Tag Archives: Public

The Economy as an Ecosystem

On Wednesday I testified before the Senate Committee on Small Business and Entrepreneurship. The title of the hearing was “Perspectives from the Entrepreneurial Ecosystem: Creating Jobs and Growing Businesses through Entrepreneurship.”

It was a less-formal type of hearing than I have done before. There were lots of witnesses, no formal oral statements, and we could more or less raise our placards whenever we wanted to talk.

In my one-minute introduction, I noted that George Mason University came to national prominence in 1986 when James Buchanan won the Nobel Prize here for his pioneering work in public choice. (Vernon Smith, another active researcher in the field of public choice, would become Mason’s second Nobel laureate in 2002). I then said:

Public choice focuses on the ways in which government policies are actually determined and carried out. And I think this weighs on entrepreneurship, in particular. I, too, appreciate the ecological metaphor. I think it is a really appropriate metaphor. Recently, I’ve been looking at the public choice ways in which the ecology of entrepreneurship can sometimes be interfered with. Just like a natural ecology, entrepreneurial ecologies need to be a bottom-up process. And quite often can be subject to interference from governments.

I was pleased that the Committee’s chairwoman, Senator Landrieu (D-LA) largely agreed with me. Channeling her inner-Hayek, she replied:

That is an excellent point and I hope that we’ll have a little bit more of thought provoking comments about that. Just like governments can ruin physical infrastructure—I mean physical and natural environments—governments can also, with the wrong policies, disrupt the… I don’t know if you’d call it ‘natural,’…but the strength, the dormant strength or natural strength of a people to grow jobs and produce wealth.

Unfortunately, not all of her comments were so Hayekian. Another of the witnesses was tech-entrepreneur-turned-academic, Vivek Wadhwa. Today he wrote about the hearing in the Washington Post:

Government leaders — at least some of those present — actually seemed to believe they could, through legislation and spending, increase entrepreneurship and innovation. They asked questions such as: What legislation can we enact to build innovation ecosystems, facilitate mentorship, and teach entrepreneurship? They didn’t seem to understand that these are things entrepreneurs do—not governments.

I couldn’t agree more.

The True Cost of the Columbia Pike Trolley: Priceless

A proposal to build a trolley car system on Columbia Pike in Arlington, Virginia continues to provoke strong reactions from residents. The County Board estimates it will cost between $214 million and $261 million to build and between $19.5 million and $25 million to operate and maintain.

As the PikeSpotter calculates, that’s $200 million more to build than the next best option: an enhanced bus line. Why the County Board’s push for a $50 million per mile streetcar system?

According to advocates, the Pike Transit proposal will relieve area congestion, spur economic activity and promote environmental sustainability.

However, residents from all sides of the political spectrum appear to disagree with the County Board. Arlington Yupette says the Pike Transit plans are “elitist” and intended to drive out middle class and working class residents by driving up rents. The end result: the “Clarendonization” of South Arlington. Some point to the need for resources to be directed to the overcrowding in county schools. And still others highlight the high likelihood of such projects becoming boondoggles.

Given the anecdotal lack of popular support expressed by area residents, why are officials persisting? Public finance holds a key. Should the county go ahead and commit to build a rail line here is how it will be financed. Thirty percent of funds will come from the  New Starts/Small Starts federal grant program and 14 percent from the state of Virginia. The remainder is to be provided by Arlington and Fairfax Counties.

Is this fiscal illusion at play? The Small Starts Program will provide up to $75 million if the local government provides a match. County Board officials are confident that Arlington and Fairfax can foot $140 million (Arlington will pay 80 percent of that) with the state of Virginia kicking in a further $35 million. Because a chunk of the cost of building the rail line can be externalized, that is, passed on to state and federal taxpayers, it looks like a bargain…at least for a fleeting moment. It’s still about $170 million dollars more than what it would cost to add more buses.

And there are more complications that arise from mingling federal, state and local dollars as noted by the Sun-Gazette. Virginia is a right to work state. Are union employees required to work on the rail line since the project will receive federal dollars? If yes then the increased labor costs will make the project even more costly to the county. (Lieutenant Governor Bolling believes Virginia state law trumps federal law in the matter.)

While new estimates continue to push the costs higher, at least one Arlington County Board member is undeterred by fiscal considerations, “This is a project that has the most potential to help us achieve our environmental goals and livability goals. We think it will have a very high return.”

