The American healthcare system has deviated so far from any form of competitive market that it lost any claim to the moniker ‘capitalist,’ but it has received a steady stream of denigration as an example of capitalism run amok nonetheless. Today, I’d like to go over some of the obstacles to a fair market and what can be done to improve it.
There are, of course, things that cannot be properly serviced by a market. We’d like everyone to have access to good healthcare and that is only possible if we help our disadvantaged citizens out a little bit. Humans discount low-probability but high-impact scenarios too much, so we need to be encouraged to purchase insurance and participate in preventative care more frequently. Still, there are aspects of healthcare that would be significantly worse if the invisible hand of the market didn’t encourage investments of time and money into high-quality treatments.
Perhaps both the best example of an ideal application of a competitive market and the most egregious example of corporate lobbying and legalese erecting barriers to competition is that of the pharmaceutical industry. Large pharmaceutical companies spend enormous amounts of money on R&D, but perhaps even more impressive is their legal and lobbying budget. No industry spends more on lobbyists than Big Pharma, and it isn’t even close. They make money on a few blockbuster drugs, so when they find one, they set their rabid pack of lawyers to work on preventing any new entrants to the market (like generics). They don’t need to win, they only need to delay to make those lawyers worth nearly any cost. I wrote about the issue in a bit more detail here, so I will not go too deeply into it, but the crux of the issue is anti-competitive behavior allowing pharmaceutical companies from charging exorbitant prices. Medicare is not even allowed to negotiate in the same way as private insurance companies; the whole situation is a cash grab into the pockets of the taxpayer.
Hospitals make an even larger percentage of the total healthcare spend in the US than pharmaceuticals, but they have run rampant with bureaucratic costs, monopolistic behavior, and opaque pricing. There is no menu of prices for various procedures. They hide behind deceptive labeling when they create your bill. They charge absurd prices for simple things. The same procedure can cost an order of magnitude more in one hospital than another across town. Price discrimination, while illegal in all other industries, is commonplace in hospitals. The simple truth of the matter is that there is nothing you can do as a consumer of healthcare because hospitals are almost never close to each other. They are given regional monopolies and they abuse that monopoly power with impunity while insurance companies struggle to negotiate with them because of nearly unparalleled market power.
Meanwhile, the American Medical Association (AMA), an organization made up entirely of doctors, is allowed to determine licensure for various procedures. I doubt someone who completes college, medical school, internships, and residency has anything but the best interests of their patients at heart, but they do naturally assume that anyone without their extensive training is able to give competent care. While, in an ideal scenario, everyone would have fast and cheap access to a physician, the truth of the matter is that we do not have nearly enough doctors to do everything they are meant to do for everyone. Trained nurses can perform many of the more basic tasks that are assigned to doctors competently enough and their labor comes at a fraction of the cost. Labor shortages mean that we have to pay healthcare professionals much more money per hour and care suffers as a result. Preventing people who would be able to perform those tasks from doing so only exacerbates the problem.
Despite all of that and more problems we will not be discussing today, the American healthcare system does an admirable job of providing care. Controlling for accidental deaths, gun violence, and drug overdoses, we have one of the best systems in the world. The problem lies with price. We spend more per capita than any other nation for a similar result. Fixing it should, in theory, be simple. We need to make markets more transparent and lower barriers to entry for drugs and labor. In practice, there are powerful special interests that are able to prevent those things from coming to pass. Shining a light on the dirtiness of the issue can go a long way towards pressuring elected officials to get these things done.
Until recently, CEO pay was the punching bag of choice for any journalist or politician looking to exhibit massive inequality. Billionaires have taken over as proof of the dangers of unfettered capitalism. I submit that it is not unfettered capitalism, but incentives that are broken. Market mechanisms have been meddled with and the result is a perverse system that rewards accounting trickery instead of long-term performance for CEOs of publicly traded companies. Compensation packages negotiated between boards and executives suffer from asymmetric information. Public ownership means too few take a close look at contracts and directors are incentivized to play a rigged game at the expense of the average shareholder.
This comes on the heels of a vilification of the shareholder in favor of the fuzzily defined stakeholder. Shareholders are all of us; this is particularly true in the age of widely distributed exchange-traded funds and indices. The problem with charging companies to look out for stakeholders is the same is it is for countless other well-meaning policies: implementation. In practice, we would be handing executives and boards greater power instead of focusing on the underlying issues. Key among them is an imbalance of power skewed toward executives and away from shareholders.
The owners of public companies are impacted diffusely and thus do not have the same motivation to enact change. Large shareholders are nearly always passively traded funds that have no intention of taking an active role in company management. Board members enjoy cushy gigs that are frequently headed by the very person whose pay we are discussing. Even when CEOs are not chairmen of the board, they nearly always enjoy a high level of influence over its members; it’s how they got the job in the first place. Most importantly, though, the CEO has access to detailed information that boards and shareholders do not. That gives him or her a distinct advantage in salary negotiations.
