David Brooks backs up The Dynamist

I was pleased to read David Brooks' column today in the New York Times that (more eloquently) furthers the theme of my last article, "Post-Lehman: The Banking Oligopoly Reigns Supreme", albeit from a slightly different angle.  My thesis was that the Obama administration has laid out, and is executing on, a very Hamiltonian restructuring of the financial system, while the Republicans seem to be migrating into the classic Jacksonian camp.  This was interesting to me because the two parties are switching places, with the Democrats moving away from their Southern agrarian roots (the Jeffersonian / Jacksonian camp) toward becoming the party of Northern urban elites (the Hamiltonian camp).  The Republicans are making the opposite migration.  I was focused on finance, because that is the classic cleavage between Hamiltonians and the Jeffersonians dating back to the beginning of the Republic.

David Brooks takes it a step further to use the ancient split as the metaphor to the whole populist reaction to the Obama administration.  He (accurately) dismisses the most-popular explanation that has been floating around: that these rubes can't handle the fact that we have a black president.  He and I believe the reaction to Obama's policies would have been the same if he were white.  While I agree with many of president Obama's goals (and, to a lesser extent, policies), his platform is a classic "we know what's best for you" set of policies being aggressively pushed by an administration that seems to consist mostly of college professors.  You don't have to be a racist hick to be alarmed by the massive changes to a huge portion of our economy paid for with an ungodly sum of borrowed money pushed by an elitist group of people with very little "real world" experience.

The Hamiltonians have always favored strong federal authority,
centralized financial power, the use of federal debt and strong
intervention in the economy to promote favored industries.  The
Jeffersonians and Jacksonians distrusted the urban elites that pushed
these policies and believed that such policies bred corruption and
therefore favored diffusing power among the people.  The history of the United States has always been driven by the tension between these two camps.  Whenever one side is given unchecked power, the other side goes crazy.

As Mr. Brooks puts it:

Barack Obama leads a government of the highly educated. His
movement includes urban politicians, academics, Hollywood donors and
information-age professionals. In his first few months, he has fused
federal power with Wall Street, the auto industry, the health care
industries and the energy sector.

Given all of this, it was
guaranteed that he would spark a populist backlash, regardless of his
skin color. And it was guaranteed that this backlash would be ill
mannered, conspiratorial and over the top — since these movements
always are, whether they were led by Huey Long, Father Coughlin or
anybody else.

What we’re seeing is the latest iteration of that
populist tendency and the militant progressive reaction to it. We now
have a populist news media that exaggerates the importance of the Van
Jones and Acorn stories to prove the elites are decadent and
un-American, and we have a progressive news media that exaggerates
stories like the Joe Wilson shout and the opposition to the Obama
schools speech to show that small-town folks are dumb wackos.

The Dynamist tries to be as neutral an observer of events and trends as possible.  Both the Hamiltonians and the Jeffersonians have valid arguments, but they have different priorities, and those differences will never be bridged.  Thankfully, most Americans do not fall neatly into either camp and and are wary of aggressive policies from either side.

I just pray that, through all the Sturm und Drang, in the end the American center holds.

Post-Lehman: The Banking Oligopoly Reigns Supreme

Today marks the one-year anniversary of the Lehman Brothers failure, which led to the subsequent rescue actions by the Fed and the Treasury.  Many look at the rescue of AIG, the forced marriage of Merrill Lynch and Bank of America, the TARP, the conversion of Goldman and Morgan Stanley to bank holding companies and the massive increase in the Fed's balance sheet and think that the financial system was utterly transformed.  My view is that the crisis only served to accelerate trends that were already in place, and have been for the last 40 years.  Ironically, the reforms proposed by the Obama administration will mark the final destruction of the old New Deal financial framework and will lock in place a large-scale financial oligopoly.

The battle over the very banking and money is as old as the Republic.  The traditional battle lines are between the Hamiltonians that favored a banking oligopoly to control the money supply and rein in speculation, and the Jacksonians that were suspicious of power being concentrated among an East Coast banking elite and instead favored a "free banking" model of small banks spread throughout the country.  Between the Civil War and the Great Depression, the Hamiltonians (mostly Northeastern Republicans) held sway and banking power was concentrated among the big New York banks led by JP Morgan.  During the New Deal, FDR smashed the New York "Money Trust" and created a fragmented banking system that (1) spread banking power throughout the country by prohibiting interstate banking and even restricting bank branching and (2) separated the types of banks into thrifts, savings & loans, commercial banks and investment banks.

