New Geography

Author: Michael Harrington

  • The Politics of Risk

    Barack Obama has reached for the mantle of a transformative presidency, aspiring to recast our national social contract in the interest of greater equality and fairness. In cooperation with a Democratic-controlled Congress, he has pursued this goal by expanding Federal authority in response to economic crises and supporting interventions into finance and banking, automobile manufacturing, health care, and environmental policy. This strategy adopts the “statist” philosophy of economic risk management by centralizing governmental authority and control over private markets.

    Ironically, this Europeanization of US public policy is occurring exactly when sovereign debt crises and taxpayer bailouts are casting an ominous cloud over the European model. It seems public sector risk may turn out to be more dangerous than private sector risk. But if we can connect recurring financial crises to the long-term erosion in the economic health of states, we should seriously question whether statism offers the best array of policies to manage the uncertainties of the modern world.

    A surplus of world savings drove people in the developed world to over-borrow, and concentrate debt and risk in overpriced housing assets. Banks then distilled these risky assets into securitized debt obligations and sold them to investors worldwide. What ensued was risk mismanagement on a colossal scale, as the concentration of leveraged debt made the crash far worse than dot-com or tulip bulb mania. This shell game violated all we know about prudent risk management and sucked in politicians, central bankers, financiers, the housing industry, and citizens alike.

    The response has been to substitute massive public credit for shrinking private credit, while seeking new means to regulate financial risk and reward. This sounds a bit too much like the dog that bit us. In terms of public policy it means more centralized political control over central banks and the financial sector, with unpredictable market distortions yielding more liabilities and burdens for taxpayers. The net result will be an increase in systemic risk exposure.

    The modern social welfare state would more accurately be labeled the social insurance state, as its spending priorities are dominated by programs related to old age pensions, health care, and the risks of unemployment and poverty. Social insurance has been the developed world’s primary political response to systemic risk. Regrettably, it may impose the least efficient means to manage risk, with the most costly consequences.

    Financial risk is managed by saving, pooling, hedging and, most important, asset diversification. The key concepts are savings and diversification, as these underpin the logic of insurance pooling. A financially sound insurance pool must align contribution and benefit ratios according to known actuarial data and demographic trends. The inconvenient truth is that our social insurance programs, like Social Security and Medicare, are not really insurance pools, but pay-as-you-go transfer schemes. We tax younger workers to immediately pay out benefits to older, retired citizens. This design inflicts a host of problems and costs.

    Pay-as-you-go means our Social Security and Medicare taxes have not been saved in a “trust” fund, rather they are doled out in benefit promises and used to fund other political priorities through general revenues. This is the problem of political and bureaucratic “agents” following their own short-term incentives. This is also how we get “too big to fail” and runaway budgets.

    Because taxes to fund entitlement transfers crowd out private savings and lead us to believe the government is saving for us, private savings decrease. This means we cannot adequately fund the economic growth necessary to fund future social insurance liabilities. The alternative has been to borrow from abroad, mostly from the Chinese. As birth rates decline and longevity increases, the “trust” funds will run out or overburden younger workers as baby boomers age.

    We can readily measure the consequences of our policy failures in societal risk management. Household savings rates in the U.S. have dropped from an average of 10% in the 1970s to less than 1% just before the financial crisis in 2008. In the immediate response to the crisis the rate jumped to 6%, but this was offset by roughly a trillion dollars in new public debt. (Estimates for China’s household savings rate range from 25-50%)

    US public debt as a percentage of GDP now fluctuates around 80%. This compares to Japan at 192%, Italy at 115%, Greece at 108%, France at 80%, and Germany at 77%. Chile, which privatized its social insurance three decades ago, services a public debt at 9% of GDP.

    Our current account deficit, which measures how much more we import than export, persists at 3% of GDP while China runs a 6% surplus. In simplest terms, the Chinese are lending us money to buy their goods.
    A recent survey by the Peter G. Peterson Foundation of US political leaders from both parties found unanimous agreement that US structural deficits due to entitlement programs would cause a financial collapse of US public finances within ten years unless the programs were reformed.