The vast majority (over 80%) of a CEO’s pay comes from stock options and bonuses. This was encouraged by a Clinton era policy attempting to limit executive salaries and align executive incentives with shareholder interests. It limited the amount of CEO salary that could be expensed from taxable income to $1 million with the exception of ‘pay for performance.’ In practice, it means executives are given short-term targets that release scaling bonuses. These targets are negotiated, though, and a CEO will obviously have a large advantage over the board in the form of asymmetric information. As if that isn’t enough, accounting gimmicks and single-ply-gas-station-toilet-paper excuses are frequently accepted by boards as euphemistically stated ‘adjusted’ earnings statements. Meanwhile, share buybacks supporting stock prices are frequently scheduled around insider sales of large blocks of shares or stock option bonuses nearing exercise dates. Some bonuses are even based on share performance, which, in addition to being more correlated with general market performance than actual company health in the short term, provides more opportunities for stock manipulation via share repurchase programs on the shareholders’ dime as a way of ‘returning money to shareholders.’
Still, one could argue that shareholders are getting a harder-working steward of their money by paying for performance. The conventional wisdom says that we will perform at a higher level if we are incentivized to do so. Who would slack off at a job when your pay is directly tied to how well you are doing it/ The problem, once again, is implementation. Pay packages are nearly always annual; investment holding periods are much longer. We are asking boards with incomplete pictures of the business to determine short-term goals. That’s the CEO’s job! Given those incentives, executives attack the goals at the expense of long-term company health and profitability.
The best illustration of the problem is a comparison between privately held companies and publicly traded ones. Among similarly sized corporations, private CEOs are making roughly half that of public company CEOs. Digging deeper, bonuses make up effectively none of private company CEO pay. Rather than stock options, they receive their equity in the form of restricted stock (it vests over time). Without a liquid market to sell into, they must instead hold their equity for far longer. If they want to finance a wine cave with their equity, they must borrow against it from a bank. It all boils down to longer-term thinking from private CEOs.
This problem affects all of us in the form of reduced innovation because of less R&D spending and lower returns in our retirement accounts. It hurts communities when corporate money is spent on financial tricks instead of investment in growth. It is, however, a solvable problem. We must get rid of the tax advantages for multimillion-dollar bonuses. Real compensation (what CEOs actually are paid from bonuses and stock options) should be taxed in the same way we tax payroll for average workers. Public company executives should be compensated in more restricted stock; making it more difficult for them to sell their shares would encourage longer-term thinking. We can help them use their ingenuity to maximize innovation instead of a paycheck.
The past several decades in the history of municipal law have seen an ever-tightening noose settle over the neck of housing growth. We are in the midst of a crisis of our own making. The cost of living in areas with high levels of opportunity has skyrocketed, which has made those opportunities unattainable to those outside of the elite. The supply of housing per person is dangerously low in these opportunity zones. With insufficient supply available, prices have nowhere to go but up. Restrictive zoning needs to be scaled back across bot the East and the West coasts in particular or this pain will just keep growing for middle class families.
Before we go further, though, it may be helpful to take a look at how we got here. The conclusion of World War II coincided with an economic boom in the US as GIs returned home from the war. The boom echoed into families as the returning heroes got to work making the next generation. With the explosion in families came an explosion in housing as these people all needed somewhere to live. Government programs to encourage home ownership were erected because it was believed that owning homes would make for better, more engaged, citizens. As a result, an unusually large portion of American savings is in their homes and people owning homes has motivated them to protect their investment by preventing supply shocks in the form of developments.
Although this is likely where much of the anti-development sentiment started, you will not hear those arguments in community meetings or letters to the editor that vociferously protest the very idea of progress. The word affordability gets bandied about rather frequently and many apply it to both rent and property taxes. Rather than accept the idea that more supply is needed to satisfy growing demand for housing, they argue that rent control should be used to combat rising prices. Another frequent protest is that of development changing the ‘character’ of a neighborhood, especially as it brings more traffic. Straining infrastructure and changing environment creates tension between the old and the new.
The truth of the matter is that places inevitably change because people change and populations change. Neighborhoods are not static, nor should they be. Communities evolve over time and the needs of those communities change with them over time. The real driver of the antipathy to development is not a change in character, though. As with so many things, it is about money. More opportunity in or near a community brings more people that want to live there, which in turn drives up prices for housing. Developers and real estate investors see that and try to build more housing, which, if done quickly enough, relieves pricing pressures. The thing that scares current members of the community is often that the segment investors frequently seek to fill first is the high end. Margins are always higher at the top end of the market, so investors will first compete there. What most people don’t see, because it is not immediately obvious, is that dense developments with high rent built nearby relieve the pricing pressures on less expensive housing. Without those additional developments, high-income residents would instead choose to live in the next available option, which middle-income residents would otherwise be occupying. Middle-income residents occupy the next lower rung of housing and so on down the line until the most disadvantaged residents are pushed out completely or even become homeless.
Meanwhile, rent control only benefits those lucky enough to receive an affordable housing unit and does nothing to abate the underlying problem. The number of people that want to live in a rent-controlled community at the price set by rent control is larger than the number of available units by definition; if it was not, the market would clear at that price or lower. Instead of creating a place where everyone who wants to live there can, you are forcing everyone to participate in a lottery where the prize is affordable housing and all the losers have to live somewhere else. Additionally, rent control disincentivizes all housing improvements within units. As long as the unit is livable, the landlord will be getting the same rent regardless of how nice it is.
