Why do I always go on about perverse subsidies?

Here in the UK where the role of government in the economy is ever-rising, and where in regions like Wales it accounts for 66 per cent of economic activity, it's worth asking whether this constitutes a problem. I don't see big government as a problem in itself. But when big government becomes remote government I think that reduces accountability and responsiveness. It also makes for inefficiency. Actually though it's quite difficult to prove how inefficient government is at spending our money. Relying on particular narrow statistics, such as the number of cancer survivors, or exam results, is not enough. Perhaps we are simply getting better at diagnosing cancer? Or perhaps poorer exam results are the result of more people staying on for education and are anyway the best that can be done given the multitude of other variables that are acting to depress aptitude and ability?

More robust indicators of poor government performance would be deteriorating broad poverty or health indicators but these also have difficulties. So perhaps the most compelling evidence that all is not as it should are perverse subsidies: not just their size but also their persistence. Perverse subsidies may be the smoking gun: proof that even the governments in the rich democratic countries can be inefficient and corrupt. Perverse subsidies are subsidies that are economically nonsense and socially inequitable and environmentally disastrous. Europe's Common Agricultural Policy is one such. Because of it, taxpayers and consumers subsidise the richest landowners and corporations and have been doing so for decades after it became widely known just what was going on. Perverse subsidies in just four sectors - agriculture, water, energy and transport - were estimated by the Earth Council in 1997 to amount to between $700-900 billion. This is an enormous sum in itself but also an indicator, in the absence of other indisputable evidence, that the rest of government spending may be similarly mismanaged.

Transport: a means not an end

Bangkok is a particularly dire example of a city that has sacrificed much of its quality of life to road transport. In this it's not unique, of course, but it is particularly sad to such large numbers of such exceptionally decent, dignified and (for the most part) gentle people living in the ever-shrinking interstices of such a hideous, brutal infrastructure. Most Thais have no, or very limited access to cars, but that doesn't stop the government building more roads and imposing its own view of development on society.

Perverse subsidies to the road lobby are common the world over; add in the subsidies to oil extraction and consumption and you get the financial cost of our governments' obsession with road transport. Other costs are equally grievous: the deaths, mutilations, noise pollution and air pollution.  

Once this sort of thing starts it's self-perpetuating. The perverse subsidies strengthen the power of the road lobby to oppose alternatives. Busy roads make it more dangerous and expensive to get about in any other way.

How would a Social Policy Bond regime differ? It would not necessarily oppose easier transport links, but it would see that they are not an end in itself. They are at best a means to other ends and a bond regime would target these ends. A bond regime would focus on genuine outcomes: things that matter to people - real people, as distinct from corporations.

As it is though, we get the typical government view of how society should develop: along the lines that favour the big and global at the expense of the small and local.

Social Policy Bonds and free-riding

In my work on Social Policy Bonds I’ve tried to make the concept accessible and so haven’t emphasised the versatility and other advantages that variants can bring to the concept. One such is time binding: in other words, making redemption conditional on the targeted social goal being achieved by a specific date. Time binding would on its own reduce the market value of Social Policy Bonds, and increase the proportional payouts for early achievement of the targeted social or environmental outcome. I think it would also have the effect of deterring still further would-be free riders: Social Policy Bonds could be issued that target, say, achievement of a 99 per cent literacy rate for children aged 11 in the UK. But if the issuers anticipated too much free-riding, they could stipulate that they would redeem the bonds only if the target rate were achieved within, say, five years. Would-be free-riders then would be holding a wasting asset, whose value as the target becomes more remote would decline even faster than if there were no specified time limitation.

There are other reasons, which do not depend on time binding, for believing that free-riding would be a self-cancelling activity: assume that most of a particular issue of bonds were held by would-be free riders. Then very little, if anything, would be done to help achieve the targeted objective. As the objective became more remote, the value of all the bonds would fall. And as the bonds lost value, they would make a more attractive purchase for people who were prepared actively to help achieve the targeted objective. So free riders would be tempted to sell, even at a loss, rather than see the value of their bonds continue to fall. Some history of falling bond prices would tend to make free riding on Social Policy Bonds less appealing with future issues.

