California’s Personnel Costs

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Over the past twenty years, as wages in the private sector have remained pretty much flat – not even keeping up with inflation – wages in the public sector have risen relentlessly. A generation ago, a public sector worker would sacrifice current pay for job security and a pension that was somewhat better than social security, but today, not only are public employee pension benefits far more generous than they used to be, but public employees generally make more in current pay than their private sector counterparts. While this assertion remains hotly debated, one seeking the truth might consider this comment – made in a guest column in the San Francisco Chronicle earlier this month – by former California Assembly Speaker Willie Brown:

“The deal used to be that civil servants were paid less than private sector workers in exchange for an understanding that they had job security for life,” Brown asserted. “But we politicians — pushed by our friends in labor — gradually expanded pay and benefits . . . while keeping the job protections and layering on incredibly generous retirement packages. . . . This is politically unpopular and potentially even career suicide . . . but at some point, someone is going to have to get honest about the fact.”

If Willie Brown, a friend of big government and big labor if there ever was one, is on record with a comment like this, it’s time to move on. Personnel costs for government employees have grown out of proportion to private sector compensation, and California is perhaps the most extreme example. Another question that requires clarity is exactly what percentage of government budgets are consumed by personnel costs? Clearly this is a figure of vital importance, because if personnel costs represent an insignificant share of California’s budget, there is far less urgency to restore the historic trade-off that is supposed to apply when you join public service, i.e., you receive lower current pay in exchange for higher retirement security.

In the table below, California’s state and local personnel costs are calculated using the most recent data available from the U.S. Census Bureau, and compiled by USGovernmentSpending.com. The first thing that should be readily evident is most of California’s government spending is at the county and city level, since of the $516 billion reported for 2009, only $138 billion of that is state spending, and the other $321 billion is local spending. The implications of this fact are ominous – less than 1/3rd of California’s structural budget deficits are caused at the state level.

In order to determine the percentage of this half-trillion of state and local spending in California that is consumed by payroll, turn to the U.S. Census Bureau’s California statistics directly for 2008 Public Employment Data, Local, and 2008 Public Employment Data, State. These tables, updated in December 2009, yield both the number of state and local government employees in California and their total payroll, not including current benefits or pension funding. Assuming an average cost for current benefits of $5,000 per year per full-time employee (probably grossly understated), the total payroll of state and local governments in California is $188 billion per year, or 23% of total spending. What about pension funding?

In a previous post, Maintaining Pension Solvency, the amount necessary to fund a typical state worker pension is calculated using four sets of assumptions – based on a public safety pension plan (assuming 90% of final pay as the retirement pension) and based on a regular non-safety public employee pension plan (assuming 60% of final pay as the retirement pension), with each of these cases calculated based on an inflation adjusted rate of return on the pension fund investments of 4.75% (CalPERS official rate used for projections), and 3.00% per year (a more conservative rate). The table below uses a rate of return of 4.75% per year, and takes into account census data which indicates 13% of Calfornia’s state and local government employees are in public safety, and the other 87% are not, in order to calculate the percent of payroll that must be allocated to pensions. In this case, 23% of payroll, or 5.0% of total government spending, must be allocated to pension funding each year. In all, using these assumptions, 28% of of California’s total government spending is for personnel costs.

What if pension funds don’t return 4.75% per year, but only average 3.0%? Or what if they do average 4.75%, but since they are so underwater currently, a greater than usual contribution must be made each year from now on anyway? The next table shows the result of calculations using a 3.0% return on pension fund investments. In this case, 37% of payroll, or 8.4% of total government spending, must be allocated to pension funding each year. In all, using these assumptions, 31% of of California’s total government spending is for personnel costs.

There is a lot to chew on here. If you calculate personnel costs as a percent of revenue, instead of as a percent of spending, for example, eliminating the roughly $100 billion dollar annual deficits that state and local budgets combined easily exceed in California, and you use the 3.0% inflation-adjusted return on investment for your pension fund, personnel costs swell to 39% of total state and local budgets. If you also assume the costs of current benefits are not $5,000 per year on average, but $10,000 per year (a figure which may still be on the low side), personnel costs swell to 42% of total state and local budgets. What about the current year funding requirements for future retirement healthcare benefits – a line-item cost only rivaled by pension funding requirements – only beginning to be discussed in the context of total annual costs for government workers. And if you take into account the amount of remaining expenditures that are “pass-throughs” to quasi-governmental agencies and contractors, many of whom constitute the last entities outside of government to have enjoyed regular cost-of-living increases over the past 20 years along with pension plans that dwarf social security in their generosity, the percentage of state and local spending that is represented by personnel costs probably doubles – pick a number. Better yet, let’s hear from Willie Brown again – quote:

“Talking about this is politically unpopular and potentially even career suicide for most officeholders. But at some point, someone is going to have to get honest about the fact that 80 percent of the state, county and city budget deficits are due to employee costs.”

If 80% of California’s government expenditures go to personnel costs (probably accurate if you include pass-throughs to contractors who also enjoy swollen pay and benefit packages), and the combined annual state and local budget deficits in California are $100 billion, then basic algebra might suggest the following solution: Reduce the $400 billion that California’s state and local governments spend annually on compensation – including all government-funded project labor agreements for infrastructure, and, for that matter, as a prerequisite to any organization receiving state and local funds – by 25% across the board, and you balance the budgets without compromising programs or raising taxes. How many workers in the private sector would love to have a job that paid them 75% of what they made during the bubble booms?

No matter how you fine-tune an analysis like this, some conclusions are unavoidable. There is a tremendous consequence to the fact that California’s state and local government expenditures for employee compensation, per employee, have grown dramatically over the past twenty years at the same time as private sector compensation has remained relatively flat. When reform advocates suggest rolling back the pay, benefits, and pension packages for public employees in order to eliminate deficits and preserve worthy government programs, they are not making spurious arguments based on anti-government bias, or anti-government employee bias. They have simply run the numbers, and recognized reality.