In much the same way, an inescapable result for a community of growing desirability is rising land values. This is the one aspect of gentrification (the change in a community from lower income to higher income) that is not helped, and in fact may be exacerbated, by increasing density and development. Oftentimes, this means higher property taxes for long-time residents and legacy commercial properties. The casualty of a better neighborhood for everyone is an old way of life for long-time residents. The upside is that if property taxes are reflective of the underlying value of the property and those property taxes have risen so high as to become unaffordable for long-time owners, they will have made enough from the appreciation of their investment in their home or business that they will have done very well for themselves. Sales of those properties will net life-changing amounts of money. Perhaps they will have to reside in a smaller unit, but with higher density comes more amenities, which will hopefully help cushion the blow. The community, meanwhile, benefits from a more efficient use of a scarce resource (land) and housing stays more affordable for everyone.
This does not call for a completely unregulated market either, though. The market is not infallible; sometimes incentives are not aligned with societal goals. For example, public amenities that may benefit a community than private ownership and development suffer from the ‘free rider’ problem (This is when many benefit from something, but they can still use it even if they do not pay for it.) Parks and public transit improve quality of life and make it easier for diverse, mixed income communities to live happily even in extreme density. Without an over-arching plan, cities may sprawl or construction bubbles can create homogenous concrete jungles separated only by parking lots. Green space and robust infrastructure, by contrast, create livable communities with proven lower levels of stress that are set up for equitable growth.
Sometimes this approach is not politically feasible on its own, though. Resident owners who are firmly entrenched and able to bring community support to bear may have the power to prevent further development and fortify their own presence. In those situations, it may be best to set ceilings on growth for property taxes on elderly and long-time community members to ease the transition to progress. Other times, developers may need some encouragement to include middle-income residents in their long-term plans instead of just building luxury condo building after luxury condo building. In such a scenario, it may be a game of chicken to see who can last the longest before conceding that they have overbuilt at the high end and need to offer lower rents. Assessing value based on asked-for rent rather than actual income could cure this problem very quickly; nobody wants to pay enormous amounts of taxes on empty units that are asking too much for rent.
I will conclude by saying that every community is different and each must be approached in its own way. New York struggles with development because of overuse of landmarking while the Bay Area has a thicket of zoning regulation so tight you need a machete to build a mailbox; development of large-scale housing projects is all but impossible.
Perhaps the best illustration would be to give concrete examples of success and failure of housing markets. For the example of a failure, let’s look at the Bay Area. After enormous economic growth came in the form of the tech sector, people came in droves looking for good jobs. As the population swelled, the housing stock began to creak under its weight and real estate investors came to build. People who already lived there balked at rising property taxes and insufficient infrastructure, so instead of building better infrastructure and increasing density they started shutting out the possibility of development and put a moratorium on raising property taxes based on value. Now, the Bay Area suffers from the most unaffordable (using as a barometer the cost of housing as a percentage of median income) housing market in the country despite having some of the highest incomes. Service industry workers up through middle income folks like teachers are forced to make astronomically long commutes to work. Even highly paid workers must dedicate a significant portion of their income to housing. Contrast that with Chicago, a city that has more parks, better public transportation, and a larger population. Despite its much higher density, Chicago has some of the most affordable housing in the country. What gives? Chicago’s zoning has historically been fairly liberal (although we must be careful as we have seen some down-zoning recently), which has kept supply sufficient for demand. Units have also been upgraded frequently to compete in a crowded market. If coastal cities were able to learn from this, opportunities could be more widespread, the economy would be more dynamic, and income would naturally become less unevenly distributed.
Four years ago, I wrote about how the pessimism inherent in the brands of populism bandied about by both Donald Trump and Bernie Sanders carried a lot of similarity and that they both misunderstood market mechanisms (albeit in distinctly different ways). In the same essay, I mentioned that sustained expansion would finally be reaching lower-income residents and lamented the risk of that growth misinforming a generation on the effectiveness of populist policies. Four years later, we are looking at a similar election with those exact same candidates leading arguments of which type of populism is best with both of them at the forefront of the political conversation. The only difference is a further minimization of the pragmatic voice and a level of divisiveness not seen since the era of civil rights legislation and the war in Vietnam.
The cherry on top of this distasteful cake is a loss of trust in both institutions and formerly unimpeachable sources of information. Fears of bias in the media abound and there is no shortage of those willing to play off of the emotions of their consumers to generate a few extra clicks. At the heart of it is the perfectly understandable belief that the people setting the rules of the game are looking out for themselves instead of normal people – the bulk of their constituents.
Many feel they do not have a fair shot at succeeding – at breaking out of their economic class – while big corporations are given every possible advantage. Others complain of the expenses of healthcare and housing or paying down student debt. Meanwhile, growth has been anemic for more than a decade. Unexpected extreme weather events are cropping up more frequently because of climate change. Problems are diverse and proposed solutions so disparate that keeping track has become much too time-consuming for the average person to maintain.
