True Believers

June 19, 2011

Commentators tend to describe political confrontations (e.g. the upcoming fight in Congress over raising the debt ceiling) as negotiations among rational institutions (e.g., the Republican and Democratic Parties).  The implication is that the parties will reach a rational agreement and in particular will not do something that his mutually self destructive.  By this simplistic reasoning, Republicans and Democrats will reach a debt ceiling deal before the impasse causes real problems.  Unfortunately, the lack of a deal and the specter of an American government that is irrational and self-destructive are already causing problems and are likely to cause more.

The rational-institutions model covers up an important complication.  Institutions do not negotiate; only the people who lead those institutions negotiate.  A negotiation cannot produce an agreement that is good for the institutions, unless that agreement is also good for the leaders.   

As a description of the Republican and Democratic Parties, the rational-institutions model is particularly misleading because the American political process increasingly selects politicians that are not rational people, but are true believers.  The selection process is particularly acute in primary elections where voter turnout is thin and dominated by the ideologically committed.  To win in such an election a politician must be seen as an absolutely reliable advocate for whatever issues dominate the ideology.  Ideological voters seek, not representatives who are smarter and wiser than themselves, but uncompromising zealots.

The political parties cannot act rationally unless their leaders are rational.  Unfortunately, it is unlikely that an institution made up of zealots will select rational leaders.  The leaders of both political parties (particularly the Republican Party) are not fully rational.  They are not seeking the interests of their Party or even their own selfish interests.  They are instead people who are animated by their faith in an ideal.

Niccolò Machiavelli’s friend Francesco Guicciardini put the issue nicely in the following quote.

“The pious say that faith can do great things, and as the gospel tells us, even move mountains.  The reason is that faith breeds obstinacy. To have faith means simply to believe firmly – to deem almost a certainty – things that are not reasonable; or, if they are reasonable, to believe them more firmly than reason warrants.  A man of faith is stubborn in his beliefs; he goes his way, undaunted and resolute, distaining hardships and danger, ready to suffer any extremity.”
Francesco Guicciardini, Maxims and Reflections (Ricordi), Pennsylvania Paperbacks edition 1972, p 39

On the rational-institutions view, Republicans and Democrats should nearly always reach a mutually beneficial compromise, and it should be very unlikely that they stubbornly set themselves on a course of action that is destructive to both parties.  However, the abysmal approval ratings that American voters give the U.S. Congress suggest otherwise.  

On the rational-institutions view, Republicans and Democrats will reach a compromise on a bill to extend the debt ceiling.  They will not be so obstinate that they will extend negotiations so long that the uncertainty spooks the market and they will not attach to the bill austerity measures that are so severe that they choke off the economic recovery.   Unfortunately, given the high numbers of true believers, obstinacy is exactly the outcome that we can expect.

U.S. banks believe that the actions of the Congress have already been self destructive.  Because of the protracted negotiations over the debt ceiling, the banks are curtailing their use of U.S. Treasury bond.  Banks use Treasury bonds as collateral for financial transactions because the bonds carry an excellent credit rating and they are so plentiful that they are easy to sell and thus make attractive collateral. 

If banks believe that U.S. bonds are becoming unattractive as collateral, it is a safe bet that demand for U.S. government bonds will decrease and that interest rates will have to rise to spur demand.   This will, of course, increase the cost of financing the debt and do measurable harm not only to both political parties, but to the U.S. economy.

Politicians and the media are all abuzz about the U.S. debt “crisis.”  That debt is roughly equal to the nation’s annual GDP.  So what? 

The annual GDP (Gross Domestic Product) is (roughly speaking) all the money that residents of the U.S. make (and either spend or save) in a year.  It is analogous a family’s annual income.   A family with an annual income of 50,000 per year and a $110,000 mortgage for its house is in much worse shape.  Yet, by conventional wisdom, assuming that the house is worth the investment, the family has made a sound economic decision. 

Is America’s national debt really a crisis?

Niccolò Machiavelli’s friend Francesco Guicciardini would answer as follows.

 “Wise economy consists not so much in avoiding spending – for that is often necessary – as in knowing how to spend well; that is to spend a grosso, and get twenty-four quattrini’s worth.”   [One grosso is twelve quattrini].

Francesco Guicciardini, Maxims and Reflections (Ricordi), Pennsylvania Paperbacks edition 1972, p 56.

By Guicciardini’s criterion America’s debt is worrying only because so little of it is a good investment.  Roughly 20% of government spending ($687,105,000,000) goes to the military.  That is 6 times the amount of the next most well defended nation, the Peoples Republic of China.    Defense spending is essentially a subsidy for business. It produces profit for defense related industries and contractors, but produces no value for the country.  Sadly, cuts in defense spending are off the table.

The only government spending of which Guicciardini would approve are projects that improve the nation’s infrastructure, its resources, or its people.  These would be programs for roads, communications, conservation, education, and health care.  These, however, are exactly the programs that both sides (and especially the Republican’s) propose to cut.

Social Security and Medicare do not really figure into the question of the quality of the government’s spending as an investment.  These programs are basically mandatory, non-profit financial services that the government provides for its citizens.  If they were privatized, they could not be more efficient.  Privatization would replace the government’s single, integrated system with many private systems, which would produce diseconomies of scale.  Furthermore, each private provider would have to generate a profit for shareholders and pay high salaries to its executives. 

The idea that private industry could, in spite of these added expenses, provide the same service at the same cost to the citizens is fanciful.  That would be possible only if the privatized firms were miraculously efficient.  My experience is that private bureaucracies are not more efficient than public bureaucracies, they are just more expensive. The recent financial meltdown and great recession underscore the additional point that private firms are also more risky.   All that privatization will do with certainty is to create another subsidy for the financial services industry. 

A true believer in the divinity of the Free Market might argue that the government, as well as a private business can go broke.  That is true but if the provider of your private retirement plan goes bankrupt, the courts will decide who and how much creditors are paid.  You will be powerless.  If the government becomes insolvent, at least you will get a vote in how the problem is resolved.

To be sure, the Social Security and Medicare programs are becoming insolvent, because people are living much longer beyond retirement.  There are fewer person years of employment that can be taxed to pay for more person years of retirement and health care.  This imbalance means that to maintain the current quality of service, we will have to increase payroll taxes, increase the retirement age, or both.  

The imbalance is a problem for politicians, not for the country.  Politicians want to increase services without raising taxes.  When costs are rising faster than revenues, each side wants to serve its constituency, at the expense of the constituency of the other party.   

Furthermore, in America every political issue sooner or later has something to do with race.  The Republican Party depends on lower-middle-class, white, southern, voters; many of whom feel that their taxes are subsidizing lazy, morally degenerate Blacks and Hispanics.  The Democratic Party depends on Blacks and Hispanic voters; many of whom feel that their labor is subsidizing lazy, morally degenerate old white people who control the economy.  Republicans and Democrats pander to their supporter’s prejudices.  Republicans want to exploit the Social Security/Medicare funding imbalance to create an artificial crisis, in the heat of which they will be able to dismantle these “subsidy” programs.  The Democrats want to exploit the “crisis” to provide political cover for the necessity of raising payroll taxes or increasing the retirement age.

Underfunding Social Security and Medicare and the resulting political squabbles are a problem, but not a financial crisis.  Farsighted leaders would have addressed the funding imbalance years ago (when it was a minor problem) by small, incremental adjustments that pegged the retirement age to life expectancy.  However, foresight is not a virtue of the democratic process.  A democracy can deal with problems only when they have become serious and well known.  The challenge now is not to overreact.