Category Archives: Social Contract

Only Leadership Will Get Americans Out of This Dilemma

A variety of structural crises threaten America’s economic and social health.  Massive stimulus has mortgaged the nation’s future in exchange for a temporary boost in national income and employment.  Its inevitable withdrawal now threatens to hold down future growth.  Government deficits and debt are reaching new highs.  In the short-term this is largely because of the recession and efforts to counteract it.  However, the long-term threat stems largely from a long pattern of promising government benefits but not setting aside the funds needed to pay for them.  As a result, pensions and health care benefits on the federal, state and local level have reached unsustainable levels.

Two things are needed for long-term recovery.  The first is a readjustment of government spending to match government revenue.  In the private sector this is usually accomplished by the renegotiation of contracts, either voluntarily or through bankruptcy.  This process can be helped by a series of broader policy initiatives that increase economic growth.  Worthwhile policies include devoting a large share of public and private spending to investment rather than consumption, tax reform, and the elimination of unnecessary regulation.  So why can’t we accomplish these reforms?

The problem is that progress on each of these area is made nearly impossible because current laws contain a morass of special provisions that benefit one group of Americans at the expense of everyone else.  The vast majority of these policies lower national wealth in two ways.  First, they divert productive effort away from beneficial activities and into those activities that the government has chosen to favor, that is unless the current beneficiaries can also get the government to pass laws that protect them from competition.  Second, the government’s use of this arbitrary power encourages large investments in attempts to influence its decisions.  These investments include lobbyists, campaign contributions, personal gifts, and outright graft.  Mancur Olson wrote that stable societies were in danger of facing sclerosis as the gradual growth of special interests skewed incentives and limited innovation.

The the crux of this problem can be understood if we look at how an individual might choose between four alternative states of the world and how government policy might or might not affect their incentives to act on these preferences.  In evaluating an area such as tax policy, each individual faces four alternatives which we will call winner, social cooperation, social loss, and sucker.  The situation that the individual faces is determined by whether he retains those government policies that specifically benefit him and whether the rest of society retains the benefits that favor them.  It is important to realize that, while an individual has some ability to choose whether to give up his benefits, she takes the choices of others as given.

Most individuals probably rank their preference for each outcome in the following order:

  1. I win you lose.  I get to keep my special tax breaks but we repeal yours in order to get faster growth.
  2. We all cooperate.  Everyone gives up their tax breaks.  This allows benefits society the most.
  3. No one cooperates.  We all keep our special privileges.  This comes close to the status quo.
  4. I am a sucker.   I give up my tax break in order to improve public policy, but no one else does.  We are stuck with basically the same system, but I am worse off.

From the point of view of society as a whole, the proper ranking should be; 1) we all cooperate, 2) I win, you lose (because only one special tax break exists), 3) I am a sucker, and 4) no one cooperates.   Given this, how can we productively look at issues such as tax reform?

The first thing to notice is that we are largely stuck in the system where no one cooperates.  The tax code is riddled with special provisions benefiting one group or another.  There is a growing consensus that the complexity of system as a whole imposes large burdens on Americans and that few of the tax provisions can be justified on policy grounds.  Most people think that comprehensive tax reform, similar to the 1986 reforms would make the country better off.

If the average taxpayer would prefer universal cooperation (which in this case would mean everyone giving up their individual tax provisions) why is it so difficult to enact reform?  Largely because, without leadership,  each person or group takes the actions of others as largely given.  The  choice they face is not between we all cooperate and no one cooperates.  It is beween  no one cooperates and I am a sucker.  If homeowners voluntarily step forward to give back  the tax deduction for home mortgages, the oil industry is unlikely to follow their lead.  The extra revenue will be divided among everyone else or, worse, be used to give a new tax break to another group.  In this case, the homeowners have indeed become suckers, sacrificing their interests for the sake of others but not achieving the social benefits that would come from broader reform.

The role of government in this situation is to craft a comprehensive agreement that allows the parties to effectively chose broader social cooperation.  It is to frame the debate in terms of the status quo or full cooperation (or close to it).  Groups are more likely to cooperate if their sacrifices can be made conditional on the cooperation of others.  Bringing more groups into the agreement increases the total social gains that each group realizes in return for its cooperation.  This argues for bold and comprehensive reforms like the 1986 act.  But it also means moving toward simplicity rather than complexity in the way laws are drafted.  Unwieldy reforms such as health care reform, climate change legislation, and financial reform add further layers of special privileges onto an already burdened system, reducing the public’s trust that true reform has been achieved.

But even if comprehensive reform is enacted, the government’s role is not done.  Social cooperation is never a stable outcome because each group has a higher preference: that it gets its special provision added back while others are cooperating.  Having achieved cooperation, they now want to win.  These changes deliver large benefits to the targeted group and, although they reduce total national income, the burden felt by others is often minor.  The problem is that every group wants this outcome and success by one only encourages other attempts.  Thus government must remain ever vigilant in protecting the broader agreement against special interests that attempt to undermine it.  This requires policymakers to forswear the power to dole out special favors, even in cases where there is a good policy argument for using it.

There are strong indications that Americans see the benefits of comprehensive reform and are ready to make sacrifices to achieve it.  Putting America back on course could be this generation’s contribution to posterity.  But few people are willing to give up their own benefits unilaterally.   Unfortunately, they are losing faith in their elected leaders who seem largely uninterested in giving up the discretion to benefit some at the expense of others and who shrink from the leadership needed to craft bold reforms.