The diffuse nature of the banks limited large scale banking and resulted in the development of the securities market, which is why the US securities markets are much more robust than those of other countries such as Japan and in Europe that have traditionally relied more on bank financing.  It also meant that the US didn't have any global-scale banks as the world economy was becoming more globalized.

Starting in the 1970s, the US government embarked on a piece-by-piece dismantling of the New Deal regulatory framework.  As the commercial banks grew very large and were permitted to enter the securities business in the late 1990s, the investment banks, who traditionally had much smaller capital bases than commercial banks, felt the need to expand their balance sheet to compete, which meant taking on more leverage.  Couple the high leverage with over-confidence in financial innovations such as modern portfolio theory, derivatives math and value at risk measures, the investment banks got overextended and finally succumed to a classic run-on-the-bank.

The result was the forced merger of the investment banking system into the money-center commercial banks.  We now have sitting atop our national financial system an oligopoly of six massive firms: JP Morgan, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.  These six firms together dominate the market for securities underwriting, syndicated loans, derivatives trading, prime brokerage, non-agency mortgage securities underwriting and credit cards.  The federal government now effectively controls the mortgage market and is in the process of pushing private lenders out of the student loan business.  Oh, and at least temporarily it now has a huge chunk the market for US auto loans through its ownership of GMAC and Chrysler Financial.

Given the trends that were in place, this turn of events was unavoidable, unfortunately.  The reforms proposed by the Obama administration are the logical culmination of this system.  Creating a unified regulator, bolstering capital levels, limiting risk-taking, even the proposed consumer protection agency all have the effect of locking-in a conservative financial oligopoly.  Viola, you have the re-creation of the concept behind Alexander Hamilton's Bank of the United States.

Personally, given the choices on the table, I favor this outcome.  The current system of privatized profits and socialized losses is preposterous and literally threatens our democracy by turning the public against the business community.  The banking system, as long as it operates under a fractional reserve model (i.e. with leverage) is intertwined with the money supply in such a way that we can't pretend that it can exist as a truly free market.  The size of the banking system's liabilities relative to its assets is so large, that unless the government is willing to risk the aftermath of a massive debt deflation it will always be forced to step in to bail out the banks when they run into trouble, which they periodically will do.  So Obama's Hamiltonian vision should be supported by centrists as the least extreme potential outcome.

The Republicans, now the naturally the party of the South, the Mountain West and Sunbelt, will likely migrate into the Jacksonian camp.  There is just no upside for the Republican Party to continue to support the current system, as the financial industry is clearly trending Democratic and is based in the super-blue states of New York, Connecticut, New Jersey and Illinois.  You see glimmers of this trend with the (at the time irresponsible) refusal to support the bank bailout, but we have yet to see a positive reformist vision emerge.  My Jacksonian solution would be to force a downsizing of the big six, not in scope, but in scale.  Jacksonians should favor a the migration away from large scale banking and to the securities market.  Just because the CDO math was wrong for the last ten years doesn't mean that securitization itself is a bad idea.  Perhaps moving to a "covered bond" model, where the bank holds 20% of the securities it underwrites, would strike the right balance.

The debate over the nature of banking and money has been raging in the United States has been for a long time.  Jefferson vs. Hamilton, Jackson vs. the Second Bank of the United States, William Jennings Bryan vs. the Gold Standard, FDR vs. the Money Trust…these great ideological battles over banks and centralized financial power have occurred periodically throughout our history.  Ironically, it appears that the parties are switching sides as they have switched their traditional North-South alignment.  While the battle lines between left and right are still blurry, they are clearly being redrawn with the Democrats slowly embracing the vision of their ancient enemy, Alexander Hamilton.

We don’t spend enough on health care?

Craig Karpel writes today in the Wall Street Journal that we don't spend enough on health care.  Basically, he writes that as the economy has evolved, we have gone from focusing on food (in the agricultural and mercantile revolutions) to clothing (in the industrial revolution) to shelter (in the late 20th century and this decade).  It is only natural that we would now turn to focusing on our health and longevity.  It's an interesting argument, if different from the viewpoint I have expressed in my previous health care pieces.

