In Eric Falkenstein’s post on the “bad trades” being made by the federal government there are too paragraphs I think deserve some reflection:
Our economy has many such bad trades going on at any one time, and the sooner these are abandoned, the quicker people will reallocate their time towards something that actually costs less than its revenue. Consider guarantees to farmers, which supposedly allow farmers to withstand the vagaries of weather, ensuring our very survival. We have policies that encourage producer cartels, direct payments via subsidies, paying farmers to not farm, disaster aid, insurance subsidies, and export subsidies and import tariffs. So now farmers who suffered from the recent drought directly get fully insured payments, and those who avoided it get the revenue from higher prices. This isn’t helping us become more efficient farmers.
Then we have clean energy, education, defense, high-speed rail, all costly investments that potentially will pay off big eventually, but in practice are subverted by special interests into a focus on producers not consumers. If the negative present value were revealed via the negative cash flow at market prices, an efficient response would be to reallocate capital and labor. Instead, these activities are propped up under the hope that mere time will allow some sort of critical take-off point in future productivity.
There are a couple of points I’d like to make about this. First, I think it’s important to distinguish between upside gain and downside risk. There are, essentially, three different strategies: you can maximize upside gain, you can minimize downside risk, or you can attempt to strike a dynamic optimal equilibrium between the two. Although the Congress is by its very structure pretty well situated for seeking that equilibrium over the period of the last, say, century it has increasingly devoted itself to minimizing downside risk. Why do we spend as much on defense and security as we do? The Congress increases defense spending to insulate itself against criticism for failure to act in the case of an attack. Why do we regulate banks at all? So that Congress has an answer when irate voters complain about bank failures.
Private and public corporations are mostly in the business of maximizing upside gain. There are exceptions. For example, preserving market share may not actually maximize your profits but it does prevent upstarts from upsetting your apple cart. Nearly every industry with which I’m familiar has an industry leader that gets to set the terms for the entire industry—functionality and durability of products, prices, etc. That’s a position that’s worth preserving.
There are, essentially, three different strategies: you can maximize upside gain, you can minimize downside risk, or you can attempt to strike a dynamic optimal equilibrium between the two.
Actually, you’ve missed what every active (read: PE) investor looks for. An asymmetrical risk profile. That is, relatively low potential of loss, but latent opportunities to actively create upside by laying your hands on the business.
I know the setting I cite is business, not Congress, but think about policy options that might be the analogue to what an investor does.
“Public and private corps are in the business of maximizing etc.”
I think you are largely correct in the public sector. But in the private sector this is just flat damned wrong. What have I been saying for years now? Private companies, which really means closely held companies, often pull their horns in and do not maxomize for any number of risk tolerance, capital availability or managerial capability reasons. And on risk tolerance, that currently has a very large political, tax uncertainty and regulatory component. It unfortunately is our current reality.
Good contributions, Drew. Thanks.
The sad thing is that in much of what government does not only have we reached the point of declining returns to scale, we’ve reached the point of negative returns on incremental spending.
If you look at spending at all levels of government, 44% of all spending is on healthcare, education, or the military. I think we’re actually seeing declining productivity with additional spending in all of them.
I think that’s also true with infrastructure spending (“infrastructure” defined as roads and bridges) but it’s a lot harder to prove.
All I was really saying is beware the textbook explanation. It’s not really just a teeter totter.
As for this:
“If you look at spending at all levels of government, 44% of all spending is on healthcare, education, or the military. I think we’re actually seeing declining productivity with additional spending in all of them.”
Aye, laddie. Which is why I’m less pessimistic than you and others that a President Romney could make a difference. I see Doug has a post mind reading Romneys intent to spend more on the military. Haven’t read it, but if I was he, I’d be careful. Romney is a PE man, and can, in private quarters, be a ruthless analyst of junk spending vs productive spending. Same on the other two fronts. I have been slaughtered over at OTB for suggesting that these are areas where productive spending can be differentiated, wheat vs chaff if you will, from just pouring money at an issue or problem. Again, Romney knows dollars are dear. The key will be the politics of the case and the legislative battle but he won’t pander like an Obama. He’s a finance man, and a principled one. Steely eyes: “Show me the analysis. Do you understand we are going broke??? Why do we need to spend these dollars????”.
“I think that’s also true with infrastructure spending (“infrastructure†defined as roads and bridges) but it’s a lot harder to prove.”
Ah, yes, the holy grail. Gotta have those roads, you know. And thats what made America great, you know. Balls. Yes, we need a competent infrastructure. But those who cite this legitimate function of government always must reach deep, deep into their pockets for 60-70 years ago. Pathetic. Let’s cut the crap. No high speed rail. Let’s streamline the administration of routine road maintenance and repair. (Read: cut the cronyism). And let’s actually give some thought as to how logistics really works today vs in 1950. In business, we’ve basically gone to Mars. In government, we practically still have a horse and buggy.