So, who broke American capitalism? Part of the answer is that it is not as broken as most believe and most of the problems are fixable. Food costs have dropped precipitously while quality has improved. Consumer goods such as clothing, shoes, electronics, and appliances are cheaper, more accessible, and more user friendly. Information has fallen to a cost of nearly zero (if you know where to look). Even healthcare, much-maligned, has improved average (big emphasis on average) health outcomes if you control for accidental deaths, gun violence, and the opioid epidemic. Finally, carbon density per unit of GDP has been falling for decades, giving some hope to environmentalists.
What, then, of the malfunctioning bits? How did the economy break? The answer is staring us in the face. We all broke it. We broke it by legislating for special interests (that includes our own), we broke it by trying to increase the lifespan of companies that provided a couple jobs at great expense to the government and the environment, and, worst of all, we broke it by letting big corporations set their own rules in ways that prevented the little guys from gaining a foothold. Halfway solutions and misunderstanding the problems have harmed far more than they have helped. Meanwhile, some with access have manipulated the system to gain unfair advantage, to extract wealth, or even to box others out so they might maintain a semblance of the past.
To better explain the situation as I understand it and my prescription for each ailment, I will be writing a series on this. Look out for more over the coming weeks and subscribe to my newsletter by clicking here to make sure you don’t miss anything.
With a long, exhausting journey already behind them, Odysseus and crew faced a horrifying new prospect. To get home, they had to sail through a two-pronged obstacle. Straight ahead was a whirlpool that swallowed all who approached while the safe portion of the sea near the shore held cliffs with a six-headed monster occupying the summit. The monster was a hydra called Scylla and the whirlpool was called Charybdis. Odysseus knew two things: if he sailed into Charybdis, there was a near certainty of death for everyone aboard and hugging the coast ensured the death of six, who would be swallowed by Scylla. Understanding the reality of the situation he faced, Odysseus elected the certain death of six over the likely death of all. It’s a story you are familiar with if you have read The Odyssey and it still holds lessons for today. It is, in fact, a perfect allegory to the climate issue.
Emotional appeals from the ends of the spectrum on the left and the right are creating squabbles while the ship is headed for Charybdis. The US is uniquely positioned to lead – to steer the ship to Scylla and a necessary sacrifice to accomplish a sustainable future. Climate change deniers will oppose any action while moderates will be repulsed by anything that causes undue hardship. Since we live in a world populated by people of disparate interests, we must use that information when developing solutions.
Real repercussions of proposed cutbacks need to be understood before we can earnestly talk about them. Sacrifices demanded will likely prove unacceptable. The best we can do is accept the situation and foster innovation that may improve it. By acknowledging where we are, we can map our way forward rather than blindly stumbling through.
To illustrate the scope of the problem and what we need to cut, it helps to know what cutbacks would need to look like were we to make them all right now. Agriculture would need to change and meat consumption would need to be cut back, but that entire industry makes up only 11% of overall emissions and a drastic change in diet will still not completely eliminate it. Electricity and heat account for the largest portion (33%) of global emissions, which would require significantly more adjustment in everyone’s life for any measurable progress – and that’s before accounting for the fact that we would have to permanently mire those in lower-income countries in poverty. Transportation makes up 15%; we’d need to completely rebuild our infrastructure. Even if everyone switched to electric, we would need to ensure powerplants were eco-friendly. What all of this would constitute is a massive increase in costs which in turn would be passed on to consumers. In layman’s terms, everyone would have to cut back on consumption and accept a lower standard of living. These hardships would disproportionately fall on the poor (who consume nearly all of their income). Sound good? It also reduces competitiveness of American firms, so it would mean further contractions in the manufacturing industry while countries like China with less restrictive policies rush to fill the void. Now we would have exacerbated the problem. Extreme protectionism is the only way to guarantee we aren’t creating those emissions. Now what? The only possible measure that would reverse such movement would be war. Many (most) countries won’t be voluntarily cutting back on a scale anywhere near that which is required, so some show of force would need to come into play. Now we have some serious loss of life on our hands. Even if they did agree to those cutbacks, many emerging markets would be starving their citizenry. But wait, there’s more! Per unit of GDP, Western countries emit at far lower rates than undeveloped nations in Africa, Asia, or South America. Without forcefully preventing their development, our cutbacks would lead to larger emerging market emissions and larger overall emissions. Many of those countries are still investing heavily in coal power. We could continue to pull at threads, but the point is that the situation is more multifaceted than those like Greta Thunberg would like to admit.
Despite this daunting complexity, there is some reason for optimism if (and this is no small thing) we can understand that no actor – democratic nation or autocratic ruler – will accept those sacrifices. With a framework for pragmatic thought, we can propose solutions that, while not perfect, will vastly improve our situation. The first point is ensuring there is some cost to carbon, regardless from whence it comes. The second is investing in infrastructure that eases the transition from greenhouse gas emitting energy and industry. Perhaps most important, though, for a project of such scale, is leveraging federal dollars into local concessions building on climate-friendly policy.
