The Corporate-Welfare State We're In

Thank you, Paul Krugman, for putting this so plainly:

Wall Street is no longer, in any real sense, part of the private sector. It’s a ward of the state, every bit as dependent on government aid as recipients of Temporary Assistance for Needy Families, a k a “welfare.” I’m not just talking about the $600 billion or so already committed under the TARP. There are also the huge credit lines extended by the Federal Reserve; large-scale lending by Federal Home Loan Banks; the taxpayer-financed payoffs of A.I.G. contracts; the vast expansion of F.D.I.C. guarantees; and, more broadly, the implicit backing provided to every financial firm considered too big, or too strategic, to fail. Money for nothing 'New York Times', 26 April

Next time your acquaintances speak disparagingly of people on welfare, it's worth recalling that much of the corporate sector in every western economy is equally dependent on government. As well, families on welfare don't typically subvert the financial system or the environment, or manipulate the regulatory system, to suit their aims.

The Special Interest State

Discussing the 'Special Interest State', James V DeLong says:

The Special Interest State could get along quite well when it simply nibbled at the edges of the society and economy, snipping off a benefit here and there, and when the number of victorious interests was limited. But the combination of moral entitlement, multiplication of claimants, and lack of limits on each and every claim is throwing them into conflict, and rendering unsustainable the ethic of the logrolling alliances that control it.

Earlier:

Some minority-rights groups claim the right to control all speech. Victim groups of all kinds see a never-ending need for lawsuits. A provision inserted at the behest of the Teamsters into the recent stimulus bill, which was read by no member of Congress in its entirety, started a trade war with Mexico for the sake of banning 97 Mexican trucks from U.S. highways. Providers of higher education demand continuing escalation of subsidies for four-year B.A. programs rooted in the 19th century. Public employees have become perhaps the largest and most powerful interest group — 20 million strong, politically active, and dedicated to the ideals of no cuts in employment, absolute pension safety no matter what happens to everyone else’s retirement accounts, and little accountability.

Precisely so. And how sustainable is this?

As the government has grown in size and reach, it has justified its claims to power by accepting ever more responsibility for the economy and society. Failure will result in rapid loss of legitimacy and great anger. It is amusing to read pundits’ pronouncements that the Chinese government must deliver economic stability and growth or suffer social unrest; what do these pundits think will be the fate of an American government that fails in these tasks? And as the government’s reach extends, any chance that it will meet its self-proclaimed responsibilities declines.

Government has lost sight of what should be its over-arching goal: to look after the wellbeing of its people. 'People' - not institutions or special interest groups. And people are more than members of special interests. Bailing out car manufacturers, airlines, farmers or any other well-represented lobby group is not equivalent to looking after the wellbeing of the stakeholders in these groups. Of course, it's much easier for governments to listen to the lobbyists, and to equate the health of powerful interest groups with that of the people they are supposed to represent. But it is a temptation that must be resisted: it's based on, and tends to fossilise, a static view of society. Progress comes through diversity and adaptation. Looking after special interests stymies that sort of evolution. Worse, it diverts resources from the people who really need it.

And that is where Social Policy Bonds can offer a better solution. If governments were accustomed to expressing society's goals in terms of outcomes that are meaningful to ordinary people, then the bailing out of special interests would be clearly seen as the corrupt folly that it is. Social Policy Bonds would by subordinate all policy goals to such outcomes and channel our scarce resources into their achievement. Under a bond regime, government could not deceive itself and the rest of us with the pretence that, by protecting powerful interest groups, it's doing any favours to the people it should be representing.

Incentives need not be monetary

Work by Swiss professor, Bruno Frey reinforces and analyses something that economists tend to forget: that monetary incentives don't always work. Indeed, they stand a good chance of undermining our willingness to do the right things for ethical and moral reasons. People perform valuable social or environmental services not only for monetary gain, but also because they enjoy doing them for their own sake, because they believe them to be the morally right things to do, or because they believe that their actions will advance some cause to which they are committed. These ‘intrinsic’ motives are qualitatively different from external, monetary incentives, and offering monetary rewards might ‘crowd out’ or undermine these less mercenary and more civic-minded motivations. Crowding out internal motivation can occur, writes Frey, because, monetary incentives can undermine people’s feelings of self-determination and self-esteem. Also, when external incentives are supplied, the ‘person acting on the basis of his or her intrinsic motivation is deprived of the chance to exhibit this intrinsic motivation to other persons.’

Not mentioned by Frey, but also plausible is that financial incentives can undermine the cognitive outlook that sees socially and environmentally beneficial services as worthwhile in their own right, rather than as a cost for which compensation and payments must be paid by taxpayers.Professor Frey looks in some detail at these circumstances.

Links to some of Professor Frey's work are here, and you might also be interested in this video talk on the same theme, by Barry Schwartz.

