Archives: 03/2012

Obama’s War Spending Cap

Along with Chares Knight of the Project on Defense Alternatives, I have just published commentary on the National Interest’s website about President’s Obama’s proposed $450 billion nine-year cap on war spending. We argue that a war cap—better yet a war tax—is a good idea, but this particular proposal is nearly useless.

For one, it is unlikely to become law. The White House has shown little interest in pushing for it. Meanwhile, Republicans are already bashing the president for possibly shortchanging troops amid a war. And even if it does become law, the cap is unlikely to matter. By the time the cap has any effect, economic recovery may have slackened Congress’s appetite for austerity. With the president’s support, Congress may undo the cap or evade it by claiming an emergency, especially if any new war has begun. The bottom line is that there is no effective fiscal restraint here.

As is often the case, the promise of savings tomorrow serves mainly to distract us from their absence today. If the White House wanted thrift rather than its appearance, it would push an annual war spending cap.

The argument in favor of a war cap or tax follows from the arguments the late Bill Niskanen made against the (starve the beast) claim that cutting government revenue will cut government spending:

It is most implausible that reducing the current tax burden of federal spending would reduce the amount of federal services that voters demand. Orthodox price theory…is unambiguous in concluding that reducing the price of a good or service increases the amount demanded. Reducing the current tax burden of federal spending has much the same effect as a price control, increasing the amount demanded relative to that supplied from current revenues.

Just as people don’t value what they don’t pay for, democracies won’t correctly value policies with hidden or deferred costs. That prevents the competing interests from being weighed carefully, screwing up debate and policy outcomes.

Policies producing diffuse costs and concentrated benefits exacerbate this problem. As I have occasionally written (once with Bill), U.S. defense policies, including wars, fall into that policy category. Americans face few personal consequences when their government makes war. Few of us fight, and danger from fiascos is remote. Much rhetoric to the contrary notwithstanding, the survival of our freedoms or way of life is no longer at stake in our wars. Our volunteer professional military bears great risk in war of course, but professional norms prevent it from publicly complaining much. War’s cost for most of us is slightly higher taxes, subsidized by debt. We can support war casually.

A war cap or war tax would somewhat mitigate this problem. A tax encourages taxpayers to consider the value they are getting for that money. A cap heightens competition for resources within the government and thus among Congressmen and interest groups, which ought to sharpen debate. That won’t prevent dumb wars, but it ought to help.


Why Hayek Would Have Hated Software Patents

In his famous essay “The Use of Knowledge in Society,” Friedrich Hayek argued that the socialists of his day falsely assumed that knowledge about economy could be taken as “given” to central planners. In reality, information about the economy—about what products are needed and where the necessary resources can be found—is dispersed among a society’s population. Economic policies that implicitly depend on omniscient decision-makers are doomed to failure, because the decision-makers won’t have the information they need to make good decisions.

In a new paper to be published by the NYU Annual Survey of American Law, Christina Mulligan (who drafted a recent amicus brief for Cato) and I argue that the contemporary patent debate suffers from a similar blind spot. A patent is a demand that the world refrain from using a particular machine or process. To comply with this demand, third parties need an efficient way to discover which patents they are in danger of infringing. Yet we show that for some industries, including software, the costs of discovering which patents one is in danger of infringing are astronomical. As a consequence, most software firms don’t even try to avoid infringing peoples’ patents.

Patents are often described as “intellectual property,” and patent law provides for harsh property-like remedies against patent infringers. But a property system that is so convoluted that ordinary firms can’t figure out who owns what isn’t a property system at all. Genuine property rights enhance economic efficiency by bringing predictability to the allocation of scarce resources and thereby promoting decentralized decision-making. Software patents retard economic efficiency by subjecting software firms to a constant and unavoidable threat of litigation for accidentally infringing the patent rights of others. Hayek would not have approved.

Our paper is available from SSRN.

USDA Turning Taxpayer Money into Wine

Today’s example of how the federal government has become too darn big is the U.S. Department of Agriculture’s Value-Added Marketing Grant program. This (relatively) little slice of corporate welfare will hand out approximately $56 million in taxpayer dollars this year to “producers of agricultural commodities” who can use the money “for planning activities and for working capital for marketing value-added agricultural products.”