Pricing carbon can be done in one of two ways: a carbon tax, whereby the government sets a price for carbon emissions and those who emit are then taxed at that price, and a cap-and-trade system whereby the government sets the acceptable amount of carbon emissions, auctions off licenses to emit, and allows those licenses to be traded freely, so the market sets the price of carbon. While carbon taxation does disincentivize emissions, price is most effective as a tool for setting a value on scarce resources when dictated by market forces. Cap-and-trade allows us to dictate how much we are willing to emit and then allows the market to dictate how valuable the ability to emit is under that constraint. That number could be tightened over time in well-telegraphed ways which allows firms to invest and adjust. Carbon capture could be easily captured in this system as captured, metered emissions could then be sold as licenses to firms that wished to emit more (notably, this would not have to be localized to where the emissions took place). Expanding on that a little bit, we would essentially be saying that we do not care how emissions are brought down to a given level, only that it happens. The market would then dictate the best, most efficient way to reduce those emissions. If that means windmills and electric cars, great! If it means coal-fired power paying for some new carbon capture technology, that’s ok, too (author’s note: it probably won’t be coal). This doesn’t come without caveats: most obviously, we would have to closely monitor emissions to prevent cheating and monitoring can be costly.
Key to the overall effectiveness of any carbon pricing scheme, though, is including importers in it. If American producers must account for carbon emissions while their Chinese counterparts are free to emit as much as they wish, this will simply reduce American competitiveness. Both production emissions and shipping emissions must be accounted for. Measuring all this is, again, quite the undertaking and ensuring compliance is infinitely more difficult when outside of US borders. However, the US is uniquely positioned among all nations as the world’s largest consumer market.
With the implementation of a powerful new market structure, America could set a path for global shifts that would incomprehensible for anyone else. As the world’s largest consumer market, we are in a position of unparalleled leverage in that exporters across the world must cater to American peculiarities. After restrictions on emissions for all goods begin to incentivize investment in renewable energy sources, companies that make those investments will likely start by exclusively sending those products to the US. However, renewable energy has reached a critical point in that it is now cheaper over a long enough time horizon. This will, in turn, help companies abroad who have invested in renewable energy and production to outcompete their dirtier rivals. We can help this process along by using foreign aid and tax incentivizing foreign direct investment (private investment from the US abroad) in clean power. A clean power fund in conjunction with a carbon pricing scheme would both project soft power and strengthen the American institutional brand while cutting global emissions.
The catch is that this effectively serves as a potentially large new tax on American consumption. While regressive in that the lower-income population uses a much large portion of their income on consumption, it is progressive in that the wealthy tend to lead far more carbon-intensive lifestyles. Also problematic is the restriction on economic growth inherent in consumption taxes. To compensate for lost demand, we could implement stimulative measures such as investment in new infrastructure, green retooling of old infrastructure, and direct cash transfers (particularly important for the well-being of the poor who are impacted by carbon pricing). Ideally, sufficient funds could be raised to pay for the changes in infrastructure we would need to accommodate greener technology. Additionally, some of the capital could be allocated into a sovereign wealth fund focused on technology and green infrastructure functioning much like a venture capital fund.
Further, federal money flowing into states could be made contingent on approval for infrastructure projects and denser housing. NIMBYism enriches property owners while increasing carbon footprints and harming lower income families. A progressive plan without addressing that problem would be inherently regressive. Forcing sprawl via restrictive zoning adds to emissions from the automotive sector while increasing both time and cost for transportation and ballooning housing costs. It makes up a significant portion of the budget for lower income families in particular as they dedicate a larger portion of their incomes to necessities. Additionally, raising carbon prices will hit them even harder if we do not also push municipalities to be more liberal in their zoning, allowing people to live closer to where they work and giving them better access to public transportation. As a side benefit, more people will be able to access urban amenities their tax dollars are helping to fund.
Bringing it back to our opening story, a comprehensive cap-and-trade system in conjunction with public investment has the potential to completely change the global economic landscape, but it does not completely halt climate change. Much like Odysseus, we will have to make hard choices. A price for carbon comes from making it a scarce resource, and competition for that resource will spark a new wave of innovation. All of human history is a progression of doing more with less. It’s time to unleash that ingenuity.
I’ll leave you with this slightly more optimistic graph:
One question that is reverberating across the 2020 election cycle is of how to stimulate investment in today’s extended low-growth economic cycle. The answers given are a panoply of over-complicated prescriptions ranging from forcing large corporations to include labor representation on their boards to, incredibly, carrying out a trade war. The correct answer, however, is much simpler: we must increase consumer demand. A variety of tools exist to tackle the problem of underwhelming demand, but we’ll focus on two: one domestic and one international. Domestically, we must increase working class income and the number of people in the middle class. Internationally, we can drastically raise foreign investment and aid.
Demand is the engine of the car that drives the economy. Without some certainty of demand for a product, no business or entrepreneur will invest in producing it and capacity will go unutilized. Labor will go unspent. Laborers, in turn, lacking steady income, do not spend. No amount of cajoling or provision of cheap capital (ie low interest rates) is going to change that. In our car analogy, we can compare cheap money to fuel. Without enough of it, we aren’t going anywhere, but without a working engine that fuel is useless. Our current situation, globally, is of enormous tanks of gasoline standing ready for a little Vespa engine. We need to think about ways to add some cylinders.
