I haven't yet found any evidence anywhere that suggests that the classical liberal model – where practiced – can go wrong. So I was interested in this alleged counter-example.
It appears that unions in the USA have, over the past twenty years, demanded unbelievable pension and other benefits for their members. The General Motors case is widely known, but the case of socialist public sector unions is not so widely known. This article throws light on the greed of these unions.
How does any of this affect the theory of classical liberalism? Well this is THE PRECISE OPPOSITE of the classical liberal view. The classical liberal KNOW that there is no free lunch. There must therefore be significant frugality and accountability in government. What has happened in the USA is the OPPOSITE of capitalism. Loot by public sector employees is not capitalism. It is a case of severe government failure.
I talk about MINIMAL government, and outcomes based remuneration systems. None of this is in evidence in this article.
So this is not at an example of "capitalism" but an example of "crapitalism", in this case severe government failure attributable to socialist trade unions.
As usual, socialism DESTROYS. And wherever socialism has found its way into the American system, it has caused mammoth destruction.
By Michael Lewis, Vanity Fair, November 2011
(Sanjeev: The article is very long, so I've extracted key sections below and highlighted key issues)
The smart money says the U.S. economy will splinter, with some states thriving, some states not.
On August 5, 2011, moments after the U.S. government watched a rating agency lower its credit rating for the first time in American history, the market for U.S. Treasury bonds soared. The shakier the United States government appeared, up to some faraway point, the more cheaply it would be able to borrow. The fear that the United States might actually not pay back the money it had borrowed was still unreal.
On December 14, 2010, in 60 Minutes Steve Kroft interviewed Meredith Whitney [who] noted that U.S. state and local governments faced a collective annual deficit of roughly half a trillion dollars, adding that another trillion-dollar gap existed between what the governments owed retired workers and the money they had on hand to pay them. The bill owed by American states to retired American workers was so large that it couldn’t be paid, whatever the amount.
At the end of the piece, Kroft asked Whitney what she thought about the ability and willingness of the American states to repay their debts. She didn’t see a real risk that the states would default, because the states had the ability to push their problems down to counties and cities. But at these lower levels of government, where American life was lived, she thought there would be serious problems.
Meredith Whitney had found the pressure point in American finance: the fear that American cities would not pay back the money they had borrowed.
[S]he had come to view the U.S. national economy as a collection of regional economies. To understand the regional economies, she had to understand how state and local governments were likely to behave, and to understand this she needed to understand their finances. Thus she had spent two unlikely years researching state and local finance. How it started was with a question: How can G.D.P. [gross domestic product] estimates be so high when the states that outperformed the U.S. economy during the boom were now underperforming the U.S. economy—and they were 22 percent of that economy?” It was a good question.
From 2002 to 2008, the states had piled up debts right alongside their citizens’: their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion. In response, perhaps, the pension money that they had set aside was invested in ever riskier assets. In 1980 only 23 percent of state pension money had been invested in the stock market; by 2008 the number had risen to 60 percent. To top it off, these pension funds were pretty much all assuming they could earn 8 percent on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero. Toss in underfunded health-care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you were looking at multi-trillion-dollar holes that could be dealt with in only one of two ways: massive cutbacks in public services or a default—or both. Whitney thought default unlikely, at least at the state level, because the state could bleed the cities of money to pay off its bonds. The cities were where the pain would be felt most intensely.
The country, she thought, might organize itself increasingly into zones of financial security and zones of financial crisis. And the more clearly people understood which zones were which, the more friction there would be between the two. (“Indiana is going to be like, ‘N.F.W. I’m bailing out New Jersey.’”) As more and more people grasped which places had serious financial problems and which did not, the problems would only increase. “Those who have money and can move do so,” Whitney wrote in her report to her Wall Street clients, “those without money and who cannot move do not, and ultimately rely more on state and local assistance. It becomes effectively a ‘tragedy of the commons.’”
In the process she had, in effect, unearthed America’s scariest financial places.
“So what’s the scariest state?” I asked her.
She had to think for only about two seconds.