A big winner this year appears to be wine producers:

The USDA, the politicians who take credit for the awarding of the grants, and the recipients all say that these subsidies are good because the wineries will produce job, economic growth, etc, etc. Maybe they will, maybe they won’t. But as I often stress – to the point that I become blue in the face – federal subsidies are not a free lunch. Every dollar that the federal government spends helping wineries is a dollar that is taxed or borrowed from the private economy. When the federal government subsidizes particular businesses it’s merely transferring economic resources from one entity to another – a.k.a. central planning.

The $56 million Value-Added Marketing Grant program is a pretty small outlay in a $3.8 trillion federal budget. However, it’s not so much the size of the program that’s the problem. Rather, the program symbolizes the problem with allowing the federal government to spend other people’s money on virtually anything that the politicians on Capitol Hill desire. Given the government’s rising debt load, that situation must be remedied before Washington sends the economy off the cliff.

Sigh…somebody pass me a bottle of wine.

New Bill to Reform the UK Banking System

On Wednesday February 29, UK Member of Parliament Steve Baker introduced a Bill to the UK Parliament to reform the UK banking system. The purpose of this Bill is to implement a series of measures to resolve the financial crisis in the UK. The underlying principle of this Bill is to minimize moral hazards within banking, by making those who make or preside over risk-taking as liable as possible for the consequences of that risk-taking. Since rules are usually gameable, the Bill also includes mutually reinforcing measures that minimize scope for evasion.

The key provisions of the Bill are as follows:

First, board members of banks would be subject to strict and unlimited personal liability for any bank losses.  They would also be subject to stringent provisions to provide personal bonds that would be potentially forfeit in the event their banks posted losses.

These measures would create the strongest possible personal incentive for board members to ensure that their banks are managed responsibly. This is the most important requirement to resolving the crisis: with the key decision-makers’ own wealth most at risk, they would ensure that the excess risk-taking would soon disappear.

Second, the payments of any bonuses that are awarded in any given year would be deferred for a period of 5 years. The amounts involved (‘bonus pool’) would be invested on beneficiaries’ behalf in an escrow account.

Third, should a bank report losses over any period, these losses would be made good in the first instance by drawing from the bonus pool. Should a bank report losses that exceed the value of the bonus pool, then the whole of the bonus pool would be forfeit to the bank to make good the losses. The difference remaining - the difference between the reported loss and the value of the bonus pool - would then be made good by drawing from the board members’ personal bonds. Should their bonds prove insufficient to meet the whole of the remaining loss, then all their bonds would liquidated to offset that loss, and any subsequently remaining losses would be passed to shareholders.

Thus, the bonus pool and the personal bonds would provide additional levels of capital to protect shareholders and other stakeholders against losses, and the fact that both the bonus pool and the personal bonds would be at-risk before shareholders’ capital would provide a very strong incentive for key decision makers to ensure that the bank takes risks responsibly.

Fourth, for the purposes of this Bill, all relevant figures (measures of profit, loss, capital, bonuses, personal bonds posted, etc.) would be obtained using the parallel accounting rules (i.e., in effect, old UK GAAP under Companies Act legislation) proposed under the 2011 Baker Bill. This would put a stop to the manufacture of ‘fake profits’ and other accounting abuses that have become prevalent under the current International Financial Reporting Standards (IFRS) used in the UK.

Fifth, the Bill sets out a proposed solvency standard: a bank is deemed to be insolvent if its ratio of core capital to assets should fall below 3%, where its core capital is defined to be equal to the sum of the value of the bonus pool, directors’ personal bonds and shareholder capital. This definition of core capital is far better (and far less fiddleable) than the capital definitions in the Basel II capital adequacy regime, which have been widely abused by banks.

Sixth, the Bill calls for the government to bring before Parliament measures to create a fast track bankruptcy regime for banks and to end all state support for banks. This would include: all bailout support, all lender of last resort support, all public shareholdings in banks, all central bank holdings of any bank assets and any form of state-supported deposit insurance. Any future state or central bank support for financial institutions is also to be prohibited.

Finally, the Bill calls for the government to establish a new Financial Crimes Investigation Unit that will investigate financial crimes, and whose focus will be crimes committed by senior bankers and financiers. This new unit will also begin investigations into possible criminal offenses committed in all financial institutions that have failed since 2007 and/or been in receipt of state support (e.g., bailouts).

