Simon Johnson's Blog, page 40

Jim Yong Kim For The World Bank

By Simon Johnson, co-author of White House Burning

A decision on choosing the next president of the World Bank is expected this week – perhaps as early as Monday.  The Obama administration nominated Jim Yong Kim, president of Dartmouth College and a noted public health expert.  The reaction to this nomination from development economists and people experienced in the business of lending to poor countries has been overwhelmingly negative.

They are making a big mistake.  Mr. Kim would make an excellent World Bank president.

There are three issues.  First, should the president of the World Bank continue to be an American?  Second, should this position be held by someone with a primary background in economics and finance?  Third, should this job go to a person – like Mr. Kim – who has specialized on public health?

The job of running the World Bank should not necessarily go to an American – just as the job of Managing Director at the International Monetary Fund should not be presumed to go to a European.  The divvying up of these important positions is a de facto arrangement that became established in the 1940s and 1950s, but it has really outlived its appropriateness.

There should be an open competition for both positions – and Mr. Kim faces appropriately strong competition from Ngozi Okonjo-Iweala, a well-respected Nigerian finance minister and former senior official at the World Bank.

There is no question that the White House wants this job to go to an American, mostly because no administration likes to be the one to give up such prerogatives.  And gone are the days when anyone put  up by the United States would necessarily be chosen – even the controversial Paul Wolfowitz went through with surprisingly little pushback, although he ran into trouble subsequently.

But Mr. Kim is a brilliant nomination, precisely because he is so far from the mold of standard World Bank presidents.  For a full write-up of his accomplishments, see this piece by Anjali Sastry and Rebecca Weintraub.  (Sastry is one of my colleagues at MIT, where she teaches a very successful course that integrates global health and management issues, follow her @anj_sas; Weintraub is a physician and prominent public health specialist.)

The World Bank does not need “more of the same” in terms of vision from its leadership.  Like it or not, the World Bank will continue to issue bonds and make loans to countries for infrastructure and other projects, typically at an interest rate that is somewhat below what is being charged by the private sector.  It will also try to raise donor funds that can be shared with very poor countries, preferably in a productive manner.

The World Bank will also continue to struggle having a profound impact on people’s lives with these standard development lending activities.  To understand this point, look at two books.  Bill Easterly’s The Elusive Quest for Growth is a brilliant account of what has gone wrong – repeatedly – with thinking about development, including but not limited to the World Bank.  Daron Acemoglu and Jim Robinson’s new bestseller, Why Nations Fail, provides all you need to know – and probably more than you can stomach – about why some countries stay so poor.  The very sad truth is that powerful people in some places do very well, in their own estimation, when the rest of the country remains in ruins.  And there is nothing the World Bank – or anyone else in development economics – can do to break through and share prosperity more broadly in those places.  (You can follow Easterly and Acmeoglu/Robinson on twitter: @bill_easterly and @WhyNationsFail; the conversation around @WhyNationsFail is particularly lively and informative at present.)

But public health is different.   In contrast to the lack luster performance of development economics over the past half century, public health intellectuals and officials have completely transformed health outcomes around the world.  This process started early in the 20th century but really picked up pace in the 1940s and 1950s (for more historical background and medical details, see “Disease and Development,” a 2007 paper co-authored with Daron Acemoglu.)

The very poorest people in the world did not participate fully in this global health transformation – partly because of the problems outlined in Why Nations Fail.  But leaders like Mr. Kim – and in fact Mr. Kim himself – are leading a second breakthrough, in which better health services are being delivered even to very poor people in some of the most difficult conditions imaginable.

There is a great deal more to be done.  The World Bank does good work supporting public health initiatives, but it could do much more.  If Mr. Kim becomes World Bank president – and preferably stays in that position for a decade – we should expect to see a great deal more progress.

The task now is to mobilize private donors, pharmaceutical companies, and officials in a robust coalition focusing on improving health and increasing life expectancy.  The mortality of children under the age of 5 is likely to be a top priority in that context.  Reducing maternal mortality should also get a great deal of attention.

All of this is completely achievable.  Public health has done well in the past half century.  We should provide more resources and encourage greater success.  Save and improve millions of lives.

Mr. Kim is exactly the right person to lead the next transformation of global health outcomes.

