Philip Greenspun’s Weblog

I have drafted an article on teaching helicopter students to hover. Comments would be appreciated.

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In March 2009, I wrote “How Rich Countries Die”, a posting summarizing Mancur Olson’s The Rise and Decline of Nations. It looks as though Olson is being proved right. GM, Chrysler, and their present and retired employees tapped the taxpayers for $100 billion. Teenagers, on the other hand, are unemployed in record numbers (New York Times story today, reporting that 25 percent of teenagers who want a job can’t find one). Classical economics says that unemployment is impossible. If there are a lot of teenagers looking for work, the wage for a teenager will fall to a market-clearing level and every teenager who wants a job at the new (lower) wage will have one. Olson showed how entrenched workers can protect their above-market salaries at the expense of the young.

One disturbing fact from Olson’s book was a chart demonstrating the slow growth rate of U.S. per-capita GDP from 1950 through 1980. We underperformed France and Germany, for example. One wonders if this is because it took us so long to recover from the burden of paying back debt incurred during World War II, as well as the cost of the Vietnam War. Our government is currently borrowing, as a percentage of GDP, a comparable amount to what was borrowed to fight Germany and Japan. We’re spending, on Iraq and Afghanistan, a comparable percentage of GDP to what we spent on the Vietnam debacle. An economist might say that we can handle an extra $9 trillion in debt, but one has to wonder if it won’t come at the cost of economic stagnation from 2020 through 2050.

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… just wait until the pension collapse hits. That’s the premise of While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next Financial Crisis. The book was written, presumably, in 2007, and published in May 2008. The author has already been proved wrong as the U.S. managed to initiate a worldwide financial crisis without referring to pension debt. Nonetheless, the book is interesting for its demonstration of a dynamic in which managers, politicians and union leaders, pursuing their self-interest, manage to wreck enterprises, states, and ultimately countries.

I’m working my way through the first part of the book, which concentrates on General Motors. The management of GM gets a heavy whipping by the author. The leaders of GM were accustomed to a growing car market. The U.S. had 4 cars for every 10 Americans in 1950. By the 1970s there were 10 cars for every 10 Americans and growth slowed to 1 percent per year. The leaders of GM were accustomed to an oligopoly in which any costs could be passed on to consumers through price increases. As long as Ford and Chrysler were also subject to similar union agreements, there was no problem with agreeing to higher wages, benefits, and retirement benefits. They could not see a day in which Japanese, Korean, or Chinese manufacturers would be able to sell significant numbers of cars in the U.S.

What did the GM managers agree to? Workers could retire at age 48, assuming that they started with the company at age 18. GM would pay for all of their health care costs and health care for their dependents, regardless of what advances in medical technology or increases in health care prices transpired. Workers would be paid when not working (the “jobs bank”, initially limited to less than one year but eventually extended to infinity). By agreeing to these long-term obligations, GM bought short-term freedom from strikes and therefore higher short-term profits. If a liability 30 years in the future ended up bankrupting the company, that would be some other manager’s problem.

What did union leaders agree to? Underfunded pension plans. At non-union companies, pension plans tended to be pretty well funded. If the company promised to pay money in the future, it put aside cash now. In collusion with management, union leaders allowed companies to skimp on present cash outlays. The union leader was able to claim a big victory to his members, though he knew if the company went into bankruptcy 20 or 40 years hence the promises would never be fulfilled (though perhaps the UAW leaders were prescient; after sucking all of the value out of GM they were able to top up their pension plans with $100 billion of taxpayer money (extracting taxes from 65-year-old workers at Walmart to pay 50-year-old GM retirees)).

Politicians running cities and states behave more or less the same as GM’s managers. In order to win electoral support from public employee unions they agree to crushing burdens to be paid by taxpayers 20 or 30 years from now.

Social Security is not the nation’s biggest problem, according to the author. Congress can, and probably will, keep raising the age of eligibility for benefits. A person retiring in 2015 might have to be 75 years old in order to draw Social Security, for example. That would instantly solve any problems with the system. A pension obligation, however, cannot be revoked except in bankruptcy.

The lunacy of pension commitments is presented fairly clearly. When GM would agree to give fat pensions to all of its workers, that included someone who was 47 years old, for example. The guy was one year away from retirement and GM was promising to pay him a lot of money for each of his remaining years of life (maybe more than 60 years; one GM retiree was drawing a pension at age 111, plus supplemental health care). That might have worked if GM had been putting aside cash for the years that this guy had been working at the company, but as the pension commitment was new there was no way that they had been. The UAW had its retirees as voting members and they would often negotiate higher pensions for workers who had already retired. GM management agreed to pay people for whom there was no possibility of putting aside pension funding as they worked (because they were no longer working).