Taken together, these measures would remove the most flagrant abuses and restore the integrity of the UK financial system; they would also address the widespread indignation over bankers’ behavior and meet the public demand for accountability and justice in modern UK banking.

The Ex-Im Bank and Crony Capitalism

My esteemed colleague Sallie James broke ground last summer with an excellent expose of the corporate welfare role played by the Export-Import Bank of the United States.  Until this past weekend, Sallie’s had been about the only analysis in the public domain to find the Ex-Im Bank’s activities unseemly, market-distorting, and anathema to free market capitalism.

Thus, I was heartened to see that an editorial in the last Saturday/Sunday edition of the Wall Street Journal picked up on Sallie’s theme and emphasized some of her most salient points.  Hopefully, the WSJ and other prominent news outlets read and amplify Sallie’s follow-up, forthcoming analysis, which shines some light on ExIm’s growing role in the business of financing the domestic sales of select U.S. companies.


Time for Some Rapprochement in U.S.-China Economic Relations

Has the Chinese government indulged in protectionist, provocative or otherwise illiberal policies that have, on occasion, violated its commitment to the rules of international trade? Yes.

Do the Chinese maintain other policies that very likely would be found to violate China’s WTO obligations? Yes.

Is the U.S. government within its rights to bring formal complaints about benefit-impairing Chinese trade practices to the World Trade Organization for adjudication and resolution? Yes.

But before getting all righteous and patriotic and demanding that China be deemed an economic pariah worthy of exceptionally harsh treatment, keep in mind that the U.S. government has been found out of compliance with its WTO obligations more than any other WTO member, and it remains out of compliance on a few issues to this very day.

In some respects, the Chinese are emulating the tack taken by U.S. policymakers during the past three presidential administrations and ten congresses by presuming there is no policy or practice that violates WTO rules unless and until that policy or practice has been determined by the WTO Appellate Body to be out of conformity, and sometimes not until after retaliation has been authorized, and sometimes not even then.

China’s protectionist policies – policies that make its markets less accessible to U.S. exports and investment – should be identified and challenged. But U.S. policymakers should consider abandoning self-destructive, protectionist policies that hurt U.S. interests more than Chinese ones in favor of greater cooperation from China resolving problems facing U.S. companies in that market. But greater cooperation doesn’t come at the barrel of a gun.  It requires good will and an attitude of willing reciprocity from the U.S. side.

This new paper gives some background and offers the one important reform that could prove to be the elixir.


Why Did El Salvador’s President Come Out Against Drug Legalization?

President Mauricio Funes of El Salvador has come out against the proposal of his Guatemalan counterpart to legalize drugs as a way to tackle drug trafficking in the region. Funes, a center-left politician who initially backed the Guatemalan proposal, stated his opposition [in Spanish] shortly after a visit by U.S. Homeland Security secretary Janet Napolitano to San Salvador.

Why did Funes retreat from his original support to discussing drug legalization? Did Washington exert pressure on the Salvadoran president? It’s hard to say. For once, thanks to DR-CAFTA, Central American countries no longer face trade sanctions if they upset Washington. Having a free trade agreement with the United States removed the uncertainty of depending on unilateral trade concessions from Washington that were constantly up for renewal or modification.

However, there is another unilateral program that could explain why president Funes withdrew his support to Guatemala’s proposal. It’s the Temporary Protected Status program (TPS), which grants certain migratory benefits to citizens of designated countries “that temporarily prevent [them] from returning safely, or in certain circumstances, where the country is unable to handle the return of its nationals adequately.”

El Salvador was designated a beneficiary of TPS in March 2001 after a couple of earthquakes caused an estimated $1.6 billion in damages—about 12 percent of the El Salvador’s GDP. The benefits were later extended after hurricane Stan battered the country in 2005. However, seven years afterwards, the TPS has become a permanent bargaining point as Salvadoran presidents repeatedly ask Washington for more renewals. Approximately 212,000 Salvadorans benefit from the TPS.

Coincidentally, it’s up to the Homeland Security Department to extend the TPS. It did so for citizens of El Salvador last January 10, but the benefits are set to expire on September 9, 2013—unless there’s another renewal.

The TPS also benefits nationals from Honduras and Nicaragua and they are set to expire next year. Let’s not expect much enthusiasm about Guatemala’s proposal coming from Tegucigalpa and Managua.