With a slightly better grasp of the ailment, we can start to see how some popular prescriptions are a bit like giving a cancer patient some opioids. We may feel a bit better, but we’ve done nothing to fix the underlying issue. Lower interest rates, in spite of what the Cheeto-in-Chief may believe, can only weakly stimulate demand through the wealth effect (e.g. stocks go up, you feel richer and thus spend a bit more). A trade war, meanwhile, dramatically raises uncertainty, lowering both availability of supply and existence of demand. Even upon a full capitulation from all opponents, effects on demand would be modest at best and dependent on the dubious hypothesis that Chinese consumers would suddenly start consuming more, which would require a redistribution of income from the government and the wealthy to the poor and middle class. This is because those in lower income brackets spend more as a portion of their income. Meanwhile, proposals on regulation for employment create disincentives for hiring, so regardless of the effects on those who retain their jobs, people are worse off in aggregate.
A domestic policy with shorter odds for actually sparking rapid growth, then, would go directly at the timid consumer spending.growth. Specifically, it must put money directly into the hands of working class citizens. Andrew Yang’s “Freedom Dividend” would accomplish that, but so would spending money on labor-intensive projects. When creating such projects, if it creates an asset of greater value than its cost, debt can even be offset. Finding productive investment in an environment awash in cheap capital could be difficult, but our roads and bridges are badly in need of maintenance and we lack any of the high-speed rails prevalently connecting European and Asian cities.
Additionally, domestic demand can be stimulated with more domestic workers. As the average American gets older, productivity gains will become more difficult to come by. We can offset that by importing more skilled workers, which also provides an immediate boost to demand via a greater population.
Demand, however, does not merely exist domestically for products manufactured here. In the same way American demand benefits other nations, boosting international demand benefits the US. Drawing any comparison to the Marshall plan that followed World War II is problematic as Europe had the skilled workers and simply lacked the capital to rebuild. While, like then, we could accomplish numerous foreign policy objectives, the human capital simply does not exist in many of the places where US dollars could be effectively deployed. Nor do robust institutions preventing misuse of that capital. Many Latin American countries in particular would benefit from an injection of dollar assets, but many are notably corrupt and few have high levels of skilled labor. A program of investment would have to be tightly managed while including the sorts of jobs by which people could learn new skills in addition to the qualification to the qualification that it be productive. Buying foreign assets with dollars has the supplemental boon of of strengthening foreign currencies relative to the dollar which makes American exports that much more competitive.
At the same time, there are two major economies with consistently and abnormally high exports: China and Germany. China’s surplus comes from excessive governmental capital investment, which, through some rather opaque use of financing, encourages extreme inequality and reduces consumption as a portion of GDP. The German problem comes from the combination a government-negotiated agreement between the unions and the industrialists that capped pay while nearly guaranteeing continued employment and an artificially weak currency in the Euro relative to the other countries in the currency bloc. In a mechanism beyond the scope of this essay, both instances act as regressive transfers of wealth which then raises “savings rates” and encourages exports of capital. Since capital accounts and current accounts must balance, this means they both have enormous deficits of demand and thus place a strain on aggregate global demand. Both of them would greatly stimulate the global economy by simply redistributing wealth downward. While there is nothing the US can do to directly force this action, encouraging it via collaborative negotiation is well within the realm of possibility, especially in the shadow of an increased role for foreign aid.
Note: this is the lowest in the world by a wide margin. Consumption in the US, for example, stands at around 65% of GDP, which is typical of a healthy economy.
Demand, then, is the engine for economic growth. Building it is a process that simply takes a little bit of redistribution. At the end of the day, there is no commerce without the customer. Broadening that base can only help not only the poor, but businesses everywhere.
Overzealous protection of consumers’ safety coupled with robust patent protection has created a mechanism whereby large pharmaceutical companies can rapaciously raise prices without any fear of competition. It’s easy to blame the greed of the drug companies. They are, after all, the ones profiting from the situation. What do we know of human nature, though? If it’s possible to profit from a loophole or by gaming the system, someone will do it. So, how DO they do it?
Upon successful application for a patent and FDA approval, a company has 20 years of government-mandated monopoly in the form of a utility patent. In today’s age of invention, 20 years may appear to be an absurd amount of time. It gets worse, though. While generics can, in normal circumstances, gain FDA approval relatively easily after a patent expires, they cannot do so if a NEW patent has been filed on that drug with an improvement, however marginal. In layman’s terms this means that an owner of a patent can extend the patents on their drugs by making superficial improvements every 20 years. I don’t know about you, but I’d rather have access to a slightly less effective drug at a fraction of the price than continue to line the pockets of patent trolls. Additionally, the existence of a cheaper option puts pricing pressure on the name-brand drug and makes it more difficult for them to raise prices.
Unfortunately, that STILL isn’t the end of the story. Generics have an avenue to fast FDA approval, but biosimilars must go through a far more vigorous and expensive approval process. It even includes the necessity of expensive clinical trials. Why? The primary difference between generics and biosimilars is the size of their protein molecules. While this may render proving identical properties more difficult, it by no means necessitates the rigor with which it is treated. In fact, we are alone in the world in doing so. Cheap biosimilars for insulin exist everywhere but here for precisely that reason. Just for emphasis, I’ll say that another way: people all over the world are having their lives saved by drugs the FDA is not approving. Obviously we do not want dangerous or ineffective drugs on the market, but we have crossed the line from protection to prevention of access to affordable and beneficial care. The costs of waiting must be weighed against the benefits of a slightly lower chance of a harmful drug being used to treat patients. As competition enters the market, costs are immediately driven down and consumers benefit. What, then, should we do?
