsibility Act, introduced by Rep. J. D. Hayworth (R-Ariz.) and Sen. Sam Brownback (R-Kan.), would require congressional approval of significant agency rules. As to the complaint that voting on agency regulations would bog down the Congress, stop and think a minute: do we really want a society that makes so many laws the legislature can't even pass them all during waking hours?

In addition to improving congressional accountability, better cost disclosure is vital. A lot of regulatory data already exists, but is scattered across government agencies. For example, 4,509 rules were at various stages in the pipeline in 2001 -- but how many policymakers knew that? And of these rules, 149 will cost more than $100 million each annually.

A breakdown of the numbers of such costly rules -- as well as those sent back by OMB -- could be included in an annual "regulatory report card." The agency "guidance" documents that often function as stealth regulation that escapes OMB review could be tallied the same way. Other useful items that could easily be included in an annual Report Card include: total numbers of rules produced by each agency; the top rule-making agencies; numbers of rules facing statutory or judicial deadlines; and the numbers of rules impacting small businesses, or impacting state and local governments. Historical tables for all such data would help shine a spotlight on the regulatory state.

A report card would expose where cost estimates do and do not exist, thereby highlighting the best and worst agency efforts at cost disclosure and competence in congressional oversight. A report card would also help reveal whether or not we can say with certainty that the regulatory enterprise does more good than harm, which seems to be one of the Bush goals.

The problem with focusing on agency-driven, cost-benefit analysis at the expense of congressional accountability, on the other hand, is that, to work, agencies would frequently need to admit their rules' benefits do not justify the costs. That chafes against bureaucratic incentives. After all, no matter how costly or inconvenient, a nationwide 15 mph speed limit and mandatory 15-ft bumpers would save lives.

Instead, in preparing regulatory report cards, agencies could concentrate on assessing and fully presenting the costs of their initiatives -- much as the federal budget focuses only on the amounts of taxes, not the benefits of the dollars spent.

Emphasizing costs doesn't mean that benefits can be ignored. Quite the contrary: the proper time to assess regulatory benefits is while Congress is contemplating legislation that later will become translated into regulations. Saving benefit appraisals for the time regulations are written has it backwards. Those benefits were presumably the reason for Congress's seeking legislation in the first place.

The proper regulatory reform goal is assurance that regulatory compliance dollars are allocated according to where an accountable Congress believes benefits to lie.

Moreover, OMB has the experience and know-how to create "benefit yardsticks" by which it can objectively critique high cost, low benefit rules. OMB could note the cost of a new regulation and compare its anticipated benefits to the alternative benefits that could be had if the compliance costs went instead toward hiring policemen or firemen, buying smoke detectors, and so on.

Improving congressional accountability and instituting annual reporting would primarily affect future regulatory mandates. So what about overhaul of the existing multi-hundred-billion-dollar regulatory state?

For starters, Congress could ask agencies and OMB to propose rules to cut each year. Increased inter-agency competition generated by those report cards may increasingly make it apparent that regulatory benefits are not always what their proponents claim. More formal review and "sunsetting" of regulations are also options.

Limited regulatory cost budgeting could help as well. For example, an agency might be asked to offset the cost of a new regulation by eliminating one or more existing rules of roughly equivalent cost, or by persuading another agency to eliminate a regulation on its behalf.

"Pollution credits for regulatory emissions," one might say.

Finally, another reform worth considering is that embodied by the military base closure and realignment commission, which for a time helped resolve the politically impossible task of closing obsolete military bases one at a time by instead assembling a bundle of them to vote on at once. Since everybody stood a good chance of getting "hit," the bundling provided some political cover. Likewise, a congressionally appointed, bipartisan regulatory reduction commission could hold hearings and assemble a yearly package of proposed regulatory reductions to vote on, with no amendments permitted.

OMB has its work cut out for it with its new regulatory proposals. Since government spending and regulating can be substitutes for one another, today's pressures to regain and maintain the federal budget surplus could increase incentives to regulate instead. Regulatory report cards and holding Congress accountable for rules are the best bets for offsetting that tendency and for improving disclosure and openness in the regulatory state.

Amtrak's latest move is part of an ongoing process in which the railroad tries to hold on to its profligate practices. On Nov. 9, 2001, the Amtrak Reform Council, created by the Amtrak Reform and Accountability Act to monitor that railroad, found that the railroad would not be able to survive without federal operating subsidies by the end of 2002. Under the law the Council must prepare a plan to reorganize Amtrak -- release date Feb. 7 -- while Amtrak itself is required to prepare a plan, in the words of the act, for its "complete liquidation."

But a handful of senators recently forbade Amtrak from using any funds to prepare that plan, figuring that if they just don't look at the railroad's problems they will go away. Liquidation would force Amtrak to open its books.

How might Amtrak's liquidation proceed? Unpaid creditors could force Amtrak into Chapter 11 bankruptcy. Such a move would mean the appointment of a trustee to manage the disposition of Amtrak's assets.