That is, the costs of building the streetcar line are concrete, and the returns are mired in the counterfactual.

 

 

 

Olivia Mitchell on the future of defined benefit pensions

Steve Forbes’ interview with Dr. Olivia Mitchell of Wharton on the health and future of defined benefit pension plans raises a few points worth considering for policymakers and beneficiaries:

  • Public pension liabilities are undervalued and thus underfunded.
  • In general, future retirees including Baby Boomers, face a “much more fragile retirement” than the previous generation.
  • Be concerned as public plans try to make up for losses with riskier asset portfolios.
  • The fiscal burden of public plans will put immense pressure on several major cities and states including Philadelphia, Chicago, Illinois and Hawaii.
  • Public sector transitioning to a 401(k) doesn’t solve the problem of the expense of past negotiated benefits.

Dr. Mitchell also speaks on the topic of Social Security reform, longevity, 401(K) plans and annuities. You can watch the interview here:

Pension accounting narratives

The controversy over just how expensive public pension plans are, and are likely to be, is growing more contentious. The reason is that some defenders of the current system cavalierly dispense with insights of financial economics in favor of a story that unravels on closer inspection.

Here is one current narrative. State budgets only require 3.8 percent of total spending to pay for pension obligations. This is taken from a report by the Center for Retirement Research at Boston College by Alicia Munnell, Jean-Pierre Aubry, and Laura Quinby.

Read the report more closely. This claim is based on what states contributed on average in 2008. First, it is an aggregate number. Second it is based on an 8 percent discount rate. That is, this is what states contributed, on average, based on the flawed notion that it is possible to lower the size of your debts by assuming high returns on your assets. Yes, they weren’t contributing very much. Their accounting is set up to ensure they underfund their pensions.

Secondly, some states have made a habit of deferring payments. So, what states contributed in 2008 tells us nothing about what they will need to contribute to make up for the shortfall. The next thing to keep in mind is that while some states are moderately funded, other states like Illinois and New Jersey are very badly underfunded. The aggregate “hides substantial variation” as the authors admit. The authors go on to calculate under more realistic discount-rate scenarios (Alicia Munnell adds one percentage point to the Treasury rate to get to 5 percent), Illinois and New Jersey will need to start contributing 12 to 13 percent of their budget. Now also consider a new report by Willshire Associates indicating no state will be able to meet its assumed investment returns over the next ten years.

The second claim being made by a few opinion makers is so deeply contradictory, I am not sure how it can be reconciled.

It is this. And, I quote two articles in full:

Nor are state and local government pension funds broke. They’re underfunded, in large measure because — like the investments held in 401(k) plans by American private-sector employees — they sunk along with the entire stock market during the Great Recession of 2007-2009. And like 401(k) plans, the investments made by public-sector pension plans are increasingly on firmer footing as the rising tide on Wall Street lifts all boats.

And, from today’s Washington Post:

“Public-employee unions say that although the occasional stories of workers who game the system make for good headlines, the real problem was reckless behavior on Wall Street, which caused the value of pension-fund assets to plummet. To force state and local employees to accept what now passes for retirement security in the private sector would amount to a race to the bottom for all workers, they contend.

AFSCME Secretary-Treasurer Lee A. Saunders said: “401(k)s have been around for a generation and the result is tens of millions of workers who lack retirement security. We need to figure out ways to expand effective retirement programs to more Americans. We gain nothing by destroying the defined benefit plans that public employees agreed to and funded over the course of their careers.”

Now, consider the primary critique of public sector defined benefit accounting. Current public sector pension accounting claims it’s possible to measure pension obligations according to what the assets are expected to return when invested in the market.  This has led plans to apply an 8 percent discount rate to value their liabilities. This in turn has led them to invest increasingly in higher-risk vehicles like hedge funds and real estate. The reason: they need to get 8 percent or better on average in order to have enough assets set aside to pay their obligations, which are already underestimated, because of this circular logic.

Economists have been stating consistently that  public plans should be valued using the yield on Treasury bonds (currently 4 percent) to reflect the safety and security of a government pension. What follows from this? An accurate calculation of the size of what is owed; and a more conservative investment strategy.

But defenders want to cling to the math that has led plans to embrace risk and underfund promises.  Remarkably, and without any sense of contradiction, the same defenders express dismay when the market doesn’t return what they anticipated.