In 2008, GM was promising to pay an 18-year-old employee a pension when he retired in 2038. They were also promising to pay for the guy’s health care during his retirement, regardless of what procedures, tests, and drugs were available starting in 2038 and continuing through perhaps the year 2100 (anything that Medicare didn’t pay, GM was promising to pay). A company that promised a defined pension benefit was betting its life on interest rates. If the pension plan was set up when interest rates were 10 percent per year and interest rates subsequently fell to 5 percent per year, the company could easily go bankrupt, wiping out shareholders. If the War on Cancer that President Nixon declared in 1971 had been won, the company would certainly have gone bankrupt.

The author of this book paints GM as truly the dumbest company on the planet, though presumably municipalities will end up looking just as bad pretty soon (esp. if low interest rates continue to prevail). The GM managers set things up so that they needed to continue growing in output, health care costs per person had to stop inflating, interest rates needed to remain high, and foreign competitors needed to be excluded from the U.S. market. If any of those conditions failed, the company would go bankrupt.

What can we learn from this book? If you’re a shareholder in a company that allows people to retire at age 50, sell immediately. If you’re a taxpayer in a city or state that allows people to retire at age 41 (MBTA here in the Boston area, for example), move. Eventually the government will have to confiscate your house and all of the rest of your assets in order to pay its pension obligations.

More: read the book.

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A friend visiting from California today was deploring the condition of her home state. “When I was going to California public schools in the 1960s, they were some of the best in the nation, at least as good as my son’s elite private school is today.” She thought the rest of the state government services had fallen apart too. What was her explanation for the problem? “The schools don’t get the funding they need,” she said, “and neither does the rest of the state”. An ardent supporter of Barack Obama, she blamed California Republicans for the mournful state of affairs. I asked her how it was possible that the state government was underfunded. California collects a higher percentage of its residents’ income in taxes than other U.S. states and at least as much as it was collecting in the 1960s, surely (source). If at least as much money is going in at the top, how can the problem be a simple one of “not enough money”?

Her explanation was simple: illegal immigrants. They burdened the school systems with their prodigious birthrate. They got paid under the table and therefore did not pay taxes.

I pointed out that even an immigrant paid in cash paid sales tax. Los Angeles has the highest sales tax rate in the U.S., at 9.75 percent (combining state and local). An immigrant who rented an apartment paid property tax through his or her landlord. An immigrant who drove a car paid state and federal gas taxes as well as registration fees. An immigrant who uses someone else’s Social Security number is paying payroll taxes and having income tax withheld.

A Sacramento Bee article supports her argument to some extent, noting that one third of California’s schoolchildren are themselves illegal immigrants. The parents of these kids no doubt have, on average, some lower wage jobs. But the entire U.S. economy in the supposedly glorious public school days of the 1960s consisted of what are, by current standards, lower wage jobs. How come we could afford to educate a laborer’s children in 1965 but we can’t afford to do it in 2009? The immigration status of the parent or child should not affect the cost to teach the child to read, write, and do math.

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A friend who lives on Martha’s Vineyard chastised me for questioning Ted Kennedy’s beatification. “Everyone on Martha’s Vineyard knows the real story about Chappaquiddick,” this lifelong Democrat said. “He was with a married woman in the front seat and had no idea that Mary Jo had crawled into the back seat and fell asleep. His evasiveness after the accident was to protect the reputation of the married woman. Ted Kennedy never had any idea that anyone was in the back seat.” How did he ever find out? “When he phoned his family and friends later that night, they must have told him that Mary Jo had been in the back.” The death of Mary Jo, the failure of Ted Kennedy to summon help, and the lack of any explanation to Mary Jo’s family, thus stems not from a lack of gentlemanly conduct, but from an excess.

[This Google Map shows the section of very rough dirt road that Ted Kennedy traveled to get to the Dike Bridge. Even today, in an era of near-infinite property taxes, the road is painfully bumpy and washboardy. A person would have to be virtually comatose not to wake up while in the back seat of a car on this road, yet the Wikipedia page on Mary Jo notes that she “rarely drank much.”]

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Here’s an interesting article on a self-paced online college education, offered at a flat $99 per month (i.e., an extremely energetic person could earn a bachelor’s degree in one month for $99).

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Just finished A Crack in the Edge of the World: America and the Great California Earthquake of 1906. The book does not draw comparisons with the 2005 flooding of New Orleans by Hurricane Katrina, but is made much more timely because of that event.