California Iron Man
[Arnold Schwarzenegger’s] view of his seven years trying to run the state of California can be summarized as follows. At his core he thought government had become more problem than solution: an institution run less for the benefit of the people than for the benefit of politicians and other public employees. He behaved pretty much as Americans seem to imagine the ideal politician should behave: he made bold decisions without looking at polls; he didn’t sell favors; he treated his opponents fairly; he was quick to acknowledge his mistakes and to learn from them; and so on. He was the rare elected official who believed, with some reason, that he had nothing to lose, and behaved accordingly. When presented with the chance to pursue an agenda that violated his own narrow political self-interest for the sake of the public interest, he tended to leap at it.
Two years into his tenure, in mid-2005, he’d tried everything he could think of to persuade individual California state legislators to vote against the short-term desires of their constituents for the greater long-term good of all. “To me there were shocking moments,” he says. “When you want to do pension reform for the prison guards,” he says, “and all of a sudden the Republicans are all lined up against you. It was really incredible, and it happened over and over: people would say to me, ‘Yes, this is the best idea! I would love to vote for it! But if I vote for it some interest group is going to be angry with me, so I won’t do it.’ I couldn’t believe people could actually say that. You have soldiers dying in Iraq and Afghanistan, and they didn’t want to risk their political lives by doing the right thing.”
He came into office with boundless faith in the American people—after all, they had elected him—and figured he could always appeal directly to them. That was his trump card, and he played it. In November 2005 he called a special election that sought votes on four reforms: limiting state spending, putting an end to the gerrymandering of legislative districts, limiting public-employee-union spending on elections, and lengthening the time it took for public-school teachers to get tenure. All four propositions addressed, directly or indirectly, the state’s large and growing financial mess. All four were defeated; the votes weren’t even close. From then until the end of his time in office he was effectively gelded: the legislators now knew that the people who had elected them to behave exactly the way they were already behaving were not going to undermine them when appealed to directly. The people of California might be irresponsible, but at least they were consistent.
Home of the Free . . . Lunch
A compelling book called California Crackup describes this problem more generally. Joe Mathews and Mark Paul explain why Arnold Schwarzenegger’s experience as governor was going to be unlike any other experience in his career: he was never going to win.
California had organized itself, not accidentally, into highly partisan legislative districts. It elected highly partisan people to office and then required these people to reach a two-thirds majority to enact any new tax or meddle with big spending decisions. On the off chance that they found some common ground, it could be pulled out from under them by voters through the initiative process. Throw in term limits—no elected official now serves in California government long enough to fully understand it—and you have a recipe for generating maximum contempt for elected officials.
Politicians are elected to get things done and are prevented by the system from doing it, leading the people to grow even more disgusted with them. “The vicious cycle of contempt,” as Mark Paul calls it. California state government was designed mainly to maximize the likelihood that voters will continue to despise the people they elect.
But when you look below the surface, he adds, the system is actually very good at giving Californians what they want. “What all the polls show,” says Paul, “is that people want services and not to pay for them. And that’s exactly what they have now got.” As much as they claimed to despise their government, the citizens of California shared its defining trait: a need for debt. The average Californian, in 2011, had debts of $78,000 against an income of $43,000. The behavior was unsustainable, but, in its way, for the people, it works brilliantly. For their leaders, even in the short term, it works less well. They ride into office on great false hopes and quickly discover they can do nothing to justify those hopes.
In Paul’s view, Arnold Schwarzenegger had been the best test to date of the notion that the problem with California politics was personal, that all the system needed to fix itself was an independent-minded leader willing to rise above petty politics and exert the will of the people. “The recall was, in and of itself, an effort by the people to say that a new governor—a different continued from page 183 person—could solve the problem,” says Paul. “He tried every different way of dealing with the crisis in services. He tried to act like a Republican. He tried to act like a Democrat. He tried making nice with the legislature. When that didn’t work he called them girlie men. When that didn’t work he went directly to the people. And the people voted against his proposals.”
The experiment wasn’t a complete failure. But on most issues, and on virtually everything having to do with how the state raised and spent money, he lost. In his first term Schwarzenegger had set out to cut spending and found he could cut only the things that the state actually needed. Near the end of his second term, he managed to pass a slight tax increase.