Entrepreneurs or Predators?

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About five years ago the New Yorker magazine abandoned its official nonpartisanship and, for the first time in eighty years, endorsed a Presidential candidate. Their preferred candidate, John Kerry, didn’t win, but the partisanship continued. If you want to read about art, culture, literature, music, personalities, trends, and pretty much anything that isn’t political in nature, the New Yorker remains probably the best general interest magazine in the English language. But when it comes to politics, the New Yorker has become a high-brow version of your average left-wing alternative weekly free newspaper.

Now one of the New Yorker’s regular writers, Malcolm Gladwell, has issued a muddled dissertation on entrepreneurs (The Sure Thing, January 18th, 2010) that reads, if you skim the piece, as a blatant attack on entrepreneurship, and under closer scrutiny, comes across as simply muddled thinking. The premise of the article is that entrepreneurs are not risk takers, but in fact are risk averse. Quoting other authors, Gladwell then describes entrepreneurs as predators.

Gladwell’s primary example of an entrepreneur is Ted Turner, a spectacularly successful entrepreneur. Gladwell argues that Turner took far fewer risks than one might think. His first example is Turner’s purchase of a UHF television station in Atlanta. Gladwell points out how Turner bought the station in a stock swap, meaning “he didn’t have to put a penny down.” He explains how Turner was able to market the station by using unsold billboard space owned by his current company. He suggests that Turner “realized he could persuade the networks in New York to let him have whatever programming their affiliates weren’t running.” And Gladwell suggests this meant Turner was not taking any risks!

The reality is that without the benefit of hindsight, these were all extremely risky premises. A stock swap isn’t free money. Try thinking that and see what happens when your company goes under and the stockholders sue you. Try to navigate the terms and conditions of a stock swap and eliminate all the contingency risk – dilution, failure to complete milestones, options to convert to debt, to name a few pitfalls in the equity game. And what about these New York networks? What if they didn’t get persuaded? What if they decided they wanted into the UHF game, or wanted to pull the plug once Turner’s ratings started cannibalizing the audiences of their affiliates? What about the fact this UHF station in question was losing a half-million per year, had equipment “that was falling apart,” and had “incompetent” staff? No risk there?

Gladwell is correct to state Turner had an appreciation for the synergy created by the advertising that his billboard company could offer his new UHF TV station, but it is difficult to imagine how this justifies the suggestion he took minimal risk, and what’s more, knew it at the time.

In another example using Ted Turner as his foil, Gladwell suggests there was minimal risk to Turner when he purchased the Atlanta Braves baseball team, because “Turner had realized how important live sports programming could be in building a television brand.” But what about the fact the team was losing a million dollars a year, and wanted a ten million dollar asking price? The fact that Turner ended up talking the Braves into taking this money over an eight year time span is irrelevant. If he couldn’t turn the franchise around, he would have eaten a million per year in operating losses, and another million per year paying the former owners. It is fine to say Turner had vision, hindsight makes this quite clear, but to say he wasn’t taking a risk is unfair.

Gladwell builds on the idea that entrepreneurs are better described as predators, and they are not risk takers, but are risk averse. Paraphrasing the French scholars Michel Villette and Catherine Vuillermot,” he writes: “The truly successful businessman is anything but a risk taker. He is a predator, and predators seek to incur the least possible risk while hunting.” Later in the article, Gladwell conflates business entrepreneurship (or business predation) with financial entrepreneurship (or financial predation), an unfair comparison that invites additional criticism, but let’s stay on point.

There are two huge problems with describing entrepreneurs as predators. Most importantly, Gladwell gets the nature of entrepreneurship precisely wrong. Successful entrepreneurs are not predators, they are altruists. They identify a need, they invent a solution, and they invest their fortunes and their lives in bringing that solution to reality. If their altruistic vision is true to their time and place, and if they manage to navigate the many pitfalls of growing a new business, eventually they earn money, and society gains a new comfort or cure. The predator consumes. The entrepreneur creates.

The other problem is Gladwell wants to have it both ways – if an entrepreneur is successful, he is a predator, and if he is unsuccessful, he is just an entrepreneur. Notwithstanding the cruelty of suggesting only losers can be entrepreneurs, this dichotomy depends on hindsight. You can’t predict in advance which entrepreneurs will be successful, if you could, no entrepreneur would ever fail. And Gladwell is at his worst when he shares his reasons why entrepreneurs fail. Apparently only entrepreneurs who take risks fail – and the risks, according to Gladwell, could be avoided if entrepreneurs simply follow “the established principles of new business formation,” such as adequate capitalization, acquiring an existing business instead of starting from scratch, and writing a business plan. This is naive. Wonderfully formulated business plans often yield nothing, most of the truly revolutionary innovations that make our lives better were ushered in by entrepreneurs who started from scratch, and often breakthrough ideas of staggering potential are way too far out of ordinary investor’s comfort zones to allow for adequate capitalization. Risk is endemic to entrepreneurship, and the greater the altruistic potential, the greater the risk.

Given the biases of writers like Malcolm Gladwell, it is no wonder left-wing commentators have little aversion to the government coming in and running more and more sectors of our economy. Apparently business failures are predicated on predictable shortcomings that good academic training and proper bureaucratic decision-making can avoid – and anyway, successful entrepreneurs are dangerous predators. This mentality informs the thinking of far too many people who have never been on the front lines of a small business; their influence is poisoning the minds of America’s youth, infesting our government, and, most tragically, corrupting industry after industry as they go galloping to government for hand-outs instead of earning the voluntary consent of the consumer – risking failure in the process.

Mr. Gladwell might try starting up a business of his own. To make his experience instructive, he should start a business that makes something tangible – developing land, extracting resources, producing energy, manufacturing a product – in a free market where the only value you can sell is the worth of your product to a willing customer. He might see things differently. He might know the nature of risk and reward in a completely different way. He might see the entrepreneur as an altruistic risk taker, betting everything on the chance to make the world a better place, and he might recognize the true predators – who inhabit the safe corridors of government, and the back rooms of union halls, where coercion is the currency of success, instead of inspiration and hard work.