What do these findings mean for Social Policy Bonds, which at first sight seem to be entirely based on pecuniary incentives? It's important to note that, as Frey points out, the crowding-out effects are not always significant. In markets, which are based on relationships amongst essentially self-interested strangers, financial incentives as exhibited through the price effect do work as classical economics predicts. That is, they work to increase supply. And when (as they would be under a bond regime) external rewards are seen as recognition of the importance of, say, civic duty rather than an attempt to ‘buy’ one’s civic performance, they may well support, rather than undermine, moral and other intrinsic motivations. A bond regime could give bondholders incentives to further Frey’s research, exploring the relationships between financial incentives and civic performance. They could use this knowledge to minimise the costs of achieving targeted objectives by, for example, finding out when monetary incentives are least likely to supplant the intrinsic motivations of people who help achieve objectives, and concentrating their use in those circumstances.

Social Policy Bonds in this view, then, are not merely a system by which monetary incentives are funneled into the most efficient providers of public goods and services, but a 'meta-system' that motivates bondholders to find the best ways of encouraging socially beneficial behaviour - whether these be monetary or not.

Wish I'd said that...

After pointing at research showing that nitrous oxide is a much more potent greenhouse gas than had been thought, 'The Economist' opines that:

T]he case of biofuels shows that without proper consideration of all greenhouse gases, not just CO2, it is too easy to rush headlong into expensive methods of mitigation that actually make things worse. 'Biofools', Economist, 11 April

My title is an ironic references to the many times I've said (this blog, passim) that we urgently need to solve problem of climate change, rather than its supposed causes, about which we do not yet have enough knowledge. For more, see my paper on Climate Stability Bonds.

Cap-and-trade, carbon tax, or Climate Stability Bonds?

Barry Brook and Tim Kelly present a useful submission about cap and trade. Their arguments against it have force:

1. A cap and trade mechanism is by its nature, an all consuming policy instrument that extinguishes the effectiveness of voluntary actions, harming rather than enhancing the evolution of a low carbon economy.

2. With a cap and trade approach, the target is everything as both the emissions cap and emissions floor are locked in. No one can do better than the cap, and so the cap must be a science based [all-]consuming sustainable target pathway that won’t lock in failure. ....

3. ... The cap and gateway will either be too aggressive and will cause a political backlash, or [too] soft leading to coasting when we should be transforming the economy. [My ellipses] CPRS vs carbon tax: Senate Inquiry

They have further points, all pointing to a carbon tax in preference to cap-and-trade. My own thinking is that there's nothing a carbon tax can do that Climate Stability Bonds cannot do better. If investors in Climate Stability Bonds think cutting back greenhouse gas emissions is the best way of stopping climate change then they will have a powerful incentive to demonstrate that and lobby for it. But if they come up with better ways of cutting back emissions - or halting climate change - then they will explore and implement these. In such a way, the risk that a carbon tax will fail to halt climate change is transferred away from taxpayers, consumers and indeed the world's entire human, animal and plant life, to investors in the bonds. And the investors have far more compelling incentives to get things right than whoever levies and pays (or more likely, tries to avoid) any carbon tax.

Short selling and Social Policy Bonds

A correspondent asks me whether short selling would pose a problem for Middle East Peace Bonds - an application of the Social Policy Bond idea aimed at eliminating violent political conflict in that part of the world: "If bonds are freely tradable, then presumably a terrorist organization might choose to short these bonds, thereby profiting from the much more easily and cheaply achieved goal of causing destruction to the peace process."

The gist of my reply is that, first, the comparison should be with the current system, rather than a Utopian ideal. MidEast Peace Bonds (MEPBs) I think would improve on the current possibilities, but they will not be perfect. Under the current system terrorists could profit by short-selling of share indices before they commit an outrage. If they short-sold MEPBs, the probability of their being traced would be greater than under the current system, simply because there would be fewer traders of the bonds than share indices. Efforts to track or deter such trading could be made simpler by the bonds being issued for large sums combined with some system of ownership registration, as with current financial instrument trading; they could be issued in denominations of $1 million or upwards, say.

By short-selling the bonds the terrorists would therefore risk exposure, as well as suffer the public opprobrium of appearing calculating and pursuing pecuniary benefit, which might not sit well with some of their supporters.

More generally, it is almost certain that the price of any particular Social Policy Bond would not always be rising monotonically from its float price to its redemption value. It would be justifiable, as well as efficient, if bondholders could hedge against consequent falls in the value of their assets. People who do not hold bonds might want to participate in markets for derivatives of bonds, some of which would rise in value as the targeted goal became more remote. This in turn means that speculators and short sellers could certainly profit from short-term bond price falls, and the question again arises as to whether these people would then take steps to impede progress towards any targeted goal.