David Crane, the former economic adviser could itemize the result: The pensions of state employees ate up twice as much of the budget when Schwarzenegger left office as they had when he arrived, for instance. The officially recognized gap between what the state would owe its workers and what it had on hand to pay them was roughly $105 billion, but that, thanks to accounting gimmicks, was probably only about half the real number. “This year the state will directly spend $32 billion on employee pay and benefits, up 65 percent over the past 10 years,” says Crane later. “Compare that to state spending on higher education [down 5 percent], health and human services [up just 5 percent], and parks and recreation [flat], all crowded out in large part by fast-rising employment costs.”
In 2010, for instance, the state spent $6 billion on fewer than 30,000 guards and other prison-system employees. A prison guard who started his career at the age of 45 could retire after five years with a pension that very nearly equaled his former salary. The head parole psychiatrist for the California prison system was the state’s highest-paid public employee; in 2010 he’d made $838,706. The same fiscal year that the state spent $6 billion on prisons, it had invested just $4.7 billion in its higher education—that is, 33 campuses with 670,000 students. Over the past 30 years the state’s share of the budget for the University of California has fallen from 30 percent to 11 percent, and it is about to fall a lot more. In 1980 a Cal student paid $776 a year in tuition; in 2011 he pays $13,218. Everywhere you turn, the long-term future of the state is being sacrificed.
He’d come to power in the bust after the Internet bubble; he’d left in the bust after the housing bubble. It was in the middle of 2007, he said, when he first noticed something was not quite right in the California economy. He’d been finishing up budget negotiations and arrived at a number, however phony, where the budget could be declared balanced. An aide walked into his office to give him a heads-up: the tax receipts for that month were less than expected. “We were all of a sudden short $300 million in revenue for the month,” says Schwarzenegger. “I somehow felt, Uh-oh. Because there was something in the air.” Soon after that he visited the George W. Bush White House, where he gave a talk that was, as ever, upbeat. “At the end of it this guy—he was the guy who was in charge of housing, I forgot the name. Great guy. For some reason or other he was very honest with me. I don’t know why. He probably didn’t think I’d go out and blab, which I didn’t. He says, ‘That was a great speech you gave, but we’re heading to a major problem.’ I said, ‘What do you mean?’ He said, ‘I looked at some of the numbers, and it’s going to be ugly.’ That’s all he said. He wouldn’t elaborate.” A housing-price decline in the United States meant a housing-price collapse in California, and a housing-price collapse in California meant an economic collapse and a decline in tax revenues. “The next month our revenues came in short $600 million. By December we were short a billion.”
City of Broken Dreams
About an hour into the weekly meeting of the San Jose City Council, a mere handful of people are left to hear the San Jose city manager offer the latest bleak financial news: the state of California was clawing back tens of millions of dollars more, and “140 employees have been separated from the city.” (New times call for new euphemisms.) A pollster presents his finding that, no matter how the question is phrased, the citizens of San Jose are unlikely to approve any ballot measure that raises taxes. A numbers guy gets to his feet and explains that the investment returns in the city’s pension plan are not likely to be anything near as high as was assumed. In addition to there not being enough money in this particular pot to begin with, the pot is failing to expand as fast as everyone had hoped, and so the gap between what the city’s employees are entitled to and what will exist is even greater than previously imagined.
The relationship between the people and their money in California is such that you can pluck almost any city at random and enter a crisis.
San Jose has the highest per capita income of any city in the United States, after New York. It has the highest credit rating of any city in California with a population over 250,000. It is one of the few cities in America with a triple-A rating from Moody’s and Standard & Poor’s, but only because its bondholders have the power to compel the city to levy a tax on property owners to pay off the bonds. The city itself is not all that far from being bankrupt.
It’s late afternoon when I meet Mayor Chuck Reed in his office at the top of the city-hall tower. He’s got a problem so big that it overwhelms ordinary politics: the city owes so much more money to its employees than it can afford to pay that it could cut its debts in half and still wind up broke. “I did a calculation of cost per public employee,” he says as we settle in. “We’re not as bad as Greece, I don’t think.”