Stopping Taxpayer Funded Unions

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When fiscal conservatives run for office, or fiscally conservative initiatives are put onto the ballot, the candidates and proponents have to go out and ask for money to finance their campaigns. But in the case of public sector unions, who overwhelmingly support fiscally liberal, big government programs, and consistently oppose attempts to shrink the size of government, this is not the case. In California, for example, every year these unions automatically collect literally hundreds of millions in dues from unionized state and city workers, which they can use to engage in partisan political activity. In California, ever since 1977, when legislation was enacted to permit collective bargaining by public sector employees, unions have become increasingly involved in influencing public issues and policy. It has now reached the point where public sector unions exercise nearly absolute control over California’s state government, and most of California’s local government entities.

One would think workers in the public sector would object to unions who purport to represent them using their money to pursue a big government agenda that has now put public entities into such a financial crisis that they face furloughs and layoffs. One would think government workers would question why their taxes and fees are automatically and involuntarily siphoned into the coffers of union leaders who use the money to control elections and set the agenda for government. And this is particularly true when these unions financially support – using their money – a liberal agenda that not all public employees necessarily support as individual voters.

Despite the fact that California’s electorate splits almost exactly three ways, with about 35% usually voting Democrat, 33% claiming they are independents, and 29% identifying themselves as Republican, public sector unions overwhelmingly pursue a big government agenda. In practice, this means public sector unions have backed Democratic candidates to the point where California’s legislature is on the verge of having a new tax-enabling 2/3rds Democratic majority – and the political survival of these big-government Democrats depends on receiving union money – taxpayer’s money – for their campaigns. Do you think you are taxed enough already? If so, you are of an opinion contrary to the public sector unions, who are using your taxes to advance a political agenda that requires even higher taxes, and who relentlessly and successfully back policies to further expand government.

The result of public sector unions taking control of California’s government are predictable – removed from the necessity to please customers and sell products and make profits, necessities that compel unions in the private sector to exercise restraint in their demands on management – public sector unions have pursued an agenda of government expansion that has now left every public entity in California teetering on the brink of bankruptcy. Ordinary taxpaying workers in the private sector have been left behind in this extravagant joy ride, as the costs to pay for needlessly expanded government programs and the costs to business to comply with over-reaching regulations have increased the cost of living at the same time as they have reduced the ability of private sector business to provide workers good jobs and regular raises.

Private sector workers in California have been slow to awaken to the financial disaster wrought by out of control unions, as has the press, because they were bamboozled and betrayed by politicians whose political survival depends on campaign funds supplied by public sector unions. The financial clout of public sector unions is unparalleled, with millions of members who are each required to pay several hundred dollars per year in union dues, these unions can make or break any politician they want in the state of California. During Schwarzenegger’s unsuccessful “year of reform,” in the fall of 2005, public sector unions spent over $50 million to defeat just one of Schwarzenegger’s reform initiatives, the one that would have required public sector unions to obtain employee consent before using their dues to conduct political activity.

In spite of the fact that public sector unions can usually outspend their opponents by margins of ten to one or more, however, recent polls indicate the level of understanding of the arrogance and overreach of public sector unions is much higher among voters today compared to 2005. Public employees as well realize the unfairness of seeing their dues diverted to agendas that clearly serve the agenda of the union leadership, instead of the broader interests of society, or their own values. A perfect example is the antics of California’s teachers union, who have imposed crippling constraints on the ability of administrators to reward excellent teachers and dismiss incompetent ones, and have consistently opposed efforts to establish charter schools despite the fact they deliver outstanding educational results. And what has happened to California’s public schools has happened throughout California’s government bureaucracies, thanks to public sector unions.

In November 2010 there will be several reform initiatives on California’s ballot, and one of them aims to begin to rein in the influence of public employee unions. The Citizen Power Initiative will limit the ability of public sector unions to collect a portion of worker’s tax payments, through mandatory union dues assessed on public employees, to pursue their big government political agenda. If this initiative qualifies for the November ballot, expect unions to spend whatever it takes to defeat its passage. But this time around, with workers barely able to pay the many taxes and fees they already suffer, it will be a harder for the unions to use their money to confuse the issues, and derail genuine reform at last.

The initiative has already been cleared for circulation by the California Secretary of State.

Here is the title and summary, which provides a pretty good description of what this initiative will accomplish, if passed:

1403. (09-0054)

Makes Illegal the Use of Public Employee Wage Deductions for Political Activities. Initiative Constitutional Amendment.

Summary Date: 12/04/09 | Circulation Deadline: 05/03/10 | Signatures Required: 694,354

Proponents: Mark W. Bucher, Dawn M. Wildman, Allan R. Mansoor, Lawrence D. Sand, and Mark J. Meckler (714) 573-2201

Amends the California Constitution to make it illegal to deduct from wages or earnings of a public employee any amount that will be used for political activities as defined. Prohibits any membership organization that receives public employee wage deductions from using those funds for any political activities, but does not apply to deductions for charitable organizations, health, life or disability insurance, or other purposes directly benefitting the public employee. Authorizes the Legislature and Fair Political Practices Commission to adopt related laws and regulations. Summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government: Probably minor state and local government implementation costs, potentially offset in part by revenues from fines and/or fees. (09-0054.)

You can also read the title and summary (scroll down to #1403) here:

The full text can be found here:

The signature petition is here:

A one-page fact sheet on this initiative is here:

The website for the campaign promoting this initiative is here:

Maintaining Pension Solvency

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One of the biggest challenges facing governments is determining how to adequately fund present and future pension benefits for their employees. While public employees are working, if a sufficient amount of money is set aside for them each year and invested competently, then by the time the employee retires, their fund balance should be adequate to draw down each month to pay their pension, yet not be fully depleted until after they’ve died. As will be seen, however, unless some very optimistic scenarios are used as the basis for projecting future pension solvency, the amounts that are currently being contributed to public employee pension funds are grossly inadequate.

