Monthly Archives: August 2017

What is the proper size of government?

Ilya Somin’s book, Democracy and Political Ignorance, ends with a strong thesis statement. Political ignorance is a serious weakness of democracy, but we can reduce its dangers by limiting and decentralizing the role of government in society.

The government that governs least is not always best in every way. Yet it is the form of democracy least vulnerable to political ignorance. Democratic control of government works better when there is less government to control.

But we don’t have to imagine what America would be like with a smaller government. We can just look back at America throughout its history up until 1932.

The steamboat Helen McGregor, Capt. Tyson, on her way from New Orleans to Louisville, stopped at Memphis, on Wednesday morning, February 24, 1830. She had been lying at the wharf about thirty minutes, when one or more of her boilers exploded, with the usual destructive and melancholy effects. The loss of life by this accident was, at that time, unprecedented in the records of steam navigation. In the bustle incident to the landing and receiving of passengers, a part of the deck near the boilers was crowded with people, all of whom were either killed instantaneously, or more or less injured. No person in the cabins was hurt. The number of those who perished at the moment of the explosion is variously estimated at from thirty to sixty. As many of them were strangers whose homes were far distant, and whose bodies were never recovered from the water, into which they were projected, it is very plain that an accurate account of the number of the victims is not to be expected. (Lloyd’s Steamboat Disasters)

Small government means no safety requirements or inspections. Feedback devices to bleed off excess pressure (called governors or regulators, hint, hint) were still in the future.

The 19th century was dominated by the slavery debate. It paralyzed the Federal government and led to the projection of state power over other states through the Fugitive Slave Law, for example. We were unable to avoid the Civil War, massive loss of life and economic disruption.

Towards the end of the century, we saw the rise of monopolies, trusts, and company towns that strangled the free market and freedom to contract with coercive business practices. Patent medicines were peddled from town to town without concern for whether they worked the cures they were touted to produce.

Finally, the capital markets ran right off a cliff in 1929 under the influence of speculation in a new form of financial instrument – the mutual fund. The markets had always been lurching back and forth between runs on banks to crashes of the stock exchanges, but this Great Crash and subsequent Great Depression brought to a close the era of small government in America.

Promote the general welfare

The Preamble of the U.S. Constitution says that among the chief purposes of the Federal government are “provide for the common defense, promote the general welfare…” and these are specifically repeated in Article 1, Section 8. The quick review of one hundred years of history from 1830 to 1929 shows that the small government version of the Federal government active during that period did a spectacularly bad job of promoting the general welfare.

But what about the free market? Didn’t unfettered market capitalism solve the nation’s problems? No. Instead, the market was captive to various interests, including slavery. The capital market careened from ditch to ditch as speculators touted the high technology of the day – canals, railroads, telegraph lines – that ended in bankruptcy after bankruptcy. Far from protecting the country in the absence of a robust government, the markets could not even protect themselves.

Small and limited government is clearly a danger to the economy and nation it is meant to protect and promote if it is too small or too limited. So how do we ‘right-size’ government?

The proper size of government

If ‘small’ isn’t the answer, what is? How do we decide on the proper size of government?

One answer is that the proper size is zero. Various idealist philosophies and economic systems hold to a belief, unsupported by evidence, that human society doesn’t need government, and should move towards such a state.

While there is nothing to support such a belief in history, psychology, or group behavior let’s be charitable and just say that this is probably an ‘unstable equilibrium’. If by chance it was achieved, any perturbation would force society away from this state.

Another view might be that government should be a certain absolute size larger than zero, but not growing or changing as society grows and changes. For example, Congress is now fixed at 2 Senators per state and 435 Representatives. It doesn’t matter if the population grows or the economy grows, those numbers are fixed.

In the area of sports, the number of umpires or referees on the field is also fixed, but so is the number of competitors. For sports with complicated rules, the number of ‘regulators’ on the field can be 25% of the total participants.

While this might work for sports and legislators (and some think it doesn’t work) it obviously doesn’t work for meat inspectors, VA doctors, or weather scientists. Our government needs for these jobs varies with the economy, warfare, and the climate.

Most people accept that the size of government should somehow be proportional to the size of the nation. Here again, we can ask what is the constant of proportionality and what is the variable or variables we should use.

In Political Ignorance Somin usually refers to the ratio of government spending to GDP. He also at times refers to the complexity of government, noting the number of cabinet level departments and independent executive agencies.

The US currently runs a ratio of all levels of government spending to GDP of about 36%. During the response to the financial crisis, this was as high as 41%. For comparison, the ratio was about 7% in 1900 during the small government era.