The Conventional Wisdom of Tax Reform

By James Kwak

In the Times this weekend, David Leonhardt has a generally good overview of the tax policy showdown that is scheduled for later this year, as the Bush tax cuts approach expiration on January 1. He outlines several of the central issues we face: “hypothetical solutions are a lot more popular than actual ones”; everyone says she wants tax reform, but the tax expenditures that would have to be eliminated are very popular; and any significant deficit solution will directly affect vast numbers of Americans.

I have a few differences with Leonhardt, however. First, after his colleagues David Brooks and James Stewart, he seems to have fallen briefly under the spell of Paul Ryan: “Mr. Ryan’s plan would cut the top rate to 25 percent, from 35 percent, and still leave overall tax collection roughly where it has been, by eliminating tax breaks.”

Paul Ryan has no tax reform plan. His bizarrely much-heralded “plan” is to cut tax rates to specific levels (25%, at the top end) and “broaden the tax base to keep revenue as a share of the economy at levels sufficient to fund critical missions that rightly belong in the domain of the federal government.” Nowhere does he say how he would broaden the tax base. This is a statement of an objective, not a plan.

As Leonhardt says, “What’s missing from these plans is any detail on which tax breaks would be eliminated”—which means they should be taken as political gambits, not as tax reform plans. A plan, like Domenici-Rivlin or chapter 7 of White House Burning, has to say what you would actually do, and Ryan fails that simple test.

More importantly, Leonhardt propagates a misleading framing of tax reform:

“The notion of tax reform also has widespread support from economists, liberal and conservative. As they define it, reform would reduce marginal tax rates while eliminating or reducing various tax breaks.”

There’s no definitional reason why tax reform has to reduce marginal rates. You could simplify the tax code and eliminate loopholes, reducing both administrative and compliance costs and economic distortions, without touching marginal rates. Sure, this would increase revenues. But it seems pretty obvious to me, as it would to a third grader, that if the problem is the budget deficit, then you want to increase revenues.

It’s also obvious to Daniel Shaviro, a leading tax professor who has been writing about deficits and tax reform for well over a decade.  From the abstract:

“First, if tax expenditures are properly viewed as spending through the tax code, a revenue neutrality norm in which the budgetary gain from their repeal ostensibly needs to be offset by rate cuts is intellectually incoherent. Second, the long-term U.S. fiscal gap makes rate-cutting, in particular for individuals, potentially imprudent. Third, if one wants to address rising high-end income concentration in the United States since 1986, the option of raising, rather than reducing, the top marginal income tax rates may need to be squarely considered.”

You may disagree with the third point, but the first two seem pretty irrefutable to me.

So why do people inside the Beltway reflexively equate tax reform with lower rates? It’s a political question, not a substantive policy one. Everyone knows that you can’t get any Republican votes for any bill that increases tax revenues. Ergo, there are only two ways tax reform could pass: either you make it revenue neutral—in which case you should admit that it will have no impact on the deficit—or you wait for (and campaign for) a Democratic sweep. Since doing the latter is “partisan” by definition, most wannabe centrists settle for the former. But it is certainly not correct to say that “liberal” economists define tax reform as rate reduction.

The other problem with revenue-neutral tax reform is that it presumes that the overall tax level set by the Bush tax cuts—lowered from the 1997 budget bill, itself lowered from the 1993 budget bill—is the right one. Revenue-neutral tax reform would make permanent a set of huge tax cuts that were passed (a) when the budget was almost in balance, (b) before the huge expense of the Iraq War, and (c) before the financial crisis and ensuing recession. Those tax cuts are due to expire precisely because the Bush administration could not find sixty votes in the Senate for them, and had to use reconciliation. If we’re going to aim for revenue neutrality—even though, as Shaviro points out, the concept doesn’t make sense because of the tax expenditure phenomenon—there’s no compelling reason why current tax rates should be the baseline rather than current tax law, in which we revert to 1997 rates on January 1.

The problem is that the conventional wisdom inside the Beltway is that tax reform means rate reductions to achieve revenue neutrality at Bush levels. If people believe that, Grover Norquist has already won.

How The Banks Stole Medicare

By Simon Johnson

The world’s largest banks have been accused of many things in recent years, including taking excessive risk in the run-up to 2008, doing great damage to the American economy by blowing themselves up and then working hard to resist any sensible notions of financial reform.

All of this is true, but it misses what is likely to be the most profound negative impact of the banks’ behavior on most Americans. The banks’ actions led directly to an increase in government debt, which in turn has made the reduction of that debt by “cutting runaway spending” a centerpiece of the Republican presidential campaign to date.