While the calculation of how much money needs to be set aside each month to build up an adequate pension fund is not simple, it is not so complex or arcane as to defy analysis by policymakers, journalists and commentators, voters, employee advocates, or anyone else concerned with this issue.

In the analysis to follow, four cases are presented, each one calculating what percentage of payroll must be allocated to annual pension funding under various assumptions. These cases concern the pension of a single individual, but when assessing the sustainability of public employee pension benefits, these calculations apply in aggregate as well.

In the four examples below, the same assumptions are made for each individual pension fund chronology – the individual enters public employment at age 25, works until they are 55, and dies at age 85. All calculations and assumptions deal in “real” dollars, meaning that there are no cost of living adjustments either during the worker’s career nor during their retirement. During their career, it is assumed that in real dollars, their annual salary doubled between the time when they started working and the time when they retired, presumably based on merit increases. In one case the employee retires with a pension equivalent to 60% of their final pay – representing the now common “2% per year for 30 years” benefit granted to most non-safety public employees, and in the other case the employee retires with a pension equivalent to 90% of their final pay – representing the now common “3% per year for 30 years” benefit granted to most public employees involved in safety-related occupations. What percent of their salary must be invested each year to make certain their pension will remain solvent until they are 85 years old?

With these assumptions thus made, there is only one variable left to consider, which is the projected long-term real rate of return of the pension fund investments. For each example, I’ve used two rates of return, one provided by David Lamoureux from CalPERS, which is currently the rate they use in their projections, and one somewhat lower rate which I believe to be a more realistic rate. Here is what Lamoureux wrote in response to my inquiry regarding their pension projections: “Our assumption is composed of a 3% inflation and a 4.75% real return for a total of 7.75%.”

Since this analysis excludes inflation in the pension pay-ins and pay-outs (i.e., no COLAs), the rate of return on the fund we’ll start with is 4.75%. This is what CalPERS currently projects as the rate, after lowering returns for inflation, they believe they can sustain over the next several decades.

Each of the examples summarized here are shown on spreadsheets following the text of this analysis. The reader is encouraged to check these spreadsheets and verify the calculations. Here is the summary of what we found:

(1) At a real rate of return of 4.75% per year, a worker would need to set aside an additional 21% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 60% of their paycheck.

(2) At a real rate of return of 4.75% per year, a worker would need to set aside an additional 32% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 90% of their paycheck.

(3) At a real rate of return of 3.00% per year, a worker would need to set aside an additional 35% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 60% of their paycheck.

(4) At a real rate of return of 3.00% per year, a worker would need to set aside an additional 52% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 90% of their paycheck.

Several points bear mention here. First of all, other than the rates of return – we’ll come back to those – these are all very conservative assumptions. The spreadsheet formulas are constructed, for example, to calculate interest on annual contributions for the entire year in which each of them are made, even though contributions occur gradually over the course of the year. Similarly, interest is calculated on the fund’s entire ending balance of each preceding year during the retirement phase, even though that balance is declining steadily throughout each retirement year to pay the monthly pensions. Without dissecting the entire spreadsheet, these examples are meant to emphasize the formulas are constructed to present the best possible case. As for the assumptions themselves, what if the pension recipients live, on average, longer than 85 years? Since a significant number of pensions pay the surviving spouse once the primary beneficiary is deceased, and since medical technology, thankfully, continues to advance, it is likely an average life expectancy of 85 is on the low side. What if workers retire before age 55, something fairly common, which increases the length of their projected retirement? What if they work more than 30 years, increasing their payout calculation? Moreover, no impact of pension “spiking” is considered in this analysis, where a worker’s final year of earnings (upon which the pension benefit is calculated) is sharply increased to a level not representative of their earnings growth over the course of their career.

With all this in mind, policy advocates and public administrators should ask themselves: Are we contributing at least 21% per year of our non-safety employees payroll to their pension fund? Are we contributing at least 32% per year of our safety employees payroll to their pension fund? Because that is the absolute best case in terms of what it will take to keep their pensions solvent. It is important to emphasize that retirement pensions are not the only financial obligations taken on by public employers to their retirees – often lifetime medical benefits are included, and the costs to fund these future benefits during the working years of public employees must be evaluated using the same methodology presented here for pensions. This will add several additional percentage points to what amount of payroll must be set aside each year for future benefits.

Returning to the issue of return on investment is crucial, of course. If CalPERS, for example, could earn a real rate of return of, say, 8.0% per year, the annual payment obligations to fund future retirements would be greatly diminished relative to the numbers here. But 4.75% per year is not a conservative projection, it is probably a very best case, because funds this big cannot expect to outperform the growth of the economies in which they invest. Pension funds that in aggregate manage literally trillions of dollars in assets should not expect to earn real rates of return exceeding the rate of global economic growth.

To put this in a historical perspective, global GDP grew at an annual rate of 1.0% or less until the industrial revolution, which increased growth to around 2.0% per year until about 1950. During the period from 1950 to 2000, the rate of global economic growth increased dramatically, to an average annual rate of nearly 4.0%, as the industrial revolution went global, catalyzed further by information technology. But in recent decades, part of the reason for higher rates of global economic growth was the accumulation of unsustainable levels of debt. It is going to take several years – if not decades – for this to unwind, and until there is light at the end of the tunnel, it is imprudent to project more than a 3.0% inflation-adjusted long-term rate of return for massive pension fund investments.

This begs an even more ominous question our public administrators must ask themselves, heralded not on rhetoric but on transparent calculations and cold reality: Are we contributing at least 35% per year of our non-safety employees payroll to our pension fund? Are we contributing at least 52% per year of our safety employees payroll to their pension fund? Not including what we must also set aside for retirement medical coverages? Because in the world we’re living in, with most public employee pension asset values already well below safe levels, that is what it will probably take to keep their pensions solvent.