Free-riding, in my conversations with economists, always seems to loom large in their doubts about the Social Policy Bond concept. But for the reasons given here, and for others that I mention in my longer work, I don’t think it would be a serious problem.

A new type of organisation

I’m often asked about the apparent mismatch between the fluidity of holdings of Social Policy Bonds and the targeting of long-term objectives. At first it seems unlikely that the tradability of the bonds would enhance the achievement of such objectives.

Essentially bondholders would form a coalition whose main interest is to enhance the likelihood of early achievement of the targeted social or environmental goal. The composition of this organisation might be changing all the time because the Social Policy Bonds could constantly change hands. That need be no impediment to solving short-term, small-scale social or environmental problems, where progress toward solution can be readily monitored. But how could such a protean organisation of bondholders work to solve long-term social and environmental problems?

It’s actually quite easy: consider what people buying bonds targeting global climate change might do. They would want to see some appreciation of the value of their Climate Stability Bonds even if they have no intention of holding on to them until the  (in all probability) extremely remote target of climate stability has been achieved. They would quickly see that their bonds will lose value unless they set up some sort of body with a longer-term commitment. One possibility is that larger bondholders would collude to set up an investment company for the lifetime of the bonds. This company would have a stable structure and its job would be to vet potential climate-stabilising projects and help finance the efficient ones. The bondholders, once they’ve set up this company up could of course always sell their bonds on the open market: the setting up of the investment company could be one of the first projects they undertake in order to maximise the appreciation of their bonds. In principle, it’s no different from any other project. Climate Stability Bonds sold after the formation of this company would perform in the market like shares in the investment company. In keeping with the Social Policy Bond ethos, of course, all the company’s activities will be dedicated toward achievement of, in this case, climate stability.  

More generally, in order to maximise the value of their bonds, those who buy Social Policy Bonds at flotation will have incentives to set up the most efficient objective-achieving institutional structure they can. And they will be free to set up any institutional structure that maximises their gains from bondholding.

The unimportance of outcomes in medicine

From Medical Guesswork, by John Carey, 'BusinessWeek', 29 May: the first quotes refer to Dr David Eddy, a heart surgeon turned mathematician and health-care economist:

He began to ask if there was actual evidence to support what doctors were doing [ie cardiac surgery]. The answer he was surprised to hear, was no. Doctors decided wheher or not to put a patient in intensive care or use a combination of drugs based on their best judgement and on rules and traditions handed down over the years, as opposed to real scientific proof.

...Eddy proved again and again that the emperor had no clothes. In one study, he ferreted out decades of research evaluating treatment of high pressure in the eyeball, a condition that can lead to glaucoma and blindness. He found about a dozen studies that looked out outcomes with pressure-lowering medications used on millions of people. The studies actually suggested that the 100-year-old treatment was harmful, causing more cases of blindness not fewer.

Carey rightly sees, in a related article, the importance of incentives:

The way the U.S. health-care system is structured offers doctors, hospitals, and companies enormous financial incentives to provide more and more care. Surgeons will get paid if they do a bypass operation, insert ear tubes in children, or take out a prostate. If they recommend waiting or doing drug therapy instead, there's no payday.

Of course, as the article does make clear, there are plenty of areas of medicine where the benefits have been huge and unarguable. But the message is clear. Medicine in the US has been badly skewed by perverse incentives, and the information asymmetry between health-care providers and consumers.

Speaking not for attribution, the head of health care atone of America's largest corporations puts it more bluntly: "There is a massive amount of spending on things that really don't help patients, and even put them at greater risk. Everyone that's informed on the topic knows it...."

What do we really want?