    A true national insurance program cannot be a shell game that transfers resources from one group to another. The nation must accumulate real savings to be invested to fund future needs. The danger of our current treatment of risk management through entitlements is that we are not really insuring against our risks, but merely passing them on to others. This is neither moral, nor economically viable.

    Our only chance of solving these problems must focus on managing economic risk by boosting savings and promoting the widespread diversification of assets. The increased concentration of political, economic, and financial power currently dominating the developed world is antithetical to such solutions and financial reform should not risk reinforcing a Wall Street-Washington oligarchy.

    The unfocused blame put on markets for our financial crises is disingenuous. The heavy reliance on credit and debt, the opacity of financial technology, the capture of regulatory agencies by the industries they regulate, and the volatility of asset markets are all symptoms of misguided policies. History and theory have both shown how functioning private markets are most efficient in allocating and managing diversified risk. The best financial regulation, then, is not another politicized agency, but the continued promotion of open, competitive, and transparent financial markets. The caveat for financiers is that failure and bankruptcy are essential features of free markets.

    A world defined by risk and uncertainty is like a sea full of hidden icebergs. Politicians like to reinforce social solidarity and national cohesion by claiming we are all in the same boat and must pull together. Mr. Obama seems to favor this metaphor, but, in terms of systemic risk, it also fits the Titanic analogy. A more useful metaphor is that we are all in different boats on the same sea. This can apply to countries, states, cities, markets, workplaces, and families. The multiplicity and diversity of institutional structures is a lesson conveyed by nature through biodiversity. All we need do is apply the lesson. As one Greek citizen was quoted saying about his country’s latest crisis: “It could be a chance to overhaul the whole rancid system and create a state that actually works.”

    Flickr photo: “Loaded” by Niffty

    Michael Harrington is a policy analyst who has taught political science at UCLA and conducted economic research for The Reason Foundation, The Milken Institute and the US Chamber of Commerce. His work has appeared in the Wall Street Journal, Barron’s, Business Week, the Economist, the Christian Science Monitor, the Los Angeles Times, and other publications.

  • The Crisis Next Time: Public Finance

    The financial crisis of 2008 paved the way for the employment crisis of 2009, which has now paved the way for the upcoming public finance crisis of 2010. Most federal, state and municipal budgets are strained to the breaking point while the economy still has not found its footing. Meanwhile our national politics is obsessed with expensive overhauls of environmental policy and healthcare reform. Our latest policy strategy is an attempt to borrow and spend our way to prosperity, ala Japan of the past twenty years.

    It’s tempting to point to a few simple causes of these economic misfortunes, such as mortgage subsidies, loose credit standards, or excess financial leverage, but the truth is that we are experiencing the fallout of a failed policy paradigm.

    This paradigm was rooted in the past century with the creation of the Federal Reserve in 1913, the Employment Act of 1946 and the Humphrey-Hawkins Full Employment and Stabilization Act of 1978. It’s a paradigm dependent on many admittedly useful policy tools, including both Keynesian demand stimulus and the Austrian school’s theory of money and credit, the monetarism of Friedman, as well as the supply-siders of the 1980s.

    So, in what ways have these approaches failed?

    The policy goals are clearly stated: stable GDP growth and full employment. But the economic results have been decidedly mixed: the growth of real incomes laden with an exploding entitlement state, structural budget crises, widening wealth disparities, a catastrophe-prone banking system, and volatile asset markets. We’ve heard the term “systemic risk” bandied about the recent financial crisis, but this report card captures the true risks of the system we’ve created.

    Politically and socially, Americans clearly want a society where a growing middle class thrives, opportunity exists for individual success and advancement, and a prosperous elite accepts the responsibilities of power not to exploit the weak and disadvantaged. Instead, our political economy is hollowing out the middle class, creating more dependency among the poor, and fostering a culture of corruption and irresponsibility among the elites. Elsewhere I’ve characterized this current state of affairs as Casino Capitalism and Crapshoot Politics.