The problem, he explains “started in the 1990s with the Internet boom.” San Jose’s budget, like the budget of any city, turns on the pay of public-safety workers: the police and firefighters now eat 75 percent of all discretionary spending. The Internet boom created both great expectations for public employees and tax revenues to meet them.
In its negotiations with unions the city was required to submit to binding arbitration, which works for police officers and firefighters. Each side of any pay dispute makes its best offer, and a putatively neutral judge picks one of them. There is no meeting in the middle: the judge simply rules for one side or the other. The problem with binding arbitration for police officers and firefighters, says Reed, is that the judges are not neutral. “They tend to be labor lawyers who favor the unions,” he says. And what politician wants to spat publicly with police officers and firefighters?
Over the past decade the city of San Jose had repeatedly caved to the demands of its public-safety unions. In practice this meant that when the police or fire department of any neighboring city struck a better deal for itself, it became a fresh argument for improving the pay of San Jose police and fire fighters. “Our police and firefighters will earn more in retirement than they did when they were working,” says Reed.
When did we go from giving people sick leave to letting them accumulate it and cash it in for hundreds of thousands of dollars when they are done working? There’s a corruption here. It’s not just a financial corruption. It’s a corruption of the attitude of public service.”
He hands me a chart. It shows that the city’s pension costs when he first became interested in the subject were projected to run $73 million a year. This year they would be $245 million: pension and health-care costs of retired workers now are more than half the budget. In three years’ time pension costs alone would come to $400 million, though “if you were to adjust for real life expectancy it is more like $650 million.” Legally obliged to meet these costs, the city can respond only by cutting elsewhere. As a result, San Jose, once run by 7,450 city workers, was now being run by 5,400 city workers. The city was back to staffing levels of 1988, when it had a quarter of a million fewer residents. The remaining workers had taken a 10 percent pay cut; yet even that was not enough to offset the increase in the city’s pension liability. The city had closed its libraries three days a week.
By 2014, Reed had calculated, a city of a million people, the 10th-largest city in the United States, would be serviced by 1,600 public workers. The problem was going to grow worse until, as he put it, you get a single employee to service the entire city, presumably with a focus on paying pensions. At that point, if not before, the city would be nothing more than a vehicle to pay the retirement costs of its former workers. “It’s a mathematical inevitability.”
In his negotiations with the unions, the mayor has gotten nowhere. “I understand the police and firefighters,” he says. “They think, We’re the most important, and everyone else goes [gets fired] first.” The police union recently suggested to the mayor that he close the libraries for the other four days.
I ask him what the chances are that, in this pinch, he could raise taxes. He holds up a thumb and index finger: zero.
Living on the Default Line
Welcome to Vallejo, city of opportunity, reads the sign on the way in, but the shops that remain open display signs that say, we accept food stamps. Weeds surround abandoned businesses, and all traffic lights are set to permanently blink, which is a formality, as there are no longer any cops to police the streets. Vallejo is the one city in the Bay Area where you can park anywhere and not worry about getting a ticket, because there are no meter maids either. The windows of city hall are dark, but its front porch is a hive of activity. A young man in a backward baseball cap, sunglasses, and a new pair of Nike sneakers stands on a low wall and calls out an address:
“Nine hundred Cambridge Drive,” he says. “In Benicia.”
The people in the crowd below instantly begin bidding. From 2006 to 2010 the value of Vallejo real estate fell 66 percent. One in 16 homes in the city is in foreclosure. This is apparently the fire sale, but the characters involved are so shady and furtive that I can hardly believe it. I stop to ask what’s going on, but the bidders don’t want to talk. “Why would I tell you anything?” says a guy sitting in a Coleman folding chair. He obviously thinks he’s shrewd, and perhaps he is.
The lobby of city hall is completely empty. There’s a receptionist’s desk but no receptionist. Instead, there’s a sign: to foreclosure auctioneers and foreclosure bidders: please do not conduct business in the city hall lobby.