One goal of liquidation is to reimburse creditors by selling assets, which would be valued in the free market. For example, Chicago Union Station might be sold to the local Metra Commuter rail system, which uses the station more than Amtrak does, or even sold to private developers. Trains needn't be scrapped. Some of Amtrak's coaches might be purchased by private operators for financially sensible short-distance trains, like the Chicago-Milwaukee run. Double-decker Superliners might be purchased for land-cruise runs that offer tourists scenic vistas.

Many money-losing routes would probably be abandoned. But major parts of the system, most notably the Northeast Corridor between Washington, New York, and Boston, likely could be operated profitably by private owners. Companies that have expressed interest in purchasing the Corridor -- which includes the trains, tracks, and stations -- or in operating it under a franchise include Peter Pan Bus Lines, Railway Service Corporation, Guilford Rail System, and British train operators Great Western Trains, Stagecoach, Virgin Management Group and GB Rail.

Railroad liquidations through insolvency proceedings were common in the 19th century when railroads were the principal means of transportation in America. Over 27,000 miles of rail were taken over by courts, and another 40,503 miles of track were sold at foreclosure sales of railroad assets between 1894 and 1898. Amtrak's passenger rail operations constitute a small part of transportation today and thus liquidation that shuts down weak lines would hardly disrupt travel. To put this point in context, in 2000 Americans made only 22.5 million trips by Amtrak compared to 665 million on commercial airlines.

The Reform Council's plan for Amtrak includes reorganizing the railroad by putting its train operations into one subsidiary, its real estate, tracks, and facilities into another subsidiary, and permitting Amtrak to control a future rail franchising system. This plan is too little, too late. Amtrak is certain in the future to fail again and again.

Ayn Rand's Atlas Shrugged tells the story of a railroad -- and a country -- collapsing under the weight of government controls. In that novel the way to get the trains to run again is for the government to get out of the way. In the real-life case of Amtrak it is time for the government to do just that: to return the trains to private owners and leave them alone to run them efficiently and profitably. Liquidation would be the best way to stop the waste of taxpayers' dollars and to give parts of Amtrak's passenger operations the best chance of survival.

Everyone knows Social Security is in trouble (and President Bush's Commission to Strengthen Social Security released its report on reform yesterday). But few people understand what that trouble is and whom it will affect. Understanding that is the key to understanding the scam.

Right now, Social Security is in great health. This year, like so many before, hundreds of billions of dollars will pour into it from FICA and payroll taxes, and only some will go back out as benefits to retirees. The rest will be exchanged for government bonds, which the federal government will pay back -- with interest -- to Social Security in the coming years.

But things will change in the next decade, when the Boomers will retire and start collecting benefits. By 2016, so many people will be drawing Social Security that the money needed to cover benefits will be more than what we Gen-X/Y workers will be paying in taxes. Fortunately, the program will be able to cash in the bonds that it's now buying, and will use the repaid principle and interest to keep up the benefits.

However, that can only support Social Security for a few more decades. The bonds will all be cashed in by 2038, just as we Gen-Xers (whose Social Security tax money will purchase many of those bonds and whose federal tax money will pay them off) approach retirement age. So, just as we're about to collect Social Security, there will be nothing left in the Social Security storehouse for us to collect.

Hence, the Social Security crisis does not involve today's seniors -- Social Security will have plenty of money for the next 35 years. Instead, the crisis concerns us Gen-X/Yers, who will pay in a lot and receive just a little.

Ever since we Gen-X/Yers began working, we've paid 12.4 percent of our earnings to Social Security -- half taken through the "FICA" tax on our paycheck and half through the payroll tax. In the coming years, Congress likely will increase that rate to more than 17 percent to delay the 2038 catastrophe. What is more, the Medicare tax (which is now a mere 2.9 percent) will increase because that program faces an even worse crisis than Social Security.

In contrast, the Boomers will get a bargain. When they entered the workforce in the late 1960s, they paid only 6.5 percent of their earnings to Social Security and nothing to Medicare. For about half of their working years, the Boomers paid 10 percent or less to Social Security and less than 1.25 percent to Medicare. Only from 1990 on, when the Boomers had earned paychecks for a quarter-century, did they start paying 12.4 percent to Social Security and 2.9 percent to Medicare -- the same percentage we Gen-X/Yers have paid our whole lives.

That's the Boomers' bargain: They've paid less of their earnings into Social Security than we Gen-X/Yers, yet they'll receive more in benefits than we will and we'll pick up the tab. And when we retire, there will be no money saved in Social Security to pay for our retirement, unless we pull the same scam on our children that the Boomers are pulling on us.

The Boomers are working hard to protect their sweet deal. Many Boomer-elected politicians claim it's "too risky" to change Social Security and do away with the scam. One, Rep. Jerrold Nadler (D-NY), even asserts that the program is in no trouble at all and should be left alone.

