385Readings(Y)

In accounts of the political unrest sweeping through the Middle East, one factor, inflation, deserves more attention. Nothing can be more demoralizing to people at the low end of the income scale—where great masses in that region reside—than increases in the cost of basic necessities like food and fuel. It brings them out into the streets to protest government policies, especially in places where mass protests are the only means available to shake the existing power structure.

The consumer-price index in Egypt rose to more than 18% annually in 2009 from 5% in 2006, a more normal year. In Iran, the rate went to 25% in 2009 from 13% in 2006. In both cases the rate subsided in 2010 but remained in double digits.

Egyptians were able to overthrow the dictatorial Hosni Mubarak. Their efforts to fashion a more responsive regime may or may not succeed. Iranians are taking far greater risks in tackling the vicious Revolutionary Guards to try to unseat the ruling ayatollahs.

Probably few of the protesters in the streets connect their economic travail to Washington. But central bankers do. They complain, most recently at last week's G-20 meeting in Paris, that the U.S. is exporting inflation.

China and India blame the U.S. Federal Reserve for their difficulties in maintaining stable prices. The International Monetary Fund and the United Nations, always responsive to the complaints of developing nations, are suggesting alternatives to the dollar as the pre-eminent international currency. The IMF managing director, Dominique Strauss-Kahn, has proposed replacement of the dollar with IMF special drawing rights, or SDRs, a unit of account fashioned from a basket of currencies that is made available to the foreign currency reserves of central banks.

The turmoil in Iran is reminiscent of another period when the Fed was on an inflationary binge, the late 1970s.

About the only one failing to acknowledge a problem seems to be the man most responsible, Federal Reserve Chairman Ben Bernanke. In a recent question-and-answer session at the National Press Club in Washington, the chairman said it was "unfair" to accuse the Fed of exporting inflation. Other nations, he said, have the same tools the Fed has for controlling inflation.

Well, not quite. Consider, for example, that much of world trade, particularly in basic commodities like food grains and oil, is denominated in U.S. dollars. When the Fed floods the world with dollars, the dollar price of commodities goes up, and this affects market prices generally, particularly in poor countries that are heavily import-dependent. Export-dependent nations like China try to maintain exchange-rate stability by inflating their own currencies to buy up dollars.

Mr. Bernanke has made it clear that his policy is to inflate the money supply. His second round of quantitative easing—the controversial QE2 policy to systematically purchase $600 billion in Treasury securities with newly created money—serves that aim. But even for the U.S. it is uncertain that Mr. Bernanke can hold to his 2% inflation target. Oil is going up. Foodstuffs are going up. And when the Fed sneezes money, the weak economies of the world, and the poor masses who are highly vulnerable to price rises in the necessities of life, catch pneumonia.

The turmoil in Iran is reminiscent of another period when the Fed was on an inflationary binge, the late 1970s. The Iranian oil boom had brought many thousands of peasants out of the villages into the cash economy in population centers like Tehran. On top of the disorientation resulting from that change itself, Iranians were then victims of an outbreak of inflation and a sharp decline in the purchasing power of the rials in their pay envelopes. Confused and angry, they supported the clerical revolution that unseated the shah and has been a thorn in America's side ever since.

Today's Iranian revolt has similar causes and, if successful, could be the flip side of 1979, a nation again friendlier toward the U.S. But there is no guarantee of that, or that states now friendly, like Bahrain, will remain so after an Egyptian-style upheaval.

Indeed, it is unlikely that Americans themselves will escape the inflationary consequences of current Fed policy. Aside from the rise in oil and foodstuffs, higher prices of manufactured goods are in the offing. China's inflation rate is hovering at 5%. MKM Partners, a research and trading firm, last November reported that an internal study at Wal-Mart, a big importer from China, showed that the huge retail chain's prices are edging up at an annual rate of 4% a year. That recent trend showed up in last week's consumer-price index report.

The Fed is financing a vast and rising federal deficit, following a practice that has been a surefire prescription for domestic inflation from time immemorial. Meanwhile, its policies are stoking a rise in prices that is contributing to political unrest that in some cases might be beneficial but in others might turn out as badly as the overthrow of the shah in 1979. Does any of this suggest that there might be some urgency to bringing the Fed under closer scrutiny?

Mr. Melloan, a former columnist and deputy editor of the Journal editorial page, is author of "The Great Money Binge: Spending Our Way to Socialism" (Simon & Schuster, 2009).

Icelandic Freeze-Out

The tiny island nation shouldn't have to bear the costs of the Dutch and British bailouts.

Iceland's voters will once again get to have their say over whether they should bear the cost of the 2008 bailouts of British and Dutch depositors in Icelandic banks. And a new poll out yesterday suggests that this time, they might just approve the deal, struck in December between the governments of the three countries. A yes vote in a referendum likely to be held in early April would leave Iceland in hock to London and The Hague for as long as 35 years—and this because the British and Dutch governments decided, of their own volition, to bail out their own citizens.

The dispute dates back to the height of the financial panic. Icelandic banks, which had aggressively marketed high-yielding savings products in the EU, collapsed when the financial markets seized up that fall, leaving the deposits of more than 300,000 Dutch and British depositors in jeopardy. The decision to bailout Icesave depositors in their countries cost those governments £3.1 billion ($5 billion)—but all of that money went to their own countrymen, those who had made the choice of investing their savings in Iceland. It did nothing to stave off the near-total collapse of Iceland's banking sector or the collapse in its currency. And thanks in part to British and Dutch demands for repayment, Iceland remains, two and a half years later, shut out of global capital markets.

Last year, Icelandic voters overwhelmingly rejected an earlier deal to repay the money over 15 years. The new agreement should prove much less costly to Icelandic taxpayers than the original, with the President estimating that they could be on the hook for as little as £246 million in direct costs. But it's unclear why Iceland should bear the costs of bailing out the Dutch and British at all.

If those countries' governments felt it necessary to make their people whole, that is their affair. It's hardly surprising that the people of Iceland would prefer to put the whole business behind them, as the most recent polling suggests. But that should not be taken as vindication of the U.K.'s and Netherlands' two-and-a-half year campaign of vilification of Iceland.

The Myth of Corporate Cash Hoarding

Companies hire more workers when there's income to pay them. They don't liquidate financial assets.

By ALAN REYNOLDS

American nonfinancial corporations were "sitting on" $1.93 trillion in liquid assets at the end of last year's third quarter, according to the Federal Reserve Board. This has become one of the most frequently echoed statistics, viewed as indisputable evidence that U.S. business leaders are unduly timid or evil.

Last September, Chris Matthews, the host of MSNBC's "Hardball," asked Politico's Charles Mahtesian, "You think business can sit on those billions and trillions of dollars for two more years after they screw Obama this time? Are they going to keep sitting on their money . . . to get Mr. Excitement Mitt Romney elected president? Will they do that to the country?" Mr. Mahtesian concurred.

More recently, Washington Post columnist Harold Meyerson opined that, "U.S. corporations can't sit on their nearly $2 trillion in cash reserves forever, but that doesn't mean they're going to invest their stash in job-creating enterprises within the United States." And the "nearly $2 trillion in cash" was included in this newspaper's four key numbers of the year—right up there with jobs, oil prices and world trade. "In an ideal world," that report suggested, "2011 would see cash-rich companies step up their hiring."

Like so many statistics used to score political points, this datum de jour has been totally misunderstood. The chorus of media outrage about supposedly excessive corporate cash reveals nothing about the financial health of any U.S. business. It simply reveals appalling ignorance of elementary accounting.

2) Liquid assets serve as a vital safety cushion to minimize the impact (on workers and suppliers) of unanticipated business difficulties.

4) Corporations commonly use both internal and external sources of funds to acquire both real and financial assets at the same time. Larger investments in money-market funds and bank CDs do not mean smaller investment in plant and equipment, as many seem to imagine.

Point No. 1, about two-sided balance sheets, reminds us that single-entry bookkeeping will not do. The financial health of corporations is not measured by the form in which assets are held (liquid or not), but by net worth.

From 2007 to September 2010, the value of nonfinancial corporate real estate fell by more than 30%—a loss of more than $2.8 trillion. The ratio of cash to total assets rose largely because the value of total assets collapsed. Meanwhile, liabilities topped $13.6 trillion last fall, up from $12.9 trillion at the last cyclical peak. With real estate falling and debts rising, the net worth of nonfinancial corporations was only $12.6 trillion at last count—down from $15.9 trillion in 2007.

Point No. 2, about safety cushions, alerts us to the fact that $1.93 trillion of liquid assets would not begin to cover $3.67 trillion of short-term debts, let alone ongoing expenses such as payroll. To describe the liquid assets as "hoarding" (regardless of debts) is witless. The recession in 2008-09 would have been far less painful if nonfinancial corporations in 2007 had been "hoarding" more liquid assets (they had $1.53 trillion).

Point No. 3, about the difference between a balance sheet (what a company owns and owes) and an income statement (money received and spent) is basic accounting. Outraged proclamations about the $1.93 trillion figure show zero understanding of this difference.

Firms hire out of income, not by liquidating assets or adding to debt. No sensible employer plans on meeting routine payroll expenses by drawing down assets, liquid or not.

Decisions to increase or reduce hiring are unrelated to decisions to increase or reduce any assets on the balance sheet. Companies add workers if the expected addition to after-tax revenues is likely to exceed the addition to costs (including taxes and mandated benefits).

Point No. 4 is related to Point No. 3. Consider that in the balance-sheet section of the Federal Reserve flow-of-funds accounts, where the now-famous $1.93 trillion appears, investments in liquid assets are a use of funds, not a source of funds.

Sources of funds are both internal (profits) and external (debts). Uses of funds include adding to financial assets. The Smith family may invest part of its monthly paycheck in a bank CD or mutual fund and the Jones Corporation may likewise invest part of its monthly profits in the same way. Such liquid investments are viewed as something that could be tapped to meet unexpected expenses, or to make longer-term investments later—not as a substitute for regular monthly income.

Another use of funds is capital expenditures on tangible assets—plant, equipment and inventories. Such capital expenditures by nonfinancial corporations (at home, not abroad) were growing at an annual rate of nearly $1.1 trillion in the third quarter of 2010—a 42% increase from $752 billion in the second quarter of 2009. U.S. corporations obviously can and do increase their investments in plant and equipment at the same time they are increasing investments in so-called "liquid" assets (which include bonds, time deposits and mutual funds).

The widely repeated notion that prudent corporate investments in liquid assets have somehow reduced real investments or hiring is unqualified nonsense based on inexcusable ignorance of elementary economics and accounting.

Mr. Reynolds, a senior fellow at the Cato Institute, is author of "Income and Wealth" (Greenwood Press, 2006).

The war on baby girls

IMAGINE you are one half of a young couple expecting your first child in a fast-growing, poor country. You are part of the new middle class; your income is rising; you want a small family. But traditional mores hold sway around you, most important in the preference for sons over daughters. Perhaps hard physical labour is still needed for the family to make its living. Perhaps only sons may inherit land. Perhaps a daughter is deemed to join another family on marriage and you want someone to care for you when you are old. Perhaps she needs a dowry.

Now imagine that you have had an ultrasound scan; it costs $12, but you can afford that. The scan says the unborn child is a girl. You yourself would prefer a boy; the rest of your family clamours for one. You would never dream of killing a baby daughter, as they do out in the villages. But an abortion seems different. What do you do?

For millions of couples, the answer is: abort the daughter, try for a son. In China and northern India more than 120 boys are being born for every 100 girls. Nature dictates that slightly more males are born than females to offset boys’ greater susceptibility to infant disease. But nothing on this scale.

For those who oppose abortion, this is mass murder. For those such as this newspaper, who think abortion should be “safe, legal and rare” (to use Bill Clinton’s phrase), a lot depends on the circumstances, but the cumulative consequence for societies of such individual actions is catastrophic. China alone stands to have as many unmarried young men—“bare branches”, as they are known—as the entire population of young men in America. In any country rootless young males spell trouble; in Asian societies, where marriage and children are the recognised routes into society, single men are almost like outlaws. Crime rates, bride trafficking, sexual violence, even female suicide rates are all rising and will rise further as the lopsided generations reach their maturity (see article).

It is no exaggeration to call this gendercide. Women are missing in their millions—aborted, killed, neglected to death. In 1990 an Indian economist, Amartya Sen, put the number at 100m; the toll is higher now. The crumb of comfort is that countries can mitigate the hurt, and that one, South Korea, has shown the worst can be avoided. Others need to learn from it if they are to stop the carnage.

The dearth and death of little sisters

Most people know China and northern India have unnaturally large numbers of boys. But few appreciate how bad the problem is, or that it is rising. In China the imbalance between the sexes was 108 boys to 100 girls for the generation born in the late 1980s; for the generation of the early 2000s, it was 124 to 100. In some Chinese provinces the ratio is an unprecedented 130 to 100. The destruction is worst in China but has spread far beyond. Other East Asian countries, including Taiwan and Singapore, former communist states in the western Balkans and the Caucasus, and even sections of America’s population (Chinese- and Japanese-Americans, for example): all these have distorted sex ratios. Gendercide exists on almost every continent. It affects rich and poor; educated and illiterate; Hindu, Muslim, Confucian and Christian alike.

Wealth does not stop it. Taiwan and Singapore have open, rich economies. Within China and India the areas with the worst sex ratios are the richest, best-educated ones. And China’s one-child policy can only be part of the problem, given that so many other countries are affected.

In fact the destruction of baby girls is a product of three forces: the ancient preference for sons; a modern desire for smaller families; and ultrasound scanning and other technologies that identify the sex of a fetus. In societies where four or six children were common, a boy would almost certainly come along eventually; son preference did not need to exist at the expense of daughters. But now couples want two children—or, as in China, are allowed only one—they will sacrifice unborn daughters to their pursuit of a son. That is why sex ratios are most distorted in the modern, open parts of China and India. It is also why ratios are more skewed after the first child: parents may accept a daughter first time round but will do anything to ensure their next—and probably last—child is a boy. The boy-girl ratio is above 200 for a third child in some places.

How to stop half the sky crashing down

Baby girls are thus victims of a malign combination of ancient prejudice and modern preferences for small families. Only one country has managed to change this pattern. In the 1990s South Korea had a sex ratio almost as skewed as China’s. Now, it is heading towards normality. It has achieved this not deliberately, but because the culture changed. Female education, anti-discrimination suits and equal-rights rulings made son preference seem old-fashioned and unnecessary. The forces of modernity first exacerbated prejudice—then overwhelmed it.

But this happened when South Korea was rich. If China or India—with incomes one-quarter and one-tenth Korea’s levels—wait until they are as wealthy, many generations will pass. To speed up change, they need to take actions that are in their own interests anyway. Most obviously China should scrap the one-child policy. The country’s leaders will resist this because they fear population growth; they also dismiss Western concerns about human rights. But the one-child limit is no longer needed to reduce fertility (if it ever was: other East Asian countries reduced the pressure on the population as much as China). And it massively distorts the country’s sex ratio, with devastating results. President Hu Jintao says that creating “a harmonious society” is his guiding principle; it cannot be achieved while a policy so profoundly perverts family life.

And all countries need to raise the value of girls. They should encourage female education; abolish laws and customs that prevent daughters inheriting property; make examples of hospitals and clinics with impossible sex ratios; get women engaged in public life—using everything from television newsreaders to women traffic police. Mao Zedong said “women hold up half the sky.” The world needs to do more to prevent a gendercide that will have the sky crashing down.

Technology, declining fertility and ancient prejudice are combining to unbalance societies

Gendercide

XINRAN XUE, a Chinese writer, describes visiting a peasant family in the Yimeng area of Shandong province. The wife was giving birth. “We had scarcely sat down in the kitchen”, she writes (see article), “when we heard a moan of pain from the bedroom next door…The cries from the inner room grew louder—and abruptly stopped. There was a low sob, and then a man’s gruff voice said accusingly: ‘Useless thing!’

“Suddenly, I thought I heard a slight movement in the slops pail behind me,” Miss Xinran remembers. “To my absolute horror, I saw a tiny foot poking out of the pail. The midwife must have dropped that tiny baby alive into the slops pail! I nearly threw myself at it, but the two policemen [who had accompanied me] held my shoulders in a firm grip. ‘Don’t move, you can’t save it, it’s too late.’

“‘But that’s...murder...and you’re the police!’ The little foot was still now. The policemen held on to me for a few more minutes. ‘Doing a baby girl is not a big thing around here,’ [an] older woman said comfortingly. ‘That’s a living child,’ I said in a shaking voice, pointing at the slops pail. ‘It’s not a child,’ she corrected me. ‘It’s a girl baby, and we can’t keep it. Around these parts, you can’t get by without a son. Girl babies don’t count.’”

In January 2010 the Chinese Academy of Social Sciences (CASS) showed what can happen to a country when girl babies don’t count. Within ten years, the academy said, one in five young men would be unable to find a bride because of the dearth of young women—a figure unprecedented in a country at peace.

The number is based on the sexual discrepancy among people aged 19 and below. According to CASS, China in 2020 will have 30m-40m more men of this age than young women. For comparison, there are 23m boys below the age of 20 in Germany, France and Britain combined and around 40m American boys and young men. So within ten years, China faces the prospect of having the equivalent of the whole young male population of America, or almost twice that of Europe’s three largest countries, with little prospect of marriage, untethered to a home of their own and without the stake in society that marriage and children provide.

Gendercide—to borrow the title of a 1985 book by Mary Anne Warren—is often seen as an unintended consequence of China’s one-child policy, or as a product of poverty or ignorance. But that cannot be the whole story. The surplus of bachelors—called in China guanggun, or “bare branches”— seems to have accelerated between 1990 and 2005, in ways not obviously linked to the one-child policy, which was introduced in 1979. And, as is becoming clear, the war against baby girls is not confined to China.

Parts of India have sex ratios as skewed as anything in its northern neighbour. Other East Asian countries—South Korea, Singapore and Taiwan—have peculiarly high numbers of male births. So, since the collapse of the Soviet Union, have former communist countries in the Caucasus and the western Balkans. Even subsets of America’s population are following suit, though not the population as a whole.

The real cause, argues Nick Eberstadt, a demographer at the American Enterprise Institute, a think-tank in Washington, DC, is not any country’s particular policy but “the fateful collision between overweening son preference, the use of rapidly spreading prenatal sex-determination technology and declining fertility.” These are global trends. And the selective destruction of baby girls is global, too.

Boys are slightly more likely to die in infancy than girls. To compensate, more boys are born than girls so there will be equal numbers of young men and women at puberty. In all societies that record births, between 103 and 106 boys are normally born for every 100 girls. The ratio has been so stable over time that it appears to be the natural order of things.

That order has changed fundamentally in the past 25 years. In China the sex ratio for the generation born between 1985 and 1989 was 108, already just outside the natural range. For the generation born in 2000-04, it was 124 (ie, 124 boys were born in those years for every 100 girls). According to CASS the ratio today is 123 boys per 100 girls. These rates are biologically impossible without human intervention.

The national averages hide astonishing figures at the provincial level. According to an analysis of Chinese household data carried out in late 2005 and reported in the British Medical Journal*, only one region, Tibet, has a sex ratio within the bounds of nature. Fourteen provinces—mostly in the east and south—have sex ratios at birth of 120 and above, and three have unprecedented levels of more than 130. As CASS says, “the gender imbalance has been growing wider year after year.”

The BMJ study also casts light on one of the puzzles about China’s sexual imbalance. How far has it been exaggerated by the presumed practice of not reporting the birth of baby daughters in the hope of getting another shot at bearing a son? Not much, the authors think. If this explanation were correct, you would expect to find sex ratios falling precipitously as girls who had been hidden at birth start entering the official registers on attending school or the doctor. In fact, there is no such fall. The sex ratio of 15-year-olds in 2005 was not far from the sex ratio at birth n 1990. The implication is that sex-selective abortion, not under-registration of girls, accounts for the excess of boys.

Other countries have wildly skewed sex ratios without China’s draconian population controls (see chart 1). Taiwan’s sex ratio also rose from just above normal in 1980 to 110 in the early 1990s; it remains just below that level today. During the same period, South Korea’s sex ratio rose from just above normal to 117 in 1990—then the highest in the world—before falling back to more natural levels. Both these countries were already rich, growing quickly and becoming more highly educated even while the balance between the sexes was swinging sharply towards males.

South Korea is experiencing some surprising consequences. The surplus of bachelors in a rich country has sucked in brides from abroad. In 2008, 11% of marriages were “mixed”, mostly between a Korean man and a foreign woman. This is causing tensions in a hitherto homogenous society, which is often hostile to the children of mixed marriages. The trend is especially marked in rural areas, where the government thinks half the children of farm households will be mixed by 2020. The children are common enough to have produced a new word: “Kosians”, or Korean-Asians.

China is nominally a communist country, but elsewhere it was communism’s collapse that was associated with the growth of sexual disparities. After the Soviet Union imploded in 1991, there was an upsurge in the ratio of boys to girls in Armenia, Azerbaijan and Georgia. Their sex ratios rose from normal levels in 1991 to 115-120 by 2000. A rise also occurred in several Balkan states after the wars of Yugoslav succession. The ratio in Serbia and Macedonia is around 108. There are even signs of distorted sex ratios in America, among various groups of Asian-Americans. In 1975, calculates Mr Eberstadt, the sex ratio for Chinese-, Japanese- and Filipino-Americans was between 100 and 106. In 2002, it was 107 to 109.

But the country with the most remarkable record is that other supergiant, India. India does not produce figures for sex ratios at birth, so its numbers are not strictly comparable with the others. But there is no doubt that the number of boys has been rising relative to girls and that, as in China, there are large regional disparities. The north-western states of Punjab and Haryana have sex ratios as high as the provinces of China’s east and south. Nationally, the ratio for children up to six years of age rose from a biologically unexceptionable 104 in 1981 to a biologically impossible 108 in 2001. In 1991, there was a single district with a sex ratio over 125; by 2001, there were 46.

Conventional wisdom about such disparities is that they are the result of “backward thinking” in old-fashioned societies or—in China—of the one-child policy. By implication, reforming the policy or modernising the society (by, for example, enhancing the status of women) should bring the sex ratio back to normal. But this is not always true and, where it is, the road to normal sex ratios is winding and bumpy.

Not all traditional societies show a marked preference for sons over daughters. But in those that do—especially those in which the family line passes through the son and in which he is supposed to look after his parents in old age—a son is worth more than a daughter. A girl is deemed to have joined her husband’s family on marriage, and is lost to her parents. As a Hindu saying puts it, “Raising a daughter is like watering your neighbours’ garden.”

“Son preference” is discernible—overwhelming, even—in polling evidence. In 1999 the government of India asked women what sex they wanted their next child to be. One third of those without children said a son, two-thirds had no preference and only a residual said a daughter. Polls carried out in Pakistan and Yemen show similar results. Mothers in some developing countries say they want sons, not daughters, by margins of ten to one. In China midwives charge more for delivering a son than a daughter.

Chasing puppy-dogs’ tails

The unusual thing about son preference is that it rises sharply at second and later births (see chart 2). Among Indian women with two children (of either sex), 60% said they wanted a son next time, almost twice the preference for first-borns. This reflected the desire of those with two daughters for a son. The share rose to 75% for those with three children. The difference in parental attitudes between first-borns and subsequent children is large and significant.

