Tag Archives: Goldman Sachs

Chief Resiliency Officers Versus Antifragility

At The Atlantic CitiesEmily Badger writes about a new program from the Rockefeller Foundation called 100 Resilient Cities, focused on equipping cities with a new employee called a Chief Resiliency Officer. The program states its goals as follows:

Building resilience is about making people, communities and systems better prepared to withstand catastrophic events – both natural and manmade – and able to bounce back more quickly and emerge stronger from these shocks and stresses.

[. . .]

There are some core characteristics that all resilient systems share and demonstrate, both in good times and in times of stress:

  • Spare capacity, which ensures that there is a back-up or alternative available when a vital component of a system fails.
  • Flexibility, the ability to change, evolve, and adapt in the face of disaster.
  • Limited or “safe” failure, which prevents failures from rippling across systems.
  • Rapid rebound, the capacity to re-establish function and avoid long-term disruptions.
  • Constant learning, with robust feedback loops that sense and allow new solutions as conditions change.

In his book Antifragile: Things that Gain from DisorderNassim Taleb defines antifragile as something that not only recovers from shocks, but becomes stronger after recovery, in line with the stated objectives of 100 Resilient Cities. Following its Great Fire of 1871, Chicago demonstrated antifragility. It rebounded rapidly from a disaster that killed 300 people and left one-third of city residents homeless, many without insurance after the fire bankrupted local insurers or the blaze destroyed their paperwork. Despite this great loss, residents of Chicago quickly rebuilt their city using private funding and private charity that was small relative to the amount of damage, but without any government funding. In rebuilding, Chicago developed safer building techniques both through entrepreneurship and with new insurance requirements and  new municipal building codes. The city invested in a better-equipped fire fighting force to lower the risk of fire damage in the future. Despite not having the telecommunications that seem critical to allowing fast disaster recovery today, Chicagoans began building new, safer buildings immediately, investing $50 million in the year after the fire, and tripling the real estate value of the burned blocks within 10 years. Its difficult to imagine a twenty-first century city allowing property owners to move so quickly through the approval process, and its difficult to imagine a Chief Resiliency Officer widening this bottleneck.

A bureaucrat like a Chief Resiliency Officer would not be able to learn the lessons from a natural disaster that the residents of Chicago did in their rebuilding efforts because this knowledge is dispersed, only to be discovered by individuals acting in what they believe to be their own best interest. Taleb describes bureaucrats as fragilistas because they do not suffer from downside risks and therefore cannot learn and grow stronger from shocks. If a disaster strikes a city equipped with a Chief Resiliency Officer and it turns out the city was ill-prepared, he or she will not be held accountable for failing to predict what may have been a very low-probability event. In fact, we often see government efforts toward making cities more resilient introducing fragility contrary to their stated intentions. For example, federal flood insurance minimizes the downside risk of owning flood-prone property. In turn, this encourages more people to live in the highest risk areas, putting them at greater risk when disaster strikes. Cities will not have an opportunity to learn from this to better prepare for future flooding because their rebuilding is subsidized; however, bureaucrats cite this insurance as a success because it facilitates rebuilding without adapting to risk.

The Transportation Security Administration offers a preview of what bureaucratic disaster prevention looks like; top down planning for low-probability events results in attempts to prevent the catastrophic events that we’ve seen in the past without realizing that we’re unlikely to see these same events in the future. As TSA critic Bruce Schneier explains:

Taking off your shoes is next to useless. “It’s like saying, ‘Last time the terrorists wore red shirts, so now we’re going to ban red shirts,’” Schneier says. If the T.S.A. focuses on shoes, terrorists will put their explosives elsewhere. “Focusing on specific threats like shoe bombs or snow-globe bombs simply induces the bad guys to do something else. You end up spending a lot on the screening and you haven’t reduced the total threat.”