As a result of this pressure, Medicare now stands on the brink of being eliminated as a viable form of social insurance. Yet the executives who lead these banks – and the politicians with whom they work closely – will not be held accountable this election season.

How is this possible? The economic mechanism through which a bank-led financial crisis has a broader adverse fiscal impact is straightforward. The recession that deepened sharply in 2008 implied a deep loss of tax revenue, mostly because people lost their jobs. Lower revenue means larger government deficits, particularly when the government also provides unemployment insurance. This deficit implies a surge in government annual borrowing and in its stock of debt.

The Congressional Budget Office estimates that the total increase in federal government debt because of the severe financial crisis will end up around 50 percent of gross domestic product. Let’s call that $7.5 trillion in today’s money (our G.D.P. per year is currently around $15 trillion).

Here’s how that calculation works. In January 2008, when almost no one expected a financial disaster, the C.B.O. forecast that by 2018 federal government debt would be just over 20 percent of G.D.P. Once the severity of the problems brought on by the credit contraction after the collapse of Lehman in September 2008 became clear, the C.B.O. redid this medium-range forecast – now taking a view on what debt would be after a difficult economic recovery to trend growth.

In its forecast of August 2009, the C.B.O. expected that debt would reach nearly 70 percent of G.D.P. in 2018. The change in this C.B.O. forecast for 2018 – to 70 percent of G.D.P. from 20 percent – is the likely total fiscal impact of the 2008 crisis and deep recession.

To be clear, there was already a potential fiscal issue looming in the distance, in the 2020s and beyond – with the retirement of the baby boomers, increase in life expectancy and, most of all, our collective failure to control health-care spending.

But until 2008 we had time to deal with this – and gradual solutions seemed most likely, preferably including ways to control the growth of health-care spending more broadly across the economy.

But the perception of a “fiscal crisis” brought the longer-run budget issues forward in time and the jump in government debt created a sense of panic in some quarters, so measures to “fix” the budget in a dramatic fashion are now on the front burner in Washington.

Ironically, although the main reason for the recent increase in public debt was the financial crisis, brought on by extreme deregulation, the situation has strengthened the hand of people who want, above all, to cut spending.

Medicare had been in the sights of conservatives for some time, but providing health care for Americans at age 65 is a very popular program, and with good reason. Before Medicare was created, it was very hard for people in their 70s, 80, and 90s to buy health insurance. If Medicare were to end, the adverse impact on older Americans with limited resources, including almost everyone who is not very wealthy, would be significant.

Yet that is what those committed to reducing the size of government and its programs are prepared to do. Whether they can convert this popular theme in the Republican primaries into political momentum that carries through the general election and gives the G.O.P. the presidency and control of Congress remains to be seen.

It is not surprising Paul D. Ryan, Republican of Wisconsin and chairman of the House Budget Committee, is suggesting that we effectively eliminate Medicare over the next decade or so (for the details of how this would happen, see this piece by my colleague James Kwak, drawing on the analysis of the C.B.O.).  The New York Times reports,

“Medicare would be turned into a subsidized set of private insurance plans, with the option of buying into the existing fee-for-service program. The annual growth of those subsidies would be capped just above economic growth, well below the current health care inflation rate.”

The surprise should be that his proposal is being so warmly welcomed by many people who see themselves as centrists in American politics; in the past they would have been more skeptical.

It does not have to be this way. Social insurance programs like Medicare can be kept in place at the same time as the federal budget is brought under control. To be sure, we need to adjust Medicare’s terms and some features of how it operates, but moderate and gradual changes would be sufficient, along with returning tax rates to where they were in the mid-1990s.  (In Chapter 7 of White House Burning, we propose one way to do exactly this.)

Few people want to engage with this issue in a substantive way. The right is focused on not raising tax revenue. The left wants to protect Medicare and Social Security but for the most part does not discuss the details of how this can be done while limiting debt relative to G.D.P. over the next two decades.

This is a tactical mistake, opening those on the left to charges of fiscal irresponsibility. In fact, it was the administration of George W. Bush that oversaw big tax cuts, two foreign wars and a runaway banking system.

Part of the problem is that the Obama administration saved the failing big banks in 2009 and then defended them against being broken up in 2010 – the president’s top advisers consistently asserted that we need highly leveraged and very large financial institutions, irrespective of the damage they cause.