Until the 1980s people in poor countries could do little about this preference: before birth, nature took its course. But in that decade, ultrasound scanning and other methods of detecting the sex of a child before birth began to make their appearance. These technologies changed everything. Doctors in India started advertising ultrasound scans with the slogan “Pay 5,000 rupees ($110) today and save 50,000 rupees tomorrow” (the saving was on the cost of a daughter’s dowry). Parents who wanted a son, but balked at killing baby daughters, chose abortion in their millions.

The use of sex-selective abortion was banned in India in 1994 and in China in 1995. It is illegal in most countries (though Sweden legalised the practice in 2009). But since it is almost impossible to prove that an abortion has been carried out for reasons of sex selection, the practice remains widespread. An ultrasound scan costs about $12, which is within the scope of many—perhaps most—Chinese and Indian families. In one hospital in Punjab, in northern India, the only girls born after a round of ultrasound scans had been mistakenly identified as boys, or else had a male twin.

The spread of fetal-imaging technology has not only skewed the sex ratio but also explains what would otherwise be something of a puzzle: sexual disparities tend to rise with income and education, which you would not expect if “backward thinking” was all that mattered. In India, some of the most prosperous states—Maharashtra, Punjab, Gujarat—have the worst sex ratios. In China, the higher a province’s literacy rate, the more skewed its sex ratio. The ratio also rises with income per head.

In Punjab Monica Das Gupta of the World Bank discovered that second and third daughters of well-educated mothers were more than twice as likely to die before their fifth birthday as their brothers, regardless of their birth order. The discrepancy was far lower in poorer households. Ms Das Gupta argues that women do not necessarily use improvements in education and income to help daughters. Richer, well-educated families share their poorer neighbours’ preference for sons and, because they tend to have smaller families, come under greater pressure to produce a son and heir if their first child is an unlooked-for daughter**.

So modernisation and rising incomes make it easier and more desirable to select the sex of your children. And on top of that smaller families combine with greater wealth to reinforce the imperative to produce a son. When families are large, at least one male child will doubtless come along to maintain the family line. But if you have only one or two children, the birth of a daughter may be at a son’s expense. So, with rising incomes and falling fertility, more and more people live in the smaller, richer families that are under the most pressure to produce a son.

In China the one-child policy increases that pressure further. Unexpectedly, though, it is the relaxation of the policy, rather than the policy pure and simple, which explains the unnatural upsurge in the number of boys.

In most Chinese cities couples are usually allowed to have only one child—the policy in its pure form. But in the countryside, where 55% of China’s population lives, there are three variants of the one-child policy. In the coastal provinces some 40% of couples are permitted a second child if their first is a girl. In central and southern provinces everyone is permitted a second child either if the first is a girl or if the parents suffer “hardship”, a criterion determined by local officials. In the far west and Inner Mongolia, the provinces do not really operate a one-child policy at all. Minorities are permitted second—sometimes even third—children, whatever the sex of the first-born (see map).

The provinces in this last group are the only ones with close to normal sex ratios. They are sparsely populated and inhabited by ethnic groups that do not much like abortion and whose family systems do not disparage the value of daughters so much. The provinces with by far the highest ratios of boys to girls are in the second group, the ones with the most exceptions to the one-child policy. As the BMJ study shows, these exceptions matter because of the preference for sons in second or third births.

For an example, take Guangdong, China’s most populous province. Its overall sex ratio is 120, which is very high. But if you take first births alone, the ratio is “only” 108. That is outside the bounds of normality but not by much. If you take just second children, however, which are permitted in the province, the ratio leaps to 146 boys for every 100 girls. And for the relatively few births where parents are permitted a third child, the sex ratio is 167. Even this startling ratio is not the outer limit. In Anhui province, among third children, there are 227 boys for every 100 girls, while in Beijing municipality (which also permits exceptions in rural areas), the sex ratio reaches a hard-to-credit 275. There are almost three baby boys for each baby girl.

Ms Das Gupta found something similar in India. First-born daughters were treated the same as their brothers; younger sisters were more likely to die in infancy. The rule seems to be that parents will joyfully embrace a daughter as their first child. But they will go to extraordinary lengths to ensure subsequent children are sons.

The hazards of bare branches

Throughout human history, young men have been responsible for the vast preponderance of crime and violence—especially single men in countries where status and social acceptance depend on being married and having children, as it does in China and India. A rising population of frustrated single men spells trouble.

The crime rate has almost doubled in China during the past 20 years of rising sex ratios, with stories abounding of bride abduction, the trafficking of women, rape and prostitution. A study into whether these things were connected† concluded that they were, and that higher sex ratios accounted for about one-seventh of the rise in crime. In India, too, there is a correlation between provincial crime rates and sex ratios. In “Bare Branches”††, Valerie Hudson and Andrea den Boer gave warning that the social problems of biased sex ratios would lead to more authoritarian policing. Governments, they say, “must decrease the threat to society posed by these young men. Increased authoritarianism in an effort to crack down on crime, gangs, smuggling and so forth can be one result.”

Violence is not the only consequence. In parts of India, the cost of dowries is said to have fallen (see article). Where people pay a bride price (ie, the groom’s family gives money to the bride’s), that price has risen. During the 1990s, China saw the appearance of tens of thousands of “extra-birth guerrilla troops”—couples from one-child areas who live in a legal limbo, shifting restlessly from city to city in order to shield their two or three children from the authorities’ baleful eye. And, according to the World Health Organisation, female suicide rates in China are among the highest in the world (as are South Korea’s). Suicide is the commonest form of death among Chinese rural women aged 15-34; young mothers kill themselves by drinking agricultural fertilisers, which are easy to come by. The journalist Xinran Xue thinks they cannot live with the knowledge that they have aborted or killed their baby daughters.

Some of the consequences of the skewed sex ratio have been unexpected. It has probably increased China’s savings rate. This is because parents with a single son save to increase his chances of attracting a wife in China’s ultra-competitive marriage market. Shang-Jin Wei of Columbia University and Xiaobo Zhang of the International Food Policy Research Institute in Washington, DC, compared savings rates for households with sons versus those with daughters. “We find not only that households with sons save more than households with daughters in all regions,” says Mr Wei, “but that households with sons tend to raise their savings rate if they also happen to live in a region with a more skewed sex ratio.” They calculate that about half the increase in China’s savings in the past 25 years can be attributed to the rise in the sex ratio. If true, this would suggest that economic-policy changes to boost consumption will be less effective than the government hopes.

Over the next generation, many of the problems associated with sex selection will get worse. The social consequences will become more evident because the boys born in large numbers over the past decade will reach maturity then. Meanwhile, the practice of sex selection itself may spread because fertility rates are continuing to fall and ultrasound scanners reach throughout the developing world.

Yet the story of the destruction of baby girls does not end in deepest gloom. At least one country—South Korea—has reversed its cultural preference for sons and cut the distorted sex ratio (see chart 3). There are reasons for thinking China and India might follow suit.

South Korea was the first country to report exceptionally high sex ratios and has been the first to cut them. Between 1985 and 2003, the share of South Korean women who told national health surveyors that they felt “they must have a son” fell by almost two-thirds, from 48% to 17%. After a lag of a decade, the sex ratio began to fall in the mid-1990s and is now 110 to 100. Ms Das Gupta argues that though it takes a long time for social norms favouring sons to alter, and though the transition can be delayed by the introduction of ultrasound scans, eventually change will come. Modernisation not only makes it easier for parents to control the sex of their children, it also changes people’s values and undermines those norms which set a higher store on sons. At some point, one trend becomes more important than the other.

It is just possible that China and India may be reaching that point now. The census of 2000 and the CASS study both showed the sex ratio stable at around 120. At the very least, it seems to have stopped rising. Locally, Ms Das Gupta argues†††, the provinces which had the highest sex ratios (and have two-thirds of China’s population) have seen a deceleration in their ratios since 2000, and provinces with a quarter of the population have seen their ratios fall. In India, one study found that the cultural preference for sons has been falling, too, and that the sex ratio, as in much of China, is rising more slowly. In villages in Haryana, grandmothers sit veiled and silent while men are present. But their daughters sit and chat uncovered because, they say, they have seen unveiled women at work or on television so much that at last it seems normal to them.

Ms Das Gupta points out that, though the two giants are much poorer than South Korea, their governments are doing more than it ever did to persuade people to treat girls equally (through anti-discrimination laws and media campaigns). The unintended consequences of sex selection have been vast. They may get worse. But, at long last, she reckons, “there seems to be an incipient turnaround in the phenomenon of ‘missing girls’ in Asia.”

* “China’s excess males, sex selective abortion and one child policy”, by Wei Xing Zhu, Li Lu and Therese Hesketh. BMJ 2009

** “Why is son preference so persistent in East and South Asia?” By Monica Das Gupta, Jiang Zhenghua, Li Bohua, Xie Zhenming, Woojin Chung and Bae Hwa-Ok. World Bank, Policy Research Working Paper 2942.

† “Sex ratios and crime: evidence from China’s one-child policy”, by Lena Edlund, Hongbin Li, Junjian Yi and Junsen Zhang. Institute for the Study of Labour, Bonn. Discussion Paper 3214

†† “Bare Branches”, by Valerie Hudson and Andrea den Boer. MIT Press, 2004

††† “Is there an incipient turnaround in Asia’s “missing girls” phenomenon?” By Monica Das Gupta, Woojin Chung and Li Shuzhuo. World Bank, Policy Research Working Paper 4846.

Nigeria Rejects IMF Currency View

By PETER WONACOTT And WILL CONNORS

ABUJA, Nigeria—The Central Bank of Nigeria will stick to a stable exchange-rate policy as the country ramps up its economic growth, the bank's top official said, rejecting recent comments from the International Monetary Fund that its currency is overvalued.

In an exclusive interview, Nigeria's central-bank governor, Sanusi Lamido Sanusi, said devaluing its currency, the naira, wouldn't help the economy and could fuel inflation—already in the low double-digits.

"Price stability is the mandate of the central bank," he said. "We aren't targeting a particular exchange rate."

Earlier this month, the IMF released a report on Nigeria stating that the central bank's policies of protecting the value of the currency and keeping interest rates low have eroded foreign-exchange reserves.

The IMF report "stressed that greater exchange-rate flexibility would prevent one-way bets in the foreign-exchange market and cushion external shocks."

But Nigeria's central-bank governor took issue with the IMF diagnosis. A cheaper currency wouldn't aid exports, he said, since much of what the country sells overseas is oil at prices dictated by the international markets. And since much of what Nigerian factories make depend on foreign materials, he warned a sharp currency devaluation that would make imports more expensive "could shut down manufacturing."

At the end of 2010, the IMF estimated Nigeria's foreign-exchange reserves at $34.1 billion, down from $42.4 billion the year before.

But Mr. Sanusi said the more important priority than preserving reserves was keeping on the economy on track. Last year, Nigeria not only had to deal with the global financial crisis; it also face heightened political uncertainty at home. The country's president died, militants kept up attacks on its oil infrastructure, and there was renewed fighting between Muslims and Christians around the volatile region of Jos.

The political uncertainty is set to continue for at least a couple more months. In April, Nigeria will hold elections for president as well as posts for powerful state governors.

And yet, Africa's most populous country and second-largest economy has weathered the global downturn better than most. The IMF projected Nigeria's economic growth at 8.5% in 2010, more than twice as fast as the continent's largest economy, South Africa. It predicted the economy would grow by 7% this year, thanks in part to the emergence of a consumer class and demand for retail goods, telecommunications and other services.

The central-bank governor said Nigeria could grow at twice that projected clip by overhauling the nation's lackluster infrastructure.

Rather than exchange-rate adjustments, Mr. Sanusi said, steps to improve roads and spotty power supply as well as distribution of fresh farm produce—most of which rots before arriving at market—will be more effective at boosting growth and bringing down prices.

The Corporate Governance Fix for Korea

Executives, lawmakers, prosecutors and minority investors all have a role to play.

By YOON BAE PARK

Korean companies are among the best in the world, delivering innovative products from washing machines to high-tech smart phones. Yet this success is not reflected in the values of these companies' stocks, a problem Korea needs to fix to keep growing. Improving corporate governance is the key.

Although many Korean companies have reached developed-economy scale in terms of revenue, name recognition or number of employees, they're still stuck in a family-business model in terms of corporate governance. Among the top 100 companies in market capitalization, almost all are controlled by members of the founding family. This encourages a sense that the company, even if it's listed, is the family's private possession, to be divided up or handed down to the children as the patriarch sees fit.

That fact alone can serve as a temptation toward activities that hurt the interests of small investors. For instance, it is considered normal to turn control of a company over to children of the founder at a relatively early age. According to a 2009 survey of 37 of these "royal kids" by business website Chaebul.com, the average age at which they take directorial positions is only 31.

The problem is compounded by weak institutional protections for minority shareholders. In theory, legal changes after the 1997 financial crisis bolstered the role of outside directors on corporate boards and created a better electronic reporting system for regulatory filings to enhance shareholder access to information. However, the culture still discourages regulators—especially public prosecutors—from vigorously defending the ability of minority owners to assert the few rights they do have.

Koreans cling to a belief that their economy is founded on the health of large conglomerates, known as chaebol, and that what's good for the chaebol (and its ruling family) is good for Korea. This explains why prosecutions of corporate corruption cases involving chaebol families are infrequent and rarely result in stiff sanctions even if prosecutors secure a conviction.

This was most clearly on display in 2008 in the case of Lee Kun-hee, chairman of Samsung and son of the chaebol's founder. In July of that year, he was convicted of tax evasion and other charges in connection with a scandal over transfer of his managerial control and wealth to his son. He was given a three-year prison term suspended for five years, and fined 110 billion won ($100 million). Yet he never served a day in prison; instead he received a presidential pardon. According to newspaper reports, President Lee Myung-bak decided to pardon Mr. Lee in view of the "national interest."

This kind of behavior—and Samsung's Mr. Lee is hardly alone in Korean corporate history—is a serious damper on the interests of minority shareholders. That may be one of the reasons for the so-called Korean discount, whereby the Korean market trades at lower average price-to-earnings ratios than its peers in Asia. Yet the back-scratching alliance of government and business often deters minority shareholders from exercising their rights or blocks them when they try. It's notable in this regard that one of the most common types of corporate scandal involves conglomerates maintaining slush funds with which to make political donations.

There are no quick fixes, and many pieces will need to fall into place—from policy makers to prosecutors to individual executives—to improve corporate governance. Lawmakers in particular must revise tax laws and corporate codes so that families are no longer able to extract shareholder value. The Korean government and the National Assembly are reorganizing the country's inheritance tax laws and other laws governing transparency of corporate financial dealings. These changes would be important improvements. But by themselves they won't be enough.

Crucially, minority shareholders are not powerless to push for change under the existing laws and regulations. One part of the solution is for these shareholders themselves to start exercising their rights more vigorously.

My company has achieved small victories improving corporate governance in several cases. Most recently, we pushed for significant changes at Taekwang Group, the 40th-largest chaebol with subsidiaries in petrochemical, finance, cable television and many other businesses. Although the founding families control 46% of the outstanding shares, we were able to start shedding a light on what we believe is wrongdoing that has hurt the interests of our fellow small shareholders.

In particular, we believe based on our own review of corporate financial statements, interviews with former executives, news reports, and in some cases tips from company insiders, that Chairman Lee Ho-jin transferred assets improperly between various business units and to outsiders. Based on company financial statements, he appears to have made almost $90 million by ordering affiliate companies to buy memberships in an unbuilt golf course owned by his own family. The prosecution alleges that he has created 440 billion won of slush funds in accounts held under false names and used part of the money for personal purposes.

Our research provided sufficient evidence for prosecutors to launch their own investigation. After a four-month investigation that covered our findings as well as other issues raised by former insiders, prosecutors indicted the chairman and six other senior executives on charges of embezzlement and breach of trust. According to news reports, the company admits to engaging in the undocumented transactions, but denies allegations related to efforts to lobby politicians. According to local media reports, Mr. Lee has not commented other than to apologize for causing the controversy, which in the Korean context is a standard response in such cases.

Public prosecutors might ordinarily be reluctant to take on such a case, given the prominence of the company and people involved. But Korean law allows minority shareholders to press prosecutors in such cases, and my firm has done just that. We have also spent two years conducting our own investigation into what we believe are governance failures at the company.

Our experience offers some evidence that bad governance accounts for part of the "Korea discount." After we started pursuing our case, the stock price of Taekwang Industrial—which had stagnated for almost three years—surged. The company's market capitalization reached 1.5 trillion won in late January, up from 800 billion won five months earlier. There was no other news at the time that might have moved the stock price, suggesting investors were responding to the prospects of better governance and, as a result, better earnings in the future.

We can't improve corporate governance alone. But we also can't afford not to do our part to improve governance. Doing so is good for us and our own investors, and for Korean companies and ultimately for Korea's healthy capitalism.

Fishy Business in Washington

A case study in nonsensical regulation.

President Obama has trumpeted his intention to rationalize economic regulations, and he even derided overzealous oversight of salmon in his State of the Union address. While he's on the subject of fish, Mr. Obama might want to school himself on the campaign against the Vietnamese pangasius.

The U.S. Department of Agriculture is seeking public comment on its proposal to classify the pangasius as a "catfish." A lot rides on that name. The 2008 farm bill specifies new safety inspection on imported catfish so onerous it would amount to a ban for at least several years while foreign fishermen struggle to comply. Pangasius is the target because it has a similar taste and texture to American catfish but is cheaper—the main reason American catfish farmers have tried for years to ban the imports.

The problem is that the pangasius is an entirely different species of fish. In an earlier bout of protectionism, Congress even passed a law making it illegal to call pangasius "catfish" for marketing purposes. Since that hasn't deterred American consumers from buying pangasius, Washington is willing to call the Vietnamese fish a catfish again if that makes it easier to ban.

s would be funny if it weren't so costly and probably illegal. On health-and-safety grounds, both the 2008 law and USDA's moves to enforce it make little sense. Vietnamese pangasius, like all fish imports, already is regulated by the Food and Drug Administration. There have been no reported safety problems with the Vietnamese imports. In contrast, USDA has no experience regulating fish despite its history overseeing meat, and catfish will be the only fish species under its regulatory purview.

This explains why the Government Accountability Office last week included USDA regulation of catfish in its biennial report on federal programs at "high risk" for "fraud, waste, abuse and mismanagement." The GAO quotes a USDA estimate that it will cost $30 million over two years to ramp up a special inspection regime for this single fish while FDA remains responsible for other seafood. It's not clear from the language of the 2008 farm bill that the FDA would not still be responsible for catfish after the USDA takes over, raising the prospect that catfish could be regulated twice.

As for the illegality, stricter regulation is unlikely to pass muster at the World Trade Organization. Trade expert James Bacchus, in an opinion commissioned by fish importers, argues that the U.S. would likely lose if Vietnam sued precisely because FDA regulation already is effective. Trade judges would conclude the only reason to change the regulation was protectionism, and they'd be right. A former Democratic Representative from Florida, Mr. Bacchus was the chief judge of the WTO's appellate panel for eight years.

No wonder this pangasius stir has American exporters worried about retaliation. Senator Max Baucus (D., Mont.) is on record worrying that the Vietnamese could block imports of U.S. beef in response, and producers of soy products also have reason to be nervous. All this to protect American catfish farmers from competition and force American consumers to pay more for fish.

The Administration still has a chance to short-circuit this foolishness, if USDA exercises its discretion to rule that pangasius is not a "catfish." Barring that, Congress and Mr. Obama could revamp the questionable section of the 2008 farm bill. For anyone looking to cut waste and rationalize regulation, this should be shooting fish in a barrel.

Cocoa at 32-Year High As Ivory Coast Ban Extended

By CAROLINE HENSHAW

LONDON—Cocoa prices surged to 32-year peaks after the internationally recognized president of Ivory Coast extended a ban on the export of the key ingredient in chocolate.

The front-month contract, for March delivery, earlier hit an intraday high of $3,666. Although IntercontinentalExchange Inc. only has records from the mid-1990s, data from Dow Jones Market Data Group showed the front-month contract last settled at $3,635 on Jan. 12, 1979.

A bitter struggle for political control of the world's top producer of cocoa has sent cocoa prices rallying since December.

The monthlong ban implemented by Alassane Ouattara, who in November won the country's first election in a decade, was due to expire Wednesday but was prolonged to March 15, according to an order from Mr. Ouattara's government.

Major cocoa exporters say they are complying with the restrictions. Some analysts say it is likely that Ivory Coast cocoa beans are being shipped to international markets through neighboring countries.

Fresh clashes erupted between supporters of the rival presidents Monday, with army gunfire killing one civilian and injuring more than a dozen, while African leaders launched a new bid to break the impasse.

Kona Haque, a commodity analyst with Macquarie, said she expects cocoa prices on ICE to target $3,700 a ton as the crisis escalates.

"Despite favorable weather and attractive prices, the short-term outlook for cocoa supplies out of Ivory Coast has turned sharply negative," she said.

The extended ban is likely to put greater pressure on the small farmers who grow most of the cocoa beans. The flow of beans from the countryside to the ports will slow, resulting in quality problems and "severe social consequences for the rural communities," said Rodger Wegner, managing director of the German Cocoa Trade Association.

Cocoa's growers burn cocoa beans in front of the European Union delegation headquarters in Abidjan on Feb. 17, to protest against sanctions imposed on the cocoa-export trade to European countries.

Farmers are having problems financing and storing the upcoming crop, due to be harvested between April and May. Banks have closed branches, and warehouses are overflowing.

About 300,000 tons of cocoa are currently held in the country, including 100,000 tons at the ports, but observers warn that cocoa beans stored in poor conditions may deteriorate rapidly.

Trade has also been hurt by European Union sanctions barring ships entering the country's main ports. French shipper CMA CGM, the main carrier of Ivorian cocoa to Europe, said earlier this month that it had suspended visits to Ivory Coast by ships from a subsidiary.

Shipping services "have almost completely ceased, thereby inhibiting both export of products such as cocoa, and import of foodstuffs such as wheat and rice," the European Cocoa Association and the Federation of Cocoa Commerce said in a joint statement last week.

Some recent articles on democracy

February 6, 2006

Liberty vs. Democracy

Many mistakenly believe democracy means liberty, but that is not true.

By : Richard W. Rahn http://www.cgeg.org/issue_template.php?issue_id=2491

This piece was originally published February 5, 2006 in the Washington Times.

Would you prefer to live in a country that has:

(1) The rule of law with an honest civil service, strong protection of private property and minority rights, free trade, free markets, very low taxes, and full freedom of the speech, press and religion, but not a democracy?

(2) Democracy and a corrupt court and civil service, many restrictions on economic freedom, including very high taxes, with limited rights for minority religions, peoples and speech?

The first example describes Hong Kong under the British, which had full civil liberties, little corruption and the world's freest economy. The Chinese took over Hong Kong in 1997 and have allowed it to continue as the freest economy in the world. As a result of the British being benevolent dictators and the Chinese largely continuing economic noninterference, with a number of restrictions on freedom of speech and the press, Hong Kong has achieved a per capita income close to that of the United States and higher than almost all democracies.