Likewise, preparing for low-probability natural disasters, such as 100-year storms, is not something that can be done from the top down. To the extent an event is foreseeable, some individuals and firms will prepare for it, as we saw with Goldman Sachs’ generator and sand bagging efforts in the aftermath of Hurricane Sandy. The disaster revealed successful preparation methods, allowing more individuals and the city as a whole to learn and be better prepared for the next disaster. Chief Resiliency Officers are unlikely to accurately foresee low-probability shocks to their cities. To the extent that they protect cities from these shocks, they will likely take away the learning process that would make cities better able to withstand larger shocks, introducing fragility instead of greater resiliency.

Can a reduction in government spending stimulate the economy?

This, of course, is quite relevant given the latest news. To help find the answer, I consulted my graduate macroeconomics text. There, on pp. 546-7, I found this passage:

[A] small reduction in current government purchases could signal large future reductions, and therefore cause consumption to rise by more than the fall in government purchases.

Surprisingly, these possibilities are more than just theoretical curiosities. Giavazzi and Pagano (1990) show that fiscal reform packages in Denmark and Ireland in the 1980s caused consumption booms, and they argue that effects operating through expectations were the reason. Similarly, Alesina and Perotti (1997) show that deficit reductions coming from cuts in government employment and transfers are much more likely to be maintained than reductions coming from tax increases, and that, consistent with the importance of expectations, the first type of deficit reduction is often expansionary while the second type usually is not.

I did my graduate work at George Mason, so you may be thinking that this is some free-market fundamental text. It is actually David Romer’s Advanced Macroeconomics (David, of course, is the husband of President Obama’s former CEA chair, Christina Romer).

Since Mr. Romer wrote the passage above (the second edition was published in 2000), the case for expansionary spending cuts has, if anything, strengthened. Consider this 2010 piece by Harvard’s Alberto Alesina. He finds:

[N]ot all fiscal adjustments cause recessions. Countries that have made spending adjustments to reduce their deficits have made large, credible, and decisive cuts. Even in the very short run, many reductions of budget deficits, even sharp ones, have been followed immediately by sustained growth rather than recessions.

Or consider this 2010 piece by David Henderson. It focuses on the Canadian experience of cutting spending in the 1990s. He writes:

Canada was able to escape from chronic deficits and trimmed its debt from nearly 70 percent of GDP to 29 percent of GDP, all without sacrificing growth.

What’s more, “There were six to seven dollars in budget cuts for every dollar of tax increases.”

Or consider another piece, also by Henderson, focusing on post-WWII spending cuts in the U.S. He writes:

In the four years from peak World War II spending in 1944 to 1948, the U.S. government cut spending by $72 billion—a 75-percent reduction. It brought federal spending down from a peak of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948.

The post-WWII U.S. economy is widely regarded to have been quite healthy. This, of course, confounded Keynesians like Paul Samuelson who had predicted that war demobilization would lead to the “greatest period of unemployment and industrial dislocation which any economy has ever faced.” (emphasis original)

Or try this 2010 piece by Goldman Sachs economists Ben Broadbent and Kevin Daly. They report:

In a review of every major fiscal correction in the OECD since 1975, we find that decisive budgetary adjustments that have focused on reducing government expenditure have (i) been successful in correcting fiscal imbalances; (ii) typically boosted growth; and (iii) resulted in significant bond and equity market outperformance. Tax-driven fiscal adjustments, by contrast, typically fail to correct fiscal imbalances and are damaging for growth.

In contrast, some people are pointing to a new IMF report that claims “fiscal consolidation typically reduces output and raises unemployment in the short term.” But as Alberto Alesina argues, the IMF findings are not all that different from his own. Critically, the IMF agrees that “tax increases are much worse for the economy than spending cuts.” Moreover, the IMF agrees that “after a few years, even large (but spending based) fiscal adjustments create growth for the economy.”

To me, the evidence suggests that Obama’s Deficit Commission chairs are on the right track in emphasizing 75 percent spending cuts relative to 25 percent revenue increases.