One reason that I do believe it is in fact unfair to compare the cost of care in the US to that in other countries is that the rest of the world free rides off the medical innovation that mostly takes place in the United States.  The entrepreneurial medical culture in the US incentivizes the use of advanced technologies, which eventually spread throughout the rest of the world.  Other countries use their monopsony buying power to push down prices so that, in effect, American workers subsidize the health of the rest of the world.

The benefit of spending money on health care versus other items like consumer goods or petroleum is that it is a domestic industry.  In addition, the accumulated R&D that takes place in the United States translates to a large amount of net exports.  Better health care and advances in longevity should also allow for a long term rise in the average retirement age, increasing the productive life of an American worker and boosting the long term potential growth rate of the economy.

The health care conundrum is the classic "on the one hand, on the other hand" situation that permeates economics.

Health care is killing the American worker

In the "everything is connected" category, I was reading Michael Santoli's column in Barron's this week and he brought up something interesting:

"There may be no position of more comprehensive agreement than that the U.S. consumer is shot — earning less, spending less, saving more, repayng debt. How many times have we seen the same numbers trotted out, about how consumer spending jumped from a long-term average of below 65% of gross domestic product to a recent 70%, and must fall back; how household debt soared from 64% of GDP in 1995 to 100% of GDP, and must retrench; or how the savings rate that used to average 7% to 11% before 1992 has just lately popped from zero to 6.9%?

It's all true, and should be expected to restrain spending and economic activity over time. But the nuances within the numbers — and the unknowable trajectory and degree of adjustment — helpfully complicate the picture.

The consumer as 70% of GDP needs a footnote. Almost all the growth in personal consumption as a share of the economy has been health-care spending — even though government covers half of health expenditures. As strategists at Citi and Barclays have noted, personal spending ex-health-care as a share of GDP has been flat for decades. This suggests there may not be too much frivolous shopping to cut out."

I'll admit expecting consumer spending as a percent of GDP to fall has been one of my core economic theses. So I pulled the numbers myself. And lo and behold, the economists at Citi and Barclays are mostly right.

If you exclude medical care, personal consumption as a percent of GDP is only slightly above where it has been since the early 1960s and is below where it was in the 1950s. Half of medical care expenses are paid for by the government and close to half are paid for by employer-based insurance. Please note that these statistics are for medical services. Drugs and medical devices are classified as goods.

This chart really emphasizes my point:

Another statistic that's often bandied about is how the median worker's inflation-adjusted wage has stagnated since the early 1970s. The stat is usually cited by the left as proof that greedy corporations have been raking in all the profits and holding down workers' pay or that all the economic benefits have been flowing to the rich. It turns out that what has actually been happening is that the rightful fruits of worker's productivity gains have been Hoovered up by the medical-industrial complex.

The Clinton era is hailed by the left as a time when more progressive taxation and such finally allowed the median worker's wage to rise after its long stagnation under Nixon, Reagan and Bush. It turns out, the 1990s was also the age of the hated HMO that "rationed" health care. Health care as a percent of GDP fell slightly from 1993 to 1999 and the average worker's wage surged.

Source: Minneapolis Fed

The following calculation, which includes benefits, shows that American wages have actually risen quite a bit since the early 1980s.

In other words, HMOs created the great Clinton-era wage boom.

Not to pick only on the left. The right (or at least the Wall Street Journal editorial page) is constantly raising the bugaboo of "health care rationing" as the threat of Obama's proposed health care reform. Of course health care needs to be rationed. What else doesn't get rationed in some form? The big question is how to ration health care. Is it done by insurance companies, like under the HMO model? Is it done by the government, like in Canada and Europe? Is it rationed by changing incentives for doctors and hospitals, like what was suggested in my previous health care post?

If health care doesn't get rationed in some form or another, Americans' standard of living (ex. health care) will stagnate. For a while Americans borrowed against their houses to pay for increases in their standard of living. That option is now gone.