There are two main reasons why they would probably not. The first is that, in the long term, the weight of money would be against them. Provided sufficient funds were allocated to achieving the targeted objective, there would be a net positive sum of money payable if the targeted objective were to be achieved, and a net zero sum paid as long as the goal were not achieved. All the long-term incentive would be to achieve the targeted objective. Those who, for whatever reason, would suffer from achievement of the objective could be compensated by bondholders, or bribed to change their ideas. Note also that for every buyer of a 'put' option there would be a seller, and that for every futures contract bought on the expectation that the bond price would fall, there would be an equivalent futures contract sold on that basis, so that the net incentive generated by derivatives would be in line with the incentive created by the underlying financial instrument, the Social Policy Bond: in the long run, this would favour achievement of the targeted objective. The other reason that short sellers, or holders of 'put' options, in Social Policy Bonds might not take actions aimed at interfering with achievement of the goal is that such actions might well already be illegal or, again given the incentives that the bonds would generate, be made illegal - or have their provenance more enthusiastically investigated - once the bonds had been issued. Some miscreants might be tempted to sell bonds targeting water pollution short (or buy 'put' options) then dump a million tons of manure into Chesapeake Bay. But they would know that such an act is illegal - and that there will be people at the other end of their transactions who will be highly motivated to see the law enforced to its fullest extent.

The last two paragraphs, above, are based on an excerpt from my book on Social Policy Bonds, completed recently and available here, in electronic or hard copy.

Incentives are important

In a remarkable illustration of the power of lobbying in Washington, a study released last week found that a single tax break in 2004 earned companies $220 for every dollar they spent on the issue -- a 22,000 percent rate of return on their investment. The study by researchers at the University of Kansas underscores the central reason that lobbying has become a $3 billion-a-year industry in Washington: It pays. Investments Can Yield More on K Street, Study Indicates (registration), Dan Eggen, 'Washington Post'

It's sad that only highly-paid specialists have ready access to the people in power. The political process is so legalistic and arcane that ordinary people haven't the time or the legalistic knowledge to get involved. One solution might be for policy to be expressed primarily in terms of outcomes.

If Social Policy Bonds were issued, there would be still be scope for lobbyists, but their focus would be on the precise definition of targeted outcomes. Take climate change for example. The definition of a climate stability target could include any combination of a wide array of scientific, financial and human indicators. Discussion of these and their targeted values would no doubt be protracted and esoteric. But there is a difference between such debate and the current lobbyists' efforts. Currently, lobbyists represent the bodies that pay them: they will argue that, for instance, cutting back carbon dioxide emissions hurts 'the coal industry'. The trade-off between such pain and the goal of emission reduction would then be made opaquely; even the decision-makers would be making subjective judgements.

It would be different under a bond regime. Lobbyists for the coal industry would have to argue not that cutting back emissions from coal burning would hurt the coal industry, but that the targeted climate stability goal was inappropriate. The relationship between coal burning and climate change would be for investors in Climate Stability Bonds to explore, rather than policymakers. The policy debate, centring as it would on outcomes, will be accessible to far more people than the restricted group of specialists who currently have an interest in policymaking.

Shock: somebody else concerned about policy outcomes!

But a progressive policy needs more than just a bigger break with the economic and moral assumptions of the past 30 years. It needs a return to the conviction that economic growth and the affluence it brings is a means and not an end. The end is what it does to the lives, life-chances and hopes of people. Look at London. Of course it matters to all of us that London's economy flourishes. But the test of the enormous wealth generated in patches of the capital is not that it contributed 20%-30% to Britain's GDP but how it affects the lives of the millions who live and work there. What kind of lives are available to them? Can they afford to live there? If they can't, it is not compensation that London is also a paradise for the ultra-rich. Can they get decently paid jobs or jobs at all? If they can't, don't brag about all those Michelin-starred restaurants and their self-dramatising chefs. Or schooling for children? Inadequate schools are not offset by the fact that London universities could field a football team of Nobel prize winners. (Emphasis added) Socialism has failed. Now capitalism is bankrupt. So what comes next?, Eric Hosbawm

This is where Social Policy Bonds come in; or, at least, outcome-based policy. We cannot afford any more ideological experiments, even benign ones. But neither can we return to the days when the world was simple enough for the relationships between policies and their effects to be reasonably accurately identifiable. The only solution I see is to express policy in terms of agreed, targeted outcomes. It seems Hobsbawm agrees.