    Second question: why has our democratic politics failed to deliver? The short answer: Our government is doing too much of what it shouldn’t be doing and not enough of what it should.

    Free market economies are very good at producing wealth by harnessing the incentives of market participants. Market prices are valuable information signals that tell everyone how much of each good to produce. Governments, however, no matter how enlightened, cannot attain this efficiency. But, due to the political imperative to “do something” in response to countless demands, they feel compelled to try. Thus the focus on “growing the economy” and “creating jobs.”

    Unfortunately, these goals often demand incompatible policies, highlighting the differences between the private and public sectors. Private firms earn profits (i.e., create wealth) by increasing productivity, often by reducing labor costs. However, the public sector follows no profit criteria, so the government increases employment without attention to productivity. Thus, with more public sector jobs we create more employment while producing less. At the same time, the growth of the public sector empowers a politically powerful public union interest in its continued expansion. This is no way for a nation to grow rich.

    When we peel away the logic we find the true goal of public sector job creation: political redistribution of the economy’s wealth-creating capacity in order to mitigate the effects of markets. This is not an unworthy societal goal, but our public policies adopt counterproductive means to achieve it.

    To be fair, the political problem arises because private markets are agnostic towards the distributional effects of their success. Inequality, poverty, pollution, environmental degradation, the concentration of economic and political power – all these are unfavorable distributional effects of markets that give rise to political demands. The question is over how government should meet these demands.

    The 20th century attempt to tax and redistribute wealth has landed the modern welfare state in a cul-de-sac of exploding budgets, rising costs of living, slower economic growth and structural unemployment. We’re robbing Peter to pay Paul and neither – except for a relative handful of bureaucrats and rent-seeking capitalists – is better off for it. This adds up to less opportunity all around. Again, the problem is with our failed paradigm. We need to align our policies with behavioral incentives without surrendering our policy goals to an agnostic market mechanism.

    To construct a new paradigm we might do best to return to first principles of what Americans want: freedom, opportunity and justice. In order to enjoy these principles, citizens need to be empowered with choice, autonomy, and protection from unmanageable risks. Only functioning free and competitive markets can provide the necessary resources.

    So, what should be the proper role for government?

    The maldistribution of resources can be mitigated if citizens participate in the wealth creating process as more than an input labor cost. Public policy should cease deficit spending to promote employment and instead look to creating the necessary environment for private risk-taking, saving, investment, and production. This includes insuring market competition and mitigating the effects of economic risk and uncertainty. Tax and regulatory policies should promote the widespread accumulation, diversification, and access to capital to empower individuals and families with the necessary resources to build wealth and insure themselves against uncertainty. Where private insurance markets are incomplete, there is a role for limited social insurance to fill the gap.

    Numerous specific policies flow from this general paradigm shift, for example, we can stop penalizing savings through overly loose credit and onerous tax policies on interest and dividend income. There is no reason not to have a tax-free threshold for capital income that reflects the desired savings level of the median annual income household.

    Why have we stuck with a failed policy paradigm? Part of the answer is the Kuhnian nature of scientific revolutions, but the pursuit of power and influence by narrow interests is certainly a determinant factor. Economically and socially, we know where we need to go. Getting there politically is another matter. Our present political leadership (of both parties) certainly is not taking us in that direction.

    Michael Harrington is a policy analyst and writer with a multidisciplinary background in economics, finance and political science. His specialties are international capital markets, trade, and social insurance. He has taught political science at UCLA and conducted economic research for The Reason Foundation, The Milken Institute and the US Chamber of Commerce. His published writings and opinions have appeared in numerous business journals, including the Wall Street Journal, Barron’s, BusinessWeek, the Economist, the Christian Science Monitor and the Los Angeles Times.

  • Michael Harrington

  • Redrawing the Electoral Map? Not so fast.