Many mistakenly believe democracy means liberty, but a quick review of world democracies show that is not true. Almost all democracies restrict economic liberties more than necessary. Many have corrupt court and civil service systems, inhibit women's rights, constrain press freedom and do not protect minority rights and views. Iran, though a very restrictive theocracy, calls itself a democracy and holds elections.

The American Founding Fathers were concerned with liberty, so they set up a Republic to protect individual liberties from the passions of the majority at the moment. They worried about the excesses of democracy.

James Madison, the primary Framer of the U.S. Constitution, noted: "Democracies have been spectacles of turbulence and conflict." His views were shared by the other Founders. That is why the U.S. Constitution was designed to restrict a democratic majority from limiting freedom of speech, press, religion and so forth. It is a document of liberty, not of democracy.

The Bush administration has placed itself in a difficult position by advocating democracy rather than liberty as its global mission. The democratic elections in Iraq and Palestine may well result in subjugation of women, containment of basic freedoms of speech and the press, and support for terrorist activities.

We, the victors in Iraq, had a perfect right -- in fact, a responsibility -- to insist any new constitution protect individual liberties, including full rights for women, property rights and the right to follow one's own religious beliefs and not be forced to wear the majority's religious garb.

Remember, Gen. Douglas MacArthur and his fellow American officials virtually dictated the constitution of Japan after World War II, which abolished the emperor's role as a deity. That constitution served the Japanese well.

The Allies would have not accepted a German constitution that restricted minority rights, for good reason. Standards of tolerance and civil liberties should not have been lowered for majority Muslim nations. By doing so, we may end with hollow victories. Religious Muslims can do perfectly well under regimes that protect the liberties of all citizens, as demonstrated by successful Muslim communities in the U.S. and elsewhere.

It is argued you cannot have sustained periods of liberty without democracy, and that argument does have merit. Those economic/political units today that have liberty without democracy are almost all colonies or territories of large democracies (the notable exception is Hong Kong, which remains largely free because of the treaty).

England enjoyed several centuries of substantial liberty without being a real democracy. However, such cases were rare: Even the most liberal (in the original sense) monarchies and oligarchies most often ended up restricting liberties.

The Bush administration needs to revise its rhetoric and actions to put advancement of human liberty, including economic freedom, in the forefront of its global agenda. This does mean support for democratic governments and institutions within countries that help preserve liberty. Democracy should not be seen as the end goal in itself, but only as a mechanism, if properly constructed, to help create, preserve and enhance liberty.

Richard W. Rahn is director general of the Center for Global Economic Growth, a project of the FreedomWorks Foundation.

Democracy is more than voting

Jan 30, 2006

by Jack Kemp ( bio | archive | contact )

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Since the surprising victory by Hamas in the Palestinian parliamentary elections, there has been a significant measure of schadenfreude on the part of the media and Bush administration critics. Pointing out that the administration has based its foreign policy largely on the thesis that spreading democracy throughout the Middle East is both doable and desirable, an article in the aftermath of the Palestinian elections posted at Salon by Juan Cole, professor of modern Middle East and South Asian history at the University of Michigan, asked sarcastically, "How do you like your democracy now, Mr. Bush?"

Formerly known as the Islamic Resistance Movement and designated as a terrorist group by the United States government and the European Union, Hamas declares itself opposed to the very existence of Israel and has claimed responsibility for dozens of suicide bombings. Beyond the sheer political embarrassment, Hamas' victory places the United States in a dicey diplomatic and legal situation.

Under U.S. law, the government may not have contacts or official dealings with any state or organization on the State Department's official terrorist list. Yet the Palestinian elections were urged by the administration in spite of the fact that Hamas had not disarmed nor had it renounced its intention to drive Israel off the face of the Earth. By every indication, the elections were fair and legitimate, and Hamas has the right to form a government.

The short answer to the gloaters and the basis for crafting a policy to deal with the situation is there is more to democracy than simply voting. Elections without the accompanying institutions of democracy - the rule of law, individual liberty and civil rights, private property, civil society, functioning government institutions - is "all sail and no rudder." The political system scuds along at a frightening pace in whatever direction the wind is blowing, but it lacks any institutional steering mechanism to drive the system into the political winds to reach its ultimate destination of security and efficient delivery of government services.

The common-sense observation that democracies do not spring fully formed was confirmed by a United Nations University study that concluded premature or inadequately designed elections in a volatile environment may fuel violence, magnify chaos and lead to authoritarian regimes, thereby retarding - and sometimes reversing - progress toward democracy.

In theory the Palestinian democracy may have cast off too soon in such stormy seas, but in practice it is an accomplished fact, and the question is, can some political rudder be installed with Hamas at the helm? The first practical problem that Europe and the United States must address is how a Palestinian government controlled by Hamas will be funded. The Palestinian Authority's annual budget is $1.6 billion, the majority of which comes from Europe, which has indicated it won't continue to finance a Palestinian government controlled by Hamas. Clearly, the United States government shouldn't, either, which means the $150 million in aid scheduled to go the Palestinian Authority in development projects cannot now occur.

Bush was right when he said of Hamas, "I don't see how you can be a partner in peace if you advocate the destruction of a country as part of your platform. And I know you can't be a partner in peace if your party has got an armed wing."

That said, what policy should the U.S. government pursue now?

One option is to withhold any funding until Hamas either renounces its use of violence and its intention to destroy Israel or its government collapses. The problem with this option is that there may be undesirable sources of money, i.e., Al-Qaida, Iran and others within the radical Islamic movement willing to fund a Hamas-controlled Palestinian government. If we allow a Hamas government to struggle and collapse for lack of revenue, we may only increase the likelihood that the Palestinian Authority will implode into a failed experiment in democracy and become a breeding ground for terrorism.

The good news is that in spite of Hamas' continued anti-Israel rhetoric and its refusal to disarm, there has existed a yearlong cease-fire - the product of a complicated four-way negotiation between Israel, the Palestinian Authority, Egypt and Hamas - that actually has been observed better than the cease-fire between Israel and Fatah. If Hamas is not to suffer the same fate as Fatah at the hands of voters, it will need to do what Fatah could not - provide security, end corruption, deliver day-to-day services and advance negotiations with Israel toward final establishment of a Palestinian state. Hamas has every incentive now to maintain the cease-fire.

Perhaps this same back-channel mechanism that gave rise to the imperfect cease-fire with Hamas can also be used and expanded to convince Hamas to begin to accept the state of Israel as a fait accompli. Now is clearly the time for creative diplomacy.

Jack Kemp is Founder and Chairman of Kemp Partners and a contributing columnist to Townhall.com.

HOW TO WIN FREEDOM

------------------------------------------------------------------------

Ousting an authoritarian regime is often far easier than sustaining

freedom afterward. Indeed, the best way to achieve freedom is to use

"people power," rather than top-down reform or armed revolt, says

Freedom House.

A study of 67 transitions from authoritarian rule over the past 33

years found that there are four key characteristics of political

transitions: the societal forces driving it, the strength of nonviolent

civic resistance, the level of violence and the sources of that

violence. These determine how successful transitions to democracy are

achieved, says Freedom House.

According to researchers:

o Regime changes generated by nonviolent civic resistance are

more likely to be "free" or "partly free" today

than countries in which political elites have launched the

transition or opposition groups have used violence to

topple the government.

o About five of the 47 countries that experienced generally

peaceful transitions are currently rated "not free,"

compared with four of the 20 countries in which the

opposition employed violence.

o Policy makers should offer support to nascent civic

resistance movements in order to foster democratic change.

Furthermore, in Iraq's case, the study offers no guide; only three

of the transitions - Panama, who is rated "free," Bosnia "partly free"

and Cambodia, who is "not free" - were driven by external

interventions, says Freedom House.

Source: Adrian Karatnycky and Peter Ackerman., "How Freedom Is Won:

From Civic Resistance to Durable Democracy," Freedom House, 2005.

For text:

http://www.freedomhouse.org/research/specreports/civictrans/FHCIVICTRANS.pdf

For more on International:

http://www.ncpa.org/pi/internat/intdex1.html

The golden calf of democracy

By: Lawrence W. Reed

1-18-05

http://www.bipps.org/ARTICLE.ASP?ID=282

No one knew better how to deflate the inflated than the late political satirist and commentator H. L. Mencken. “Democracy,” he once said, “is the theory that the common people know what they want, and deserve to get it good and hard.” He also famously defined an election as “an advance auction of stolen goods.” With so many promises made in this year’s elections to so many, his description seems especially fitting.

Mencken was not opposed to democracy. He simply possessed a more sobering view of its limitations than does today’s conventional wisdom, which regards it as the unmentioned fourth branch of the Trinity.

Democracy may be the world’s single most misunderstood concept of political governance. Commonly romanticized, it is assumed in most circles to ensure far more than it possibly can. The Norman Rockwell portrait of engaged, informed citizens contending freely on behalf of the common good is the utopian ideal that obscures the very messy details of reality.

Pure, undiluted democracy would be unshackled majority rule. Everybody would vote on everything, and 50 percent plus one extra vote would decide every “public” issue — and inevitably, a lot of what ought to be private ones, too. Ancient Athens for a brief time came closest to this, but no society of any size and complexity can practice this form of governance for very long. It’s unwieldy, endlessly contentious, and disrespectful of the inalienable rights of individuals who find themselves in the minority.

People like the sound of “democracy” because it implies that all of us have an equal say in our government, and that a simple majority is somehow inherently fair and smart in deciding issues. Subjecting every decision of governance to a vote of the people, however, is utterly impossible. Many decisions have to be made quickly and require knowledge that few people possess or have the time to become expert on. Many decisions don’t belong in the hands of any government at all. A pure democracy, even if possible, would quickly degenerate into the proverbial two wolves and a sheep voting on what to have for lunch.

Suppose someone says, “I just don’t like people with boats and jewelry. I think we should confiscate their property. Let’s have a vote on that.” A democratic purist would have to reply, “All in favor say ‘Aye’!” Anyone interested in protecting individual rights would have to say, “That’s not a proper function of government, and even if 99 percent of the citizens vote for it, it’s still wrong.”

In common parlance, “democracy” has been stretched to mean little more than responsive government. Because of such things as elections, government officials cannot behave in a vacuum. That fact is laudable, but it hardly guarantees that government will be good or limited. Even the best and most responsive of governments still rest upon the legal use of force — an inescapable fact that requires not blind and fawning reverence, but brave, intelligent and determined vigilance.

Elections are a political safety valve for dissident views, because they rely on ballots instead of bullets to resolve disputes. They allow for political change without resorting to violence to make change happen — but the change a majority favors can be right or wrong, good or evil. The folks who work to make it easier to vote so more votes are cast should also spend their time encouraging others to be well-informed before they vote.

In spite of this year’s candidates singing interminable paeans to “our democracy,” America is thankfully not one and never has been. Our founders established a republic, modifying democracy considerably. It provides a mechanism whereby almost anyone can have some say in matters of government. We can run for office. We can support candidates and causes of our choosing. We can speak out in public forums. And, indeed, some issues are actually decided by majority vote.

But a sound republic founded on principles that are more important than majority rule (like individual rights) will put strong limits on all this. In its Bill of Rights, our Constitution clearly states, “Congress shall make no law. ...” It does not say, “Congress can pass anything it wants so long as a majority supports it.”

If you worship the golden calf called democracy, you might want to think about finding a different religion.

— Lawrence W. Reed is president of the Mackinac Center for Public Policy in Midland, Mich., and an adjunct scholar with the Bluegrass Institute.

Categories: Government, Federal; Government, General

Democracy: No Panacea By Dale Franks 08/13/2002

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against each other."

We've all heard this bromide so often

that we uncritically accept it as true.

Upon thinking about it a second

time, however, perhaps the real

conclusion on this adage should be

the "Scottish verdict": Not proven.

Certainly, in modern times,

democracies have tended to be allies, rather than enemies. It is less

certain, however, that the tendency of modern democracies to foreswear

war against each other stems from some shared quality of democracy,

except insofar as democracies are reluctant warriors as a general matter.

But, until recently, there simply weren't a lot of democracies to begin with.

Prior to the First World War, the number of actual democratic states could

be counted on one's fingers. Indeed, even today, the number of

democracies is far smaller than the number of authoritarian regimes of

various stripes.

In addition, until the breakup of the Soviet Union, modern Europe, where

most of today's democracies are concentrated, has always operated

under the threat of one or another authoritarian government attaining

continental dominance. Indeed, the struggle between republican France

and imperial Germany to become the dominant continental power in

Europe lasted from the German Unification of 1870 until the end of the

Second World War. In that struggle, France's traditional enemy, Britain,

became a French ally against Germany. The authoritarian German state

was a greater threat to Britain - which was, by the end of the 19th century,

about as democratic a government as existed anywhere - than republican

France. This was true not, it must be understood, because France was no

longer a threat to Britain, but rather because Germany was a greater one.

In the post-World War II era, the number of democracies - in Europe, at

least - increased drastically. At the same time, those democracies were

forced to ally themselves against the threat posed by the Soviet Union.

It is true that democracies have tended not to war against each other in

modern times, but, as we've seen, they had other fish to fry. Authoritarian

regimes, who do not have to concern themselves with public audit, have

tended to be prone to cause trouble. In consequence, democracies have

banded together against the threats posed by autocrats because such

threats were more immediate. That may say a lot about the democracies'

shared commitment against authoritarianism, but it may not tell us an

awful much about how democracies treat each other in the absence of

compelling authoritarian threats.

We do, however, have knowledge of a time and place where democracies

rather regularly warred against each other. The democratic city-states of

Greek Classical Antiquity were built on a foundation of civic militarism.

The free yeoman farmers, who also served as the hoplites of the Greek

phalanx, voted on whether to go to war. They usually elected their military

leaders. As often as not, those leaders faced rigorous civilian audit of their

conduct of military campaigns when they returned to the polis and their

former hoplite subordinates reverted to their prior status as civilian voters.

In some cases even successful, victorious generals were put on trial for

their lives due to their lack of attention to their men's welfare while on

campaign.

Modern democracies may, perhaps, tend to be less inclined towards

warfare in general when compared with authoritarian states. But it is not

entirely certain that democracies cannot evolve into warlike states

themselves.

As UC Fresno Professor of Classics Victor Davis Hanson writes in his

book, Carnage and Cultures, "[T]he choice of military response to win or

protect territory was a civic matter, an issue to be voted on by free

landowning infantrymen themselves." Additionally, he reminds us, that

republican Rome operated in a similar fashion. "[T]he republican

legionaries themselves felt confident that they fought to preserve the

traditions of their ancestors (mos maiorum) and in accordance with the

constitutional decrees of an elected government."

Being a democracy seems to have done little to bar the development of

Athens as an imperial power in classical Greece, just as it presented no

particular obstacle in preventing republican Rome from doing likewise.

Both states were democratic. In both states, the military leadership was

elected or appointed by civilian leaders, and subjected to civilian audit of

their conduct on a regular basis. Yet, they both became warlike and

aggressive states.

There is no guarantee that a modern democracy could not do likewise.

For example, if a free, fair, and honest election were held in Palestine

tomorrow, the chances are quite good that Yasser Arafat and the

Palestinian Authority would be removed from power. Unfortunately, the

replacement government would probably come from the more radical ranks

of Hamas and the Al-Aqsa Brigades. It would be a perfectly democratic

result, but such a democracy would be fairly threatening to their

neighboring democrats in Israel.

Westerners in general, and Americans in particular, are prone to believe

some rather unrealistic things about democracy. Chief among these is the

idea that democracy in and of itself is inculcated with some virtue that

makes the people more peaceful and reasonable. Such a view is entirely

specious.

The reason democracy works as an ameliorating institution in the West is

because it is based upon a host of other liberal ideals. Democracy is the

result of ideas such as individual equality, open debate, freedom of

thought and speech, and freedom of the press. It is not a precursor to

them. Such ideas need to have relatively firm root in a society for

democracy to work as a restraining force.

Democracy is, of course a fine institution. If nothing else, it is a wonderful

method for ascertaining what the people want, and selecting leaders to

carry out the people's will. It is not, however, in and of itself, a particularly

good way of ensuring that what people want is the right thing.

Some Thoughts on the Problems of Democracy

found at http://www.mercatus.org/

Gordon Tullock

March 15, 2002

Democracy is frequently referred to as a system of majority voting. Granted, the

last election in the United States the opposing candidate received more popular

votes than the winner, and neither received a majority of popular votes because of

the existence of other candidates, it is surprising that our system is called that." Of

course the winner did get a majority both in the Supreme Court and in the electoral

college. The loser got a majority in the Florida Supreme Court. 1

Why do we call it "majority voting" when . . .

The failure to get a majority in the popular vote is not particularly uncommon.

Lincoln, for example, got only 35 percent of the popular vote and if one of the

three of his opponents in the election, Douglas, had met him in a 2 candidate

election, he would have won. The 1912 election, once again, had a winner who

received less than half the popular votes. In Wilson's case he had two opponents,

either one of which could have beaten him if the other had not been present. The

current government in Canada received less than half the popular vote and, except

in wartime, no British government has been elected by more half the voters since

1920. In both of these cases, of course, the winner had more than half of the

representatives in Parliament. During its long reign in India, the Congress party

never received a majority of the popular vote. Normally it received less than 45

percent.

Another and interesting case is the election of 1960. Nixon had more popular votes

than Kennedy but lost in the electoral college. The fact that Nixon had more

popular votes, although not a majority of all votes, is almost a secret. 2

The election of 1960 is interesting and here I foreshadow the major part of this

article in that the two strongest candidates for the final election were eliminated in

the selection processes of the two parties. It is reasonably certain that Johnson

could have beaten Nixon in both popular and electoral votes and that Rockefeller

could have beaten Kennedy . All of this does not indicate the system is inferior, but

it does suggest that we stop calling it majority voting.

The problem of more than two alternatives

As on my readers will know, there are two general types of democracy, one

originating in England long ago in which the voters directly select individual

candidates. The other, which originated on the continent in the 19th century, is

called proportional representation and I will to a large extent leave it out of the

discussion below. Actually, I rather prefer proportional representation, but it is a

different subject and requires different analysis.

But to return to my main subject, the reader will have noticed that in each of the

cases with a winner who did not have a majority of the votes, more than two

alternatives were presented to the voters. With only two candidates or proposals

before the voters these problems do not occur. Unfortunately, there are many

people who would like to be the president and many ways which the government

income could be spent.

In the real world, it is likely that the system is confronted with more than two

alternatives and it must either cut them down to two by some means or be willing to

accept a candidate or proposition chosen by less than a majority. Of course it may

happen that although there are three candidates or proposals one of him gets more

than half of the votes. But we should not have a system which depends on that

chance.

The paradox: from Condorcet to Black and Arrow

This problem has been known for a very long time and procedures to either simply

take the one that has the most votes or reduce the number of alternatives to two

and then vote on the those two are orthodox. Unfortunately, none of these

procedures really overcome the problem. Shortly before the French Revolution

two French aristocrats, Condorcet and Borda, looked into the problem and

Condorcet found what is now known as Condorcet Paradox while Borda

produced system which avoided that Paradox but introduced another.

This was of course the period of the great expansion of democracy and, perhaps as

a result of the enthusiasm for democracy, the problem was largely forgotten

although some mathematicians seem to have known about it. In the mid-19th

century, Lewis Carroll rediscovered the paradox and did considerable work on it

without finding a solution. He too was largely forgotten and the problem was

rediscovered by Black who also discovered that he had predecessors lost in the

obscurity of minor mathematical publications.

Black succeeded in reviving interest in the issue which is a little paradoxical since it

is obvious he did not like the idea of democracy having paradoxes. Working with

Newing he produced a proof that this paradox could not the avoided if there were

more than two alternatives. 3 Notably he did not put out his work as a criticism of

democracy because he was a firm believer in democracy. Nevertheless careful

reading of his book with Newing shows the impossibility of avoiding the Paradox

except in special cases.

While Black and Newing were working, Arrow produced a general proof that the

paradox cannot be avoided in the general case. 4 This was his famous general

impossibility theorem. Notably it was only a remarkably long delay in the refereeing

process which prevented the Black and Newing paper from being published before

Arrow.

In the early days of research in public choice, papers dealing with the paradox

were a major component of papers submitted to me as editor of the journal. I think

that most of these papers were inspired by desire to avoid the paradox or at least

to minimize it. If this was the inspiration, it failed. The paradox continues and indeed

I have invented a much simpler although less elegant proof. 5

After considerable delay I discovered a proof that the problem was not

nonexistent, but of less importance than had been thought. If the voting preceded in

the usual way of legislatures with anyone free to introduce an amendment is, it

would precede to an outcome very close to the center of the cloud of individual

optima. A dictatorial chairman, however, could lead the votes to almost anywhere

he wished. Since the usual procedure is not involving a dictatorial chairman, this

meant that the voting normally would lead to a more or less satisfactory outcome.

Professor Arrow, in a very kind letter, accepted in the bulk of my reasoning but

pointed out that the latter part was not really mathematically strict. He was right,

but the reasoning was very strong even if not perfect, mathematicians standpoint. 6

What are fans of democracy to do?

The end result of all of this work is most disappointing for proponents of

democracy. Since the author and all of the readers of this paper are such

proponents of democracy we should all the unhappy about it. As far as I can see,

however, the usual response is not to be sad, but to sweep the problem under the

rug. Psychologically this is no doubt an optimal response, but it seems to me that

scholars should busily search for some better way of dealing with the paradox. I

frankly admit I have not found one, but the point of this article is to attempt to

interest other scholars in a revival of voting problem, so important in the early days

of Public Choice, but normally today not even mentioned in the average issue or,

This is particularly surprising granted that intellectuals are currently vigorously

producing arguments for democratic governments, and hence would be one would

think particularly interested in eliminating paradoxes in democracy. The new

arguments for majority voting, and the authors normally refer to majority voting

rather than simply democracy fall into two categories. The first is the allegation that

In the first place, economists have long known for (or at least many of them have)

that a capitalistic system is a better method and of producing prosperity than a

centrally directed one. In the last few years most intellectuals have adopted this

idea. Note however, that except for a certain number of "reactionary" economists

As a result he was practically drummed out of the economic profession. Note that

efforts to duplicate his research turned out to be surprisingly similar although the

CIA which disagreed. To repeat, Nutter's career was more or less terminated in

the economic profession. The University of Virginia did not give him significant pay

because other universities also thought that he was following his ideology and not

This was a personal tragedy for Nutter and a policy tragedy for many governments.

felt this way remained in favor of democracy for reasons other than its economic

effects. Nevertheless, the recent view sweeping intellectuals that democracy works

better in economics than a communist dictatorship is recent. Further, as far as I can

see, like the earlier enthusiasm for communist dictatorships in the economic field, it

was based on nothing more than one of the waves of enthusiasm that tend to sweep

the intellectual classes, although the collapse of the old order in Russia undoubtedly

democracies and doing very badly in their economies while Singapore and Hong

dictatorship and a rather impressive one, currently claims the highest rate of growth

of any significant country. Speaking for myself, I tend to distrust communist

statistics, but observation on a recent trip to China indicates it is very much better

Another recent argument for democracy is that democracies are relatively peaceful.