On the third floor I find the offices of the new city manager, Phil Batchelor, but when I walk in, there is no one in sight. It’s just a collection of empty cubicles. At length a woman appears and leads me to Batchelor himself. He’s in his 60s and, oddly enough, a published author. He’s written one book on how to raise children and another on how to face death. Both deliver an overtly Christian message, but he doesn’t come across as Evangelical; he comes across as sensible, and a little weary. His day job, before he retired, was running cities with financial difficulties. He came out of retirement to take this job, but only after the city council had asked him a few times. “The more you say no, the more determined they are to get you,” he says. His chief demand was not financial but social: he’d take the job only if the people on the city council ceased being nasty to one another and behaved civilly. He actually got that in writing, and they’ve kept their end of the bargain. “I’ve been in a lot of places that have been in a lot of trouble, but I’ve never seen anything like this,” he says. He then lays out what he finds unusual, beginning with the staffing levels. He’s now running the city, and he has a staff of one: I just met her. “When she goes out to the bathroom, she has to lock the [office] door,” he says, “because I’m in meetings, and we have no one else.”
Back in 2008, unable to come to terms with its many creditors, Vallejo declared bankruptcy. Eighty percent of the city’s budget—and the lion’s share of the claims that had thrown it into bankruptcy—were wrapped up in the pay and benefits of public-safety workers. Since the bankruptcy, the police and fire departments have been cut in half; some number of the citizens who came to Phil Batchelor’s office did so to say they no longer felt safe in their own homes. All other city services had been reduced effectively to zero. “Do you know that some cities actually pave their streets?” says Batchelor. “That’s not here.”
The people who had power in the society, and were charged with saving it from itself, had instead bled the society to death. The problem with police officers and firefighters isn’t a public-sector problem; it isn’t a problem with government; it’s a problem with the entire society. It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences. It’s not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They’d been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans.
Too Fat to Fly
The road out of Vallejo passes directly through the office of Dr. Peter Whybrow, a British neuroscientist at U.C.L.A. with a theory about American life. He thinks the dysfunction in America’s society is a by-product of America’s success. In academic papers and a popular book, American Mania, Whybrow argues, in effect, that human beings are neurologically ill-designed to be modern Americans. The human brain evolved over hundreds of thousands of years in an environment defined by scarcity. It was not designed, at least originally, for an environment of extreme abundance. “Human beings are wandering around with brains that are fabulously limited,” he says cheerfully. “We’ve got the core of the average lizard.” Wrapped around this reptilian core, he explains, is a mammalian layer (associated with maternal concern and social interaction), and around that is wrapped a third layer, which enables feats of memory and the capacity for abstract thought. “The only problem,” he says, “is our passions are still driven by the lizard core.
We are set up to acquire as much as we can of things we perceive as scarce, particularly sex, safety, and food.” Even a person on a diet who sensibly avoids coming face-to-face with a piece of chocolate cake will find it hard to control himself if the chocolate cake somehow finds him. Every pastry chef in America understands this, and now neuroscience does, too. “When faced with abundance, the brain’s ancient reward pathways are difficult to suppress,” says Whybrow. “In that moment the value of eating the chocolate cake exceeds the value of the diet. We cannot think down the road when we are faced with the chocolate cake.”
The richest society the world has ever seen has grown rich by devising better and better ways to give people what they want. The effect on the brain of lots of instant gratification is something like the effect on the right hand of cutting off the left: the more the lizard core is used the more dominant it becomes. “What we’re doing is minimizing the use of the part of the brain that lizards don’t have,” says Whybrow. “We’ve created physiological dysfunction. We have lost the ability to self-regulate, at all levels of the society. The $5 million you get paid at Goldman Sachs if you do whatever they ask you to do—that is the chocolate cake upgraded.”
The succession of financial bubbles, and the amassing of personal and public debt, Whybrow views as simply an expression of the lizard-brained way of life. A color-coded map of American personal indebtedness could be laid on top of the Centers for Disease Control’s color-coded map that illustrates the fantastic rise in rates of obesity across the United States since 1985 without disturbing the general pattern. The boom in trading activity in individual stock portfolios; the spread of legalized gambling; the rise of drug and alcohol addiction—it is all of a piece. Everywhere you turn you see Americans sacrifice their long-term interests for short-term rewards.