What is so scary about 401(k)s? Investment risk must be borne by the individual worker and it cannot be made to disappear with actuarial alchemy.

Perhaps defenders of the accounting mess really think the numbers don’t matter and underfunding is nothing concerned about. After all, the government has a sure hedge against this risk: the taxpayer.

Hurricane Season Begins

Today is the first day of the 2010 hurricane season, which NOAA predicts will be more active than usual, with 14 to 23 named storms. (In fairness, NOAA has been way off the mark in recent years, to the relief of the residents of the Gulf and Atlantic coasts.)

The Mercatus Center’s Gulf Coast Recovery Project has put out over 50 studies since 2005 looking at the rebuilding of the Gulf Coast after Hurricane Katrina. Below are links to eight studies that state and local policy makers may find useful today and in the coming months.

  • A Policy Maker’s Guide to Effective Disaster Preparedness and Response. In the years since Hurricane Katrina devastated the Gulf Coast region of the United States, scholars, policy makers, and concerned citizens have been working to understand what exactly went wrong in the response to the event and how better to prepare for future natural disasters. Post-Katrina New Orleans presents a unique opportunity to study how and how not to undertake the rebuilding of a major population center after such a catastrophe. Proper study of this subject, if conducted objectively and rigorously, will not only save other communities countless dollars but will also save lives.
  • Building a Safe Port in the Storm: Public vs Private Choices in Hurricane Mitigation. This Policy Comment analyzes the connection between hurricane mitigation and insurance. As many people fail to purchase government-subsidized flood and earthquake insurance, some researchers argue that market failure explains the lack of mitigation. But empirical evidence shows that markets do value natural hazards risks, including hurricane mitigation, and thus the case for market failure has been overstated.
  • The Entrepreneur’s Role in Post-Disaster Community Recovery. This Policy Primer recommends that in the aftermath of a disaster, government relax non-disaster regulations in order to allow entrepreneurs, who are in the best position to assess local conditions and needs in the rapidly changing, post-disaster environment, to step in and quickly respond to the community’s needs.
  • The Road Home: Helping Homeowners in the Gulf Post-Katrina. This comment explores Road Home’s policy goals and design, placing them in the context of the destruction wrought by the hurricanes and the role of insurance and government before and after a disaster. It then contrasts Road Home’s goals and design with the policy goals and design of Mississippi’s Homeowner Assistance Program.
  • Disastrous Uncertainty: How Government Disaster Policy Undermines Community Rebound. This Policy Comment looks at the ways in which public policy has had negative unintended consequences on the ability of communities to make informed decisions about sustainable rebuilding after Hurricane Katrina.  Based on fieldwork, the authors explain why social capital and signals generated by market and civil interactions are important to recovery efforts and how policy makers can encourage rather than retard grassroots rebuilding efforts.
  • Making Hurricane Response More Effective: Lessons from the Private Sector and the Coast Guard During Katrina. Many assume that the only viable option for emergency response and recovery from a natural disaster is one that is centrally directed. However, highlighted by the poor response from the federal government and the comparatively effective response from private retailers and the Coast Guard after Hurricane Katrina, this assumption seems to be faulty. Big box retailers such as Wal-Mart were extraordinarily successful in providing help to damaged communities in the days, weeks, and months after the storm. This Policy Comment provides a framework for understanding why private retailers and the Coast Guard mounted an effective response in the Gulf Coast region.
  • Ensuring Disaster: State Insurance Regulation, Coastal Development, and Hurricanes. This policy comment examines how state insurance regulation affects societal vulnerability to hurricanes. States provide insurance for high-risk properties at below market rates primarily through insurance pools. Seven states, including Louisiana and Mississippi, have wind pools, with over 1.8 million policies and a total liability of over $500 billion as of early 2007. Wind pools are financed, in part, through additional charges on other citizens’ premiums throughout the state to cover excess losses from hurricanes. State guaranty funds, which ensure payment of claims of insolvent insurers, also subsidize high-risk properties.

For more information about these studies or to request hard copies, feel free to email me using the link here.

Talk on States Fiscal Health at GMU, April 21

George Mason University’s Department of Public and International Affairs is hosting Ray Scheppach, executive director of the National Governors Association, on April 21 from 4 to 6 PM for a talk entitled “The State Fiscal Situation, Health Care Reform and Federalism.” This should be of interest for most of the readers of this blog. The talk will be in Enterprise Hall on GMU’s Fairfax Campus. Continue reading