Our expensive health care system is robbing American workers of the fruits of their labor. Bring down the cost of health care and more workers will be able to afford coverage. Bring down the cost of health care and more workers will receive pay raises. Bring down the cost of health care and the US can close its trade deficit. Bring down the cost of health care and reduce the future Medicare liability. Bring the cost of health care and reduce US indebtedness to the rest of the world.

I can imagine no more important issue facing voters today.

Must-read health care article from the New Yorker

Everyone thinks we need to do something about our health care system, but there's not much agreement about what needs to be done.  I am far from an expert in this field, but have come across some interesting articles recently.  I am a big picture guy, mostly, so I'll start from the top.

The Democrats generally focus on providing coverage for the uninsured and the Republicans generally focus on the high cost of our system (if they aren't defending the status quo, which they also do).

This chart from the Economist tells us alot:

On the basic question, the Republicans appear to be more correct, the US clearly has a problem with costs, without providing better outcomes.  The fact that there is a high number of uninsured is a symptom of the fact that health insurance is expensive, not the core failing of the US system.


What is different about the US system that results in high costs?  Here are some possiblities:

  • We waste money on the bureaucracy of private insurance – maybe, but the chart shows that we spend as much as or more than other countries publicly, even though most people get their insurance through the private market…besides since when are government bureaucracies known for being efficient?
  • Other countries free ride on our innovation – true, but I doubt that makes up the whole difference
  • Other countries don't have large medical malpractice claims – also true, but also unlikely to make up the difference
  • Since everything is free, people overconsume – true, but it is free in other countries too, and besides, do consumers really stand a chance of figuring out what they should pay for procedures, how to negotiate prices and what is necessary and unnecessary?
  • Our care, for those insured, is better – this is true in some ways…we are more likely to make use of cutting-edge technology but our outcomes are not necessarily better in key measures
  • Other countries ration – also true, but they do not necessarily have worse outcomes…besides everything else in the world gets rationed in some way, why not health care?  Since when do we expect to get unlimited free anything?

This article from the New Yorker looks in depth at the cost issue by comparing two Texas cities with similar demograpics, similar health outcomes, but vastly different healthcare spending per capita:


Supposedly, Obama is making this article required reading for his staff.  Obama talks about the cost problem all the time, like he totally gets it, but then he rolls out a plan that involves spending over a trillion dollars more than we already do.  It's mindboggling.  Why, Obama, why???

Anyway, what is the punchline?


The system incentivizes doctors to order expensive procedures, incentivizes the use of specialists, incentivizes the use of expensive drugs, incentivizes the use of tests, incentivizes the use of expensive technology, and disincentivizes the use of general practictioners, collaboration between doctors and preventive care.

The difference between the two Texas cities is that one has an entreprenurial culture among doctors whereby they rack up huge costs and the other doesn't.  Supposedly, if the high cost areas of the US were brought down to the levels of the better low-cost areas (like the Mayo Clinic), the gap between the US and other countries would vanish. 

I do suspect, however, that there is a vast medical-industrial complex that will fight this sort of change, thus we will end up just poring more slop into the trough for the health care pigs to feed off, with little actual reform.

As an final note: an article in this week's BusinessWeek highlights the medical-home model that may serve as an antidote to our health care boondoggle:


On the question of how do we incentivize for outcomes (quality) rather than quantity of care?  Honestly, I have no idea.

Hot and Cold on Obamanomics

While my blog is not a blog about politics, it is about economics, and you can't talk about economics these days without talking about politics. The big investment opportunities are often directly or indirectly caused by distortions in government policy and the unwinding of those distortions. That's not to say I think government involvement in the economy is bad per se. It's just that the federal government is such a large actor and (in the case of the United States) not governed by normal rules of business and economics, its actions have an outsized effect on the economy.

As I noted in Part IV of my 2009 economics series, the American people have done a good job managing fiscal policy over the past 70 years by switching out presidents and congressional control. Obama's willingness to run large deficits via large doses of government spending is appropriate for the current deflationary environment, and it makes sense to back him up with Democratic majorities. It was appropriate to elect Bush in 2000, to ease fiscal policy via tax cuts, given the weakness in business investment, budget surplus and strong dollar at the time. I was appropriate to elect Clinton in 1992 as a moderate progressive to focus on policies that supported consumer spending after 12 years of "supply-side" Republican rule, but then also appropriate to put in a Republican congress in 1994 to focus on deficit reduction after 14 years of high deficits. I could keep going back, but you get the picture. Circumstances change frequently, but the political parties change ideology much more slowly, so the people conduct economic management for the parties by changing them in and out of power.