Apparently, after a while, some intellectuals read the history of 19th-century in

particularly surprising since many of the intellectuals who made it were American

opportunity to fight each other this was undoubtedly true. Still it should be kept in

mind that in 1914 it could easily have been argued that both England and Imperial

democracy was canceled and one of the world's worst autocracies put in its place.

The dissolution of Austria-Hungary was disastrous by any standard. The history of

with United States and England. Indeed it did most of the fighting. Japan had an

elected legislature and the Emperor's powers were very modest. It seems likely that

they should be regarded as a constitutional monarchy rather than as a dictatorship.

dictatorship so that Europe in 1945 was less democratic than it had been in 1930.

I have been presenting all of this material which could be regarded as an attack on

for democracy in the last 10 years and for communist dictatorship in the early '50s

were simply examples of the instability of intellectual opinion. Personally I prefer

democracies, but I must admit that the arguments for a democratic state are much

weaker than those for a capitalistic economy. Further, when you look around the

world you realize that Prince Bismarck's invention, the welfare state is largely

dominant in democracies. Since the long run prospects of that system are poor, this

could be an argument against democracy. It is however quite possible to feel as I

do that in spite of its defects, democracy is better than the currently known

So far this paper has not had any dominant theme except that it shows little

enthusiasm for democratic methods of government. I have to admit that I am not

The purpose of this note is first to deal with certain popular arguments for

democracy, which I think are false, as a preliminary to encouraging my listeners to

I find when talking to people about improvements in government the first response

democracy but adds something on to it. I have no suggestions at the moment but I

believe that seeking a better form of government then democracy is sensible policy.

It may be of course that the better form is a modification of our present democracy.

more successful than others. In my opinion the Swiss government is not only the

Constitution. Melding the two might be an excellent idea. But I hope that the public

But let me return to my main theme which is problems with our present democracy.

Roughly speaking, simple majority voting works very well if they're only two

alternatives. When there are more the outcome may be close to random. In

are then voted on. It is not obvious that one of the alternatives eliminated in the

pattern down to two alternatives. I above mentioned cases in the American system

in which no one got a majority because there were more than 2 alternatives which

attracted significant votes. If one looks at policy choices we once again find a

successive votes in accord with the procedural rules in use in that particular voting

body. Granted the prospect of paradox, it is by no means obvious that one of the

To take a simple and artificial set of choices, suppose that the various alternatives

actually offered as amendments in the Senate are: A, B, C, D, E, and F. Note that

considered those offered in committee, the set of amendments to the House version

possible variants are proposed at one or another stage in the process. One of these

numerous alternatives could be capable getting majority against the winner in the

formal vote. Suppose for example that the votes are taken F against E, the winner

against D. and so forth. This leads to B winning, but that B as never been offered

This is simply an example of the standard possibility of circular majorities. We have

no real measure of how often it happens. The first effort to find out how often was

for a large body of synthetic voters in the computer memory and then tested them

regard the possibility as a minor defect, and go ahead. If they were common they

But let us go on to the candidates selected by election. In addition to the paradoxes

mentioned above, in the United States there is another very serious problem. In the

-- presumably mainly in order to retire. Of the remaining to 394, all but 11 were

re-elected. It is sometimes said that the security of tenure held by members of the

The basic reason for this security is that the members of the House are able to get

the federal government to expend great resources for their re-election. They have

large staffs, considerable free travel, access to a free television studio in the

basement of the capital, and many other advantages. There doesn't seem to be any

exact accounting for this money, but I asked a professional lobbyist how much he

thought it was worth and he gave a figure of two and half million per congressman

Senators do not have as firm a grasp on their offices as the members of the House

and a President probably even less. In the case of the President resources spent by

the federal government to get him re-elected are immense. It is probably true that

resource expenditures have the highest payoff when there is little other information.

This leads us perform a mental experiment. There must be several thousand people

who would like to be President and who think at least a little bit of running. Most of

them drop the idea almost immediately, but some will give it further consideration

and talk to people about the possibilities. At this stage we're down to something

him as " testing the water" and said he received an enthusiastic response. This put

At this point he would begin trying harder to get support from one of the parties,

candidate was eliminated early in the game is certainly good. In other words the

paradox exists here as well as in the choice of issues. Indeed it appears to even

This rather lengthy essay has raised a number of difficulties of a fundamental nature

system, but they do indicate that we should substitute hard research for enthusiasm.

In recent years there's been very little effort to solve these problems. I would like to

government I should like to list some suggestions that already been made. This is

not intended to be a complete list of possible changes, but only a set which have

been made but have received little or no attention. I think they should be given

more attention by students in this field, but I hope that someone will invent even

I begin with Clarke's demand revealing process. This has had more attention than

the others including a complete issue of public choice devoted to it. As the reader

system. It permits the voter to express not only which alternative he prefers, but

also how much he prefers it. The outcome might lead to a minority of intense voters

My second proposal is Earl Thompson's suggestion to put individual policy changes

losers. The third proposal is Hanson's betting procedure in which the voter may be

Nevertheless they are a start. Note that all three permits a minority to win over a

majority. Also, all three of these suggestions are subject to the Arrow, Newing and

Black problem. If there are more than two alternatives, the order in which they are

taken up may lead to different outcomes. Voting on all alternatives at the same time

may also lead to different outcomes. As in other cases where these problems arise,

voting on the order of taking them up to also leads to paradoxes. Still these are a

start in investigating radically different ways of making decisions, and they're not

These are variants on the actual voting procedure. Other possible changes involve

the problem of who can vote. Dennis Mueller suggested that voters to given a short

examination before being permitted to vote. The intent, of course, is to restrict the

voting to people who at least know some elementary facts about the government. I,

for different offices would be of different degrees of difficulty. A man who would

fail the president's exam might well pass that for alderman. Again following the

Chinese precedent the examination would leave several candidates for each office

It is not obvious that one man one vote is ideal. Corporations give different people

was originated by Lord Clive. He not only started the British Empire in India by his

victory at Plassey, but he also, in an unsuccessful effort to control the Honorable

strongly opposed to, let us say, the one vote for every dollar in taxes paid. Whether

this is merely opposition to a new idea or a rational position, I do not know. When

I talk to people about it their objections normally are not well reasoned. Indeed

There are other proposals for giving different people to different numbers of votes.

Nevil Schute wrote a whole novel, In the Wet, devoted to this idea, and one of the

richest men in United States - Hunt -- also produced a book on it. The additional

votes could be distributed in terms of payment for services. For a modest example,

Another radical idea is to permit people to hold their votes in abeyance. I could, for

example, decide not to vote for president in 2004 and then cast two votes in 2008.

Perhaps to charge interest, I might be prohibited from casting votes for Senators in

The reader should keep in mind that it is not necessary for the government form to

governments which form only a part of the nation. If these were undemocratic, they

In military matters economies of scale require large government units. There are

Nevertheless, I think they should receive careful study. Further, I think we should

look for other forms of government. There is no natural law which says we cannot

invent new forms of government which are better than the current sample. It is to

encourage the reader to engage in such radical thought that this essay is dedicated.

Oil prices are rising. Food prices are up. The world economy is gaining momentum. Central banks, still fighting aftereffects of the financial crisis, are keeping interest rates low. Is an outbreak of U.S. inflation around the corner?

Federal Reserve Chairman Ben Bernanke says it isn't. It's hard to sustain inflation with so many people out of work and so many offices, stores and factories empty, he reasons. Plus he sees no big rise in "inflation expectations," the wage and price increases that business executives, consumers, workers and investors anticipate.

"Inflation expectations remain well anchored," Fed officials concluded confidently at their last meeting, minutes show, despite obvious inflationary threats abroad. Translation: Food and energy price increases won't prompt higher wages and prices throughout the U.S., partly because people don't think they will.

The notion is that if we all expect inflation, we'll seek higher wages, prices and rents, and that will produce the inflation we expect. Conversely, no matter what's happening in Libya or grain markets, no matter how much yelping about commodity prices squeezing profit margins, if we all believe the Fed won't permit inflation to take off, it won't. Call it the Tinker Bell school of economics.

This actually was an improvement in economic thinking. Fifty years ago, economists assumed people expected future inflation to match the recent past. Then came a generation of economists arguing that people are smarter than that: Their expectations change when the world does. (If it usually takes you 20 minutes to get to work, and you hear one lane will be closed for construction, you'll leave earlier.)

So central bankers began tracking inflation expectations. It seemed smarter than steering the economy by looking in the rear-view mirror of last month's consumer price index. "The state of inflation expectations," Mr. Bernanke said in a 2007 lecture, "greatly influences actual inflation and thus the central bank's ability to achieve price stability."

Managing inflation expectations became part of a central banker's job—with substantial success. As Goldman Sachs wrote in a recent note, food and oil price spikes in the mid-1980s led to large, persistent increases in economy-wide inflation. Lately, they haven't. "[T]he most likely explanation for this change...is the improved anchoring of inflation expectations since the mid-1980s," Goldman's Sven Jari Stehn wrote.

One is that inflation expectations are easier to define than to measure precisely.

The Federal Reserve Bank of Philadelphia surveys professional forecasters quarterly. They see a spike in inflation this quarter on higher food and energy prices, but over the next decade see 2.3% annual consumer-price-index inflation, a bit below forecasts they have made over the past decade.

Consumers aren't so relaxed, perhaps because they focus more on gasoline and groceries. The University of Michigan/Reuters survey found, on average, that consumers expect prices to rise 3.4% over the next year, faster than they did a year earlier. But the five-to-10-year outlook, which the Fed watches, is stable at about 2.9%.

Alas, there is no reliable inflation-expectation survey of business decision-makers. But in a 1992 survey by Princeton economist Alan Blinder, half the businesses said they "never take economy-wide inflation into account" in setting prices.

An alternative is to look to financial markets. To gauge their expectations, compare yields on Treasury debt that pays interest at a fixed rate, say 3.5% for 10 years, with yields on debt that adjusts so the return rises with the Consumer Price Index. The late economist Milton Friedman liked this measure so much, he proposed that Congress require the Fed to target it. But this gauge can be hard to read, particularly in a financial crisis in which jittery investors flock to the most liquid Treasury securities—conventional ones—and shy away from inflation-protected securities.

At face value, this measure suggested a late-2008 deflation scare that has abated. Inflation expectations now are back at pre-crisis levels, hardly a warning of danger. A more complicated dissection of markets by the Cleveland Fed finds a steady decline in inflation expectations over the past 20 years and now see inflation of just 1.8% over the next decade.

The other rub is that inflation expectations are "anchored"—until they're not. They may change faster than the Fed responds. "The tricky issue is forecasting whether inflation expectations might change," says Joel Prakken of Macroeconomic Advisers, whose model uses inflation expectations to help forecast inflation. "They have been remarkably steady for more than a decade. Presumably this is related to Fed credibility, but it also might be that we've been lucky not to have the big inflation shocks we suffered in the '70s and '80s."

Not so long ago falling inflation expectations at a time of low inflation had the Fed worrying about much-dreaded deflation. That moment has passed. Now, the central bank faces a two-fold challenge: To avoid being stampeded into tightening credit prematurely by the uproar over food and energy prices while also avoiding complacency bred by overreliance on measures of inflation expectations.

CEOs: Bright Brazil Outlook

BETTER?: What is the outlook for Brazil, here represented by Sao Paulo? (Photo: Mario Roberto Duran Ortiz)

Brazil remains a shining star for many multinationals despite its share of challenges.

BY JOACHIM BAMRUD

Foreign investors are expecting solid growth in Brazil this year, driven by a combination of factors, including a growing middle class, expanding technology, hospitality and energy sectors and the upcoming 2014 World Cup and 2016 Olympics.

“Brazil’s economy continues to be the envy of many developing and developed states with strong domestic demand and rapidly recovering investment flows pushing real GDP growth to the highest level in 15 years,” says Rodolpho Cardenuto, Latin America president for Germany-based SAP, the world’s largest business software company. “Brazil is already one of the five most important operations in the world for SAP, and we don’t plan on slowing down.”

Brazil led the other BRIC countries (China, Russia and India) in growth during fiscal year 2010 for US-based Microsoft, the world’s largest software company. A large reason for that is a 16 percent growth in PC’s sold in Brazil, according to Hernan Rincon, Latin America president for Microsoft.

“Microsoft intends to ...

Martin Lynch anticipated that his family would leave Ireland to pursue better opportunities.

CARLOW, Ireland—The people of Ireland go to the polls Friday to deliver what's expected to be a knock-out blow to the governing party. But many are choosing to vote in a traditional Irish fashion: with their feet. Tens of thousands are joining in a new wave of emigration, turning their backs on a country mired in economic malaise.

Martin Lynch's family is one of many that are being scattered to the four winds. In the past year, one son has moved to Germany, another to England. His daughter is planning her departure for London, and Mr. Lynch and his wife are bound for Australia.

"Ireland has let me down," says the 62-year-old, a retired caretaker of the local technology institute here in the southeastern town of Carlow. "We just seem to be incapable of governing ourselves."

Nothing seems to better symbolize Ireland's economic crisis than the re-emergence of large-scale emigration, a scourge many hoped had been slain for good. It's a theme that has cast a long shadow over the campaign for this election, which polls suggest will uproot Fianna Fail, the party that has dominated Irish politics for 80 years.

The great recession has triggered yet another wave of Irish emigration. WSJ's Don Duncan reports on how that is playing out in the national election.

On the hustings and on voters' doorsteps, emigration is on everyone's lips. For many it encapsulates the sense of hopelessness that has descended on Ireland as the country grapples with one of the worst economic crises in its history.

"We never thought we'd see this again," says Alan Barrett, an expert in migration at the Economic and Social Research Institute, a Dublin think tank. "It brings back a lot of bad memories."

Forced emigration was long Ireland's curse. A million fled in the decade after the great potato famine of the mid-19th century, which killed some 800,000 people. There was a huge exodus a hundred years later, with thousands lured away by a building boom in the U.K. Another mass migration followed in the 1980s.

The country's fortunes appeared to change for good in the mid-1990s, when years of big spending on higher education, low corporate taxes, generous European Union aid and an influx of foreign investment helped transform Ireland into the "Celtic Tiger." Between 1995 and 2000, the economy grew nearly 10% a year on average, and Ireland began to catch up with its richer European neighbors. The country's far-flung diaspora started trickling back to feast on the new opportunities.

However, by 2008, as Ireland's banking crisis triggered a deep recession and unemployment soared to 13%, the tide turned again. Ireland's Central Statistics Office predicts that 100,000 people will emigrate over the next two years, more than twice the number that left in 2009 and 2010. That comes to about 1,000 per week, and exceeds the last peak in emigration in 1989 when 44,000 people moved away.

The overall figure represents just over 2% of Ireland's population of 4.47 million, which economists say by itself isn't enough to prevent a recovery.

But there are fears that the more people leave, the greater the tax burden on those who stay and the bigger the decline in public services like education and health care.

An exodus could also reduce demand for housing, depressing already low prices and deepening the losses faced by Irish banks. Since the government is on the hook for banks' liabilities, more losses could worsen Ireland's fiscal crisis, leading to more austerity measures and higher unemployment. Such a "fiscal feedback loop" could increase the incentive to leave, says John McHale, an economist at the National University of Ireland, Galway.

And while demographic data on emigrants is scarce, many of those leaving are believed to be well-educated professionals—precisely the people Ireland needs to lead a recovery. "In a modern, knowledge-based economy, dense, diverse cities full of highly-skilled people are a critical competitive advantage," says Mr. McHale. "If the most enterprising people leave, you undermine that advantage."

Ireland's loss is others' gain, and global demand for Irish workers has increased dramatically. "We've had more inquiries over the last six weeks from companies targeting Irish people than we've ever had before," says Stephen McLarnon, head of SGMC Media Group in Dublin, which organizes exhibitions for those wanting to work abroad. Mr. McLarnon says two-thirds of his current applicants have college degrees. Booths at SGMC's next exhibition have been snapped up by federal and state governments in Australia, New Zealand and Canada.

It's not just English-speaking countries that the Irish are heading for. After the U.K., the favorite destinations for Irish people last year were new European Union member states such as Poland and the Czech Republic, with older EU countries like France and Germany coming in third, according to figures from Ireland's Central Statistics Office.

Opposition politicians pin the blame on Fianna Fail. Enda Kenny, leader of Fine Gael, and the man expected to be Ireland's next prime minister, said in an interview that fighting unemployment, the main driver of emigration, will be his party's top priority if it wins the election. The party has pledged to create 20,000 new jobs a year over the next four years, and invest €7 billion, or $9.5 billion, in broadband, renewable energy and water infrastructure.

Yet whoever comes to power, Ireland faces years of austerity as it tries to wrestle down a massive budget deficit. To secure a €67.5 billion international bailout last year, the country committed to a four-year spending plan that envisages savings of €15 billion, or nearly 10% of its annual economic output. Pensions and benefits will be cut and taxes hiked.

Not all economists see emigration as a bad thing. Some say it could act as a crucial safety valve to help restore equilibrium to labor markets. And in a globalized world, moving abroad for work isn't necessarily a permanent loss for the homeland. Workers could gain experience and skills that will give them an advantage in the job market if they return home.

"It's terrible that it has to happen, but it's probably preferable to go abroad in search of work than to stay unemployed here," says ESRI's Dr. Barrett. "At a minimum it keeps their skills active, and it takes the strain off the social welfare budget."

Mr. Lynch's story encapsulates the history of Ireland, with its ebb and flow of migration and return. His father moved to London in 1924 from the hardscrabble western county of Roscommon in search of work. It was a difficult time, with job ads routinely featuring the phrase, "No Irish Need Apply." He flourished nonetheless, running a string of pubs in London.

But he always felt homesick, and the family moved back to Dublin in the early 1950s, when Martin was five. They managed pubs there, but never attained the quality of life they'd enjoyed in Britain. "My parents always regretted coming back," Mr. Lynch says.

In the 1950s, the main pattern of migration was in the other direction. In the decade after 1945, some 320,000 people left Ireland, most of them for the U.K., then in the grip of a post-war labor shortage, and for the U.S. The Irish countryside was littered with abandoned houses, and parishes struggled to muster full football teams.

Mr. Lynch remembers the "American wakes" of the time, all-night parties fueled with dancing and potcheen, a local moonshine, that marked the departure of young men for the U.S. "It was just like a wake, because you knew you'd never see them again," he says.

In 1966, Mr. Lynch emulated his father, moving to England to serve in the British army. But he returned after less than a year when his parents fell ill. Over the next 14 years he worked in sales at various Irish oil and gas companies. In the recession of the 1980s he lost his job, and spent much of the next eight years unemployed.

It was a tough decade for the whole country, and many emigrated. Mr. Lynch recalls seeing tearful reunions at Dublin Airport as smartly-dressed sons and daughters came back home for the Christmas holidays. "I remember thinking—I hope to God my kids don't end up leaving like that," he says.

Last year, his eldest son, Eoin, 29, met and fell in love with a German woman, took two years' leave of absence from his job at an insurance company and moved to Stuttgart. The college graduate is now studying German there in the hope of becoming a teacher. He says he was glad to get out when he did.

"There was a lot of negativity," he says. "People didn't have lots of money to spend on life insurance and pensions." Germany, in contrast, "is absolutely booming."

Another son, Damien, 28, studied aeronautical engineering at Limerick University but couldn't find work in Ireland. He landed a job last year with a British engineering firm in the northern English town of Derby.

Neither Eoin nor Damien say they had qualms about quitting Ireland. But their sister, Clare, who is 24, is more conflicted.

A nurse, she recently completed postgraduate training in pediatrics. But since the course ended last October, she's been unable to find a full-time job, partly due to a hiring freeze imposed by Ireland's state-run health service.

She has a temporary job with an agency, working at a center for children with learning disabilities in Cork. It's a 60-mile commute every day from her home in Limerick. She doesn't know from one week until the next whether she'll be kept on.

"When I started, people said nurses and teachers would have jobs for life," she says. But by the time her studies were drawing to an end, that had changed. Clare recalls her dean of studies telling her at her graduation ceremony, "'I hope we won't lose you to England, but I'm pretty sure we will.'"

That prediction has now come true. Ms. Lynch says she has made the "painful" decision to try her luck in the U.K., where demand for nurses runs high. She spent New Year's with her brother Eoin in Germany, and "realized that we were all going to be living in different countries," she says. "It's heart-breaking."

For Mr. Lynch, Carlow symbolizes Ireland's downturn. A town of 18,000 in the country's southeast, it was once a magnet for foreign companies. But investment has dribbled away. A big sugar factory closed in 2005, taking 350 jobs with it, and a German engineering firm shut down its car component plant in 2007. Two years later, Procter & Gamble Co.'s Braun unit, which had once employed more than 2,400 staff in the town, closed an electrical appliance factory. Carlow's quaint high street—once nicknamed the Golden Mile—is pockmarked with boarded-up shops.

"Our economic miracles are always of such short duration," says Mr. Lynch. "We just can't seem to have a sustainable economy."

Declan Gordon, a tattooed mechanic who repairs wind turbines, says most of his friends are packing their bags. Some are bound for the U.K., he says, where the 2012 London Olympics has spurred demand for construction workers. The membership of his local Gaelic Football club has dwindled from 30 to 15 in less than a year as teammates have drifted away.

"It's not like the U.S., where you can move to another state if the work dries up," he says. "This place is so small, you have to leave."

An Antidote for the Corporate Poison Pill

Shareholders could reduce its toxicity if they could replace board majorities more quickly.

By LUCIAN BEBCHUK

In a major decision issued last week, William Chandler of Delaware's Court of Chancery ruled that corporate boards may use a "poison pill"—a device designed to block shareholders from considering a takeover bid—for as long a period of time as the board deems warranted. Because Delaware law governs most U.S. publicly traded firms, the decision is important—and it represents a setback for investors and capital markets.

The ruling grew out of the epic battle between takeover target Airgas and bidder Air Products. Air Products made a takeover bid for Airgas in 2010, increased it several times, and kept it open until last week's decision. Airgas's directors argued that defeating the premium offer would prove, in the long run, to be in shareholders' interests. As the Chancery Court stressed, however, the directors based their opinion solely on information publicly available to shareholders. Why should shareholders, who have powerful incentives to get it right, not be permitted to make their own choice between selling and staying independent?

Chancellor Chandler stated that he would have preferred to let shareholders make the choice at this stage, as they "know what they need to know . . . to make an informed decision." But he felt that denying shareholders' right to choose was required by previous Delaware cases, which recognized directors' right to block offers out of concern that shareholders would accept them "in ignorance or a mistaken belief" concerning the value of remaining independent.

Yet the empirical evidence indicates that when directors use their power to block offers, it often proves detrimental to shareholder interests. A research project I am carrying out with colleagues John Coates and Guhan Subramanian has found that boards that defeated premium offers failed on average, even in the long run, to produce returns for their shareholders that made remaining independent worthwhile.

Moreover, the power of boards to block bids weakens the disciplinary force of the market for corporate control. A substantial body of empirical research indicates that boards' increased insulation from such discipline is associated with lower firm value and worse corporate performance and decision-making.

Despite the Delaware court's decision, investors still have recourse—because a poison pill is powerful only as long as the directors supporting it remain in place.