It will be very hard for the president to change his narrative at this point.

And it may be too late; many in the center have become enamored of Mr. Ryan, who also appeals to the Republican base and may even become Mitt Romney’s vice-presidential running mate. Certainly his ideas are likely to become a prominent part of the Republican platform for the general election.

In financial crises, it is people at the bottom of income distribution who end up being hurt; most of the rich do fine. When I made this point in “The Quiet Coup” in April 2009, some commentators shrugged off the comparison of the United States and emerging markets that had experienced crises, such as Russia or Indonesia or Brazil.

Surely, they argued, the United States had a much stronger democracy. But while the precise mechanism differs across countries, the link from financial elite misbehavior to squeezing the lower half of society is present everywhere. In the United States, it most likely will take the form of ending Medicare.

To many people, the financial crisis of 2008 seems but a distant memory. If you kept your job or found another, you might feel that the adverse consequences are behind you.

That would be a mistake. The worst is yet to come. When you are 85 and cannot afford decent health care, think about the banks.

An edited version of this post appeared yesterday morning on the NYT.com’s Economix blog; it is used here with permission.  If you would like to reproduce this material in full, please contact the New York Times.

The Incredible, Magically Metamorphosing Taxpayer-Subsidized Executive Perk

By James Kwak

Once upon a time, the story goes, corporate America was fat and happy. Top executives worked in palatial office suites bedecked with flowers, flew everywhere in private jets, and ate every meal at the Four Seasons or Le Bernardin.

Then there was the shareholder value revolution. Michael Jensen and the rest of the Chicago School efficient-market legions showed that shareholder value was the only thing that mattered and stock prices were the only measure of shareholder value. Activist investors demanded an end to executive perks and ushered in the era of pay for performance, in which executives are paid in stock options, so they only make (a lot of) money if shareholders make money. Congress event went along by capping the tax-deductible amount of executives' base pay, which helped along the shift to stock-based compensation.

We know how one side of this deal has turned out. Executives are paid largely in stock, which has produced a vast increase in total compensation. But pliant boards and captured compensation consultants have figured out all sorts of ways to ensure huge paydays regardless of performance, some illegal (backdated stock options) and others legal (simply repricing options when the stock falls).

What about the other side? Are executive perks—paid for by shareholders, remember—a thing of the past?

Apparently not. It turns out that having the company pay for the private jet—even the private house, in some cases—is too tempting for CEOs to lay off. Not only that, as Steven Davidoff writes, CEOs have figured out a way to get taxpayers to subsidize their royal lifestyles. Ordinarily, if a company pays for an executive's personal travel on a corporate or other private jet (just like any other personal travel), the value of that travel is counted as income for tax purposes. But:

"If an outside security consultant determines that executives need a private jet and other services for their safety, the Internal Revenue Service cuts corporate chieftains a break. In such cases, the chief executive will pay a reduced tax bill or sometimes no tax at all.

"Even when tax is due, the company sometimes takes care of it."

Now, I understand that sometimes it makes sense for executives to fly on corporate or chartered jets for business. That's a tax-deductible business expense. No problem there.

If a company wants to go out of its way to let the CEO take the corporate jet on vacation, that's income, pure and simple. It might be justified on the grounds that if the company didn't pay for the jet, then the CEO would demand more compensation in other forms. That's just a classic corporate governance question.

But in this case, it's highly likely that the company is paying for the jet because of the tax break. Think about it. If you're the CEO, which would you rather have, use of the jet or cash? Rationally speaking, you should prefer the cash, since you could (a) fly first-class commercial and pocket the difference or (b) fly NetJets and pocket the difference. This is a case where the executive perk exists because of the arbitrage opportunity created by the tax code: companies have found a way to get taxpayers to pick up part of the tab for their executives' lifestyles.

This tax season, this seems to me something that all of us could get mad about.

Public Service: Why Nations Fail Crib Notes

By James Kwak

I'm reviewing Why Nations Fail for a print publication, so I'm out of basic courtesy I'm not going to preempt my review here. But if you're like me and not an expert in the history of every part of the world, sometime around page 250 you probably got confused about where Acemoglu and Robinson discussed the Kingdom of Aksum as opposed to early modern Ethiopia or the Kuba Kingdom as opposed to the Kingdom of Kongo. After a while I created my own crib sheet, which I reproduce here for those who may find it helpful.

