No Bottom-Line Responsibility = Financial Crisis

Cities, states and countries are now facing serious fiscal problems which arise from the simple fact that public managers face no bottom-line accountability. Managers, with horizons driven by election cycles, not the longer term interests of the “company,” too easily cave in to special interests and public pressure. When the garbage collectors go on strike, the pressure on city politicians to settle is strong indeed. Over the past few decades, government has grown in size and largess.

In California, prison guards and highway patrol officers earn up to $100,000 a year (with overtime) and can retire as early as age 50 with a benefit that can reach 90 percent of income [The Economist, February 27, 2010, page 38]. Even in small cities, pay and retirement packages for government workers far exceed comparable jobs in the private sector.

In Greece, the retirement age is 61 and the retirement benefit is 80 percent or more of the last pay earned for public and private workers (and they receive 14 “monthly” paychecks per year).[Financial Times, March 1, 2010, page 10]. These stories are replete in city after city, state after state and country after country. Private companies cannot survive such mismanagement. General Motors is a classic example.

Over the decades, the UAW, with pressure from government to avoid strikes and promises of protectionism, helped destroy the company. The bottom line was terrible, but politics trumped rationality, and GM is now a government-owned enterprise. Taxpayers will never recover their (involuntary) “investment” in GM which many feel should have been allowed to go through a structured bankruptcy that would have kept what was good and shed the units and contracts that guaranteed that GM would remain unprofitable in a competitive market. This administration has made clear its intent to support public and private unions in spite of these growing problems.

Add to this extended periods of cheap and easy credit which further lowers the cost of caving in to pressure and the stage is set for the fiscal disasters we face today. The larger the role of government in a country, the larger the potential for inefficiency and mismanagement, corruption and graft. Government entities avoid “bankruptcy” by taking an ever-rising share of private-sector income, but even this has it limits as we are about to discover (40 percent of tax filers don’t pay any tax).

In Defense of Chirpy Forecasts

The March 30 edition of Newsweek had an article by Kenneth Rogoff and Carmen Reinhart entitled, “Don’t Buy the Chirpy Forecasts.” He’s a professor at Harvard and a former, well-regarded chief economist for the IMF. She’s a professor at Maryland. They have a forthcoming book, This Time Is Different: Eight Centuries of Financial Folly, which sounds interesting. Related work can be found on Rogoff’s Harvard faculty contact page.

Here’s their main point: “The recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11-12 percent in 2011.”

As you know, I put a great deal of emphasis on historical precedents. My favorite book on this subject remains Manias, Panics, and Crashes. Reading it should convince you that we’ll only have such a dire outcome if policymakers make mistakes as bad as those their predecessors made after the Panic of 1907 (the Federal Reserve System
wasn’t created until December 1913) or in 1929-1932 (there was no bank deposit insurance, the Fed allowed the money supply to shrink by 1/3, Congress enacted the catastrophic Smoot-Hawley tariff and kept raising taxes as government revenues declined). Click here to read the full post and comment (Insights subscribers) »