Some years ago, when the Chinese Government was rounding up Falun Gong meditators and bundling them into vans for 're-education' (ie torture or worse), there were extraordinary scenes of protest in the United Kingdom - against a small rise in the price of petrol. That's what we really care about it seems. Through perverse subsidies, governments have got us all hooked on our cars; so much so that we don't really seem to mind that we are trashing the planet and piling up weapons of mass destruction. It's the same the world over:

Whatever else is happening, from temporary triumphs in Iraq to Administration scandals, when prices at the pump jump for more than a month, the [US] President's popularity almost always falls. Businessweek

I shouldn't read too much into this, and Businessweek does point out that the relationship is one of correlation rather than causation, but still, it is a bit disheartening to see so much attention given to trivia, while urgent global challenges go unmet.

Motivation

[M]ost firms are ephemeral. It is not immediately obvious that the real business world is like this, because we notice the firms that last, such as General Motors or Ford. But most do indeed go under (or get taken over) on a relatively short timescale. Of the largest 5000 US firms operating in 1982, for example, only 35 per cent still existed as independent entitites in 1996. There is a high 'turnover' of companies, which many economic theories of the firm do not acknowledge.

So why do firms fail? In [Robert] Axtell's model there is a typical trajectory. First, a new firm grows more or less exponentially over time as increasing returns cause workers to flock to it. But at some point the firm reches its peak, after which collapse is usually sudden and catastrophic. ... This collapse is a consequence of the firm's own success. Once it grows big enough, it becomes a haven for free-riders who capitalize on the efforts of others. So the firm becomes gradually riddled with slackers, until suddenly the other workers decide they have had enough and jump ship. (Note that firms fail in this model because the workers leave for better jobs, not because the market for their products disappears or because there is a terrible warehouse fire, or for any other reason.) Critical mass: how one thing leads to another, Philip Ball (page 333).

Some firms though are not allowed to fail. It's unfortunate that these are the ones whose remit is to solve our serious social and environmental problems. I refer of course to government agencies. However many slackers they employ, and however many diligent people leave them, these agencies are notoriously difficult to kill off.

So why not hand the solution of our social and environmental problems to the private sector? I don't mean letting private companies perform one or two processes previously done by the public sector, or merely changing the ownership of existing public operations. I mean contracting out the achievement of broad social and environmental outcomes to the private corporations in such a way that their success is strictly correlated with public goals. This is what a Social Policy Bond regime would achieve. Unlike under the current system, the companies that employed slackers under a bond regime would quickly go out of business. Taxpayers would get value for money and society as a whole would benefit from a more motivated workforce striving to achieve public goals.

Summing it up

The selection of issues that should rank high on the agenda of concern for human welfare and rights is, naturally, a subjective matter. But there are a few choices that seem unavoidable, because they bear so directly on the prospects for decent survival. Among them are at least these three: nuclear war, environmental disaster and the fact that the government of the world’s leading power is acting in ways that increase the likelihood of these catastrophes. It is important to stress the "government," because the population, not surprisingly, does not agree. That brings up a fourth issue that should deeply concern Americans, and the world: the sharp divide between public opinion and public policy....

This excerpt from Noam Chomsky's Superpower and Failed States sums up humanity's predicament accurately, though I would not myself ascribe particular blame to the US Government but rather to political systems everywhere, which all emphasise image, identity and ideology rather than outcomes. In an increasingly complex world it's too easy to escape or deflect censure for corrupt or incompetent policies: relationships between cause and effect are too obscure; blame can always be shifted. Political debate mirrors they system's obsession with irrelevance. But clear away the fog of strident commentary and party politics and you will find a high degree of consensus over what people actually want. Chomsky's probably right: most of us would see nuclear war and environmental disaster as humanity's most serious challenges. But our system doesn't allow us to articulate them as priorities; at best we can choose people who say - amongst many other things - they care about these issues but who when in power cannot or will not focus on them. It's not the politician's fault: they are part of a corrupt, corporatist system, whose raison d'etre is basically to keep things going as they are. Hence the chasm between public opinion and public policy.