1. So Close and Yet So Different: Spanish Conquest, Jamestown, Mexico (19th century)

2. Theories That Don't Work

3. The Making of Prosperity and Poverty: Korea, Kingdom of Kongo

4. Small Differences and Critical Junctures: The Weight of History: Black Death (14th century), early modern Western Europe

5. "I've Seen the Future and It Works": Growth Under Extractive Institutions: USSR, Kuba Kingdom, Neolithic Revolution, Mayas

6. Drifting Apart: Venice, ancient Rome, Kingdom of Aksum (Ethiopia)

7. The Turning Point: England (17th-18th centuries)

8. Not on Our Turf: Barriers to Development: Spain, Austria-Hungary and Russia, China, Ethiopia, Somalia

9. Reversing Development: Dutch East Indies, Central Africa

10. The Diffusion of Prosperity: Australia, French Revolution, Japan

11. The Virtuous Circle: Great Britain, United States (Progressive movement and 1930s), Argentina

12. The Vicious Circle: Sierra Leone, Guatemala, American South, Ethiopia

13. Why Nations Fail Today: Zimbabwe, Sierra Leone, Clombia, Argentina, North Korea, Uzbekistan, Egypt

14. Breaking the Mold: Botswana, American South, China

15. Understanding Prosperity and Poverty: China, Brazil

White House Burning Open Thread

By James Kwak

Now that the book has been available for a week, I imagine at least two or three people have started reading it. This post is for people to discuss the book if they are so inclined.

If you want to hear Simon discussing the book, the book website has a page of links to past media appearances. Several are the five-minute cable news variety, but for in-depth interviews there are Fresh Air and Leonard Lopate, among others.

This Must Be a Joke

By James Kwak

From the Times article on President Obama's signing of the JOBS Act (emphasis added):

While soliciting investment funds online has triggered fears of fraudulent schemes, the law's backers said the greater availability of information through social media sites like Facebook would allow would-be investors to conduct their own background checks, making it difficult for such schemes to succeed.

"While it seems reasonable to worry about these issues, there is just so much more information these days," said Timothy Rowe, the chief executive of the Cambridge Innovation Center, which provides office space for start-up firms next to the campus of the Massachusetts Institute of Technology.

The thing speaks for itself.

(True, the phrase "social media sites like Facebook" is paraphrase from the reporter, not a direct quotation, but I have no reason to believe it isn't an accurate representation of what the act's backers said.)

Someone Is Wrong In The Times*

By James Kwak

James Stewart has doubled down on his infatuation with Paul Ryan. Ryan's budget, he says, is a viable centrist starting point for budget negotiations, and attacks from "left and right" are mere "partisan rhetoric."

This is several different kinds of crazy. First, Stewart repeats his belief that Ryan's plan would increase taxes on investment income. But that belief has no basis other than Stewart's own belief that it would be a good idea. As I pointed out before, Ryan's own budget argues against raising taxes on capital gains and dividends. The only thing Stewart can find is Ryan's apple-pie platitudes about the need for tax reform. But Ryan's own vision of tax reform, as evidenced by his budget's own words, doesn't include higher capital gains taxes. (In addition, as a signatory to the Taxpayer Protection Pledge, Ryan is sworn to "oppose any and all efforts to increase the marginal income tax rate for individuals and business." That sounds to me like it includes the capital gains tax rate, which is a marginal income rate.) This is further evidence of columnists' ability to project their own fantasies onto Paul Ryan's handsome face.

More generally, Stewart pins high hopes on Ryan's embrace of tax reform. But all Ryan's budget actually says about tax reform can be summed up in two points: tax reform is good; and tax rates should be lower (25 percent for the top individual rate and for the top corporate rate, both down from 35 percent today). This of course allows credulous people to see themselves in Paul's blue eyes (see above). But if you want a serious starting point for tax reform, you should look at Simpson-Bowles or Domenici-Rivlin, both of which spelled out actual tax expenditures they would close (or Feldstein, Feenberg, and MacGuineas, or White House Burning, or any one of many other policy proposals that do the same). Ryan's "tax reform" is nothing more than a few talking points designed to score political points (why else would you specify the lower tax rates but not the closed loopholes), not a starting point for anything.