Ruminations on Optimal Governance

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If there were two words to describe how we might ensure our civic finances were sustainable, abundant, equitably collected and equitably distributed, it might be this – “Optimal Governance.” That theme, along with Civitas Fidelis, is a guiding principle for what we believe and advocate. There is a great deal of analysis and commentary, posted onto our earlier site EcoWorld (sold in May 2009) that can provide useful information and insight into many of the key issues surrounding these themes. With no further ado, here are 20 favorites:

The Abundance Choice –  March 28th, 2009

Smart Growth, or Green Bantustans? –  March 17th, 2009

Calculating Employee Compensation –  February 8th, 2009

Humanity’s Prosperous Destiny –  January 16th, 2009

The Tyranny of Unions –  January 6th, 2009

Principles of New Suburbanism –  November 23rd, 2008

Bonds Are Taxes –  October 22nd, 2008

Abolish Public Employee Pensions –  October 7th, 2008

The Crichtonian Green –  September 26th, 2008

Rational Environmentalism –  September 23rd, 2008

The XXIX Olympiad –  August 8th, 2008

Lucky Lucky America –  August 1st, 2008

Assault on Reason –  June 3rd, 2008

California’s Global Warming Act –  July 2nd, 2008

Environmentalist Priorities & Global Warming –  May 15th, 2008

Fossil Fuel Reality –  May 3rd, 2008

Unions: Ideals vs. Reality –  April 13th, 2008

Liberal Fascism –  February 23rd, 2008

Unions Aren’t Green –  February 20th, 2008

Inflation vs. Deflation –  September 25th, 2007

Civic Finance & Civitas Fidelis

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We’re back. The posts already appearing here on CIV FI were originally written and accessible at a website launched in the summer of 2009 that was taken down for several months, and now appear here as the opening posts on CIV FI, or https://civicfinance.org. The earlier site was a placeholder, whereas this one is intended to grow into its name.

As stated on the “About” page, “CivFi.com was created to answer a need for greater discussion among and between investors and policymakers on the issues of financial sustainability.” That is a tall order, but it is truly the only theme that feels appropriate as human civilization enters the 2nd decade of the 21st century facing its biggest financial challenges in eighty years. And these challenges are not over. They’ve just begun. But they can be solved. Ongoing, downwardly spiraling financial catastrophe is not inevitable.

Civic finance is not quite the same as economics. Unlike an economic theory, you can analyze civic finance on a spreadsheet. You can reduce it to cash flow projections. You can isolate your assumptions and you can identify your options, often with unsettling precision. This website was created because there is far too little of this sort of analysis available on the internet, and as a result, there is grossly inadequate discussion regarding everything from infrastructure investment to environmental cost/benefit analysis to public sector deficits, and on and on.

Given the times we live in, with far too many consumers still mired in debt to their eyeballs, and therefore unable to buy more products or pay higher taxes, the challenge to finance the advancement of civilization is possibly the central challenge of our time. The challenge of accumulating and deploying massive quantities of capital to build the next big pieces of our advancing civilization has become, inconveniently, a nearly impossible prerequisite. Until resolved, it thwarts our attempts to realize the dreams-come-true that advancing technology already can offer us. Dreams are expensive. Choices are hard. And the old days of endlessly available credit are done.

CIV FI is an abbreviation for Civic Finance, but it doesn’t end there. The more you examine the pair of words, the more they may grow on you. In Latin, the abbreviation “CIV” forms the beginning of the word “civicus,” meaning civic, but it also forms the beginning of the words “civilus” (civil – as in political or courteous), “civilitas” (politics), “civis” (citizen), and “civitas” (community state). Similarly, in Latin, the abbreviation “FI” forms the beginning of the word “fiducia,” meaning financial trust or assurance, but it also forms the beginning of the words “fidelis” (faithful), “fides” (belief, honor, loyalty, truth), “fidentia” (self confidence), and even “fidicen” (a lyric poet).

With all these connotations, CIV FI feels like the right name at the right time. Civitas Fidelis. Faith in Civilization. How can anyone hope to create and conduct an open, utterly transparent forum for the discussion of creative, sustainable, humane and equitable ways to restore our Civic Finance, unless their creed were also one of Civitas Fidelis. In that spirit, let us begin.

Before writing the 19 posts already available here, all written between June and August, 2009, I edited an online magazine called EcoWorld. From early 1995 through May 2009, http://ecoworld.com was a platform where I posted nearly 1,000 articles and commentaries, about half of them written by guest authors, the rest by me. That website began as an attempt to promote free market environmentalism, but as I continued to immerse myself in the environmental movement as well as, much later, within the clean technology industry, I realized there were fallacies surrounding environmentalism so profound that what was necessary was to completely redefine environmentalism.

As a participant in the clean technology industry, I further realized, especially in the last few years, that the funding and the priorities of clean technology were severely skewed. Investment and deployment of worthy technologies were being deferred, while marginal, fanciful projects and technologies were being advanced due to environmentalist concerns – reflected in government incentives – that were often without scientific merit or financial merit. Finally, I realized that these flaws that afflict mainstream environmentalism are part of something much bigger – a struggle to define what sort of political economy we choose to live under. A debate over what model for civilization is optimal, and how to get there from here.

CIV FI aspires therefore to continue where EcoWorld left off, to join that larger debate, armed with not only analysis and commentary, but spreadsheets as well.

Hyperliterate & Illiterate

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Ever since the housing bubble burst and the market crashed for financial derivatives tied to home mortgages, it has been a mystery to me how citizens and politicians could have let this happen. My theory to-date is this – the citizens who fell into this trap were financially illiterate, and the financiers who engineered the trap were financially hyperliterate. That is – ordinary people abandoned their common sense and felt they had to buy a home because prices would keep going up – accepting mortgage obligations no financially literate person would tolerate, and elite financiers were similarly unable to see the forest for the trees because they knew so much they lost their perspective – their hyperliterate quantitative models gave them a false sense of security.