Avoiding disaster

Discussing the origins of the current credit crisis, Jeff Madrick writes:

The mortgages traveled such a long distance from institution to investor that no one was in personal touch with the actual mortgage holder any longer. Now, the likelihood of defaults was assessed not by someone who tracked a specific mortgage holder but by complex, computer-generated statistical models of the entire portfolio of mortgages. Like all such models, no matter how mathematically intricate, they required an estimate about the future based on the past - an estimate that was inherently incapable of adequately taking into account the consequences of a historically rare and therefore seemingly unlikely crash in housing prices. How we were ruined and what we can do, 'New York Review of Books', 12 February

Society's burgeoning complexity means that the chances of similar disasters occurring in all areas loom ever larger. By their nature, they cannot be anticipated. Even if we can see looming calamity in, say, the way the climate is changing, or the proliferation of nuclear weapons, we cannot know in advance the precise pattern that the calamity will take, still less do anything to avoid it. Our interconnectedness, aided (as in finance) by something approaching a policy monoculture, can amplify the consequences of unanticipated events. Remedies may be too little or too much - but they will always be too late.

One solution could be to issue Disaster Prevention Bonds, which could act so as to moderate or countervail the incentives currently on offer to the people and corporations who are quite happy to militarize our planet. These bonds could function as an insurance policy, rewarding people who work to avoid human catastrophes of any sort, specified or not. Disaster Prevention Bonds would not prejudge how human calamities shall be avoided, but would simply reward the sustained non-occurrence of such calamities. Under a bond regime, diverse, adaptive approaches that are efficient would be rewarded. Failing policies would be swiftly terminated.

Different bond issues could be used to insure against different broad categories of disaster, but always with a focus on outcomes rather than abstract variables; ends rather than means. In the area of finance, for instance, rather than target economic indicators (such as growth rates or house prices), bonds could target numbers of people unemployed or homeless.

The bond principle could be applied in other policy areas. Though we might fear a nuclear exchange or climate change in particular, Disaster Prevention Bonds targeting disasters need not be so specific. They could, for instance, target separately the potentially calamitous consequences of man-made or environmental disasters. In such bond issues the desired outcome - the avoidance of millions of avoidable deaths - would be specified, but not the means of achieving it.

Kyoto is doomed

Meredith Niles looks at the US 'Clean Energy and Security Act' :

Buried about halfway through the monster 648 page draft is a crucial statement: “controlling emissions in small as well as large amounts is essential to prevent, slow the pace of, reduce the threats from, and mitigate global warming and its adverse effects.” I couldn’t agree more, which is why I was shocked to see that the bill fails to address greenhouse gas emissions from agriculture, factory farms, and animal manure whatsoever—and even goes the extra mile to specifically exempt the entire sector from any type of regulation. New climate legislation overlooks a major GHG source: industrial ag

This short excerpt supplies two reasons why, in my view, Kyoto is doomed to fail. First, monitoring small amounts of emissions is inherently going to be expensive, intrusive and divisive. But if it's not done, then controlling emissions of specified gases (let alone controlling climate change) is just not going to happen. Second, and even more obviously, if favoured sectors are exempted from Kyoto's provisions (on what basis?), then Kyoto will fail.

It's hopeless: I firmly believe that only an outcome-based approach has a chance of working at a reasonable cost. The point is simple: if we want to reduce climate instability, we should reward people for reducing climate stability. We don't know whether trying to control greenhouse gas emissions is the best way of doing that, so we need to give incentives for people to find out. About the only thing we can be certain of is that not limiting greenhouse gas emissions will do nothing to stop climate change. And that's exactly what's happening.

Biodiversity and Social Policy Bonds

The United Nations Convention on Biological Diversity estimates three species become extinct each hour. That's 72 every day; 26,280 each year. .... [Paul Ehrlich] compares nature's biodiversity to the engineered redundancy in an airplane. The “rivet hypothesis” holds that you can lose some rivets in a plane's wing and it will continue to fly, said Ehrlich. At some point, however, the loss of just one more rivet becomes catastrophic. 'Dead Reckoning', Scott LaFee

How would a Social Policy Bond try to tackle loss of biodiversity? One way could be to target not the number of species (remaining, or becoming extinct) because the data are so scanty, but rather to target some index comprising habitat and a large number of indicator species. For ease of measurement it could be stipulated that a random sample of, say 100 out of a total of 10000 species, will determine whether the redemption conditions of the bonds have been met. Similarly, with the areas of habitat loss. Investors in 'Species Preservation Bonds' would therefore would concentrate their efforts on preserving all species, and all habitat.

There are lots of fish-hooks in this idea, and all sorts of potential for abuse and corruption. But does anyone have a better alternative? I don't see any effective global alternatives to application of the Social Policy Bond principle even being discussed. The link makes clear that we are headed for an ecological catastrophe if we carry on as we are doing. By 'we', I mean human beings. Some species will benefit from our demise:

[I]f mass extinction goes on long enough – events have lasted from hundreds of thousands to millions of years – what's left may consist only of “weedy survivors,” said Peter Ward, a paleontologist at the University of Washington. These are animals supremely adaptable and opportunistic, such as flies, rats, crows, coyotes and intestinal parasites.