Personally, I'd prefer to see us move to a more balanced policy conducted on a bipartisan basis. Otherwise we're doomed to these wild swings in economic fortunes that keep requiring bigger and bigger government responses to keep the game going. As I've frequently stated, I think we're in overtime of the current game of bubble surfing that has been building since the end of World War II. I thought Obama had the chance to start a new game (and he still has that chance), but so far he seems focused on keeping the old game going. So we surf from the Great Society bubble to the 1970s inflation bubble to the Reaganomics bubble to the Dot-Com bubble to the real estate/globalization bubble to Obama's government spending bubble, racking up more and more debt as we go. In the meantime the average American is forced to endure wild swings in inflation, interest rates, stock values and real estate values. Such swings are great for hedge funds managers and Wall Street financiers, but they are tough for working stiffs who just want to work hard and provide a decent life for their family.

With that said, here is my scorecard on Obamanomics so far:

  • Financial Crisis – As I've noted previously, I generally approve of the way the Obama administration has handled the financial crisis, although I actually would have been harder on the banks. The stress tests had too low a standard in my opinion. In my analysis, I thought the banks needed another $1-1.2 trillion to shore up their balance sheets. The Treasury thinks the banks need $75 billion. Why the difference? I thought the banks should have equity equal to 10% of their assets, while the Treasury is targeting equity equal to 4% of assets. 25 to 1 leverage seems inappropriately low to me, given the highly uncertain environment facing real estate and business loans over the next two years. The Administration has lost the political will to ask for more money, so it's hoping we can skate by with what they already have. My suspicion is that within 4-5 years we'll be revisiting this issue. If we were more willing to wipe out private bank shareholders, the American people would have been more amenable to funding the TARP. Unfortunately, the financial industry is one of the biggest donors to both parties, so we are where we are.
  • Auto bailout – Up until recently, I have been supportive of the Administration's auto bailout policy. That is until they decided to rip up hundreds of years of bankruptcy law precedent to conduct a union giveaway at the expense of the secured creditors. It's what I'd expect out of Hugo Chavez's Venezuela, not the United States.
  • Stimulus – While I think it's unrealistic for the government to efficiently spend so much money in such a short period, their heart is in the right place on expanding the government's balance sheet to offset the decline in business investment, residential investment and consumer spending associated with the financial crisis. I would have preferred to see a smaller stimulus and more invested in the financial system (which we will get back with interest). A lot of the stimulus money being spent on "infrastructure" will be a boondoggle, but will provide a decent short-term boost to the economy.
  • Budget – The long term budget outline laid out by Obama is crazy in its deficit projections, but is focused in the right place by emphasizing health care, education, energy reform and infrastructure. It just spends too much for too long a period of time. Expect a Republican congress sometime in the next six years to rein it in.
  • Cap and Trade – As I expected, the cap and trade program proposed by Obama is quickly turning into a joke, with lobbyists battling for exemptions for utilities and manufacturers and watering down the whole thing. If the Administration had followed my advice, and just been honest about the fact that it is a carbon tax, it could have been more effective. Calling it a regressive tax would force policymakers to offset it with a repeal of the payroll tax, trading a tax on work with a tax on spending (on imported oil, no less). Such a trade off, including a big cut in the corporate tax, would appeal to liberals and conservatives alike.  Instead we get something ineffective, shaped by lobbyists and insiders, that will punish average people with no discernable effect on the environment, all to salve the conscious of rich liberals. It would be funny if it weren't so sad.

Overall the Administration is effectively responding to crisis, while missing some of the opportunity to put this nation on sounder long term footing.

The New Deal’s great mistake

Watching the slow-motion disaster that is the US-based auto industry, I think it is worth understanding just how we got into this mess.

Back in the day, before World War II, many viewed the large manufacturing concerns that dominated the economic landscape as basically a collection of machines.  Labor was locked in a titanic struggle with the owners of the machines (called Capitalists) over how to split the profits produced by those machines.  Economic theory treated assembly line labor as an undifferentiated input ("L") and production was measured as undifferentiated output ("Q" for quantity).  The companies that owned the machines were considered to be permanent entities.