Chomsky blames the US Government, but I rather think that blaming this or that faction is to get dragged into the very system whose failure he so well describes. As long as we see particular ideologies, parties or people as the problem, we're not going to change anything. So here is my suggestion for a transition to meaningful policymaking:

1 Politicians and their parties should check out real people's actual priorities. I believe, as I say, that they would then find themselves having to deal with the possibility of nuclear war and global environmental challenges, of which climate change is the most pressing. If, having too much of a stake in the existing circus, they won't do this then it may be up to you, readers of this blog, to do the right thing, which is:

2 Issue Social Policy Bonds that target these priorities. Social Policy Bonds are non-interest bearing bonds, sold on the open market, that would become redeemable for a fixed price once the targeted goal had been achieved. Click on the links in the right-hand column for more information. Afterwards, have a look at my handbook for those interested in issuing their own bonds.

Targeted outcomes need to be built into policies right from the start. These outcomes must be meaningful to real people, not government agencies or corporations. Every other way of doing things has been tried and has failed. The power of vested interests has seen to that.

War is a statist response

The costs of the Iraq war are officially estimated around $500 billion, a sum which may be compared to the one spent in the Korea and Vietnam wars. However, this is likely to be less than half of the war’s real economic cost. If proper accounting principles are adopted, reasonable estimates lie between $750 and $1269 billion - or between 6% and 10% of America’s GDP. Taking other economic costs into account, such as the medical costs borne by seriously injured soldiers, the loss of income produced by reservists on duty, and increases in oil price and greater uncertainty, adds $380 to $1400 billion in present value terms. Source

How would a Social Policy Bond regime deal with violent political conflict? In the first place, it would clarify, and make explicit, objectives. Under the current regime, those who initiate armed conflict may have very different goals from their stated intentions.

Second, issuing Social Policy Bonds necessitates estimating and capping of the maximum cost to society of achieving the targeted goals.

Third, Social Policy Bonds would not assume that armed conflict is the best way of achieving such stated goals. The Iraq war appears to be an example of a typical government response to a perceived threat. Let’s say the actual agenda of the conflict was regime change and the installation of a democratic government over the whole of a politically united Iraq. Does anyone seriously believe that contracting out these goals to the market would be as costly – to everybody and in every sense – as the current conflict? War seems to be very much like the ludicrous subsidy programmes, or the crazy construction schemes that characterise so much of big government: real people don’t want it, but it goes ahead anyway because of (1) the power of corporate interests and (2) the obsessive need of government bodies to retain control.

● An fascinating article by George Monbiot in the Ecologist ends by asserting that ‘there’s one obvious question with which every journal and journalist should begin: “who is funding you?”’ I can answer this question accurately and concisely: nobody. If I were to say that this is because there’s no money for original policy ideas or outcome-based policy, but only for vested interests and ideologues I’d be accused of being bitter and twisted, so I shan’t say it, even if it’s true – which it is.

US and EU follow my suggestion!

Well, in one sense:

UN Secretary General Kofi Annan said the mediators had agreed to help the Palestinians through "a temporary international mechanism - limited in duration and scope - and fully accountable". The mechanism, he said, would ensure "direct delivery of any assistance to the Palestinian people". BBC

In other words, western aid would bypass the Palestinian Government. Without getting embroiled in Middle East politics, I think it's fair to say that this arrangement has a higher chance of successfully helping real people than the usual way in which western aid is doled out. This announcement follows, within days, my post advocating that taxpayers should be allowed to nominate recipients of that proportion of their tax that goes into social welfare or other good causes. Government wouldn't redistribute; it would just fix how much should be redistributed and ensure it wasn't being siphoned off to underserving causes. The US/EU Palestinian aid arrangement has one similar feature, in that the aid will (one hopes) go directly to the people who need it.