No wonder the science of economics is not only dismal these days, but in the grip of a well deserved intellectual crisis. But there is another theory that is taking hold among a sorely disgruntled American population, a theory that if it spreads, will abruptly and severely rearrange the American political balance of power – hopefully for the better. That theory holds that this crisis was caused by a decade or more of bipartisan, elitist abandonment of the interests of hard working American citizens in favor of big government, big labor, and big finance.

A commentator of extraordinary lucidity who provides useful insights on this topic not always available in the American press can be found at Asia Times Online. Writing under the pseudonym “Spengler,” he offers a perspective on the world, and the United States in particular, that is stripped of hyperliteracy – financial or otherwise – and cuts to the chase. Here is how he characterizes what happened, and is happening, in Washington today:

The one-trick wizards of Wall Street had one idea, which was to ride the trend and pile on as much leverage as credulous investors and crony regulators would allow. It has gone pear-shaped, and those who didn’t cash out early along with the cynics are poor. Fortunately for them, Obama will let them play with the budget of the US federal government for the next four years.

Failed financiers run the Obama transition team. It used to be that the heads of great industrial companies got the top Cabinet posts. Now it is the one-trick wizards. After George W Bush fired former Treasury Secretary Paul O’Neill, who had run Alcoa, the last survivor of the species was Vice President Dick Cheney, the former CEO of Halliburton. Obama’s bevy of talent comes from finance. American industrialists have become figures of ridicule, like the pathetic chief executive of General Motors, Rick Wagoner, begging for a government loan.

America, and Americans, have been accumulating debt for 40 years. Back in 2007, in a post on EcoWorld entitled “Inflation or Deflation,” I attempted to quantify this debt, quoting Paul Rubino from www.dollarcollapse.com, who said “the past two decades of low inflation and steady expansion have been purchased with ever-greater amounts of debt. In the 1960s it took about a buck-fifty of new debt to produce a new dollar of GDP. Today it takes about six bucks…” and “Total debt in the U.S. economy grew at a seasonally-adjusted annual rate of $3.7 trillion, and now stands at $46 trillion, up from $29 trillion in 2001…”

Now our Obama administration is well on their way to more than doubling our federal debt before the end of the first term – projections now put federal debt at 17 trillion by then. This will trigger inflation – indeed the painful reality is despite the fact that failed (but hyperliterate) financial foxes are guarding the nation’s economic henhouse in Washington, this massive spending is the only way to avoid deflation, which would be far worse. Let’s return to Spengler for more on this:

For a quarter of a century, the inbred products of the Ivy League puppy mills have known nothing but a rising trend in asset prices. About the origin of this trend, they were incurious. The Reagan administration had encountered a stock market in 1981 trading 50% below its the long-term trend. Reagan restored the equity market to trend by cutting taxes, suppressing inflation and easing some regulations. The private equity sharps were fleas traveling on Reagan’s dog. They simply rode the trend with the maximum of leverage.

Now that the stock market has collapsed, the private equity strategies cannot repay their debt, and their returns have evaporated. Note that equity investors spent a decade in the cold, from 1973 to 1983; it may be even worse this time. The maturities on debt issued to finance private equity deals will come due long before the recovery.

Over the long term, we know that the average investment cannot grow faster than the economy, for investments ultimately are valued according to cash flows, and cash flows stem from economic growth. Real American gross domestic product grew by 2% a year on average between 1929 and 2007. Whence came the enormous returns to the Ivy League? Some of them surely came from betting on the right horses, but most came from privileged access to leverage.

For all Obama’s bashing of the rich, it is arguable that Obama’s administration is a product of public sector labor union power married with Wall Street power. Look no further than our public sector employee pension funds, who invested hundreds of billions – in aggregate, trillions – with hyperliterate Wall Street brokers – and all of them actually believed they could earn double-digit real returns on trillion dollar funds for generations.

For much more, read “Obama’s One Trick Wizards,” or anything by Spengler.

Healthcare in America

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As someone who has either owned small companies or worked for small companies, I have had to frequently change health care plans. Sometimes my healthcare was earned as an employee benefit, sometimes I joined a small group plan as the principal of my own company, and sometimes I participated in a COBRA program through a former employer.

With this background, it is fair to say I know what it takes to get health insurance coverage in America. For nearly 30 years now, two things have always been true: I have never been unemployed, and I have never been without a quality PPO health insurance plan. And it hasn’t been easy.

The problem with Obama’s health care plan – similar to pretty much everything Obama is doing – is that it is aimed at helping anyone but people like me. Why is this? Because I have been responsible. I have always found work, often without benefits, and I have always made sure to purchase quality health insurance – one way or another. And there is no way Obama’s health care plan is going to make health insurance better and cheaper than the health insurance I currently have – this despite the fact that as a healthy 51 year old Californian, without COBRA (which will expire soon, yet again), I will have to pay $750 per month for a good PPO. If Obama’s plan is enacted, I will have no choice but to enroll in a rationed publically administered health insurance plan. Individual plans for a person my age, if they are available at all, will cost more than $750 per month, probably much more.

There are a host of reasons why healthcare insurance has come to this juncture – but most of all we are at this juncture because of what one might call “the great leveling” is happening. That is to say, the bell curve of individual economic status is flattening, with more and more poor people at one extreme and more and more rich people at the other – and the legislation and regulations (or lack of legislation and deregulation, it depends) that have faciliated this trend have been bi-partisan.

Those of us who are too well off to collect free benefits, yet too poor to be able to pay punitive prices for insurance coverage (along with electricity, water, education, transportation and housing – all being made more expensive in the name of social justice and the climate “crisis”) – are having everything we’ve worked for systematically confiscated through higher taxes and fees and regulated prices. It is sad to see mainstream media commentators – most of them quite wealthy – describing those who criticize this trend as merely “fringe” groups. All we ask for are reforms that first recognize and reward responsible behavior before enacting policies that will make us pay more for the “disadvantaged” and “exploited” classes.