Stewart also plays the "centrist" card with unprecedented aggressiveness. He cites attacks by the Club for Growth as proof of Ryan's reasonableness. But when it comes to military spending, the Club for Growth isn't attacking Ryan from the right; it's attacking him from the left. Democrats want to reduce military spending as a share of GDP; so does every bipartisan deficit reduction panel; so does the Club for Growth (which thinks that the automatic spending cuts in the Budget Control Act should be respected). Ryan, by undoing the automatic spending cuts to preserve defense spending, is to the right of the budget debate, not in the center. In other words, everyone knows that if you want to reduce the deficit you have to cut defense spending—except Paul Ryan and James Stewart.

Then there's Medicare, one of the few areas where Ryan is willing to spell out his cost-cutting proposals. For Stewart, this shows that Ryan is a brave warrior against entitlement spending. But simply tackling entitlement spending doesn't make you reasonable, centrist, or worth listening to; everyone who talks about the deficit talks about tackling entitlement spending. (Even Simon and I do, although our entitlement cuts are smaller than most other people's.) It's the actual proposal that matters. And Ryan's proposal is only one step from the far-right fringe—that's the step he walked back since last year.

Last year he was going to convert Medicare into a voucher program where you could use your voucher toward insurance from a private company, but the value of the voucher was artificially capped so it would buy less and less health care over time. This year the only difference is that now you can buy insurance from a private company or from traditional Medicare. But in either case, the important points are: (a) the vouchers are designed to grow more slowly than the cost of health care, meaning a huge transfer of cost and risk from the government to individuals; and (b) reliance on the private market to reduce costs and improve outcomes (something it's failed at dismally for the last forty years). Having a Medicare plan shouldn't win you any points; it's what's in the plan that matters. At least for most of us.

This inattention to actual policy is how Stewart can think that "within the Ryan budget proposal is the outline of a grand compromise not all that different from the one President Obama and the House majority leader, John Boehner, reportedly came close to reaching last summer: long-term deficit reduction through tax reform, higher tax revenue and spending cuts." Well, yes, if you're going to stick to the level of abstract generalities, I guess the Ryan budget is similar to the Obama-Boehner deal in that both included tax reform and spending cuts.

In practice, though, the Obama-Boehner deal was nothing like the Ryan budget. We know the tax reform was completely different because Boehner was offering higher tax revenues that were not entirely due to supply-side fantasies. Ryan only achieves higher tax revenues by dictating that his plan will bring in 19 percent of GDP in tax revenue; nowhere does he say how we would actually achieve this while slashing tax rates. We also know the spending cuts were completely different, because Obama-Boehner did not convert Medicare to a voucher system (they did include spending cuts, but they kept the same benefit structure), while Ryan does.

Finally, here's one more way to think about the Ryan budget:

This picture shows all government spending except for Medicare, Medicaid, CHIP, Social Security, and net interest. (The data are from Tables 1.1, 1.2, 3.1, and 8.5 of the OMB's 2012 budget, historical tables.) It's a close approximation for discretionary spending, and it's what the CBO uses in its long-term projections. The Ryan Budget would reduce spending on everything except Social Security and health care to the lowest levels since before the Great Depression.

Furthermore, those numbers include defense spending. Since Ryan's budget proposes to protect military spending from the automatic cuts in the Budget Control Act, I think it's fair to assume that he won't want to cut defense spending to historical lows. Since World War II, defense spending has never fallen below 3.0 percent of GDP. Assuming that defense spending never falls below that level, you get this picture:

This is a blatant assault on the entire federal government except for health care, Social Security, and defense. This is not a courageous, centrist starting point for a real deficit solution.

* See XKCD.

The Impossibility of Defense Cuts

By James Kwak

Apparently the thing we need to keep ourselves safe is a fast, lightweight ship that can sweep mines, launch helicopters, fight submarines, and perform other assorted duties—but can't withstand heavy combat. I don't claim to know if we really need the Littoral Combat Ship to ensure our national security. According to an article in the Times, John McCain—the Republican Party's last presidential nominees and one of the Navy's more famous veterans—is critical, although other Republicans and the administration are in favor of it.