Airgas's directors were able to use a poison pill for more than a year because Airgas's board is "classified." As such, only one-third of directors come up for election in each annual meeting, so replacing a board majority requires waiting through two annual meetings.

If, by contrast, a company's shareholders could replace a majority of its board more quickly, the board's power to block a takeover bid would be correspondingly weakened.

Support for changing corporate governance arrangements to allow for board declassification is expressed in the proxy voting guidelines of many investment managers, including American Funds, BlackRock, Fidelity and Vanguard. Indeed, shareholder proposals in favor of board declassification have received average support exceeding 65% of votes cast in each of the last five years. This makes sense given the evidence (documented in a 2005 article I co-authored with Alma Cohen, and confirmed by subsequent research) that board classification is associated with lower firm valuation.

In response, public companies have been agreeing to declassify, thus committing not to block an offer favored by shareholders for too long. The number of S&P 500 companies with classified boards declined to 164 in 2009, from 300 in 2000. Still, there's a great deal of room for improvement: Among the 3,000 public companies with takeover defenses tracked by FactSet, about half still have classified boards.

While incumbents have for now won the right to use poison pills indefinitely, pressure by shareholders could substantially limit their toxicity. That would produce considerable benefits for investors and for our capital markets.

Mr. Bebchuk is professor of law, economics and finance at Harvard Law School and director of its corporate governance program. He has assisted institutional investors in negotiating board declassification at publicly traded firms.

Sergei Magnitsky and the Rule of Law in Russia

For one foreign investor, success proved ephemeral when officials set their sights on his firm.

By BILL BROWDER

Earlier this week, in a Wall Street Journal interview about investing in Russia, Russian Deputy Prime Minister Igor Sechin surprised me. He cited my experience in Russia as an example of the strength of the Russian investment climate. Mr. Sechin argued that, based on the "economic efficiency" of my investments in Russia, I should be "a happy man." While Mr. Sechin is correct that my investors realized significant returns on their investments in Russian equities, I would hope that no one ever has to endure the nightmare that my colleagues and I suffered in Russia after achieving this success.

I founded Hermitage Capital in 1996 and built up the firm to become the single largest investor in the Russian stock market. We fought corruption and pushed for transparency at a number of the companies we invested in. Not everyone appreciated our efforts. In November 2005, the Russian government suddenly revoked my visa and declared me a threat to "national security."

Until this point, Hermitage had been widely acknowledged as one of the biggest success stories of Russia's post-Soviet capital markets. Unfortunately, this success proved ephemeral once my firm was targeted by corrupt government officials. In his interview, Mr. Sechin said that "nobody touched" my investors. This is true. We were able to move all of my clients' money out of the country before senior Russian officials working in league with private criminals expropriated Hermitage's investment holding companies. Amazingly, these officials then embezzled—from the Russian state itself—$230 million in taxes that Hermitage had paid the prior year.

My Russian business was destroyed through state action, but this story is not about business or money.

It is about the human cost of corruption, and specifically the tragedy of Sergei Magnitsky, an outside lawyer working for Hermitage in Moscow. Sergei discovered the $230 million tax-refund fraud perpetrated by senior officials from within the Russian government. Instead of looking the other way, Sergei testified against these officials to the Russian State Investigative Committee. Soon thereafter he was arrested by the officials he named and thrown into pre trial detention. Over the next year, these officials systematically tortured him in an attempt to get him to withdraw his testimony. He was denied sleep, food and clean water. He was placed in freezing cells with no window panes in the depths of the Moscow winter. He was kept in cells in which sewage regularly flooded the floor. Eventually he became critically ill and needed urgent medical care, which was then repeatedly denied. Ultimately, Sergei's will was stronger than his body and he died in state custody, alone on the floor of an isolation cell, at the age of 37, leaving a wife and two children.

This is the reality behind the "attractive investment climate" that senior Russian officials like Mr. Sechin are attempting to portray: an innocent man, falsely arrested, isolated from his family for an entire year and tortured to death for exposing state corruption. One year later, on the first anniversary of Sergei Magnitsky's death, the Interior Ministry bestowed state honors on the cadre of officers who had prosecuted him. The risk of losing one's business in Russia today is real. But it is not the greatest risk investors face. Should they, like Sergei, find themselves in the crosshairs of corrupt bureaucrats working in league with criminals, investors in Russia risk losing their lives.

Given the scale of corruption in Russia and the growing list of investor horror stories, I understand why Mr. Sechin is eager to redeem Russia's image in the eyes of the world. He joins the efforts of his colleague, First Deputy Prime Minister Igor Shuvalov, who arranged last month for a small panel of high-profile western CEOs at Davos to offer soothing words about the security of their investments in Russia.

The challenge these men face is that the world knows only too well that words alone mean nothing. The way to show that Russia is safe for investors is not to offer CEO testimonials. If Messrs. Sechin and Shuvalov really want to claim that Russia's investment climate is improving, the first thing they should do is to prosecute the officials who arrested, tortured and killed Sergei Magnitsky and perpetrated the crime that Sergei exposed, the largest tax fraud in Russian history. The actions taken and roles played by Lt. Col. Artem Kuznetsov, Lt. Col. Oleg Silchenko, Major Pavel Karpov and Col. Natalia Vinogradova—whose signatures and orders surface throughout Magnitsky's ordeal and who continue to enjoy the power and authority of the Interior Ministry—deserve especially close attention.

Bringing the responsible individuals to justice would be a first step to show that the current Russian government is genuinely working to be on the right side of history. The Magnitsky case has become a lightning rod for public opinion because it is such a clear example of right versus wrong, and because it paints in the starkest terms the very real human cost of investing in Russia today.

Messrs. Sechin and Shuvalov may regret the public attention the case continues to receive around the world, but its high profile also presents them with an opportunity. Prosecuting the people who killed Sergei Magnitsky would be hundreds of times more credible than any hollow words in demonstrating that Russia is finally taking real steps to protect investors and respect the rule of law.

Why Regulators Should Let Banks Foreclose

Data show that brief additional time-outs don't allow borrowers to become current.

By JOSEPH R. MASON

On Capitol Hill last week, federal banking regulators suggested that the government may soon reach a comprehensive settlement with banks on foreclosure procedures and servicing. In theory such a settlement could unlock housing markets and boost the economy. But recent statements by Comptroller of the Currency John Walsh and FDIC Chair Sheila Bair suggest that they remain focused on using the settlement to extend, rather than end, ongoing foreclosure delays.

Meanwhile, states including New Jersey and Hawaii are considering imposing their own moratoriums on foreclosure that, if they conflict with federal policy, may lead to protracted litigation. This approach is the wrong medicine for our ailing economy.

For borrowers, delaying foreclosure only provides false hope. Today, a borrower faces a foreclosure sale only after failing to make a payment for more than a year. There is no reason to believe a brief additional time-out will allow such borrowers to become current. To the contrary, data from the Mortgage Brokers Association indicate that loans reaching the foreclosure stage almost never avoid default, and that borrowers who become 90 days delinquent cure their default only about 1% of the time.

Similarly, recent research done for the National Bureau of Economic Research demonstrates that loan-modification programs have mixed effectiveness. Data suggest that many delinquent borrowers have the means to afford their mortgage payments, but are so deeply "under water" on their mortgages that they are simply no longer willing to pay. Others have insufficient income to afford any reasonable mortgage payment.

The reality is that efforts to lengthen the foreclosure process will not substantially alter borrower outcomes.

Loan modification programs cannot help borrowers without means, and extending them to borrowers who can already afford their current mortgage payments will only create further incentives for "strategic" defaults by those who can afford their payments but would like to lower them. Federal government data from the Home Affordable Modification Program suggest that as many as a third of borrowers tentatively approved for temporary modifications do not complete their three-month "trial periods" (and thus do not obtain modifications).

For those who do obtain modifications, roughly half become delinquent again within six months. Thus, while modification efforts are laudable, they are not the solution.

The unfortunate reality is that efforts to lengthen the foreclosure process will not substantially alter borrower outcomes. They will only extend a painful time for borrowers and the economy. During that time, uncertainty will prevent borrowers from moving on with their lives, including starting to pay rent and make purchases that would inject money into the economy.

For neighborhoods, every day without foreclosures means another day of deteriorating home values. A recent study of the Cleveland area published in Urban Affairs Review found that neighborhood home values are largely unaffected by foreclosures that take less than a year. But foreclosures that take longer than a year have a negative impact on home values as the effects of neglect and vandalism mount.

For homebuilders, further delays in foreclosures are a signal to delay hiring and new construction. Academic research over the past 20 years has proven that residential construction picks up when home values increase. While stalling foreclosure could have a small positive effect on the value of some existing homes, it will not stimulate activity by builders who understand that the temporary reduction in supply is building a large backlog of homes that will hit the market just as new construction is completed. There will be no building boom until the current market is stabilized, and there will be no stability while foreclosure is deferred.

For banks, further delays in the foreclosure process create uncertainty in their balance sheets, potentially blocking channels of credit and undermining lending. Creditors, like borrowers, are hesitant to make new commitments until there is a resolution of the significant economic issues facing them.

One of the root causes of the economic crisis was a deterioration of underwriting standards: We stopped focusing on whether people could afford the homes they were buying. Continuing to delay foreclosures reflects the same kind of wishful thinking. California's 90-day moratorium in 2009 did not improve the state's economic performance, and moratoriums in other states would only prove again that a delay can't turn an unaffordable mortgage into an affordable one.

Kicking the foreclosure problem down the road creates uncertainty that discourages investment—and delays our desperately needed economic recovery.

Mr. Mason is professor of banking at Louisiana State University and a senior fellow at the University of Pennsylvania's Wharton School.

Overstimulated India

New Delhi's budget next Monday needs to cut back its stimulus.

By JAHANGIR AZIZ

Until the middle of 2010, things couldn't have been going better for India. The economy had navigated the global crisis largely unscathed, and the last few quarters had seen growth clocking 9%. Foreigners voted in India's favor with their pocketbooks, as capital poured in from all directions.

But now the tables have turned. India is seething under the threat of runaway inflation—year-on-year wholesale prices are rising above 8%. Factory output is slowing, with the monthly index of industrial production for December falling to a lukewarm annual rise of 1.6%. So far in 2011, foreign equity investors have pulled out $2 billion.

This sudden change in the macroeconomic situation sets the stage for New Delhi's annual budget statement next Monday. This one marks 20 years of economic reform, a cause of celebration. But, more pressing for policy makers, it marks an opportunity for introspection. The place to start would be examining the effect of, and quickly withdrawing, the massive fiscal and monetary stimulus injected after Lehman Brothers collapsed in September 2008.

Consider the size and impact of this stimulus. The fiscal side, pumped in starting December 2008, comprised cuts in indirect taxes as well as increases in spending. Though not as large as China's, the three tranches of fiscal stimulus—the last one was announced in February 2009—came in at 1.75 trillion rupees ($40 billion). Allocations for welfare schemes such as the rural employment guarantee scheme went up later in 2009.

On the monetary side, the Reserve Bank of India cut interest rates six times from October 2008 to April 2009. But the RBI tightened slowly, not raising its policy rates until March of last year. Real interest rates for companies that borrow for durations of one or two years were negative most of last year and may have only begun to turn positive.

All of this artificially buoyed demand. India's post-crisis boom in, say, consumer goods sales owes itself to the stimulus. The economy in the past decade has often seen aggregate demand fast outpacing aggregate supply, but this gap rose very sharply in the last two years.

This, of course, translated into the classic case of inflation—too much money, too few goods, especially as the stimulus continued even after the economy bounced back to 9% growth rates. It also meant that the boom would be unsustainable because it was an artificial and sudden bump buoyed by government spending.

Meanwhile, India's traditional driver of growth has been missing in action. Since corporate investment was unshackled 20 years ago, it has been responsible for revving up the business cycle and sustaining output growth. But neither spending, temporary cuts in taxes nor liquidity support helped revive investment starting 2009.

Investor confidence—at least among those who invest in long-term industrial projects—has seen a dramatic decline since the panic of 2008. At first, investors were spooked by the prospects of a double-dip recession in 2009. When this passed, India-specific concerns became prominent. Regulatory uncertainties, especially in sectors that needed environmental clearances, surfaced; large corruption scandals came to light. And now in the face of persistently high inflation, questions about the ability of policy makers to maintain macroeconomic stability have emerged.

To restore confidence all these concerns need to be addressed. This will be a long-term exercise. But a show of strength by the government that it can stay ahead of the curve and keep the broader economy stable is urgently needed. India needs to sacrifice a little now or it will lose a lot later. The best way to calm inflationary expectations would be to lower aggregate demand—which would imply that India has to sacrifice short-term growth. Though a good chunk of the exercise to decrease demand has to come from tighter monetary policy, Finance Minister Pranab Mukherjee's budget speech is a chance to portray fiscal soundness to this end.

One way the government will indicate its fiscal tightening is via its fiscal deficit. The central government's deficit hit 6.8% of GDP in 2009. This figure ostensibly came down in 2010, but has to go down further. Mr. Mukherjee himself has promised so. The catch is that the government will massage this statistic. Over the past year, New Delhi has reaped a windfall by selling public assets: It divested 400 billion rupees worth of stakes in state-owned enterprises when the stock market was hot and sold off telecom spectrum worth 1.4% of GDP. Mr. Mukherjee will use this one-time gain in revenue to argue that public finances are under control by touting a deficit of 5%. But excluding the spectrum sale, the fiscal deficit barely declined over the past two years to 6.7%.

Investors should look at spending. In 2010, the central government's expenditure was at 15.5 % of GDP, with the biggest components being interest payments and subsidies. The latter, which makes up 5.5% of GDP, surely needs trimming. New Delhi currently subsidizes oil products, fertilizers for farmers and food. The big addition to the subsidy regime—the right to food act that the Congress Party has floated—will probably not be budgeted as yet, but is expected to cost 150 billion rupees.

The government also needs to rationalize tax collection. New Delhi has been putting off the implementation of the unified goods and services tax, which simplifies indirect taxation and widens the tax base to increase revenue. The budget should give assurances of the new tax's rollout. Mr. Mukherjee is expected to partially eliminate temporary cuts to indirect taxes that had featured in the fiscal stimulus. If the government is interested in tightening, it should fully withdraw all these cuts as a prelude to launching the GST and also widen the base of the central government service tax in anticipation of the GST.

These measures will not be sufficient tightening on their own, but they will make the RBI's job much easier. At the same time, New Delhi must aim to boost aggregate supply for the longer run via reforms. One important area to reform, particularly in light of anxiety over food prices, is agriculture. Allowing foreign direct investment in multi-brand retail—letting the likes of Walmart in—could be critical to raising productivity. But just as important are new laws for land holdings to help create transparent land markets.

Such reforms will increase opportunities and incentives for corporate investment. Like the budget 20 years ago, Mr. Mukerjee has the chance to get back on the reform path.

MABINI, the Philippines—The world's currencies are gyrating, but the strains are being felt beyond financial capitals and corporate boardrooms. Millions of families in developing countries rely on relatives sending dollars, euros and other weakened currencies from abroad to prop up spending at home.

Lorena Baquillos's husband, Jimmy, is one of nearly 10 million Filipinos working around the world. She's managed to open a small grocery here on the money Jimmy sends home as a merchant seaman, but his dollar-based pay is translating into fewer pesos at home than it did a few years ago.

"I used to get 43,000 pesos every two months, but now that's down to 33,000," says Ms. Baquillos, 37, who uses her husband's earnings to feed and school their three children.

For years, the Philippines has encouraged its citizens to seek out work in other countries to keep the home economy afloat. Former First Lady Imelda Marcos used to serenade overseas Filipino workers while on visits to the Middle East in the 1980s.

Today, funds channeled home, or remittances, account for more than 10% of the Philippines' economic output, making it one of the most remittance-dependent countries in the world.

Many of these workers are in the U.S. or Britain or Italy, where currencies are struggling to recover from the global financial crisis. There are hundreds of thousands of Filipinos in places such as Saudi Arabia and Hong Kong, where currencies are closely linked to the ailing greenback.

Now, that lifeline is weakening as the dollar continues to languish. The Philippine peso has leapt 15% since the worst of the global financial crisis in 2008, to 43.41 pesos to the dollar. That outpaced a 13% gain in remittances to the country, in dollar terms, in the same period. This means fewer pesos for the families of overseas workers and a pressing need for the Philippines to rethink its remittance habit.

The pressure to adapt is acute in the town of Mabini, a two hours' drive south of Manila. Ms. Baquillos was manning the counter of her grocery store on a recent afternoon, hoisting sacks of rice onto her counter and counseling her customers in money matters. She urged one regular to start saving at least a fifth of her income.

Ms. Baquillos is tightening the purse strings and putting the savings back into a tiny mini-mart she runs across from the Western Union office in Mabini's town plaza.

It's an approach many here say needs to become widespread. "We are seeing a fundamental shift in the global economy," Philippines Finance Minister and the country's economic point-man Cesar Purisima said in a recent interview.

"We have to be honest about the consequences of that and educate people about what's going on."

The government, which was sworn in eight months ago, has started providing incentives for more outsourcing businesses to set up shop on the islands. The Philippines recently overtook India as the world's biggest supplier of voice-based call-center services.

Mr. Purisima and his colleagues also are trying to show their belief in the long-term value of the peso by issuing government bonds in that currency rather than in the dollar, as the country has long done.

There's much to be done, though, and little time to do it. Some economists expect the peso's gains against the U.S. dollar to accelerate this year, pushing the currency up faster than currencies such as Thailand's baht or Malaysia's ringgit, which have already hit multi-year highs.

French bank Credit Agricole S.A. forecasts the peso will appreciate 5.6% over the course of the year, and some analysts reckon it could break 40 pesos to the dollar. As recently as 2005, one dollar could bring 56 pesos.

A woman exchanging Philippine pesos for dollars at a money changer's stall in Manila.

Families depending on remittances in the Philippines are feeling the pinch, especially with inflation from rising food prices further crimping their spending power. Adding to the problem, the appreciating peso is pushing up the cost of Philippine exports compared with exports from competitors such as China, which has prevented its yuan from rising as quickly as currencies in Southeast Asia or Latin America.

In towns across the archipelago, local efforts are underway to help people find new ways to make money in their own backyards.

In Mabini, for example, store owner Ms. Baquillos and other remittance recipients have banded together to put on a musical comedy show about financial management and starting small businesses.

Featuring the misadventures of an overseas worker, the show focuses on family and responsibility, says Ms. Baquillos, and also on how hard it is to work thousands of miles from home, not knowing how much your paycheck will be worth from one week to the next.

"I'm so conscious now of what things cost, and think all the time about how all that money spent on fast food and the latest phones could have been used to buy a case of beer or a sack of rice for the store," says Ms. Baquillos. "We can't just rely on remittances any more."

The challenge for the Philippines is to prepare for a world in which the dollar is less desirable.

"People should try to become more entrepreneurial," says Mr. Purisima, the finance minister. "In the future, if we are to sustain growth, we need to find ways to help people do more here because we can't rely on remittances for ever."

It won't be easy. Unemployment is widespread at 6.9%, and under-employment—defined as people who work only part-time or with minimal incomes—is measured locally at 18%. Large numbers of Filipinos are still leaving in search of better prospects elsewhere because of the dearth of opportunities in a country where the average per capita income is around $1,790 a year.

Each day, hundreds of seafarers throng around Rizal Park in central Manila hoping to find work from the recruitment agents who fleetingly pass through the area.

"The dollar situation is bad, but for us there's no real alternative. We'll just have to cut our expenses where we can," says Mathias Abangan, a 35-year-old chef looking for work on a cruise ship.

Breaking the entrenched remittance culture is another obstacle. In some towns such as Mabini, nearly a fifth of the adults work abroad, and the main street is dotted with pawn shops, recruitment agencies and travel agencies.

The fear that there may be a greater dollar shock to come is a powerful motivator. Non-governmental organizations have enlisted activists like Ms. Baquillos in Mabini and others to spread the word about sound financial planning and how to build their small businesses instead of relying on a shrinking pot of remittances.

Atikha, one of these NGOs, offers job counseling and holds workshops on financial planning and entrepreneurship. Based in San Pablo, a 90-minute drive south of Manila, it was established by returning migrant workers and local religious leaders in 1995 amid worries about the impact of workers' long absences on their families.

For years, Atikha worked solely in the towns of San Pablo and nearby Mabini. Now, as the dollar and other remittance currencies slide against the peso, demand for the group's programs is spreading.

Atikha has established savings clubs for the children of migrant workers, and partnered with local banks and the Philippines' Department of Education to work with teachers who can help kids open their own bank accounts. Local companies such as Globe Telecom Inc., a telecommunications firm, and the Philippine central bank have lent support to dozens of other programs.

"We teach [participants] the language they need to have discussions about their household finances, which can be a very emotional subject," says Mai Dizon-Anonuevo, Atikha's executive director.

In some cases, Filipinos working overseas spend their paychecks on presents for their extended family back home, or else are asked to hand out cash to distant cousins or other family members. This can cause deep-seated tensions.

"We teach them how to say 'no,' which is very important in this culture, where extended families can quickly deplete the bread winner's earnings. It's almost like an intervention," Ms. Anonuevo says.

There are some early success stories. Lilian Brul, a native of San Pablo, says Atikha's financial literacy programs transformed her life. In 2005, her husband, who works for a telephone company in Saudi Arabia, suffered a heart attack.

In its wake, Ms. Brul, now 48 years old, decided that she couldn't sit by and wait for remittances to continue rolling in. She started her own business raising fish in the lakes around San Pablo.

"The heart attack was a real eye-opener," says Ms. Brul, a busy woman with long black hair who spends much of her free time cooking at the local Roman Catholic seminary. She began with 35,000 pesos—around $636 at the time—which she used to buy two large cages set in one of the seven lakes surrounding the city.

Ms. Brul expanded the business after attending one of Atikha's workshops and now owns 16 fish cages, each of which can hold three to four tons of tilapia. She also employs four fishermen and four farmers on new lots of land which she leased last year.

"We don't have to worry so much about the exchange-rate fluctuations anymore," she says. "And I've told my husband he can come home any time he likes to retire, and he says he'll do that next year when he turns 50."

The Truth About U.S. Manufacturing

The average American factory worker today is responsible for more than $180,000 of annual output, triple the $60,000 in 1972.

By MARK J. PERRY

Is American manufacturing dead? You might think so reading most of the nation's editorial pages or watching the endless laments in the news that "nothing is made in America anymore," and that our manufacturing jobs have vanished to China, Mexico and South Korea.

Yet the empirical evidence tells a different story—of a thriving and growing U.S. manufacturing sector, and a country that remains by far the world's largest manufacturer.

This is a particularly sensitive topic in my hometown of Flint, Mich., where auto-plant closings have meant lost jobs and difficult transitions for the displaced. But while it's true that the U.S. has lost more than seven million manufacturing jobs since the late 1970s, our manufacturing output has continued to expand.

International data compiled by the United Nations on global output from 1970-2009 show this success story. Excluding recession-related decreases in 2001 and 2008-09, America's manufacturing output has continued to increase since 1970. In every year since 2004, manufacturing output has exceeded $2 trillion (in constant 2005 dollars), twice the output produced in America's factories in the early 1970s. Taken on its own, U.S. manufacturing would rank today as the sixth largest economy in the world, just behind France and ahead of the United Kingdom, Italy and Brazil.