Any action is going to have consequences, both positive and negative. We can safely assume, though, that our system as it exists is too protective of pharmaceutical companies and their patents. Drug costs will plummet with the possible economic cost being that of lower investment in research and development in novel drugs may decline upon reduction of the length of patent protection. Additionally, we need to minimize costs to obtaining FDA approval and fast-track drugs already approved by similar agencies and Europe and/or Canada. We have a long way to go towards improving our healthcare system, but these actions would be a welcome beginning.
There’s an easy way to fix the student debt crisis, and it’s not “cancel all student debt.” The answer may come as a surprise because for many people it sounds like a dirty word. Bankruptcy! While it certainly sounds nice to just wave a magic wand and make the big pile of debt go away , it amounts to a regressive transfer. Robin Hood is stealing from everyone to give to the upper middle class. College graduates make nearly double what high school graduates make. It should be noted that this is ON AVERAGE, though (bear with me and we’ll get to the juicy bits soon enough). To illustrate the fact, we can see median wages with and without a bachelor’s degree:
And median wages overall:
Ok, so the median college graduate is better off than the median high school graduate. What about the people that got screwed over by a low-quality degree, a high-interest loan, or found out their incomes weren’t as high as they had expected when they graduated and are left with a mountain of debt that they simply cannot cover? It turns out we used to have a way of helping people out with too much student loan debt. In fact, it still exists for all other kinds of debt. Bankruptcy is an American institution. It has ominous connotations, but it was created to help people who bit off more than they could chew. It was meant to give risk-takers the chance for a fresh start. It’s certainly preferable to debtor’s prison. Perhaps some people groaning under the weight of their student debt feel like they ARE in a form of debtor’s prison.
Bankruptcy takes many forms in the codex of American law, but personal bankruptcy has two options: Chapter 7 and Chapter 13. If you’re light on assets and heavy on debt, Chapter 7 is probably the best solution. Your assets get liquidated and your debt is discharged. The whole process takes a matter of months (although your credit score will get dinged pretty badly and it will take a long time to bring it back up). If you have enough stuff to make that sound bad but you are light on liquid assets, Chapter 13 is perfect for you. Your debt gets re-organized into manageable payments and you can generally get yourself out of debt within 5 or so years and you get to hold onto your assets. It sounds perfect for a cohort of people that took out big loans and find themselves in a bigger hole than they would have liked, right?
Student loans used to be covered under bankruptcy law just like all other forms of debt. Why can’t we use it now? In 1976, this was changed to combat any abuse arising from conflicts of interest on the parts of the students. They sought to correct for the possibility of abuse by a recent graduate that, just having received their extremely valuable diploma but still asset-poor, decides to declare bankruptcy. Being asset-poor, they could declare Chapter 7 bankruptcy knowing that their debt would be discharged despite the fact that they would be receiving high incomes after graduation. Voila! Free College!
Anyway, back to the change in the law passed in 1976; Congress passed a law requiring 5 years of repayment of your student loans before you were allowed to discharge them in bankruptcy (in other words, wipe the slate clean). A subsequent law passed in 1998 required 7 years of repayment and, finally, the nail in the student-loan-bankruptcy coffin was passed in 2005 disallowing it in nearly all situations. Just how difficult is it, you may ask, to gain bankruptcy protection from your student loans? The name of the required court proceeding should be answer enough (it’s called an adversarial proceeding), but in the off chance you are still curious, prepare yourself. You must meet ALL THREE of the following criteria:
Student debt would keep you from maintaining a barebones standard of living defined by a demonstration of minimal expenses AND attempts to increase your income in any way possible.
Additional circumstances must make it likely that these conditions will persist for a significant portion of the duration of your loan. Qualifying criteria include physical or mental disability and a demonstrated maximization of your income potential in your chosen field.
You must have made “good faith” efforts to repay the loans by making payments, attempting negotiation of a plan, slashing expenses, increasing income, etc.
The odds that a person who does not possess the ability to pay their student loans has the resources required to battle through such a foreboding gambit are infinitesimally small. It’s a disastrous policy that threw the baby (the future of the American college-educated populace) out with the bathwater. Notice something in the chart below? Student debt ramps up into a much larger portion of consumer debt shortly after the passing of that 2005 law. The effect is kicking some of our most vulnerable citizens when they are down.
Here’s the good news: federal loans have a few options for restructuring student debt. Without delving too deeply, their purpose is to help people with a low-income whittle their payments down to 10% of their discretionary income. They are called IBR, ICR, PAYE, and REPAYE, and they all do pretty similar things, but you should do more of your own research before doing anything with them. Regardless, forgiving all federally owned student loan debt would have the effect of adding approximately 7% (a little over $900 million) to net federal debt (financial assets less liabilities), which stands at around $13.5 trillion. Utilization of bankruptcy law is a far better solution in conjunction with programs like those detailed in this paragraph.