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The United States Faces Five Big Challenges

In order to make its strategic and economic leadership secure, America must successfully deal with five complex challenges over the next 20 years.  A solution to each of these challenges is achievable with sustained effort and, if achieved, they will strongly improve America’s ability to enjoy rising livings standards and continued international leadership.  They will also have positive implications for the rest of the world.

The Reform of International Institutions

The United States has a fundamental interest in seeing other nations join it as wealthy, responsible members of the global community.  Yet as other nations develop, the relative power of the United States is certain to decline.  This makes it imperative to develop international institutions that effectively accommodate and constrain the rising power of other nations.

Americans are much better off in a world where the citizens of China, India, Brazil and similar countries enjoy rising living standards and greater freedoms and where their governments bear a proportionate responsibility for ensuring the maintenance of the Western liberal order that has governed during the last 60 years. This order stressing free trade, human rights, nuclear nonproliferation, and collective security has delivered enormous benefits to the world.  As globalization increases the number of problems needing a collective solution, international institutions will gain even more importance.

Yet important international institutions including the World Bank and the International Monetary Fund, have lost much of their relevancy.  Decision making needs to be changed to reflect the rising influence of developing countries.  Just as important, their operations need to be streamlined and focused on a new mission that better reflects the need’s of today’s international community.  Other institutions like the United Nations and the General Agreement on Tariffs and Trade, look increasingly unable to deal with increasingly complex global problems.  Both the United Nations General Assembly and its Security Council continue to have difficulty addressing global issues.

Countries such as India and China need to find that the institutional structure surrounding them both furthers their interests and restrains their ability to act unilaterally against the interests of the general community.  And the world community needs institutions capable of dealing with collective problems.

Preparing Society for the Impact of Technology

Technology continues to increase at an accelerating rate.  In fact, it is likely that the amount of change occurring during the next 30 years will be at least an order of magnitude greater than the changes over the last 30 years.  If one remembers the social, economic and political changes that technology forced over the last three decades and then multiplies by 10 or 20, it becomes clear that new technologies will have a tremendous effect on both the wealth and shape of society.

These changes will have dramatic effects on privacy, life expectancies, industrial structure, and ethics.  What will happen to entitlements and the work place when people routinely live to be 120?  Will parents be allowed to alter their child’s genetics?  Who will have access to all of the data on our personal movements and transactions that future information systems will collect?  Will everyone be guaranteed access to drugs that eliminate disease or enhance mental performance regardless of cost?  We cannot answer these questions now, but we prepare for them.  In addition, the government should change policies governing work, health care, and savings to accommodate a world in which workers need to be more mobile and continuously retrain and in which they will live much longer.  Second, the government can begin to lead a national dialogue about the responsible use and legal framework that should surround new technologies.  It should also begin to enact policies to ensure that the benefits of technology are widely shared.

Competitiveness and Innovation

Globalization will continue to require greater collective decision making by the world’s powers.  If in 20 years the United States is not among the world’s leading economic powers these decisions will still be made, but Americans will have less influence over them.  Remaining the world’s leader in economic competitiveness and innovation boosts our role in global governance and our ability to protect our vital interests.  Concerns about international competitiveness can easily be overdone and other nations face more serious hurdles than we do.  Yet there is little doubt that the United States could do a much better job of ensuring that its laws encourage rather than retard greater productivity.  Failure to generate additional wealth impacts both our national security and our living standards.

Continued technological change can make a large contribution to national productivity, but only to the extent that organizational changes allow for its full use.  Significant reforms to the education, health care, and finance sectors will be necessary before we can see the steady improvement in both performance and price that characterize other sectors of the economy.  Additional investments in the nation’s transportation, energy and communications infrastructures will also be necessary but great care will be needed to ensure that the spending generates a high rate of return.  Finally, we need broad reforms to taxes, worker training programs, and regulation in order to channel activity away from consumption and into productive activity.

The New Social Contract

To obtain the necessary political support for the above changes, a new social contract is needed that strikes a better balance between individual responsibility and collective security.  Workers need to become less dependent on their employers for pensions and health care and individuals need more control over them.  Government assistance should be conditioned on responsible behavior, including an affirmative obligation to work.  In exchange, workers should be able to count on a higher level of protection against the uncertainties and dislocations that accompany a dynamic society.  This includes a fair distribution of the benefits of higher growth, better access to decent education and health care, and tougher enforcement of laws against deceptive and anti-competitive behavior.

The new social contract should provide the minimum level of income needed for a decent standard of living.  It should take the form of an income supplement so that individuals have the maximum flexibility to meet their own needs.  And it should be accompanied by policy reforms that make it easier for everyone to find decent shelter, save, obtain the training needed to improve their prospects, and gain access to affordable health care.

Fiscal Balance

The achievement of each of these goals requires the government to have a long-term focus.  This is unlikely unless it first learns how to balance its commitments with its resources.

The recent fiscal crisis is highlighting the large gap that has developed between America’s commitments to the future in the form of entitlement programs, debt, and infrastructure needs and its present ability to pay for them.

Far too many sectors of society, including all levels of government, are burdened with commitments that they cannot keep.  These commitments need to be renegotiated so that resources are devoted to more productive uses and the burden of future investment is more evenly spread.  A government that tries to meet every want is unlikely in the end to be able to meet even its most important needs.

In facing these challenges it is important to remember that, not only do other nations face their own challenges, our problems are in many ways less serious and our strengths more solid than those of our major competitors.  But the failure of other nations should not give us hope for, until we face up to the challenges before us, we will fall far short of of our potential.

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