In 2009, the most recent full year for which international data are available, our manufacturing output was $2.155 trillion (including mining and utilities). That's more than 45% higher than China's, the country we're supposedly losing ground to. Despite recent gains in China and elsewhere, the U.S. still produced more than 20% of global manufacturing output in 2009.

The truth is that America still makes a lot of stuff, and we're making more of it than ever before. We're merely able to do it with a fraction of the workers needed in the past.

Consider the incredible, increasing productivity of America's manufacturing workers: The average U.S. factory worker is responsible today for more than $180,000 of annual manufacturing output, triple the $60,000 in 1972.

Increases in productivity are a direct result of capital investments in productivity-enhancing technology, such as GM's next generation Ecotec engine.

These increases are a direct result of capital investments in productivity-enhancing technology, which last year helped boost output to record levels in industries like computers and semiconductors, medical equipment and supplies, pharmaceuticals and medicine, and oil and natural-gas equipment.

Critics view the production of more with less as a net negative—fewer auto plant jobs mean fewer paychecks, they reason. Yet technological improvement is one of the main ingredients of economic growth. It means increasing wages and a higher standard of living for workers and consumers. Displaced workers learn new skill sets, and a new generation of workers finds its skills are put to more productive use.

Our world-class agriculture sector provides a great model for how to think about the evolution of U.S. manufacturing. The U.S. produces more agricultural output today—with only 2.6% of our work force involved in farming—than we did 100 years ago, when farming jobs represented almost 40% of the labor force. Likewise, we're able to produce twice as much manufacturing output today as in the 1970s, with about seven million fewer workers. That means yesterday's farmhands and plant workers can become today's computer engineers, medical doctors and financial managers.

I don't deny that the transition to this new economy can be a rough one for displaced workers. But turning back the clock to a less efficient economy is not the answer. Instead, let's retrain our work force to participate in this dynamic new economy—an economy that still supports America's status as the world's leading manufacturer.

Mr. Perry, a professor of economics at the University of Michigan, Flint, is also a visiting scholar at the American Enterprise Institute.

The State Business Tax Revolt

Governors get a jump on corporate tax reform.

President Obama says he wants corporate tax reform but hasn't proposed how to do it. Maybe he should take a look at the states, where as many as 10 new Governors are moving ahead to reform and reduce business taxes. The motive is to attract more businesses and create more jobs, while avoiding the fate of California and New York.

Take Iowa, which has the highest state corporate rate at 12%. Add that to the federal rate of 35%, and the Tax Foundation says the Hawkeye State may have the highest levy in the developed world. Governor Terry Branstad, back for a second stint in Des Moines after 12 years, wants to cut the top corporate rate in half to 6% because "we just can't compete with this high tax rate anymore." Mr. Branstad has been sending letters trying to recruit Illinois businesses, where the small business tax rose by 67% and the corporate rate by 30% to 9.5% in January.

Iowa's corporate tax suffers from the same defects that hobble the federal system. It imposes an onerous rate on those companies that get stuck paying it, but the legislature has carved out so many credits and loopholes for politically favored firms that the tax doesn't raise much revenue. So even though Iowa has the highest statutory rate, it ranks 36th in per capita collections. It's all pain for little gain.

Michigan has led the nation in job losses during this past decade, while former Governor Jennifer Granholm sought to attract businesses with special tax favors. New Republican Governor Rick Snyder and the GOP legislature are trying a different strategy and moving forward on a business tax makeover.

Their plan would replace an unpopular gross receipts tax that forces many small firms to pay inflated tax bills even when they don't record a profit. It would also eliminate big industry exemptions, such as the Hollywood movie maker's credit, and instead install a flat 6% corporate profits tax. That's still too high for our liking and for competitive purposes, but at least it would level the playing field across businesses and save them about $1.5 billion each year.

Florida's Rick Scott is pursuing arguably the most ambitious plan. He promised voters he'd abolish the state's $2 billion a year corporate tax over seven years, and his first budget gets that started. "Once we eliminate the corporate tax, and, remember, we don't have a state income tax, there will be no reason for businesses not to come to Florida," he says. South Carolina's Nikki Haley also campaigned on eliminating her state's $200 million a year corporate tax.

The message from these states is similar: In a global economy you can't attract businesses by extracting an undue share of their profits. Bringing rates down is especially important for competitiveness given that five states—Nevada, South Dakota, Texas, Washington and Wyoming—have no corporate income tax.

Our preference, which is supported by most of the economic evidence, is that cutting personal and small business income tax rates should be the highest tax priority for states. But corporate tax systems are complicated and onerous, while only generating between 5% and 8% of state revenues.

Workers also bear the cost of excessive corporate taxes. A 2009 study by the Federal Reserve Bank of Kansas City examined three decades of data on business taxes and worker pay checks. The study found that "corporate taxes reduce wages and that the magnitude of the negative relationship between the taxes and the wages has increased over the past 30 years." Businesses in high tax states invest less, the study found, and this leads to lower productivity and eventually lower average pay for workers.

These Governors can only do so much because the biggest hurdle to new investment is the federal tax of 35% that is the second highest in the world and far above the international average. The President's own tax commission concluded that this tax sends jobs abroad. What is Mr. Obama's Treasury Department waiting for?

The Economic Silly Season Is Upon Us

'Debt ceilings' and 'job killing' spending are two dumb ideas. Obsessing on the deficit while unemployment is at 9% is another.

By ALAN S. BLINDER

Our country seems mired deeply in the silly season when it comes to the leading economic question of the day: how to tame the federal budget deficit. That's a shame, because fixing the long-run deficit is a difficult issue that requires serious thought and a modicum of political goodwill, both of which are in short supply right now.

The silliness comes in at least four parts. The first is the debate over raising the national debt ceiling, which flies in the face of the laws of arithmetic. The increase in the debt each year is simply the difference between total expenditures and total receipts, both of which come from the annual budget. If Congress wants a smaller national debt, it must either spend less or tax more. Like King Canute, it cannot just command the tides.

Democrats may prefer more tax increases and fewer spending cuts, while Republicans prefer the reverse. That's fine. Differing budgetary priorities should be the stuff of political debate. But neither party can just command the national debt to stop growing.

Some people see the debt ceiling as a way to force spending cuts that Congress would otherwise refuse to make. Maybe. But it's a clumsy and risky way that, among other things, could endanger the credit-worthiness of the United States government if our inability to float new debt made it impossible to raise needed cash. And for what purpose? To accomplish something that Congress has the power to do anyway?

The second element of silliness is the belief that the American public stands solidly behind rapid and large budget cuts. Sure, and they also want better weather.

In fact, recent opinion polls show what they have always shown: The public wants smaller deficits, lower taxes and less spending in the abstract. But when it comes to specifics, it finds few spending cuts that it likes. (No, Virginia, we can't balance the budget by cutting foreign aid.) The right way to read the polling numbers is that they show a public that is deeply unhappy about large budget deficits, but just as unhappy about anything that would make a serious dent in the deficit. They much prefer King Canute's approach.

The necessity to choose among various spending cuts and tax increases brings me to the third element of silliness—the one that seems to afflict only Republicans. How many times have you heard Speaker of the House John Boehner (and others) refer to "job-killing government spending"? That phrase has become an official GOP mantra, on a par with "death taxes" and "death panels"—and it's just about as truthful.

A legitimate case can indeed be made that the government spends too much, or that its spending priorities are wrong, or that some particular government program is just plain stupid. That's all fine; such arguments should be what budgetary politics are all about. But even if you dislike some particular piece of government spending, how exactly does it kill jobs? (The taxes raised to pay the bills may kill jobs, but we are talking about deficit spending here.) If the government either hires people itself or purchases things from private companies, doesn't that create jobs?

Back in the 1930s, an exasperated John Maynard Keynes quipped that, if the British government refused to spend money on anything sensible, it could at least bury cash around the country and invite people to dig it up. If a ridiculous policy like that would create jobs—as it would have—then surely even lame-brained government spending will create jobs, too.

This is not a defense of lame-brained programs; the government should be a smart steward of the public's money. My point is simply that, when there is so much unused capacity and so many unemployed people hungry for work, "job-killing government spending" is oxymoronic. Virtually any type of spending, public or private, will create jobs.

The final element of silliness is the only one that requires some subtlety of thought and is at least debatable. It's the popular notion that we need deficit reduction urgently, right now, even though the unemployment rate is still 9%.

Please don't get me wrong. The federal budget deficit is on an irresponsibly unsustainable path. We need to both restrain spending and raise more revenue—and by large amounts. But not right this minute, because doing either would shrink the economy. Despite recent increases, Treasury borrowing rates remain low. There is no evidence that investors are fleeing the dollar. Our economy is still in desperate need of more demand. Each of these facts argues for waiting.

Let me correct that. It's the actual spending cuts and/or tax increases that can wait until our economy is stronger—not their enactment. A smart Congress would legislate future spending cuts and tax increases right now, but delay their start. That would show seriousness of purpose and reassure the bond market without damaging the nascent recovery.

But instead, Congress is tied up in knots over some $60 billion in immediate spending cuts. That number, while draconian in the short run (only half the fiscal year is left), is chump change in the long run. And while Congress is consuming itself in partisan acrimony over the $60 billion, it is doing essentially nothing about the multitrillion dollar long-run deficit—which, as everyone should know by now, hinges on The Big Four: Social Security, medical care, defense and taxes.

Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve.

Goulash Populism

Orbán needs to regain some of his former courage to revive Hungary's economy.

By GEORGE KOPITS

Much of the criticism leveled at Hungary's government for its misguided economic policies is entirely warranted. Independent institutions like the constitutional court, state audit office, and fiscal council entrusted with the oversight of fiscal policy have been neutered. High distortionary taxes have been imposed on large (mostly foreign) corporations. Private pension funds have been fused, practically without recourse, into the traditional pay-as-you-go system while costly social entitlements remain unreformed. The government's next plan is to weaken central bank independence. No wonder Prime Minister Viktor Orbán has been compared to Hugo Chávez and Cristina Fernandez de Kirchner.

Although similar to the pattern of governance in Venezuela and Argentina, the roots of the fitful policies and institution-bashing in Hungary are quite different. In Latin America, populism is largely the upshot of severe poverty and income inequality, compounded by the failure of the political class to cope with these conditions. By contrast, Hungary is burdened by a peculiar historical legacy. Following the repression of the 1956 revolution, the Kádár regime sought legitimacy by introducing an array of widely available social benefits, such as sick pay, early retirement, disability pensions, family allowances, and price subsidies. By using foreign credits to cater to a budding consumer society, the Communists wanted to soften the appearance of the totalitarian regime. In the West, Hungary was hailed as the merriest barrack in the East bloc. "Goulash communism" became a benign version of Soviet dictatorship.

After the fall of the Iron Curtain, the first freely elected government was followed by the rise of the Socialist party propelled by promises to preserve the inherited welfare state. The emerging political elite, across the spectrum, learned quickly that elections are won by promoting continued dependence on government handouts. The only significant distinguishing characteristic between the major political strands was that while the left appealed to Socialist nostalgia, the right attracted those who for decades had to live with suppressed national aspirations.

However, both sides unabashedly elevated political clientelism to an art form. As governments succeeded each other, they competed in enhancing welfare entitlements. But whereas in Latin America populist leaders tend to come from humble origins, a large number of Hungarian politicians, regardless of their party affiliation, are offsprings of the old nomenklatura, with no first-hand experience in the favelas.

Hungary's goulash populism peaked during the Socialist government of Ferenc Gyurcsány, which indulged in the costliest spending spree, resulting in record deficits. Under the cover of its European Union membership, and the attendant moral hazard, Hungary became the most indebted new member state—with public debt climbing to 80% of GDP from 50% in 2001. By late 2008, shaken by the effects of the financial crisis, Hungary became the first EU member compelled to apply for an IMF-EU rescue package.

Against this backdrop, and despite pledges to end bad practices and to promote transparency in public finances, Mr. Orbán remains trapped in the past. In its first nine months, his government has failed to adopt a single measure to correct Hungary's sizable structural fiscal deficit.

The nationalization of pension funds might be helpful for a symptomatic relief of the near-term budgetary gap as the funds' current revenues and assets could be used for added spending. But the long-term fiscal outlook has worsened as the government is saddled with the obligation of paying out much higher defined benefits from the traditional system than would be the case for the funded system.

Hungary's public debt problem is further aggravated by one of the most rapidly aging populations worldwide. A relatively low private saving propensity and the lowest (after Malta) labor force participation ratio in the EU—not surprising in light of the adverse incentives of the welfare system—undermine economic growth prospects. The country remains vulnerable to the gyrations of financial markets, as reflected in its risk premium, the highest on non-euro sovereign paper in the Union. But, unlike Argentina and Venezuela, Hungary cannot count on oil or other key commodity exports to avert default.

The solution lies in a major policy shift toward structural reforms that can help restore the country's debt sustainability. Deficit-reducing measures that provide incentives to work, save and invest—such as targeting welfare benefits and tightening the eligibility for public pensions—would pave the way to a higher growth path. In recent weeks, with the due date for a credible EU convergence program fast approaching, Mr. Orbán has expressed some awareness that such a shift is necessary. Given his rhetorical skills, intellectual capacity, and command over a two-thirds legislative majority, the prime minister has the means to break with goulash populism. If former president Lula da Silva was capable of overcoming much deeper populist instincts to successfully lead Brazil through the recent financial turbulence, it should be far easier for Mr. Orbán to kick the habit.

In 1989, speaking in Budapest's Heroes Square, Mr. Orbán fearlessly demanded free elections and the withdrawal of Soviet troops. If only today he mustered a fraction of that courage exhibited 22 years ago to push through reforms, Hungary's economic future would be secure.

Mr. Kopits is former chairman of the Fiscal Council of Hungary and a former member of the Monetary Council of the National Bank of Hungary.

With China's rapidly expanding economy and growing power at sea and in the air, some commentators have taken the view that it's not a question of whether but how soon China will replace the U.S. as the world's leading superpower.

This is nonsense. So long as America retains its freedom and thus its unique powers of innovation, it will continue to lead. Besides, China's elite is too scared to follow in the path of freedom because to do so would risk unity, threatening disintegration and a return to the terrible days of warlords and civil war, as in the 1920s.

Moreover, China has secret weaknesses. Its most serious: gambling and drug addiction. China's new prosperity is already producing a rapid expansion of the country's international gambling class, not to mention an appreciable increase in the number of drug addicts.

Though India was known as the "Mother of Opium" and during the 18th century produced large quantities of it, nearly all of India's opium was exported to foreign markets rather than consumed at home. The Chinese love of opium seems to have originated on a large scale with its 18th-century population explosion, when China grew from about 150 million in 1700 to 450 million in 1850. By that time China had become the world's largest consumer of opium.

This was highly convenient for the West. Although the West bought large quantities of silk and tea from China, the Chinese spurned Western goods, regarding foreign imports as immoral. As the authorities did everything in their power to restrict imports, China ran huge trade surpluses with the West. But then Western governments and trading firms discovered the Chinese appetite for opium and began to export it in large quantities through Canton. By the 1830s China's export surplus had turned into a growing deficit.

Alarmed by the loss of silver and thespread of addiction, especially among the ruling class, the imperial court in Peking sought to ban opium and prevent Western ships from bringing it in. The West--in the name of free trade--responded with naval force. Thus began the Opi-umWars, which were fought mainly by Britain, to keep China's ports open.

Some experts believe that general prosperity in a society is always and inevitably accompanied by a comparable increase in drug-taking and cite the U.S. as an example. Certainly, since China entered the world market and its living standards began to rise swiftly, its consumption of addictive drugs has risen alarmingly. Australian researcher Susan Trevaskes, who has just published a book on Chinese crime prevention, Policing Serious Crime in China (Routledge, $125), estimates that 40% of the heroin produced in Afghanistan and Pakistan and a similar percentage of the drugs coming from Laos and Burma now go to China. Trevaskes also reveals that China itself manufactures "precursor chemicals" for ecstasy and other substances, for export and domestic use.

Drug use on a large scale attracts organized crime and corruption. Under opium's economic impact government corruption in China became more oppressive, which eventually led to peasant revolts, followed by the government's savage attempts at suppressing them by burning villages. The catchphrase describing this policy: "strengthening the walls and clearing the countryside." The imperial authorities then created "strategic villages" and forced peasants to live in them.

Since the 1980s the Chinese government has conducted similar campaigns, dubbed "Strike Hard," to put down organized crime and corruption. During the last quarter of the 20th century an enormous number of "criminals" were executed. Trevaskes puts the figure at between 2,500 and 15,000 a year and calculates that the total number may have been as high as 250,000.

Such ferocious campaigns to put down crime ended in failure and were abandoned, especially since it seems they often led to the spread of corruption--at all levels of officialdom.

If, as seems likely, the expansion of the Chinese economy and the rise in living standards lead to further increases in the use of heroin and other drugs, how will Chinese authorities deal with the concurrent rise in organized crime?

The Chinese are learning that prosperity comes at a price. The Communistauthorities ruling China today have immensely more powerful and repressive machinery at their disposal than had the 19th-century imperialist bureaucracy. However, experience has shown that mere repression does not work.

Meanwhile, more and more Chinese have more and more disposable income--and a significant proportion of it is going to drugs.

Paul Johnson, eminent British historian and author; Lee Kuan Yew, minister mentor of Singapore; Amity Shlaes, senior fellow in economic history at the Council on Foreign Relations; and David Malpass, global economist, president of Encima Global LLC, rotate in writing this column. To see past Current Events columns, visit our Web site at www.forbes.com/currentevents.

Is history repeating itself?

G-20 Interim Study Faults Short Supply For Rise in Commodity Prices

A report being conducted for the world’s Group of 20 leading economies points to supply not keeping up with demand as the main factor behind price increases in wheat, sugar, cotton, metals, oil and other commodities.

The Organization for Economic Cooperation and Development’s study–which is being put together ahead of the next G-20 meeting of top finance officials in April in Washington– may lead to increased efforts to boost commodities production around the world. It could also help reduce criticism of the U.S. Federal Reserve’s easy-money policies, which some have blamed for stoking global inflation.

French President Nicholas Sarkozy, who heads the G-20, recently warned that rising commodity prices were a threat to the world economy. Finance ministers and central bankers meeting in Paris a week ago said they’d look into the underlying drivers of the price increases and consider possible actions.

“It’s very hard to distinguish between financial and structural factors behind the price increases, but it looks like demand and supply are playing the predominant role,” Pier Carlo Padoan, chief economist and deputy-secretary general at the OECD, said in an interview.

A drought and fire in Russia last summer, coupled with export restrictions imposed by the government there, helped bring about soaring wheat prices. Meanwhile, bad harvests in the U.S., Europe, Australia and Argentina have contributed to soaring agricultural commodity prices on international markets.

There have been few investments in agriculture over the past few years and productivity has been stagnant, the OECD report is expected to highlight. At the same time, demand for food has been growing in China and India, the world’s two most populous countries, as their economies continue to grow at a rapid pace.

A similar supply and demand argument can be made for oil prices, Padoan said. Oil prices have recently surged above $100 a barrel amid concerns that the recent turmoil in the oil-rich North African and Middle Eastern countries could hit production. The price of Brent oil, considered the best benchmark, is close to $110 a barrel, 15% higher than at the start of the year.

Fed Chairman Ben Bernanke has been making a similar case about commodity prices, following strong criticism that the U.S. central bank’s pumping of dollars has sent floods of cash into China and other developing economies, driving up prices for food and energy. The Fed chief puts the blame on strong growth in developing economies and their inadequate response, including China’s reluctance to let its currency rise.

At the last meeting of G-20 world leaders last November, which took place just a week after the Fed announced it would inject $600 billion into the economy to buy government bonds, U.S. President Barack Obama was challenged to defend the policy from foreign accusations that the U.S. was stoking inflation. The criticism overshadowed Obama’s priority for the summit: greater pressure on China to revalue its currency. Before G-20 leaders convene again in November, the spotlight could be back on China.

Number of the Week: Gasoline Prices Bite

Could rising oil prices derail the U.S. recovery? We’re more resilient to high energy prices than we used to be, but it’s certainly a danger.

The price of oil broke through $100 a barrel this week, and U.S. gas prices neared $3.25 a gallon, as turmoil in the Middle East bred concerns about supply. Those rising prices are already taking a bigger bite out of U.S. consumers’ budgets. In January, sales at gas stations accounted for 10.34% of all retail sales, according to the Commerce Department. That’s the highest level since October 2008.

To be sure, we have a way to go to reach the peak of July 2008, when gasoline prices exceeded $4.15 a gallon and gas-station sales accounted for 12.47% of retail sales. Some economists see reason to believe we’re less likely to experience a similar spike this time around. For one, oil inventories are significantly higher than they were in 2008, providing more of a buffer in the event of any disruptions in supply from the Middle East.

Beyond that, with the help of more-efficient cars and appliances, US consumers have gotten better at handling higher energy costs. Last time gas prices were this high, consumers were spending a larger share of their budgets on fuel. When gasoline prices rose to $3.25 a gallon in March 2008, gas-station sales accounted for 11.55% of all retail sales – significantly more than they do now.

Still, a lot depends on psychology, and U.S. consumers’ mood remains fragile. Given the weakness of the recovery and the limited resources available to stimulate the economy, it wouldn’t take much to get us in trouble.

Does growing wealth and income inequality in the United States presage the downfall of the American republic? Will we evolve into a new Gilded Age plutocracy, irrevocably split between the competing interests of rich and poor? Or is growing inequality a mere bump in the road, a statistical blip along the path to greater wealth for virtually every American? Or is income inequality partially desirable, reflecting the greater productivity of society’s stars?

There is plenty of speculation on these possibilities, but a lot of it has been aimed at elevating one political agenda over another rather than elevating our understanding. As a result, there’s more confusion about this issue than just about any other in contemporary American political discourse. The reality is that most of the worries about income inequality are bogus, but some are probably better grounded and even more serious than even many of their heralds realize. If our economic churn is bound to throw off political sparks, whether alarums about plutocracy or something else, we owe it to ourselves to seek out an accurate picture of what is really going on. Let’s start with the subset of worries about inequality that are significantly overblown.

In terms of immediate political stability, there is less to the income inequality issue than meets the eye. Most analyses of income inequality neglect two major points. First, the inequality of personal well-being is sharply down over the past hundred years and perhaps over the past twenty years as well. Bill Gates is much, much richer than I am, yet it is not obvious that he is much happier if, indeed, he is happier at all. I have access to penicillin, air travel, good cheap food, the Internet and virtually all of the technical innovations that Gates does. Like the vast majority of Americans, I have access to some important new pharmaceuticals, such as statins to protect against heart disease. To be sure, Gates receives the very best care from the world’s top doctors, but our health outcomes are in the same ballpark. I don’t have a private jet or take luxury vacations, and—I think it is fair to say—my house is much smaller than his. I can’t meet with the world’s elite on demand. Still, by broad historical standards, what I share with Bill Gates is far more significant than what I don’t share with him.