Smaller economy, bigger government

Somin at times praises other, smaller countries for running capable democracies. He doesn’t present any data on political ignorance in these countries, however, so it is hard to see what the real argument is. Indeed, Luxembourg, Belgium, and Denmark all have higher government to GDP ratios than the US.

chart1502810830616

As the above chart shows, the US Federal government is already one of the smallest in the world relative to the size of the economy it controls. Switzerland is the only appreciably different government, and the difference between the US and Switzerland can be explained in large part by differences in military spending. Indeed, looking at this image it can reasonably be asked if the US government is still too small.

Exponential growth

As noted earlier, the ratio of all-levels government spending to GDP was 7% in 1900, compared to around 36% today. We might reasonably ask if the constant of proportionality is not, in fact, constant. Even taking account of war spending, is the ratio changing consistently over time, and if so, why? And is this a good thing?

One reason the ratio might be changing over time is that we’ve chosen the wrong variable. There are many variables that grow exponentially over time in a growing economy, instead of linearly. The idea of exponential value growth is commonly termed Metcalfe’s Law.

The implication is that as the economy grows, more and more of that growth takes place in the government sector. The total economy continues to grow, but the government is an ever increasing share.

For some people, this might bring to mind smothering and sclerotic bureaucracies that shuffle paper but achieve nothing. Certainly, that is a danger. But it isn’t inevitable.

Regulation of the Body (Not) Politic

As a counterexample, let’s take a look at the growth of regulation in genetics.

Some genes code for the direct production of a protein, the working chemicals of a cell. Since the beginnings of evolution, all cells use the same basic suite of proteins. It is this fact that allows us to trace the genetic relatedness of species.

When the human genome was first being mapped, the expectation was that it would code for up to 100,000 separate and distinct proteins and that these proteins would be what distinguished humans from other living things. It was therefore quite a shock to find that the human genome, as large as it is, only coded for about 25,000 proteins – the same basic repertoire as other animals.

We eventually found that what was different about humans was the gene regulatory networks of the human genome. Humans have hundreds of cell types as adults, and hundreds more exist as intermediate stages between the one cell type we all start as and the end product.

In each of these cell types, the same basic protein manufacturing is turned on or off in varying ways. Neurons build the machinery of synapses, stomach cells build other secretion functions. The big differences are not the proteins, but the regulations of the proteins.

This tremendous regulatory scaffolding allows humans to have large bodies of many different cell types. We couldn’t be who we are without the regulatory apparatus growing more important than the basic protein apparatus. Even the most basic one-celled animals, such as yeast, have ‘operons’ – genetic switches that regulate the production of proteins. The difference between us and yeast is a more sophisticated regulatory network, not some unique protein.

Going even further back into evolutionary time, bacteria have much simpler regulation of genetic copying than eukaryotes, such as plants and animals. The result is that their genetic code is copied with mistakes much more often. Bacteria can use this (“it isn’t a bug, it is a feature!”) to change rapidly in the face of environmental stress, such as anti-bacterial drugs. But when building a body of several trillion cells that has to last 100 years copying errors really are a problem.

Copy errors are corrected (or prevented) by systems that don’t create protein. These genetic regulatory systems are ‘takers’, not ‘makers’. If the human body was run on small government principles, we would still be bacteria.

Novelty

It is also possible that instead of scaling on the number of things (GDP) or the number of connections (Metcalfe’s Law), the government scales on the number of types of things. Every innovation brings with it new cases and distinctions to be made, new kinds of behavior. A recent case had to answer the question of whether sending a text message urging suicide could be considered manslaughter.

Another aspect of novelty is the satiation of previous needs. If a government can help its citizens be well fed and avoid contagious disease, why not move on to avoiding pollution and obesity? We set new expectations of government. Entirely natural, but leading to growth in government nonetheless.

But no simpler

Albert Einstein is supposed to have said, “A theory should be as simple as possible, but no simpler.” I think this applies to government, specifically the size of government, a government being the embodiment of a political theory. Based on the examples given above, it is reasonable to expect that government will scale nonlinearly with some core aspect of society. This means that government may start small in a simpler time and less complicated society, but will grow – should grow – as that society grows and becomes more complicated. This is as close as we can get to answering in a blog post, “What is the proper size of government?”

10 Things Libertarians should unlearn

Recently, a libertarian acquaintance on Facebook linked to this Forbes article to support his positions. Now getting an article on the Forbes website is not as hard as getting published in the print magazine. There are lots of ‘contributors’ with tenuous qualifications, but this author is an economics professor. So herewith is a casual fisking of his ideas.

1 – The government cannot create wealth, jobs, or income. Wrong.

The government can create money. You’d think an economics professor would know that. “Priming the pump” was the old phrase. Further, the government can be the most efficient employer for some services. We certainly don’t want multiple private armies, and military forces are one of the largest expenditures of the government. And in the end, fighting a war does create jobs – for soldiers. The private sector can never create those jobs.
Is this eventually paid for with debt? Yes, but that debt is paid with inflated money. The actual interest rate on the debt is the stated rate minus the inflation rate. This can be negative at times, and other times less than the economic multipliers of putting the money in circulation.