The reality of healthcare in America is that everyone does get healthcare. If people aren’t able to afford health coverage, they go to emergency rooms. This isn’t perfect but it works. There are no easy answers, and nobody is suggesting reforms shouldn’t be on the table, but it is getting very tiresome to have our President – through his proposals – pretend that personal financial stability achieved through hard work and merit are only accidents of privilege, and therefore actively design policies that punish us.

American healthcare reform should start by eliminating barriers facing those who are willing and able to pay for quality healthcare, and see what that does for overall costs. The results might be quite positive for everyone. For example:

(1)  Allow individuals the same tax deductions for their health insurance premium payments as businesses receive.

(2)  Make it easier for associations and organizations to offer group health insurance plans, instead of only favoring companies who may or may not provide an individual a job for life.

(3)  Eliminate interstate barriers to health insurance companies so they can operate and compete in every state.

(4)  Enact tort reform so malpractice lawsuits are reined in. Not only do the inordinately inflated premium payments increase costs, but far more significant are the costs of over-testing and over-treating as a precaution against lawsuits.

These four reforms would be a good start towards improving America’s health care system. The idea that government should launch a “competing” public health care option sounds good, but in reality this would kill the market for individual insurance. The only private insurance plans left would be those enjoyed by employees of large private companies, and – ironically – by public sector employees. Entrepreneurs would be forced into the government program.

Maybe someday, when labor unions in the public sector (along with their “work rules”) are declared illegal, and merit (instead of seniority or belonging to a “protected status group”)  is the sole criteria for better pay and career advancement, and public sector employees get social security and medicare when they are retired, just like the rest of us, it might be possible, even palatable, to create to a publically administered health insurance plan to compete with private sector plans. Maybe then we can trust the public sector to take on more projects, but not before.

There is absolutely nothing the Obama administration is doing with respect to health care, financial reform, or environmental “crisis” management, that is doing anything for the small business, or any true entrepreneur who still respects the meaning of the word. To-date, President Obama has the most anti-entrepreneurial administration in the history of America, because his policies – however well intentioned – reward irresponsibility and indolence, and punish individual industry and initiative.

The Prosperity Choice

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Advocates of policies designed to regulate CO2 tend to invoke the precautionary principle – that is, even if something incredibly horrible is not really happening, preparing for this horror is something worth doing, because the consequences of preparation for nothing are less than the consequences of doing nothing and having the worst scenarios actually come to pass.

This position rests on two fundamental assumptions, regulating CO2 helps the economy more than it hurts the economy, and regulating CO2 would actually have a positive impact on global climate trends. But there is an alternative version of environmentalism that would argue against this, and make the following claims:

(1) CO2 regulations will cause grievous harm to the U.S. and global economy and will trample upon the freedom of individuals and nations.

(2) Imposing CO2 regulations will do nothing to mitigate alleged harmful trends in global climate.

(3) Humanity is poised at the brink of unprecedented prosperity and CO2 regulations will create a tyrannical global order of rationing and arbitrary power that will rob humanity of this positive destiny.

In support of these positions, especially the third – that we are poised at the brink of unprecedented abundance and prosperity, are three articles:

The Abundance Choice –  Abundance is a choice, and it is a choice the privileged elite must make – in order for humanity to achieve abundance, the elites must accept the competition of disruptive technologies, the competition of emerging nations, and a vision of environmentalism that embraces resource development and rejects self-serving anti-growth alarmist extremism. The irony of our time is that the policies of socialism and extreme environmentalism do more harm than good to both ordinary people and the environment, while enabling wealthy elites to perpetuate their position of privilege at the same time as they embrace the comforting but false ideology of scarcity.

Humanity’s Prosperous Destiny –  It is often easy to overlook the many positive forces of history, forces that can be identified with Euclidean precision, immutable forces that will deliver to humanity abundance in all forms, wealth to conquer poverty, cleanse the planet, and satiate the longings of peoples and nations. As the world urbanizes, voluntarily and en-masse, rural lands and wildernesses are relieved, and open space becomes abundant. As technological innovation advances at exponential rates, energy and water will also become abundant. The most important natural resource in the world is human creativity, and it is inexhaustible and will find a way to alleviate any scarcity.

Fossil Fuel Reality –  In terms of choosing between fossil fuel development and alternative energy development, another point which should be put to rest is the notion we are running out of fossil fuel. The next three charts show the potential reserves of the primary fossil fuels – oil, coal, and gas. In order to develop estimates for unconventional sources of these fuels, we have taken the midpoint between the high and low estimates. (1) If oil provided 100% of global energy, and we used twice as much as we do today (1,000 Quad BTUs per year), there would be a 59 year supply of oil based on known reserves. (2) If coal provided 100% of global energy, and we used twice as as much as we do today (1,000 Quad BTUs per year), there would be a 218 year supply of coal based on known reserves. (3) If gas provided 100% of global energy, and we used twice as much as we do today (1,000 Quad BTUs per year), there would be a 45 year supply of gas based on known reserves. So when you add it all up, at twice the current energy consumption overall, oil, gas and coal could potentially supply all the energy we need in the world for the next 300 years – not including gas hydrates.

Prosperity is indeed a choice, and to achieve global prosperity there are indeed competing versions of environmentalism. The mainstream environmentalist vision is to effectively ration fossil fuel in order to accelerate development of alternatives to fossil fuel, at the same time as this vision allegedly attempts to mitigate the allegedly harmful effects of anthropogenic CO2 emissions. And this mainstream environmentalist vision also opposes nuclear power, genetically modified crops or biochemical feedstocks, hydroelectric power, desalination, and new aquaducts, and even imposes crippling lawsuits and regulatory barriers to establishment of solar and wind energy.