Compare these circumstances to those of 1911, a century ago. Even in the wealthier countries, the average person had little formal education, worked six days a week or more, often at hard physical labor, never took vacations, and could not access most of the world’s culture. The living standards of Carnegie and Rockefeller towered above those of typical Americans, not just in terms of money but also in terms of comfort. Most people today may not articulate this truth to themselves in so many words, but they sense it keenly enough. So when average people read about or see income inequality, they don’t feel the moral outrage that radiates from the more passionate egalitarian quarters of society. Instead, they think their lives are pretty good and that they either earned through hard work or lucked into a healthy share of the American dream. (The persistently unemployed, of course, are a different matter, and I will return to them later.) It is pretty easy to convince a lot of Americans that unemployment and poverty are social problems because discrete examples of both are visible on the evening news, or maybe even in or at the periphery of one’s own life. It’s much harder to get those same people worked up about generalized measures of inequality.

This is why, for example, large numbers of Americans oppose the idea of an estate tax even though the current form of the tax, slated to return in 2011, is very unlikely to affect them or their estates. In narrowly self-interested terms, that view may be irrational, but most Americans are unwilling to frame national issues in terms of rich versus poor. There’s a great deal of hostility toward various government bailouts, but the idea of “undeserving” recipients is the key factor in those feelings. Resentment against Wall Street gamesters hasn’t spilled over much into resentment against the wealthy more generally. The bailout for General Motors’ labor unions wasn’t so popular either—again, obviously not because of any bias against the wealthy but because a basic sense of fairness was violated. As of November 2010, congressional Democrats are of a mixed mind as to whether the Bush tax cuts should expire for those whose annual income exceeds $250,000; that is in large part because their constituents bear no animus toward rich people, only toward undeservedly rich people.

A neglected observation, too, is that envy is usually local. At least in the United States, most economic resentment is not directed toward billionaires or high-roller financiers—not even corrupt ones. It’s directed at the guy down the hall who got a bigger raise. It’s directed at the husband of your wife’s sister, because the brand of beer he stocks costs $3 a case more than yours, and so on. That’s another reason why a lot of people aren’t so bothered by income or wealth inequality at the macro level. Most of us don’t compare ourselves to billionaires. Gore Vidal put it honestly: “Whenever a friend succeeds, a little something in me dies.”

Occasionally the cynic in me wonders why so many relatively well-off intellectuals lead the egalitarian charge against the privileges of the wealthy. One group has the status currency of money and the other has the status currency of intellect, so might they be competing for overall social regard? The high status of the wealthy in America, or for that matter the high status of celebrities, seems to bother our intellectual class most. That class composes a very small group, however, so the upshot is that growing income inequality won’t necessarily have major political implications at the macro level.

All that said, income inequality does matter—for both politics and the economy. To see how, we must distinguish between inequality itself and what causes it. But first let’s review the trends in more detail.

The numbers are clear: Income inequality has been rising in the United States, especially at the very top. The data show a big difference between two quite separate issues, namely income growth at the very top of the distribution and greater inequality throughout the distribution. The first trend is much more pronounced than the second, although the two are often confused.

When it comes to the first trend, the share of pre-tax income earned by the richest 1 percent of earners has increased from about 8 percent in 1974 to more than 18 percent in 2007. Furthermore, the richest 0.01 percent (the 15,000 or so richest families) had a share of less than 1 percent in 1974 but more than 6 percent of national income in 2007. As noted, those figures are from pre-tax income, so don’t look to the George W. Bush tax cuts to explain the pattern. Furthermore, these gains have been sustained and have evolved over many years, rather than coming in one or two small bursts between 1974 and today.¹

These numbers have been challenged on the grounds that, since various tax reforms have kicked in, individuals now receive their incomes in different and harder to measure ways, namely through corporate forms, stock options and fringe benefits. Caution is in order, but the overall trend seems robust. Similar broad patterns are indicated by different sources, such as studies of executive compensation. Anecdotal observation suggests extreme and unprecedented returns earned by investment bankers, fired CEOs, J.K. Rowling and Tiger Woods.

At the same time, wage growth for the median earner has slowed since 1973. But that slower wage growth has afflicted large numbers of Americans, and it is conceptually distinct from the higher relative share of top income earners. For instance, if you take the 1979–2005 period, the average incomes of the bottom fifth of households increased only 6 percent while the incomes of the middle quintile rose by 21 percent. That’s a widening of the spread of incomes, but it’s not so drastic compared to the explosive gains at the very top.

The broader change in income distribution, the one occurring beneath the very top earners, can be deconstructed in a manner that makes nearly all of it look harmless. For instance, there is usually greater inequality of income among both older people and the more highly educated, if only because there is more time and more room for fortunes to vary. Since America is becoming both older and more highly educated, our measured income inequality will increase pretty much by demographic fiat. Economist Thomas Lemieux at the University of British Columbia estimates that these demographic effects explain three-quarters of the observed rise in income inequality for men, and even more for women.²

Attacking the problem from a different angle, other economists are challenging whether there is much growth in inequality at all below the super-rich. For instance, real incomes are measured using a common price index, yet poorer people are more likely to shop at discount outlets like Wal-Mart, which have seen big price drops over the past twenty years.³Once we take this behavior into account, it is unclear whether the real income gaps between the poor and middle class have been widening much at all. Robert J. Gordon, an economist from Northwestern University who is hardly known as a right-wing apologist, wrote in a recent paper that “there was no increase of inequality after 1993 in the bottom 99 percent of the population”, and that whatever overall change there was “can be entirely explained by the behavior of income in the top 1 percent.”⁴

And so we come again to the gains of the top earners, clearly the big story told by the data. It’s worth noting that over this same period of time, inequality of work hours increased too. The top earners worked a lot more and most other Americans worked somewhat less. That’s another reason why high earners don’t occasion more resentment: Many people understand how hard they have to work to get there. It also seems that most of the income gains of the top earners were related to performance pay—bonuses, in other words—and not wildly out-of-whack yearly salaries.⁵

It is also the case that any society with a lot of “threshold earners” is likely to experience growing income inequality. A threshold earner is someone who seeks to earn a certain amount of money and no more. If wages go up, that person will respond by seeking less work or by working less hard or less often. That person simply wants to “get by” in terms of absolute earning power in order to experience other gains in the form of leisure—whether spending time with friends and family, walking in the woods and so on. Luck aside, that person’s income will never rise much above the threshold.

It’s not obvious what causes the percentage of threshold earners to rise or fall, but it seems reasonable to suppose that the more single-occupancy households there are, the more threshold earners there will be, since a major incentive for earning money is to use it to take care of other people with whom one lives. For a variety of reasons, single-occupancy households in the United States are at an all-time high. There are also a growing number of late odyssey years graduate students who try to cover their own expenses but otherwise devote their time to study. If the percentage of threshold earners rises for whatever reasons, however, the aggregate gap between them and the more financially ambitious will widen. There is nothing morally or practically wrong with an increase in inequality from a source such as that.

The funny thing is this: For years, many cultural critics in and of the United States have been telling us that Americans should behave more like threshold earners. We should be less harried, more interested in nurturing friendships, and more interested in the non-commercial sphere of life. That may well be good advice. Many studies suggest that above a certain level more money brings only marginal increments of happiness. What isn’t so widely advertised is that those same critics have basically been telling us, without realizing it, that we should be acting in such a manner as to increase measured income inequality. Not only is high inequality an inevitable concomitant of human diversity, but growing income inequality may be, too, if lots of us take the kind of advice that will make us happier.

The use of micro-data now makes it possible to trace some high earners by income and thus construct a partial picture of what is going on among the upper echelons of the distribution. Steven N. Kaplan and Joshua Rauh have recently provided a detailed estimation of particular American incomes.⁶ Their data do not comprise the entire U.S. population, but from partial financial records they find a very strong role for the financial sector in driving the trend toward income concentration at the top. For instance, for 2004, nonfinancial executives of publicly traded companies accounted for less than 6 percent of the top 0.01 percent income bracket. In that same year, the top 25 hedge fund managers combined appear to have earned more than all of the CEOs from the entire S&P 500. The number of Wall Street investors earning more than $100 million a year was nine times higher than the public company executives earning that amount. The authors also relate that they shared their estimates with a former U.S. Secretary of the Treasury, one who also has a Wall Street background. He thought their estimates of earnings in the financial sector were, if anything, understated.

Many of the other high earners are also connected to finance. After Wall Street, Kaplan and Rauh identify the legal sector as a contributor to the growing spread in earnings at the top. Yet many high-earning lawyers are doing financial deals, so a lot of the income generated through legal activity is rooted in finance. Other lawyers are defending corporations against lawsuits, filing lawsuits or helping corporations deal with complex regulations. The returns to these activities are an artifact of the growing complexity of the law and government growth rather than a tale of markets per se. Finance aside, there isn’t much of a story of market failure here, even if we don’t find the results aesthetically appealing.

When it comes to professional athletes and celebrities, there isn’t much of a mystery as to what has happened. Tiger Woods earns much more, even adjusting for inflation, than Arnold Palmer ever did. J.K. Rowling, the first billionaire author, earns much more than did Charles Dickens. These high incomes come, on balance, from the greater reach of modern communications and marketing. Kids all over the world read about Harry Potter. There is more purchasing power to spend on children’s books and, indeed, on culture and celebrities more generally. For high-earning celebrities, hardly anyone finds these earnings so morally objectionable as to suggest that they be politically actionable. Cultural critics can complain that good schoolteachers earn too little, and they may be right, but that does not make celebrities into political targets. They’re too popular. It’s also pretty clear that most of them work hard to earn their money, by persuading fans to buy or otherwise support their product. Most of these individuals do not come from elite or extremely privileged backgrounds, either. They worked their way to the top, and even if Rowling is not an author for the ages, her books tapped into the spirit of their time in a special way. We may or may not wish to tax the wealthy, including wealthy celebrities, at higher rates, but there is no need to “cure” the structural causes of higher celebrity incomes.

If we are looking for objectionable problems in the top 1 percent of income earners, much of it boils down to finance and activities related to financial markets. And to be sure, the high incomes in finance should give us all pause.

The first factor driving high returns is sometimes called by practitioners “going short on volatility.” Sometimes it is called “negative skewness.” In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition. Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed.

To understand how this strategy works, consider an example from sports betting. The NBA’s Washington Wizards are a perennially hapless team that rarely gets beyond the first round of the playoffs, if they make the playoffs at all. This year the odds of the Wizards winning the NBA title will likely clock in at longer than a hundred to one. I could, as a gambling strategy, bet against the Wizards and other low-quality teams each year. Most years I would earn a decent profit, and it would feel like I was earning money for virtually nothing. The Los Angeles Lakers or Boston Celtics or some other quality team would win the title again and I would collect some surplus from my bets. For many years I would earn excess returns relative to the market as a whole.

Yet such bets are not wise over the long run. Every now and then a surprise team does win the title and in those years I would lose a huge amount of money. Even the Washington Wizards (under their previous name, the Capital Bullets) won the title in 1977–78 despite compiling a so-so 44–38 record during the regular season, by marching through the playoffs in spectacular fashion. So if you bet against unlikely events, most of the time you will look smart and have the money to validate the appearance. Periodically, however, you will look very bad. Does that kind of pattern sound familiar? It happens in finance, too. Betting against a big decline in home prices is analogous to betting against the Wizards. Every now and then such a bet will blow up in your face, though in most years that trading activity will generate above-average profits and big bonuses for the traders and CEOs.

To this mix we can add the fact that many money managers are investing other people’s money. If you plan to stay with an investment bank for ten years or less, most of the people playing this investing strategy will make out very well most of the time. Everyone’s time horizon is a bit limited and you will bring in some nice years of extra returns and reap nice bonuses. And let’s say the whole thing does blow up in your face? What’s the worst that can happen? Your bosses fire you, but you will still have millions in the bank and that MBA from Harvard or Wharton. For the people actually investing the money, there’s barely any downside risk other than having to quit the party early. Furthermore, if everyone else made more or less the same mistake (very surprising major events, such as a busted housing market, affect virtually everybody), you’re hardly disgraced. You might even get rehired at another investment bank, or maybe a hedge fund, within months or even weeks.

Moreover, smart shareholders will acquiesce to or even encourage these gambles. They gain on the upside, while the downside, past the point of bankruptcy, is borne by the firm’s creditors. And will the bondholders object? Well, they might have a difficult time monitoring the internal trading operations of financial institutions. Of course, the firm’s trading book cannot be open to competitors, and that means it cannot be open to bondholders (or even most shareholders) either. So what, exactly, will they have in hand to object to?

Perhaps more important, government bailouts minimize the damage to creditors on the downside. Neither the Treasury nor the Fed allowed creditors to take any losses from the collapse of the major banks during the financial crisis. The U.S. government guaranteed these loans, either explicitly or implicitly.

Guaranteeing the debt also encourages equity holders to take more risk. While current bailouts have not in general maintained equity values, and while share prices have often fallen to near zero following the bust of a major bank, the bailouts still give the bank a lifeline. Instead of the bank being destroyed, sometimes those equity prices do climb back out of the hole. This is true of the major surviving banks in the United States, and even AIG is paying back its bailout. For better or worse, we’re handing out free options on recovery, and that encourages banks to take more risk in the first place.

In short, there is an unholy dynamic of short-term trading and investing, backed up by bailouts and risk reduction from the government and the Federal Reserve. This is not good. “Going short on volatility” is a dangerous strategy from a social point of view. For one thing, in so-called normal times, the finance sector attracts a big chunk of the smartest, most hard-working and most talented individuals. That represents a huge human capital opportunity cost to society and the economy at large. But more immediate and more important, it means that banks take far too many risks and go way out on a limb, often in correlated fashion. When their bets turn sour, as they did in 2007–09, everyone else pays the price.

And it’s not just the taxpayer cost of the bailout that stings. The financial disruption ends up throwing a lot of people out of work down the economic food chain, often for long periods. Furthermore, the Federal Reserve System has recapitalized major U.S. banks by paying interest on bank reserves and by keeping an unusually high interest rate spread, which allows banks to borrow short from Treasury at near-zero rates and invest in other higher-yielding assets and earn back lots of money rather quickly. In essence, we’re allowing banks to earn their way back by arbitraging interest rate spreads against the U.S. government. This is rarely called a bailout and it doesn’t count as a normal budget item, but it is a bailout nonetheless. This type of implicit bailout brings high social costs by slowing down economic recovery (the interest rate spreads require tight monetary policy) and by redistributing income from the Treasury to the major banks.

The more one studies financial theory, the more one realizes how many different ways there are to construct a “going short on volatility” investment position. To an outsider, even to seasoned bank regulators, the net position of a bank or hedge fund may well be impossible to discern. It’s not easy to unpack a balance sheet with hundreds of billions of dollars on it and with numerous hedged, offsetting, leveraged, or off-balance-sheet positions. Those who pack it usually know what’s inside, but not always. In some cases, traders may not even know they are going short on volatility. They just do what they have seen others do. Their peers who try such strategies very often have Jaguars and homes in the Hamptons. What’s not to like?

The upshot of all this for our purposes is that the “going short on volatility” strategy increases income inequality. In normal years the financial sector is flush with cash and high earnings. In implosion years a lot of the losses are borne by other sectors of society. In other words, financial crisis begets income inequality. Despite being conceptually distinct phenomena, the political economy of income inequality is, in part, the political economy of finance. Simon Johnson tabulates the numbers nicely:

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.⁷

If you’re wondering, right before the Great Depression of the 1930s, bank profits and finance-related earnings were also especially high.⁸

There’s a second reason why the financial sector abets income inequality: the “moving first” issue. Let’s say that some news hits the market and that traders interpret this news at different speeds. One trader figures out what the news means in a second, while the other traders require five seconds. Still other traders require an entire day or maybe even a month to figure things out. The early traders earn the extra money. They buy the proper assets early, at the lower prices, and reap most of the gains when the other, later traders pile on. Similarly, if you buy into a successful tech company in the early stages, you are “moving first” in a very effective manner, and you will capture most of the gains if that company hits it big.

The moving-first phenomenon sums to a “winner-take-all” market. Only some relatively small number of traders, sometimes just one trader, can be first. Those who are first will make far more than those who are fourth or fifth. This difference will persist, even if those who are fourth come pretty close to competing with those who are first. In this context, first is first and it doesn’t matter much whether those who come in fourth pile on a month, a minute or a fraction of a second later. Those who bought (or sold, as the case may be) first have captured and locked in most of the available gains. Since gains are concentrated among the early winners, and the closeness of the runner-ups doesn’t so much matter for income distribution, asset-market trading thus encourages the ongoing concentration of wealth. Many investors make lots of mistakes and lose their money, but each year brings a new bunch of projects that can turn the early investors and traders into very wealthy individuals.

These two features of the problem—“going short on volatility” and “getting there first”—are related. Let’s say that Goldman Sachs regularly secures a lot of the best and quickest trades, whether because of its quality analysis, inside connections or high-frequency trading apparatus (it has all three). It builds up a treasure chest of profits and continues to hire very sharp traders and to receive valuable information. Those profits allow it to make “short on volatility” bets faster than anyone else, because if it messes up, it still has a large enough buffer to pad losses. This increases the odds that Goldman will repeatedly pull in spectacular profits.

Still, every now and then Goldman will go bust, or would go bust if not for government bailouts. But the odds are in any given year that it won’t because of the advantages it and other big banks have. It’s as if the major banks have tapped a hole in the social till and they are drinking from it with a straw. In any given year, this practice may seem tolerable—didn’t the bank earn the money fair and square by a series of fairly normal looking trades? Yet over time this situation will corrode productivity, because what the banks do bears almost no resemblance to a process of getting capital into the hands of those who can make most efficient use of it. And it leads to periodic financial explosions. That, in short, is the real problem of income inequality we face today. It’s what causes the inequality at the very top of the earning pyramid that has dangerous implications for the economy as a whole.

A key lesson to take from all of this is that simply railing against income inequality doesn’t get us very far. We have to find a way to prevent or limit major banks from repeatedly going short on volatility at social expense. No one has figured out how to do that yet.

It remains to be seen whether the new financial regulation bill signed into law this past summer will help. The bill does have positive features. First, it forces banks to put up more of their own capital, and thus shareholders will have more skin in the game, inducing them to curtail their risky investments. Second, it also limits the trading activities of banks, although to a currently undetermined extent (many key decisions were kicked into the hands of future regulators). Third, the new “resolution authority” allows financial regulators to impose selective losses, for instance, to punish bondholders if they wish.

We’ll see if these reforms constrain excess risk-taking in the long run. There are reasons for skepticism. Most of all, the required capital cushions simply aren’t that high, so a big enough bet against unexpected outcomes still will yield more financial upside than downside. Furthermore, high capital reserve requirements insulate bank managers from the pressures of both shareholders and bondholders. That could encourage risk-taking and make the underlying problem worse. Autonomous managers often push for risk-taking rather than constrain it.

What about controlling bank risk-taking directly with tight government oversight? That is not practical. There are more ways for banks to take risks than even knowledgeable regulators can possibly control; it just isn’t that easy to oversee a balance sheet with hundreds of billions of dollars on it, especially when short-term positions are wound down before quarterly inspections. It’s also not clear how well regulators can identify risky assets. Some of the worst excesses of the financial crisis were grounded in mortgage-backed assets—a very traditional function of banks—not exotic derivatives trading strategies. Virtually any asset position can be used to bet long odds, one way or another. It is naive to think that underpaid, undertrained regulators can keep up with financial traders, especially when the latter stand to earn billions by circumventing the intent of regulations while remaining within the letter of the law.

It’s a familiar story, repeated many times in the past. If one recalls the Basel I capital agreements for banks, the view was that we would make banks safer by inducing them to hold a lot of AAA-rated mortgage-backed assets. How well did that work out? So, with no disrespect to the regulators or the sponsors of the recent bill, it is hardly clear that enhanced regulation will solve the basic problem.

For the time being, we need to accept the possibility that the financial sector has learned how to game the American (and UK-based) system of state capitalism. It’s no longer obvious that the system is stable at a macro level, and extreme income inequality at the top has been one result of that imbalance. Income inequality is a symptom, however, rather than a cause of the real problem. The root cause of income inequality, viewed in the most general terms, is extreme human ingenuity, albeit of a perverse kind. That is why it is so hard to control.

Another root cause of growing inequality is that the modern world, by so limiting our downside risk, makes extreme risk-taking all too comfortable and easy. More risk-taking will mean more inequality, sooner or later, because winners always emerge from risk-taking. Yet bankers who take bad risks (provided those risks are legal) simply do not end up with bad outcomes in any absolute sense. They still have millions in the bank, lots of human capital and plenty of social status. We’re not going to bring back torture, trial by ordeal or debtors’ prisons, nor should we. Yet the threat of impoverishment and disgrace no longer looms the way it once did, so we no longer can constrain excess financial risk-taking. It’s too soft and cushy a world.

That’s an underappreciated way to think about our modern, wealthy economy: Smart people have greater reach than ever before, and nothing really can go so wrong for them. As a broad-based portrait of the new world, that sounds pretty good, and usually it is. Just keep in mind that every now and then those smart people will be making—collectively—some pretty big mistakes.

How about a world with no bailouts? Why don’t we simply eliminate the safety net for clueless or unlucky risk-takers so that losses equal gains overall? That’s a good idea in principle, but it is hard to put into practice. Once a financial crisis arrives, politicians will seek to limit the damage, and that means they will bail out major financial institutions. Had we not passed TARP and related policies, the United States probably would have faced unemployment rates of 25 percent of higher, as in the Great Depression. The political consequences would not have been pretty. Bank bailouts may sound quite interventionist, and indeed they are, but in relative terms they probably were the most libertarian policy we had on tap. It meant big one-time expenses, but, for the most part, it kept government out of the real economy (the General Motors bailout aside).

So what will happen next? One worry is that banks are currently undercapitalized and will seek out or create a new bubble within the next few years, again pursuing the upside risk without so much equity to lose. A second perspective is that banks are sufficiently chastened for the time being but that economic turmoil in Europe and China has not yet played itself out, so perhaps we still have seen only the early stages of what will prove to be an even bigger international financial crisis. Adherents of this view often analogize 2009–10 to 1929–32, when many people thought that negative economic shocks had stopped and recovery was underway. In 2006, banks were gambling on the housing market, and maybe today they are, as the result of earlier decisions, gambling on China and Europe staying in one economic piece.

A third view is perhaps most likely. We probably don’t have any solution to the hazards created by our financial sector, not because plutocrats are preventing our political system from adopting appropriate remedies, but because we don’t know what those remedies are. Yet neither is another crisis immediately upon us. The underlying dynamic favors excess risk-taking, but banks at the current moment fear the scrutiny of regulators and the public and so are playing it fairly safe. They are sitting on money rather than lending it out. The biggest risk today is how few parties will take risks, and, in part, the caution of banks is driving our current protracted economic slowdown. According to this view, the long run will bring another financial crisis once moods pick up and external scrutiny weakens, but that day of reckoning is still some ways off.

Is the overall picture a shame? Yes. Is it distorting resource distribution and productivity in the meantime? Yes. Will it again bring our economy to its knees? Probably. Maybe that’s simply the price of modern society. Income inequality will likely continue to rise and we will search in vain for the appropriate political remedies for our underlying problems.