The Capitalists had the upper hand in the struggle throughout the late 1800s and very early 1900s, before World War I caused the old order to unravel.  The two rising ideologies were Marxist Communism, which believed that Labor should own the machines directly, and Fascism, which believed in a state-driven socialist corporatism (in addition to some other nasty stuff).  By the early 1940s, continental Europe had fallen under the control of these two forms of government. The US and the UK threaded the needle by adopting elements of socialism while maintaining the dynamism of capitalism.

Of course I think the US got it mostly right.  However the New Deal in the US didn't completely reject the popular Marxist notion that companies are a collection of machines (aka the "means of production"), and it saddled these companies with social obligations that would eventually both do the employees a disservice and put US companies at a competitive disadvantage with foreign firms. 

This was the New Deal's great misake.  Companies are not a collection of machines.  They are evolving entities. Companies operate in a highly competitive, rapidly changing environment, with fickle consumer tastes and volatile business conditions.  Regardless of how powerful a company may seem at any given time, it is destined to disappear someday. 

The evolution of a company and its industry

In a new industry a few innovative companies will get traction with a product.  As the popularity of the product grows with the general public, more companies enter the industry.  Employment in the industry rises during this phase as companies invest in growth.

About halfway through the adoption cycle among the public, growth starts to slow.  The easy money fades and the industry gets more competitive.  Firms start merging with each other or going bankrupt.  Economies of scale start to matter, and companies focus on improving profitability rather than simply investing in growth.  Employment in the industry starts to fall.

When the industry matures (its product is fully penetrated among the public), it has probably consolidated to an oligopoly of 2-3 major companies that compete on product innovation and labor-saving investments.  Eventually, a replacement product comes along that forces the industry into permanent decline.

Given this evolutionary cycle, does it make any sense for retirees to look to a company that they may have worked for 20 years prior to support their retirement and health-care?  Why should companies be in the business of providing retirement investments and health-care in the first place?  Should workers be locked in to spending their whole careers with one company that will care for them all the way to the grave?  Should people live in fear of getting fired and losing their benefits when it is all but certain that employment in all but early-stage industries will decline over time?

Time to rethink the saftey net

The Chrysler and GM situations are this broken system playing out to the extreme.  Back in the day, the unions would threaten to strike for more pay.  Management would kick the can down the road by offering unaffordable retirement promises that would blow up on someone else's watch.  (Not unlike what Congress does with Social Security and Medicare.)  The companies support hundreds of thousands of retirees when they have tens of thousands of employees.  They have traditionally run at overly high levels of production just to support the huge number of obligations they have accrued to employees and dealers.  Today the system has finally blown up.

From the auto manufacturers down to the corner deli, the system makes no sense.  Employees should either be able to shop for their own benefits or the government should provide them.  Ideally, in my view, individuals would shop for benefits from providers that receive strong government oversight.  Either way, the last place employees should be forced to look is to their employer, who is an inherently unstable entity.  Employers get acquired, go bankrupt, and lay people off all the time.  Its hard enough for companies to compete just to survive in the marketplace, let alone to be forced to be in the health care and money management businesses as well.

Crony Capitalism still Reigns Supreme

Joel Kotkin has posted a good piece that hits on a theme that I have been hitting on at the Dynamist for some time, particularly here and here.  The theme is that Obama has probably achieved a political realignment in favor of the northern blue states and the Democratic Party.  Mr. Kotkin has written that, in reality we have traded one form of crony capitalism, the Sun Belt "cowboy capitalism" of Nixon, Reagan and Bush, with that of the "collusive capitalism" of Obama…still driven by a well-connected elite, but just a different elite than that which dominated politics under the Republicans.

"Cowboy Capitalism" holds the free market supreme, but contradicts itself with direct and indirect subsidies for agribusiness, pharma, health insurers, big energy, aerospace, suburban homebuilders and consumer lenders.

Obama's "collusive capitalism" punishes the beneficiaries of cowboy capitalism while supporting hedge funds, venture capitalists, information technology, academia, green energy and urban landowners, with support from Hollywood and the media.