An alternative to mainstream environmentalism may be characterized as clean technology environmentalism, or clean development environmentalism. In this version of environmentalism, the emphasis is on economic development as the best way to empower society to have the ability to mitigate environmental challenges, whether they are the costs to clean up a superfund site or restore a habitat, or the costs to better adapt to extreme weather. The conflicts between those who want to pursue cleantech development and those who want to stop all development, everywhere, are rife with profound nuances and insufficiently explored by all concerned. Environmentalism is not monolithic, despite the roar from Gore and his like-minded multitudes.

Public vs. Private Sector Unions

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Any ideology with scores of millions of willing adherents cannot be completely without merit. For any movement numbering millions of people to flourish, at some level, their underlying ideology must resonate with mostly good people as well as with the inevitable corrupt contingent. Unions, and their ideologies, are examples of good ideas – as well as whatever bad one might ascribe to the influence of unions. And any discussion of unions in America today must assess the ideological schisms between public sector and private sector unions.

Unions for private sector companies grow when the company itself grows. If the company is not healthy, they are not healthy. When companies declare bankruptcy in the private sector, the unions and the jobs go away along with the company. Unions in the private sector envision jobs that build wealth – freeways, levees, aquaducts, new underground telecom/utility conduit upgrades in urban areas, the list is endless and inspiring. They envision jobs in capital intensive, heavy industries, construction, manufacturing, they want Americans to buy American made goods and enjoy a better and better standard of living. Private sector unions are somewhat more likely to recognize that their imperative – more union jobs – is better furthered through building infrastructure and durable manufactured goods, better furthered through competition between private companies in the free market, better furthered with less government. But the conditions that favor more jobs in the private sector conflict with the incentives that create more jobs in the public sector.

Unions represent many public sector organizations that provide absolutely essential services that are best left to government – public safety and military operations in particular. Unions in the public sector, however, also represent organizations whose numbers increase when social problems increase. Hence counter-productive redistributionist efforts by government intended to reduce, for example, poverty and inequality, because they increase the number of government worker jobs – create an incentive for these efforts to be supported by unions representing government workers – especially if these well-intentioned programs are making the problem worse. One of the most crucial battles within the public sector unions will be between those who want to see problems solved through economic growth, not redistribution, supporting a smaller government that retains the best, brightest, most capable and crucial, highly compensated employees within smaller organizations. They oppose those within public sector unions who prefer to see government power increase regardless of the economic or social cost.

One way to characterize the contrast between public sector unions and private sector unions is to say the public sector unions are internationalist and the private sector unions are nationalist. In-turn, this would suggest many well-intentioned members of public sector unions view Amerca’s national interests as always suspect to charges of being inherently ill-gotten if not criminal, because Americans consume more resources than their proportion of global population might be entitled to on a per-capita basis. These conscientious internationalists conclude America’s wealth must be redistributed to the less fortunate throughout the world. This is altruism run amok, but altruistic nonetheless.

Private sector unions, potentially, have a better understanding of the fact that it is financial sustainability, not resource sustainability, that is at issue with alleged American over-consumption. Put another way, sustainable financial growth is the result of honest hard work and innovation, which can combine in a society for centuries creating economic opportunities and wealth-producing assets, and therefore conveys to the peoples of these societies the right to a proportionately higher standard of living. According to this argument, Americans have earned the right to have a better standard of living than those of other nations. This more nationalistic position held by many private sector unions is another key reason job-creating incentives differ between public sector and private sector unions.

Private sector unions are more likely to oppose efforts to increase immigration – something that is especially harmful when fewer highly-skilled immigrants are allowed into America to work – they are wary of open borders and free trade, opposing NAFTA, for example. Nonetheless, to the extent private sector unions are nationalistic rather than internationalist furthers America’s priorities as a people; to internationalize America and redistribute her wealth to the world would require very big government and millions of new government jobs, but this new regime would diminish if not destroy the quintessential American dream, and the jobs that come every time that dream is realized again by another original American entrepreneur. The truth and reality of this uniquely American dream is the source of America’s economic vitality.

Another way unions in the public sector vs. unions in the private sector contrast regards environmentalism. In the public sector, far more revenue can be collected from the private sector by creating elaborate permit requirements and a civil/criminal legal environment of Byzantine complexity and stupefying expense, than by participating in any actual building. Private sector unions, on the other hand, benefit when something real is built, a bridge, a freeway, an aqueduct, a pipeline, a power plant.

There is a vision of environmentalism that ought to be quite popular with private sector unions, a clean development environmentalism that stands athwart the mainstream environmentalist complex (one that incorporates the entire American oligarchy – big government, big finance, big corporations, and public sector labor) and shouts “Stop the Rationing, Cut the Green Red Tape, Rebuild the Nation.”

There is a natural partnership between clean development environmentalists, and private sector unions, supporting job creating, common sense reforms – no bullet train or light rail until roads and freeways are upgraded and unclogged, no more zoning that favors building high-density clusters of McMansions that destroy semi-rural suburbs within the arbitrary “urban service boundary,” no more water rationing instead of a free water market, no more energy rationing instead of a free energy market, and especially, no CO2 regulations, which have more to do with global governance than climate management. These regressive policies further the goals of the internationalist public sector, as well as the oligarchical recipients of corporate welfare, but they do little for the private American worker, and they stunt American economic growth.

One metaphor to describe America might be said to be as a company – with assets of land and infrastructure and intellectual capital. If America can continue to create abundant wealth, America’s ability to address questions of poverty will increase at the same time as the rate of poverty decreases. Americans may owe trillions upon trillions, but America’s currency will never collapse, or hyper-inflate because America is not just a collection of financial transactions – America is a company, an economic entity of staggering wealth, a merit-based culture with a libertarian, entrepreneurial heart. How unions in the public and private sector recognize and address the consequences of their respective priorities – internationalist vs. nationalist, environmentalist vs. cleantech development, and authoritarian vs. entrepreneurial – given the fact they currently control (from within and without) a significant percentage of America’s city, county and state governments – is arguably the prevailing political question in America today.