¹See Jacob S. Hacker and Paul Pierson, “Winner-Take-All Politics: Public Policy, Political Organization, and the Precipitous Rise of Top Incomes in the United States”, Politics & Society (June 2010). For one criticism of those numbers, see Scott Winship, “Hacker-mania!”, ScottWinshipWeb, September 19, 2010. ²Lemieux, “Increasing Residual Wage Inequality: Composition Effects, Noisy Data, or Rising Demand for Skill?” American Economic Review, June 2006. ³See Christian Broda and John Romalis, “Shattering the Conventional Wisdom on Growing Inequality”, New York Times Freakonomics blog, May 19, 2008. ⁴Gordon, “Misperceptions About the Magnitude and Timing of Changes in American Income Inequality”, National Bureau of Economic Research, NBER Working Paper No. 15351 (September 2009). ⁵See Thomas Lemieux, W. Bentley Macleod and Daniel Parent, “Performance Pay and Wage Inequality”, Quarterly Journal of Economics (February 2009). ⁶Kaplan and Rauh, “Wall Street and Main Street: What Contributes to the Rise in the Highest Incomes?” Review of Financial Studies (March 2010). ⁷Johnson, “The Quiet Coup”, The Atlantic (May 2009). ⁸See “Wages and Human Capital in the U.S. Financial Industry”, Thomas Philippon and Ariell Reshef, National Bureau of Economic Research, NBER Working Paper No. 14644 (January 2009).

Taxes and the Top Percentile Myth

A 2008 OECD study of leading economies found that 'taxation is most progressively distributed in the United States.' More so than Sweden or France.

By ALAN REYNOLDS

When President Obama announced a two-year stay of execution for taxpayers on Dec. 7, he made it clear that he intends to spend those two years campaigning for higher marginal tax rates on dividends, capital gains and salaries for couples earning more than $250,000. "I don't see how the Republicans win that argument," said the president.

Despite the deficit commission's call for tax reform with fewer tax credits and lower marginal tax rates, the left wing of the Democratic Party remains passionate about making the U.S. tax system more and more progressive. They claim this is all about payback—that raising the highest tax rates is the fair thing to do because top income groups supposedly received huge windfalls from the Bush tax cuts. As the headline of a Robert Creamer column in the Huffington Post put it: "The Crowd that Had the Party Should Pick up the Tab."

Arguments for these retaliatory tax penalties invariably begin with estimates by economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez of U.C. Berkeley that the wealthiest 1% of U.S. households now take home more than 20% of all household income.

This estimate suffers two obvious and fatal flaws. The first is that the "more than 20%" figure does not refer to "take home" income at all. It refers to income before taxes (including capital gains) as a share of income before transfers. Such figures tell us nothing about whether the top percentile pays too much or too little in income taxes.

In The Journal of Economic Perspectives (Winter 2007), Messrs. Piketty and Saez estimated that "the upper 1% of the income distribution earned 19.6% of total income before tax [in 2004], and paid 41% of the individual federal income tax." No other major country is so dependent on so few taxpayers.

A 2008 study of 24 leading economies by the Organization of Economic Cooperation and Development (OECD) concludes that, "Taxation is most progressively distributed in the United States, probably reflecting the greater role played there by refundable tax credits, such as the Earned Income Tax Credit and the Child Tax Credit. . . . Taxes tend to be least progressive in the Nordic countries (notably, Sweden), France and Switzerland."

The OECD study—titled "Growing Unequal?"—also found that the ratio of taxes paid to income received by the top 10% was by far the highest in the U.S., at 1.35, compared to 1.1 for France, 1.07 for Germany, 1.01 for Japan and 1.0 for Sweden (i.e., the top decile's share of Swedish taxes is the same as their share of income).

A second fatal flaw is that the large share of income reported by the upper 1% is largely a consequence of lower tax rates. In a 2010 paper on top incomes co-authored with Anthony Atkinson of Nuffield College, Messrs. Piketty and Saez note that "higher top marginal tax rates can reduce top reported earnings." They say "all studies" agree that higher "top marginal tax rates do seem to negatively affect top income shares."

What appears to be an increase in top incomes reported on individual tax returns is often just a predictable taxpayer reaction to lower tax rates. That should be readily apparent from the nearby table, which uses data from Messrs. Piketty and Saez to break down the real incomes of the top 1% by source (excluding interest income and rent).

The first column ("salaries") shows average labor income among the top 1% reported on W2 forms—from salaries, bonuses and exercised stock options. A Dec. 13 New York Times article, citing Messrs. Piketty and Saez, claims, "A big reason for the huge gains at the top is the outsize pay of executives, bankers and traders." On the contrary, the table shows that average real pay among the top 1% was no higher at the 2007 peak than it had been in 1999.

In a January 2008 New York Times article, Austan Goolsbee (now chairman of the President's Council of Economic Advisers) claimed that "average real salaries (subtracting inflation) for the top 1% of earners . . . have been growing rapidly regardless of what happened to tax rates." On the contrary, the top 1% did report higher salaries after the mid-2003 reduction in top tax rates, but not by enough to offset losses of the previous three years. By examining the sources of income Mr. Goolsbee chose to ignore—dividends, capital gains and business income—a powerful taxpayer response to changing tax rates becomes quite clear.

The second column, for example, shows real capital gains reported in taxable accounts. President Obama proposes raising the capital gains tax to 20% on top incomes after the two-year reprieve is over. Yet the chart shows that the top 1% reported fewer capital gains in the tech-stock euphoria of 1999-2000 (when the tax rate was 20%) than during the middling market of 2006-2007. It is doubtful so many gains would have been reported in 2006-2007 if the tax rate had been 20%. Lower tax rates on capital gains increase the frequency of asset sales and thus result in more taxable capital gains on tax returns.

The third column shows a near tripling of average dividend income from 2002 to 2007. That can only be explained as a behavioral response to the sharp reduction in top tax rates on dividends, to 15% from 38.6%. Raising the dividend tax to 20% could easily yield no additional revenue if it resulted in high-income investors holding fewer dividend- paying stocks and more corporations using stock buybacks rather than dividends to reward stockholders.

The last column of the table shows average business income reported on the top 1% of individual tax returns by subchapter S corporations, partnerships, proprietorships and many limited liability companies. After the individual tax rate was brought down to the level of the corporate tax rate in 2003, business income reported on individual tax returns became quite large. For the Obama team to argue that higher taxes on individual incomes would have little impact on business denies these facts.

If individual tax rates were once again pushed above corporate rates, some firms, farms and professionals would switch to reporting income on corporate tax forms to shelter retained earnings. As with dividends and capital gains, this is another reason that estimated revenues from higher tax rates are unbelievable.

The Piketty and Saez estimates are irrelevant to questions about income distribution because they exclude taxes and transfers. What those figures do show, however, is that if tax rates on high incomes, capital gains and dividends were increased in 2013, the top 1%'s reported share of before-tax income would indeed go way down. That would be partly because of reduced effort, investment and entrepreneurship. Yet simpler ways of reducing reported income can leave the after-tax income about the same (switching from dividend-paying stocks to tax-exempt bonds, or holding stocks for years).

Once higher tax rates cause the top 1% to report less income, then top taxpayers would likely pay a much smaller share of taxes, just as they do in, say, France or Sweden. That would be an ironic consequence of listening to economists and journalists who form strong opinions about tax policy on the basis of an essentially irrelevant statistic about what the top 1%'s share might be if there were not taxes or transfers.

Mr. Reynolds is a senior fellow at the Cato Institute and the author of "Income and Wealth" (Greenwood Press 2006).

Unions vs. the Right to Work

Collective bargaining on a broad scale is more similar to an antitrust violation than to a civil liberty.

By ROBERT BARRO

How ironic that Wisconsin has become ground zero for the battle between taxpayers and public- employee labor unions. Wisconsin was the first state to allow collective bargaining for government workers (in 1959), following a tradition where it was the first to introduce a personal income tax (in 1911, before the introduction of the current form of individual income tax in 1913 by the federal government).

Labor unions like to portray collective bargaining as a basic civil liberty, akin to the freedoms of speech, press, assembly and religion. For a teachers union, collective bargaining means that suppliers of teacher services to all public school systems in a state—or even across states—can collude with regard to acceptable wages, benefits and working conditions. An analogy for business would be for all providers of airline transportation to assemble to fix ticket prices, capacity and so on. From this perspective, collective bargaining on a broad scale is more similar to an antitrust violation than to a civil liberty.

In fact, labor unions were subject to U.S. antitrust laws in the Sherman Antitrust Act of 1890, which was first applied in 1894 to the American Railway Union. However, organized labor managed to obtain exemption from federal antitrust laws in subsequent legislation, notably the Clayton Antitrust Act of 1914 and the National Labor Relations Act of 1935.

Remarkably, labor unions are not only immune from antitrust laws but can also negotiate a "union shop," which requires nonunion employees to join the union or pay nearly equivalent dues. Somehow, despite many attempts, organized labor has lacked the political power to repeal the key portion of the 1947 Taft Hartley Act that allowed states to pass right-to-work laws, which now prohibit the union shop in 22 states. From the standpoint of civil liberties, the individual right to work—without being forced to join a union or pay dues—has a much better claim than collective bargaining. (Not to mention that "right to work" has a much more pleasant, liberal sound than "collective bargaining.") The push for right-to-work laws, which haven't been enacted anywhere but Oklahoma over the last 20 years, seems about to take off.

The current pushback against labor-union power stems from the collision between overly generous benefits for public employees— notably for pensions and health care—and the fiscal crises of state and local governments. Teachers and other public-employee unions went too far in convincing weak or complicit state and local governments to agree to obligations, particularly defined-benefit pension plans, that created excessive burdens on taxpayers.

In recognition of this fiscal reality, even the unions and their Democratic allies in Wisconsin have agreed to Gov. Scott Walker's proposed cutbacks of benefits, as long as he drops the restrictions on collective bargaining. The problem is that this "compromise" leaves intact the structure of strong public-employee unions that helped to create the unsustainable fiscal situation; after all, the next governor may have less fiscal discipline. A long-run solution requires a change in structure, for example, by restricting collective bargaining for public employees and, to go further, by introducing a right-to-work law.

There is evidence that right-to-work laws—or, more broadly, the pro-business policies offered by right-to-work states—matter for economic growth. In research published in 2000, economist Thomas Holmes of the University of Minnesota compared counties close to the border between states with and without right-to-work laws (thereby holding constant an array of factors related to geography and climate). He found that the cumulative growth of employment in manufacturing (the traditional area of union strength prior to the rise of public-employee unions) in the right-to-work states was 26 percentage points greater than that in the non-right-to-work states.

Beyond Wisconsin, a key issue is which states are likely to be the next political battlegrounds on labor issues. In fact, one can interpret the extreme reactions by union demonstrators and absent Democratic legislators in Wisconsin not so much as attempts to influence that state—which may be a lost cause—but rather to deter politicians in other states from taking similar actions. This strategy may be working in Michigan, where Gov. Rick Snyder recently asserted that he would not "pick fights" with labor unions.

In general, the most likely arenas are states in which the governor and both houses of the state legislature are Republican (often because of the 2010 elections), and in which substantial rights for collective bargaining by public employees currently exist. This group includes Indiana, which has recently been as active as Wisconsin on labor issues; ironically, Indiana enacted a right-to-work law in 1957 but repealed it in 1965. Otherwise, my tentative list includes Michigan, Pennsylvania, Maine, Florida, Tennessee, Nebraska (with a nominally nonpartisan legislature), Kansas, Idaho, North Dakota and South Dakota.

The national fiscal crisis and recession that began in 2008 had many ill effects, including the ongoing crises of pension and health-care obligations in many states. But at least one positive consequence is that the required return to fiscal discipline has caused reexamination of the growth in economic and political power of public-employee unions. Hopefully, embattled politicians like Gov. Walker in Wisconsin will maintain their resolve and achieve a more sensible long-term structure for the taxpayers in their states.

Mr. Barro is a professor of economics at Harvard and a senior fellow at Stanford University's Hoover Institution.

Ireland Revolts for Stability

The new coalition won't default on its sovereign debt or raise its corporate tax rate.

By OLIVER O'CONNOR

Predictions that the financial crisis would cause unrest in Ireland have been proved wrong. On Friday, more than two million Irish voted in peaceful elections, choosing upheaval at the ballot box, not on the street.

The outgoing Fianna Fáil party was punished for overseeing Ireland's economic decline. It is set to lose more than two-thirds of its seats, according to near-complete results Sunday.

Voters chose political stability by making Fine Gael the largest party. The center-right party campaigned to cut payroll taxes in order to stimulate jobs, to reduce certain value-added tax (VAT) rates and the air travel tax, and to sell state assets. It also promised not to raise income taxes or the 12.5% rate for corporations. Most of the next €9 billion of fiscal correction will come from spending cuts, not tax hikes.

Some Fine Gael policies will be diluted, as the party will likely be forced into a coalition with the runner-up Labour Party. But the new government can be expected to stick to the constraints of the European Union-International Monetary Fund austerity package while trying to reduce 14% unemployment.

Both parties pledged to renegotiate the interest rate on EU loans to reduce the burden on Irish taxpayers. The average interest rate of 5.8% for seven years is seen as contributing to Ireland's costly debt problem.

It hasn't escaped Irish attention that Iceland renegotiated its deal with the U.K. and the Netherlands, cutting its interest rate to 3.2% from 5.5%. The Irish have also noticed that the interest rates for the EU balance-of-payments support for Latvia and Romania are around 2.5% to 3%.

Irish government debt is already about 100% of GDP (€160 billion) and will rise to about 120% of GDP in 2014, before possibly stabilizing. Many fear it won't. The government bailout of Ireland's banks alone could rise to 36% of debt this year, according to Goodbody Stockbrokers. Irish banks remain reliant on emergency funding from the European Central Bank (ECB) and the Irish Central Bank.

Nobody can say what the final costs of the banks' bailout will be. The Irish people are wondering why they should make whole the remaining €21 billion of private bank debt that is not guaranteed by the state. Why should Irish taxpayers have to suffer for bad lending decisions made elsewhere in Europe?

The simple answer is that the ECB, Germany and other governments insist that national taxpayers bear these costs. When and how this became ECB policy is unclear. It seems to have been implicitly in place even before the 2008 Irish bank guarantee.

According to outgoing Finance Minister Brian Lenihan, last November the Irish government wanted creditors to share some of the costs. The ECB refused. But there is near consensus in Ireland, if not in the EU, that some form of debt restructuring will be necessary. What form would best support growth, business and jobs is not clear yet. Some senior bank debt, for example, is owned by Irish institutions, including pension funds.

The bottom line is that while each percentage point reduction of the interest rate on the EU loans could ease the cost to Ireland by 0.4% of GDP, every 10% haircut on the unguaranteed, unsecured bank debt would equal 1.3% of GDP, according to Goodbody. That 3-to-1 ratio makes haircuts look tantalizing.

Does this mean Ireland is heading for imminent insolvency before the March 24 EU summit? Not quite. Monday morning markets don't matter for Ireland. New bank stress tests will be completed only after the summit.

But political pressure will drive the next government to seek lower interest rates. The wider euro zone is also under pressure to find a coherent response to the overall European debt problem.

In these circumstances, it would be madness for Dublin to bargain away its corporate tax policy. Suggestions that Ireland exchange a one percentage point increase in the corporation tax rate for a one percentage point reduction in the EU interest rate are misguided. Hiking the corporate tax rate would break the promise made to the thousands of international investors who own €172 billion of foreign direct investment in Ireland, the equivalent of 107% of the country's GDP.

It makes no sense to protect sovereign debt investors by burning direct investors. That would be tantamount to a default in the eyes of foreign investors. That's why the new Irish government will neither default on its sovereign debt nor its corporate tax promises.

Fortunately, Ireland still has a real economy that is increasing its competitiveness and exports. Agribusiness, medical-devices, pharma and international services are all vibrant. Hotel prices are now the cheapest in Western Europe. There is hope.

Mr. O'Connor, a business consultant based in London, is a former adviser to the Irish government.

Irish Vote Sets Stage for Showdown With EU

By GUY CHAZAN, DAVID ENRICH and PAUL HANNON

Ireland's main opposition party, Fine Gael, won a clear victory in Friday's election, setting Dublin on course for a showdown with the European Union over the terms of its €67.5 billion ($92.83 billion) international bailout.

Enda Kenny, the man expected to lead Ireland's next government after his party's success in the general election, vows to help transform Ireland. Video courtesy of Reuters.

The center-right Fine Gael, which campaigned on a promise to renegotiate key points of the rescue package, is expected to start negotiations with the smaller center-left Labour Party on forming a new government. With 154 seats decided in the 166-seat Dáil, or lower house of parliament, by Sunday evening, Fine Gael had 70, followed by Labour with 36 and the incumbent Fianna Fáil with 18. The left-wing Sinn Fein picked up 13 and Independents took 13.

Enda Kenny, the Fine Gael leader widely expected to become prime minister, said Saturday that the bailout was "a bad deal for Ireland and a bad deal for Europe" and added: "We are not going to cry the poor mouth, other than to say the reality of this challenge is too much."

Mr. Kenny will launch his renegotiation fight on Friday at a meeting in Helsinki of the European People's Party, which is made up of leaders from Europe's right-leaning Christian Democratic parties who vote together in the European Parliament. He will continue it at a meeting of the European Council in Brussels the following week.

Photos: Irish Vote

Timeline: Ireland's Woes

Fine Gael rode to power on voter anger at Ireland's economic crash and the country's huge debts, while the right-leaning Fianna Fáil bore the full force of voters' wrath, punished for failing to rein in Ireland's banks as they indulged in reckless real-estate lending.

Fine Gael officials said that once in power,they would seek to reduce the 6% the EU charges for emergency loans, and some even spoke of forcing the Irish banks' bondholders to take losses on some of their holdings.

"There is a strong feeling in Ireland that Irish taxpayers can't cope with the burden of bailing out the entire banking system on their own," said Kevin Rafter, lecturer in politics at Dublin City University. "The consensus is that it requires a broader solution at the European level, and more burden-sharing."

That sets the stage for a confrontation with European officials. In Brussels and at the European Central Bank's Frankfurt headquarters, officials have fiercely opposed any talk of imposing so-called haircuts on bank bondholders. Their concern is that such a move would erode investor confidence across the euro zone, potentially causing the Continent's banking crisis to flare up again. Also, rescheduling the banking system's debts would leave German and French banks, which are big holders of Irish banks' bonds, with substantial losses.

One of the new government's early tasks will be to decide how much to invest in recapitalizing the banking system. Under the terms of the bailout, the Irish government was set to inject up to €10 billion into Bank of Ireland, Allied Irish Banks and EBS Building Society by the end of February. But Mr. Kenny has said that should be postponed until the results of stress tests on the banks, to be completed by the end of March, are known.

Meanwhile, Fine Gael itself is somewhat split on the issue of changing the terms of the bailout. Some in the party see the threat of imposing a haircut on bondholders merely as a stick for winning concessions from Europe on the interest rate. But some newly elected Fine Gael lawmakers are determined to make sure bondholders and other lenders are punished.

Peter Mathews, a former bank analyst who won a seat in parliament in Friday's election, said he will push for lenders to Ireland's troubled banks to bear more pain. That includes not only the institutional investors that have bought bonds issued by the banks, but also the ECB, which has made tens of billions of euros in emergency loans to the sector. Mr. Mathews believes the ECB deserves to share in the suffering, since he says it didn't do more to rein in the Irish banks' excesses during the boom years.

"There will have to be a restructuring resolution sooner rather than later," he said Sunday, shortly before celebrating with his family. The ECB is "not going to be pleased, naturally," the Fine Gael lawmaker added. "But they were complicit in the whole thing. They failed to exercise their overarching supervisory responsibilities within the euro zone."

Stop the Looting Of Burma

The international community can make it harder for the generals to steal the proceeds of Burma's oil and gas exports.

By MATTHEW SMITH

The hunt for Hosni Mubarak's ill-gotten wealth is underway, with banks and governments cooperating to return what belongs to the people of Egypt. However, it may be too late to recover most of what Mr. Mubarak and his cronies stole, and in many other cases it may be impossible to prevent such losses as they are happening. There is one place, though, where it is both indisputable that the authoritarian rulers are looting the country's wealth and possible to do something about it right now: Burma.

The military junta has been diverting profits from the lucrative energy sector for nearly two decades. Natural gas sales to Thailand alone have generated billions of dollars, accounting for roughly 35% of annual export earnings. But instead of generating prosperity and hope for Burmese, this wealth has largely disappeared into the generals' pockets.

Part of the problem is that very little of the gas revenue ever officially enters Burma. A well-documented dual accounting method ensures most of the profit, paid to the military in U.S. dollars, remains outside of the country's national budget. In some cases it is located in shadowy offshore bank accounts held in trust by entities designed to avoid international sanctions.

So what can the international community do? The U.S. could fully implement existing financial sanctions that were designed to target the generals' offshore bank accounts. Section 5(c) of the JADE Act of 2008 already authorizes the Treasury Department to prohibit Burmese individuals and foreign banks from accessing the U.S. financial system if they hold cash or facilitate transactions for the Burmese regime.

Restricted access to the U.S. financial system is a risk foreign banks will not take lightly. This should have little adverse impact on Burma's general population, since they are already largely isolated from the global financial system, but it will make it more difficult for the generals to hide public money.

While the full weight of the U.S. legislation has never been applied, recent reports from Singapore suggest some banks in the island state have started refusing accounts held by politically exposed persons from Burma. This shows that bankers are very aware of the risk of tougher sanctions, and that such sanctions might be very effective.

Working with Egypt and other transitioning countries to recover lost or stolen assets is a step in the right direction, but it's not enough. A military junta should not be allowed to openly loot a country's resources with the help of the international financial system. Cutting the generals off from the tools they need to launder their stolen money is a sound measure that can change their behavior and help the people of Burma recover what is rightfully theirs.

Mr. Smith is a senior consultant with EarthRights International, which represented Burmese plaintiffs in Doe v. Unocal Corporation.

385Readings(Y) Spring, 2011

China Raises Interest Rates

· NATIONAL POST

· Dow Jones International News

RBA's McKibbin Warns on Inflation

· Citywire

King vs. Hawks

Chinese Demand Lifts U.S. Wood Sales

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To China, With Bark

Merkel's Harmonic Convergence

A single market does not require a single economic model.

Free Trade Foul-Ups

Obama and the GOP are muffing a chance for bipartisan deals.

Japan's Growing Sense of Crisis

If another generation experiences economic stagnation, Japan's otherwise stable democracy could be put to a test.

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Germany's Current Account Surplus Expands

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A Breakthrough on the Reminbi?

Now Comes the Global Revolution in Services

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Reaganomics: What We Learned

From December 1982 to June 1990, Reaganomics created over 21 million jobs. The right policies can do it again.

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New drilling method opens vast oil fields in US

Corn Pops as USDA Sees Drop in Supply

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Ethanol, Biodiesel Producers Granted Extension of Tax Credits

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European Biodiesel Costs Makes Blending Ethanol More Lucrative

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Africa Rising

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Zambian Beef Processor Expands to Nigeria With Aim of Spreading Out Across the Continent

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