Mr. Kotkin hypothesizes, correctly I think, that the threat to the domination of the Blue State economic elite comes not from the Republicans, who are currently flailing, but from the "non-gentry" left, who will become disappointed by weak job creation and a continued concentration of wealth into the hands of the New Economy elite.

Save General Motors

As General Motors and Chrysler careen toward insolvency, we the taxpayers are being asked to step in and toss them a lifeline.  The problem is that the American public instincitvely understands that the American auto industry is rife with outdated business practices that need to undergo major structural reform, and the public is right.  I think most of us, however, also think its important to have an American-based auto industry, even if that impulse is purely based on nationalist sentiment.  In the end, the American public would like to see two strong American car companies emerge that can compete with Toyota, Honda, Mercedes and BMW on the global stage.  We should figure out a way for General Motors and Ford to emerge on the other side of this recession, properly structured to compete in the auto industry of the future.

General Motors’ core problem is that it is caught in a web of relationships that were put in place back when it was the dominant producer of cars in the United States.  (Chrysler, on the other hand, is just a plain old weak company.)  GM created several brands to provide customers with diversity of choice (back before there was real diversity from foreign producers), and therefore now is hobbled with too many dealerships, excess production capacity, and an inefficient process for new model development.  It also was caught in the great false assumption of the post WWII period: that production capacity and employment was permanent, so that management and their employees are enemies engaged in a struggle to divide the spoils, rather than a partnership to compete against the likes of Toyota and Honda.

Through that prism, the way these companies have been run starts to make sense.  They can’t cut capacity, because they have a contractural need to maintain their network of dealers, their huge employee bases and their huge number of retirees.  Yes, the management that agreed to those contracts was short-sighted, but they were also dealing with what appeared to be reality at the time.  As fiduciaries, management has run the business to avoid bankrupcty as long as possible.  Either way, bankruptcy was inevitable, and has been since the 1970s.  That time has now come.

Andrew Ross Sorkin of the New York Times lays out how Chapter 11 can work while saving General Motors and "merging in" Chrysler.  GM would be reduced to four brands: Cadillac, Chevy, Buick (big in China) and Jeep.  In my view, Ford should also ditch Mercury and be left with Ford, Lincoln and Volvo.  Production capacity, the dealer networks and the employee base would be sized to make sense for the size of the industry today.  The government would facilitate this process by providing a DIP loan for a pre-packaged Chapter 11 restructuring.  As an American, I would be happy to see two, strong, restructured American car companies emerge on the other side of this crisis, rather than maintaining the three "zombie" companies that exist today.

A grand compromise on carbon taxes

Arthur Pigou was an economist that pioneered the idea of a "Pigovian Tax" in that the government should tax "externalities", also known as negative side effects.  In economic terms the burning of fossil fuels creates costs beyond just the monetary cost of the fuel, namely the environmental cost of pollution and global warming and the military cost of maintaining the balance of power in the Middle East.  The economically efficient way to discourage the use of carbon fuels relative to "cleaner" fuels (from a carbon dioxide perspective) such as renewables and nuclear.  This is a theme that has been encouraged by Thomas Freidman at the New York Times, where he has been relentlessly promoting a high gas tax to make us live in a more environmentally-responsible manner.

Of course, any national-level politician that proposed just jacking up the gas tax would lose in a landslide.  Such a tax would be regressive and hurt lower income people the most.  The other downside to a high carbon tax is that until fossil fuels were replaced with other forms of energy it would discourage certain forms of business activity in the US, particularly manufacturing and transportation.

So the compromise I propose is simple.  I start with the assumption that we want to wean ourselves off petroleum and coal and move toward alternatives and nuclear.  I also assume that the change would need to be gradual so we don’t jam a stick in the spokes of the economy.  I also must give the caveat that I have done none of the math to know what my proposal means in dollars…I just assume it’s done in a way that’s revenue neutral.

Thus, I propose the following: over 15 years phase in a carbon tax while phasing out the payroll tax (a regressive income tax) and the corporate tax.  In other words, instead of using the tax code in a way that taxes labor and discourages corporate investment, use the tax code to encourage energy efficiency and to encourage companies to locate business activity in the United States.