But we Gen-X/Yers are catching on; we're seeing through the phony claims and recognizing the generational cash-grab scam for what it is. And we are beginning to realize that we need to offer this warning: If the Boomers don't reform Social Security now, they'll have no right to complain when we do so in the future.]]> Wed, 12 Dec 2001 00:00:00 EST http://www.cato.org/pub_display.php?pub_id=3818 http://www.cato.org/pub_display.php?pub_id=3843

Before the attacks the Postal Service was projected to lose $1 billion to $2 billion annually over the next decade as people turn to electronic bill paying and as the composition of the mail changes in the email, Internet era. At the time of the attacks the USPS was completing a preliminary "Postal Transformation" discussion document to consider short, medium and long term options for the last government monopoly. Further, the Mailing Industry Task Force was wrapping up a study entitled "Seizing Opportunity" that examined the likely evolution of the entire industry, not just the USPS. In addition, Rep. John McHugh (R-NY) was circulating proposed legislation that would significantly reform the Postal Service. These three efforts demonstrate that all observers acknowledged the perilous position of the Postal Service even before the attacks. The attacks simply are accelerating the USPS's decline.

The Postal Service wants part of the bailout money to cover the cleanup and other costs associated with the anthrax attacks, and to purchase equipment such as irradiation machines to make certain that the mail is free of anthrax, smallpox or other threats. The legitimate need for funds is real enough. But should the taxpayers foot the bill and should the funds come with no strings attached?

Private companies such as Federal Express and United Parcel Service will have to pay for their own protection equipment, passing on the costs if necessary to customers. If higher prices could scare off customers, those companies might simply have to take a temporary hit on the bottom line. Pitney Bowes, which operates 1,300 mailrooms, including those of 40 percent of the Fortune 500 companies, already offered its customers a special mail security service, mainly to protect from bombs, and will be offering protection against bioterrorism as well. So why should taxpayers rather than customers pick up the tap for protection of the U.S. mail?

The argument of course is that the Postal Service is a government monopoly and that the government thus should protect it. Just as tax dollars go to protect the U.S Capitol, courthouses and other government installations, so they should protect the mail. But this argument ignores the situation of the USPS that predates the attacks, and the very need for the bailout points to the USPS problems that must be addressed.

Consider the hotels that have seen customers staying away because of the recession or fear of traveling. They have cut workforces to reduce costs and cut prices to attract more customers. But unlike a private businesses, the Postal Service will not make major workforce cuts. And predating the attacks, it had been seeking to raise the price of a stamp from 34 cents to 37 cents. Further, it wants to increase the price of commercial mail, which has already gone up twice in the last 10 months by nearly 20 percent. With larger drops in mail volume and thus in revenues projected, the USPS likely will wish to raise prices even more.

The Postal Service in the past has spent billions of dollars on new high-tech equipment, not for protecting against anthrax but for improving productivity. But in the three decades since its creation, USPS productivity has risen only by a total of 12 percent, compared to an average of 55 percent for all businesses during that period. Three decades ago nearly 80 percent of Postal Service revenues went to cover labor costs. Today the figure is about 76-77 percent. (And let's not forget that this poor showing occurs even though the USPS enjoys special privileges, e.g. it pays no taxes and is not subject to most of the regulations that burden the private sector.) In other words, the Postal Service and, more to the point, its captive customers, benefit little from innovation. New irradiation equipment might eliminate anthrax but it will not stop the Postal Service's decline.

But out of adversity often comes opportunity. Consider the example of Germany. After the fall of the Berlin Wall, when the divided country unified, the mail service in the East was on the verge of collapse. Since the West was going to have to absorb the costs of cleaning up the mess the communists had made, German officials decided they might as well clean up part of the mess that had been made by the government in the West. Deutsche Post (DP) in the West would absorb the system in the East but also would be put on the road to privatization.

A private management team was brought and DP was reorganized as a joint stock company. Inefficient operations were sold and the funds used to open new, cutting edge facilities. The workforce was reduced by about one-third, but over a period of years through attrition and early retirement rather than through massive layoffs. In 2000 an initial public offering of 30 percent of DP stock was made and in 2002 another offering will push the private share of that company to over 50 percent. DP now offers innovative lines of service and is becoming a larger European and global player. In a few years DP will lose all its monopoly protection.

American policy makers can learn from the German example. If they insist on handing tax dollars to the U.S. Postal Service, they should do so as part of a long-term plan to reorganize the USPS, to place it in private hands, and to remove its monopoly protection. Such an outcome will probably occur in any case. But the transition will be far smoother for postal workers, for managers, for postal customers, and for taxpayers if the need to deal with these terrible attacks is used as an opportunity do the right thing.]]> Wed, 14 Nov 2001 00:00:00 EST http://www.cato.org/pub_display.php?pub_id=3843