I do know that the Littoral Combat Ship is a classic example of why it's so hard to reduce budget deficits. You have local politicians who want the jobs. You have a large group of representatives who are reflexively pro-military and will vote for anything the Pentagon wants, and even things the Pentagon doesn't want. (You have Mitt Romney, who bemoans the fact that the Navy has only 285 ships, the fewest since 1917. Would he rather have the Royal Navy of 1812, which had 1,000 ships, or our navy, with eleven aircraft carrier groups—while no other country has more than one?) You have a procurement and development process that stretches on for years so that even when a weapons system turns out to be a dud, it has to be kept alive because it's too big to fail—there is no other alternative. Both the Center for American Progress and the Project on Governmental Oversight have recommended cutbacks in the Littoral program. Yet there is no practical way to check its momentum.

An even better example is the V-22 Osprey vertical-takeoff plane, which the Times profiled late last year. Even renowned insider Dick Cheney opposed the Osprey when he was secretary of defense, to no avail. Not only CAP and the Project on Governmental Oversight called for Osprey cutbacks, but so did Simpson-Bowles and the arch-conservative (and generally principled) Senator Tom Coburn. In short, just about anyone who cares about the budget wants to cut back on the Osprey. Will it happen? Well, the Paul Ryan budget reverses the automatic defense spending cuts, so we know what he thinks about it. And I'm sure the Osprey has plenty of fans in the administration and the Democratic caucus as well.

In the end, defense spending plays out the same way as Social Security. If you want to reduce government spending, you obviously have to reduce defense spending: it's basically the second biggest part of the budget after Social Security. But it's almost impossible to cut any actual defense spending. Apparently politicians don't realize that a whole is equal to the sum of its parts. Or they do realize it, and they hope that we don't.

One of our core political problems, as we discuss in White House Burning, is that it pays for politicians to take noisy stands against the whole while protecting (or increasing) each individual part. It seems so easy to get away with it—why would they ever stop?

Something for Nothing?

By James Kwak

The so-called JOBS act is a victory of faith over basic logic. The motivating idea seems to be that if we reduce the regulations that govern the process of raising capital, small companies will find it easier to raise money, and that money will translate into jobs. Many people have pointed out some of the problems with the bill: recently, for example, Andrew Ross Sorkin highlighted the potential for companies to take advantage of investors, and Steven Davidoff pointed out that regulation is probably not the reason for the decline in the number of small company IPOs.

There are a couple of more fundamental misunderstanding I want to focus on, however. First, it's not clear that relaxing regulations will actually make it cheaper for companies to raise money. Sure, eliminating the independent audit requirement will save companies a few bucks. But what really affects the cost of capital is not out-of-pocket fees but the price that investors are willing to pay for equity. The less confidence that investors have in a company's prospects, the cheaper that company will have to sell its stock. If small companies are allowed to provide less information to investors, that could simply make it more expensive for them to raise money.

Second, and more important, it is definitely not true that more capital for everyone is always a good thing. The point of the financial system is to allocate capital to its most productive uses. The housing bubble, if nothing else, should have convinced us of that point. There are plenty of startups that are are risky and should face a high cost of capital; there are plenty of others that have no business raising money at all. (Think back to the Internet bubble, for example.) Making it easier for such companies to raise money is a bad thing, not a good thing. From a public policy perspective, making it easier for small companies to dodge reporting requirements and thereby raise money from gullible investors is no better than raising taxes and having the government loan the proceeds to small companies with political connections: in either case, you're mucking around with the ordinary process of capital allocation.

Two more points on this topic: Relaxed reporting requirements can actually be bad for good companies. Good companies benefit from tougher disclosures because it makes it possible for them to differentiate themselves from bad companies. The effect of the JOBS Act will be to divert capital from good companies to bad companies, since investors will find it harder to tell the difference. (Or, in a best-case scenario, good companies will voluntarily comply with the old requirements in order to differentiate themselves—in which case the JOBS Act will have done nothing.)

In addition, the JOBS Act has reporting standards precisely backward. If you're going to have different standards for large and small companies, the requirements for small companies should be higher. One theory of securities markets is that regulation is unnecessary because market participants will police issuers—basically by studying them very carefully. I have doubts about this theory, but it is certainly more true for large companies, which get tons of attention from institutional investors, than for small ones. Sure, if you don't require independent audits, you could have fraud in any size company. But you are probably going to find it in a big company simply because so many more people will be looking at it more closely.

It is possible that, on balance, our current system includes too many regulations. I don't think so—because it is precisely those regulations that encourage broad participation in the markets, which is what lowers the cost of capital for everyone—but that's a plausible argument. But less regulation does not automatically mean provide more capital for investment—nor is more capital for small companies always a good thing.