Unfortunately, this does not apply to private loans. Private loans often have higher interest rates and are often held by those with lower quality degrees. There is no recompense for someone who is struggling under private loans and, perhaps as a result, lenders have been lax about standards for student loans. Likelihood of repayment has not been taken into account and high school students are ill-equipped to understand the risks they are taking when they apply for these loans. A return of bankruptcy protection for students would force lenders to be more careful when evaluating what the loans are being used for. Students may find it a bit harder to get one of those loans, but this is because they would not be able to take on excessive debt for low-quality degrees. Alternatives exist (MOOCs, community colleges, and trade schools to name a few) that cost less and might be more practical.
The solution to the student loan distortion in the market is to fix the market. The US has the best colleges in the world and our competitive model is a big reason why. Instead of throwing the baby out with the bathwater (again), we should tweak the system to reward the right behavior and punish irresponsible behavior. Let’s bring back bankruptcy. It’s the radically pragmatic thing to do.
Imagine you are the captain of an old ship. we’re talking about a sailing vessel the like of which you saw on Pirates of the Caribbean. This thing is massive (by the standards of the day). Your ship has multiple masts and all manner of sails, each of which has a different function. You need a large crew to operate it. Everyone fills a specific role and ensures you glide across the water in the direction you want to go.
Now, let’s scale it down. Your Black Pearl (that’s a big pirate ship on the movie for those of you who haven’t seen the film) is now the size of a kayak, but you still have the same set of sails and masts (albeit miniaturized versions). Can you still operate it? What if you come across choppy waters? You can’t fit much of a crew on that boat, so now just a couple people need to fill all of those roles while navigating and staying afloat.
Your rigging (masts and sails) is the system of rules, regulations, bureaucracy, and infrastructure in place for a given line of business in this metaphor. Every time we add regulation, we add more rigging, making it harder for startups and small businesses (the kayaks) to compete with bigger, established crews…ahem…businesses. Sometimes this is helpful. After all, a simple set of sails are simpler to operate and help move you forward. Sometimes this is necessary. We don’t want anyone dumping toxic waste in our drinking water. In many cases, however, we are adding unnecessary complexity while failing to accomplish what we would like.
By making it harder for small businesses or new entrants to compete, we limit competition and choke off potential areas of innovation and growth. Remember our kayaker? He sunk as soon as he encountered his first small swell in the water because he couldn’t figure out how to work his rigging (comply with complex regulations). A complicated system of regulations and bureaucracy also closes opportunities for all US citizens while benefiting incumbents with deep pockets and a large organization over which to distribute costs. This, in turn, encourages consolidation. If the benefits outweigh the costs, the regulations are straightforward, and there is a negative externality or a natural distortion in the market to be corrected, this is OK! Still, all first order and follow-on effects must be considered when contemplating the implementation of new rules and regulations.
From the late 18th century to the mid 19th century, Britain sent convicts to Australia. You probably knew that. What may come as a surprise is that after the initial voyage made its way across the world with a 5% mortality rate, that rose to a horrifying peak of 40% before falling back down to 2% and eventually all the way down to 1%. Why did this happen? Incentives! While the initial fleet was paid cost-plus (profit was guaranteed at some rate over costs incurred), the subsequently disastrous voyage was paid per prisoner that boarded in England. After public outcry, this was abandoned in favor of a method that paid for living arrivals. By paying for the desired outcome, they kept costs down while incurring the lowest mortality rate.
To summarize, a cost-plus method provided acceptable outcomes expensively, rewarding the wrong thing provided a terrible outcome cheaply, and rewarding the desired outcome provided the best outcome cheaply (especially if measured by cost per healthy arrival). In other words, you get what you pay for even if what you pay for is not what you want.
This lesson can be applied to a whole host of problems today, but I’d like to focus on education. We want highly skilled citizens with the ability to tackle the complex 21st century economy, but what we pay for is for people to board the boat (go to college). As a result, the cost of post-secondary education has skyrocketed and we have legions of college graduates who have expensive degrees they are unable to use. Nearly half of bellhops have 4-year degrees.
Partial subsidies have caused spiraling costs, so we can safely assume fully covering college tuition will cause another explosion in the inflation of educational costs. Variance in quality will also likely expand with fewer incentives for colleges to compete. Useless degrees will propagate. How, then can we design the right incentives?
We need to reward the outcome we want. Measuring skills acquired is difficult, but we do not actually need to do that. We can let the market measure the value of an education with the salary they pay new graduates of colleges and vocational training programs. A portion of the income tax collected from a graduate can go to the institution that provided the education over a period of 5-10 years. The market created by this policy will automatically sort students into high-value degrees and post-secondary educators will be incentivized to help their students find financially rewarding careers.
At this point you may be asking, “What about pre-existing inequality?! Won’t people from lower-income families be discriminated against?” You’d be right, too. That’s why we would have to adjust the portion of post-graduate income tax based on parental income to reflect the different expected outcomes the students have before they start their education. There is plenty of data available to design an equation that negates this effect by sliding the percentage of income tax going to the educational institution (e.g. maybe a fifth of the income tax collected from a student from a family in the top 10% goes to the school for the first 10 years and four fifths from a student in an income bracket from the bottom 10% goes to the school). With more widely available education and a market optimizing for educational outcomes, we can put America on the path to a stronger and more equal future. This is an investment that will more than pay for itself and it will create happier, better educated citizens. It’s imperative we use the right set of incentives to get there.