What happens when a society loses its ability to self-regulate, and insists on sacrificing its long-term interest for short-term rewards? How does the story end? “We could regulate ourselves if we chose to think about it,” Whybrow says. “But it does not appear that is what we are going to do.” Apart from that remote possibility, Whybrow imagines two outcomes. The first he illustrates with a true story, which might be called the parable of the pheasant. Last spring, on sabbatical from the University of Oxford, he was surprised to discover that he was able to rent an apartment inside Blenheim Palace, the Churchill family home. The previous winter at Blenheim had been harsh, and the pheasant hunters had been efficient; as a result, just a single pheasant had survived in the palace gardens. This bird had gained total control of a newly seeded field. Its intake of food, normally regulated by its environment, was now entirely unregulated: it could eat all it wanted, and it did. The pheasant grew so large that, when other birds challenged it for seed, it would simply frighten them away. The fat pheasant became a tourist attraction and even acquired a name: Henry. “Henry was the biggest pheasant anyone had ever seen,” says Whybrow. “Even after he got fat, he just ate and ate.” It didn’t take long before Henry was obese. He could still eat as much as he wanted, but he could no longer fly. Then one day he was gone: a fox ate him.
The other possible outcome was only slightly more hopeful: to hit bottom. To realize what has happened to us—because we have no other choice. “If we refuse to regulate ourselves, the only regulators are our environment,” says Whybrow, “and the way that environment deprives us.” For meaningful change to occur, in other words, we need the environment to administer the necessary level of pain.
In August 2011, the same week that Standard & Poor’s downgraded the debt of the United States government, a judge approved the bankruptcy plan for Vallejo, California. Vallejo’s creditors ended up with 5 cents on the dollar, public employees with something like 20 and 30 cents on the dollar. The city no longer received any rating at all from Moody’s and Standard & Poor’s. It would take years to build the track record needed to obtain a decent rating.
More out of idle curiosity than with any clear purpose, I drove up again to Vallejo and paid a call on the fire department. The Vallejo firefighter I met with that morning was named Paige Meyer. He was 41 years old. “I don’t want this to sound arrogant at all,” he said, “but many departments in nicer communities, they get a serious fire maybe once a year. We get them all the time.” The typical Vallejo house is a charming, highly flammable wooden Victorian. “In this town we fight fires,” says Meyer. “This town rips.”
When you take care of something, you become attached to it, and he’d become attached to Vallejo. He was extremely uncomfortable with conflict between his union and the citizens, and had found himself in screaming matches with the union’s negotiator. Meyer thought firefighters, who tended to be idealistic and trusting, were easily duped. He further thought the rank and file had been deceived both by the city, which lied to them repeatedly in negotiations, and by their own leadership, which harnessed the firefighters’ outrage to make unreasonable demands in the union-negotiated contract with the city. What was lost at the bargaining table was the reason they did what they did for a living. “I’m telling you,” Meyer says, “when I started, I didn’t know what I was getting paid. I didn’t care what I was getting paid. I didn’t know about benefits. A lot of things that we’re politicizing today were not even in my mind. I was just thinking of my dream job.”
When Vallejo entered bankruptcy, the fire department was cut from 121 to 67, for a city of 112,000 people. The department handles roughly 13,000 calls a year, extremely high for the population.
Two months ago, he became Vallejo’s new fire chief. It surprised him: he hadn’t even applied for the job. The city manager, Phil Batchelor, just called him to his office one day. “He didn’t ever really ask me if I wanted the job,” says Meyer. “He just asked how’s the family, told me he was giving me the job, and asked if I had any problem with that.”
He didn’t, actually. He sat down and made a list of ways to improve the department. He faced a fresh challenge: How to deliver service that was the same as before, or even better than before, with half the resources. How to cope with an environment of scarcity. He began to measure things that hadn’t been measured. The No. 1 cause of death in firefighting was heart attacks. No. 2 was truck crashes. He’d decided to tailor fitness regimes to fit the job. With fewer fire stations and fewer firefighters in them, the response times were going to be slower. He began, in short, to rethink firefighting.