This is very good, and perhaps could serve as a model for future international aid programmes. It's largely the corrupt governments of the poorer countries who are responsible for so much of their people's misery. Now, how about government adding some symmetry and economic rationality, and instead of directing our funds to those it thinks most deserving - a category that, thanks to the Common Agricultural Policy, includes some of the wealthiest people in the land - allowing us to give them to people in genuine need?

Markets reduce adjustment costs

When forecasting the costs of new environmental regulations, economic analysts routinely ignore a primary economic lesson: Markets cut costs through innovation. And innovation can be promoted through regulation. Eban Goodstein

...or targeting via Social Policy Bonds. If we define explicitly what we want to achieve, whether they be environmental or social goals, and let the market find the best ways of reaching those goals, we'll see our ingenuity channelled into unexpected but creative pathways. It's tragic and ridiculous that our massive collective brainpower is currently channelled overwhelmingly into achieving private goals: that is, improving the bottom line of corporations. These corporations do a lot of good; employing people, reducing poverty, etc (though they also inflict unpriced social and environmental externalities on us all). But their objectives are for the most part frivolous, at least when compared with the environmental and social challenges that we collectively face. There are financial incentives on offer to those looking for solutions to, for instance, climate change or human conflict, but they are pitiful in relation to the size of magnitude of these problems and they are only weakly correlated with people's success in solving them.

A Social Policy Bond regime would be different. By explicitly targeting our major problems, and by rewarding people in proportion to their success in solving them, it would focus our innovative capacity and ingenuity where they are most needed. Goodstein's article shows how markets can stimulate unanticipated, creative solutions when there are incentives to do so.

Social Policy Bonds: the core text

My book of about 40000 words on Social Policy Bonds is now available as a free download (pdf). It's a draft, so any comments or criticisms, large or small, would be welcome. I will put a permanent link to it in the right-hand column.

Give to charity directly, rather than via government

It makes a big difference to uptake whether the default is to opt in or opt out of, for example, a pension scheme. This made me think about income tax. Many people try to minimise their tax payments, but are more than happy to give to charities and deserving individuals. They can of course deduct charitable contributions from their taxable income when they make their tax return.

So here's an idea: why not reduce income tax drastically and let taxpayers either opt in to paying their current rate of tax, or choose to give a decent proportion of their income to charities or individuals whom they (and the government) think are deserving?

Ask yourself," wrote John Fund of the Wall Street Journal a decade ago, "If you had a financial windfall and wanted to help the poor, would you even think about giving time or a check to the government?"

Those who don't opt in to paying the higher rate of income tax would be highly motivated to ensure that their contributions to good causes were spent wisely. This could be a big improvement over the current system because governments cannot or do not discriminate between those who are genuinely poor and really do need a helping hand, and those who would actually benefit by being coerced into finding a job. This scheme could (initially) be restricted to donations to charities, who could expect to see large increases in their funding. There would be inefficiencies of course, and some ripoffs, but in comparison with the current system, whereby taxpayers fund people they do not know and with whom, increasingly, they cannot identify, is breeding cynicism and resentment.

More and more groups could be brought into the realm of registered charities, including those that supply public goods such as environmental benefits, and who are often more efficient and highly motivated than government bodies.

The benefits of this 'give to charity directly' scheme are:

• Taxpayers would be empowered and take more interest in their contributions;
• The deserving poor would most likely receive more benefits;
• Those currently on benefits who don't need really them would be coerced into finding work, and would probably also benefit in the long run by doing so;
• The supply of public goods, including the relief of poverty and the cleaning up the environment would become much more efficient, because charities and other groups dependent on direct public contributions are much more highly motivated than government employees; and
• The supply of these public goods would more closely cohere with the public's wishes than when, as now, it is mediated by a large and remote bureaucracy.