2 – Income inequality does not affect the economy. Wrong.

That poor people spend all of their income is a sign they have too little income. Rich people can put money into investments, but they also put money into assets with inflated values that are not productive. A billion dollars invested in bonds goes eventually to work. A billion dollars spent on houses and superyachts has a much smaller economic impact.
More importantly, the income spent by a poor person is working today. Even a bond investment only really starts working economically once the bond’s intended use is finished. Therefore the net present value of the income spent by the poor person has a larger effect than the bond investment.
Other forms of investment have even more remote connections to the economy. Only stock bought at the IPO will provide cash to the corporation to expand. All other stock market activity just moves money between investors.

3 – Low wages are not corporate exploitation. Wrong.
The author here (and in other places) assumes that there is always another employer, always someone else ready to make a deal. This is fantasy free market thinking. It derives from the ideal world invented by economists making “simplifying assumptions” in order to use calculus. These assumptions include the ideas that everyone has perfect information, that markets are frictionless (no transaction costs), that there are an infinite number of buyers and sellers, and that everyone has the same desire to maximize net present value.

“Greedy businesses cannot exploit workers because another greedy business would be happy to exploit them a little less until greed removed all the exploitation.”

In the real world, McDonalds and Walmart can hold coercive monopoly power in communities, demanding low wages. There is no “other greedy business” in a small town where Walmart has put the Main Street businesses out of business.

4 – Environmental regulation is a regressive tax. Wrong.
The poor suffer more from pollution than other classes. That means they benefit more from cleaning it up. Calling any spending that is not scaled to income a “regressive tax” is BS argumentation.

5 – Education is not a public good. Wrong.
The lasting benefits of invention and innovation go far beyond what the inventor is paid. Perhaps the author is not aware that patent rights lapse after 17 years. The invention and all of its benefits do not evaporate when that happens. Educating people creates benefits far greater than their earnings.

6 – High CEO pay is no worse than high entertainer pay. Wrong.
CEOs are not entertainers. People voluntarily pay ticket prices to see an entertainer. Shareholders expect profits, and high CEO salary directly cuts profits, often dramatically. Through ESOPs, 401(k)s, pension funds, and other vehicles many workers are shareholders in the company they work for and in much of the American economy. They have a right to those profits. The author seems to live in a world where the investor class and the working class do not intersect. Maybe in 1875, not today.
Shareholders, whether workers at the company or not, might see that paying all workers a higher salary rather than one person would attract better workers and make better products. But CEOs and the corporate compensation committee are sold on the Napoleon theory of corporate leadership – the ‘great man’ theory of history applied to business.
7 – Consumer spending is not what drives the economy. Wrong.
Even the author has to admit that consumer spending is 70% of the economy. That might be higher than optimal, but then consumer saving is needed. It is still consumer behavior – individual choice.
Further, consumer behavior is the driver of innovation. This has been true since at least the invention of the automobile. Supercomputers that predict the weather use graphics processors and so do Bitcoin miners. Why? Because of video games. Drones, for better or worse, are enabled by the technology of smartphones. Delivering high-quality web maps and driving directions led Google to map every street in the world, a key enabler of self-driving cars.

8 – Government programs are low quality. Wrong
The first question to ask would be ‘compared to what?’ Private infrastructure frequently collapsed and the firms went bankrupt, that is how the government wound up owning many roads, bridges, railroads, ports, etc. The main job of government is public health. We have gone from epidemics of cholera and polio to epidemics of obesity and opioid abuse. That is high-quality government work!

9 – The government cannot correct cosmic injustice.
No, but it can minimize the cost. The same as any insurance pool works by spreading risk and profit, social spending works for all of us. If a very sick child keeps their parent out of work, out of college – that affects the entire economy through lost productivity. Insurance companies don’t correct cosmic injustice. That hurricane, tornado, or earthquake really did happen. They just help our entire economy recover more quickly from the loss.

10 – There is no such thing as a free lunch. Wrong.
A free lunch is a positive net present value. Many investments have a positive NPV, otherwise, we wouldn’t make them. Public health, education, and infrastructure are exactly those kinds of things. We saw earlier that the fantasy free market drives many of the author’s conclusions. In the fantasy free market, there can be not positive NPV because the cost of any investment already includes any possible profits the investor could make from it. This is implied by the perfect information assumption.

It is sadly typical of libertarians I interact with that they believe the market can do no wrong. Buildings don’t collapse in India because the market is perfect. Buildings collapse because the market is imperfect, humans can be greedy, and we need help.

Competition is great. But there aren’t only players out on the field, there are umpires and referees, also. In major league baseball, there is a maximum of 13 players on the field and four umpires. American football has 22 players and seven officials on the field. In basketball, there are ten players and three referees. Complicated games, many rules – if we want fair play there have to be regulators, even in a sport. Or we could just let the Yankees win.