Here are a few interesting facts from the book:

• Los Angeles was a small town at the time of the earthquake, but afterwards investors were reluctant to put all of their eggs in the shaking basket of San Francisco. It was the 1906 quake that made LA the capital of the American West.
• Insurance companies were at least as badly behaved back then as they are now, coming up with all kinds of excuses for not paying. Most of the damage in San Francisco was caused by fire, which was insured. The insurers argued that the damage was caused by the shaking of the earth, which was not covered, and would try to pay between 0% and 90% of the value of the loss. German and Austrian insurance companies simply stopped answering the phone and their mail and didn’t bother to pay.
• The U.S. government very quickly mobilized all of its available resources, especially Army troops, tents, and rations, to fight the fires and shelter the homeless. There was virtually nothing more that the government could have done. The military began effective assistance within hours of the quake.
• The citizens of San Francisco, who were bright, creative, and energetic, were able to live in tent cities while rebuilding relatively quickly.
• A grand urban plan that would have made San Francisco into one of the most beautiful cities on the planet was chucked in favor of the most expedient rebuilding possible. A handful of roads were widened but no grand avenues were constructed.
• If you missed the 1906 event you may yet have your chance to experience a similar quake in a similar place. The San Andreas Fault has built up roughly as much unreleased stress as was released in the 1906 quake. It could happen tomorrow…

The book is kind of rambling and the author’s Krakatoa: The Day the World Exploded: August 27, 1883 is more interesting. Americans and Californians, however, will find plenty of food for thought in this book. Comparing the 1906 earthquake and Katrina, one is forced to draw the following conclusions:

• Americans have gotten less capable in the last 100 years
• The American government has gotten less capable in the last 100 years
• New Orleans will likely never regain its relative prominence among Gulf Coast cities.

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I met a woman the other day with a full-time job in the health care industry. She noted that her 14-year-old boy was just starting his first year of high school and that he had never been to school before. As she worked full-time, did her husband stay home to teach the kid? No. They couldn’t afford to give up his $10,000+/month income, plus great benefits and a pension. Had she been home-schooling the kid? “No! My husband doesn’t believe in home-schooling. Our son has been unschooled. He does whatever interests him and sometimes asks us questions. The only thing that we’ve done is work with him using some standard math textbooks starting at age 9.” How come the kid was going to high school now? “It was his decision. He really wants to try it out. We did not want him to go.”

What did her husband do that he was so adamantly opposed to sending his child to a traditional school? “He’s been a public school teacher for 15 years.”

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I’ve recently been asking folks “Where are the antiwar protesters now that we need them?” (i.e., now that our economy has collapsed and we can’t really afford to rebuild the U.S., much less Iraq and Afghanistan). One of my neighbors from Cambridge said that she for one was still against the war(s). She cited the cost and said that if we weren’t meddling overseas we would easily be able to fund health care for all U.S. residents. I asked her how that could be true given the enormous and growing percentage of the U.S. GDP consumed by health care. She said “military spending is much higher than health care spending.” My memory was that health care is consuming about 18 percent of GDP and the military between 4 and 5 percent. Even cutting military spending to zero would only just barely pay for universal insurance into the present system and a couple of years of inflation, or so I thought.

The picture turns out to be a little more complex. http://en.wikipedia.org/wiki/Military_budget_of_the_United_States says that budgeted military spending is in fact 4.7 percent of GDP. However, our adventures in Iraq and Afghanistan, as well as some veterans benefits, are paid for separately. We are actually spending closer to 7 percent of GDP on our military.

It might be interesting to compare these numbers to productive investment in the U.S. Total research and development spending, for example, is about 2.7 percent of GDP (source). In other words, the non-budgeted costs of running the military are comparable to the total amount that we’re investing in the R&D that is supposed to maintain our competitive edge over China and other low-wage countries (without such an edge, as far as I can tell from freshman econ, there is no reason that an American worker should earn more than a Chinese worker, a salary that would not result in a very comfortable lifestyle here).

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The government just spent billions of dollars on Cash for Clunkers and the results have come in. People traded in 10-year-old American-made cars for brand new Japanese and Korean cars. According to newspapers, the White House is saying that this will save jobs here in the U.S. I’m not sure how this is possible. A consumer driving a 10-year-old American car periodically buys replacement parts, mostly likely still made here in the U.S., and pays a mechanic, almost certainly still working here in the U.S., to install the parts. A consumer driving a new Japanese or Korean car has surely saved some jobs in Japan or Korea. He has also enriched the owner of a car dealership. But wouldn’t the net number of U.S. jobs fall when the old car needing periodic service is replaced with a new imported car that won’t need significant service for 5-10 years?

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