    With Barack Obama’s historic presidential win there has been much celebratory talk about redrawing the electoral map. Obama himself boasted that he was the only Democratic candidate who could accomplish this feat.

    However, actual voting results suggest the map only shifted slightly at the margins from the 2000 and 2004 elections and that our geographic voting patterns may be more durable than we think. Here is a comparison of the famous red-blue divide:

    Exit polls show that Obama received roughly two-thirds of the non-black minority vote and about 95% of the black vote. On top of that he got more than two-thirds of the 18-29 age cohort. But none of this data captures the electoral geography that drives the Electoral College results. The true shift from red to blue was actually driven by a slight shift at the margins of the divide. The tipping point was in the suburbs where middle and upper class suburbanites congregate and 49% of the electorate resides. These voters shifted to the Democratic candidate and tipped the balance in those swing states of Florida, Ohio, Iowa, Indiana, Colorado, New Mexico, Virginia and North Carolina. They found Obama more convincing on economic matters and fundamental change from the previous administration, but it would be a mistake to assume this means they embrace a radically new governing ideology.

    To examine the results more closely we can compare the demographic characteristics of counties won by Obama and McCain and also compare these to Bush and Kerry in 2004. The following maps illustrate county vote shares in shades from blue to purple to red to show how the underlying vote compares between 2004 and 2008. Not a big difference, is there?


    The following table compares the demographic profiles of 3115 counties and how they voted in the past three presidential elections. We can see that Obama captured more suburban counties outside the urban core than either Gore or Kerry. These counties not only have lower population densities but also higher incomes and more white inhabitants. So much for race.


    This conclusion is confirmed by looking only at those counties that flipped from red to blue (Bush to Obama) or blue to red (Kerry to McCain). Is this case we can see that Obama won more populous, whiter, and richer counties than McCain. Interestingly, the older, female heads-of-household gravitated slightly toward McCain.


    Finally, we can look at an important subset of metro counties, meaning those counties that border the 50 largest metro areas in the country. There are 417 of these counties and they are classified by concentric rings from the urban core outward to the exurbs.


    These data confirm where the major shift took place. Obama had gains of roughly 5-6% over Kerry’s results in suburban counties. Obama won handily in the mature suburbs where Bush and Kerry had evenly split. This is also where much of the non-black minority support for Obama resides. On the other hand, we again see a consistent monotonic relationship between party preference and population density: as we move outward from the urban core voting preferences shift from blue to purple to red. This suggests that the urban-rural split in American politics is still very much with us. This should not surprise us if these political differences are based on lifestyle preferences that do not change from election to election or candidate to candidate.

    *State and county maps courtesy of Mark Newman: http://www-personal.umich.edu/~mejn/election/2008/

    Michael Harrington is a political scientist, policy analyst and writer living in Los Angeles. He has extensively researched the red-blue divide of the past three presidential elections by focusing on county level census and voting data.

  • Election Geography

    For the past eight years our politics has been riven by the red versus blue state narrative. While the popular media cast red versus blue as a culture war rooted in the ‘60s, subsequent research shows our divisions have much to do with geography. As Obama and McCain distance themselves from partisan stereotypes, many hope the upcoming election will break this pattern, but recent primary results should give us pause. (We should note that explaining overall election results is different than explaining geographic patterns. For instance, all women voters could vote the same and since women voters are a majority of the electorate, that would explain how their candidate won. But since women are fairly evenly distributed across the population, no geographic pattern would emerge.)

    Our political geography has been deciphered by several studies by the Metropolitan Institute at Virginia Tech, political scientist James Gimpel with The Christian Science Monitor’s Patchwork Nation website, and journalist Bill Bishop in his book titled, The Big Sort. All these studies show how the basic divisions plays out among urban, rural, and suburban communities. The best way to examine this phenomenon is with census demographic data by county.

    The following table shows how presidential voting in 2000 and 2004 broke down by county characteristics. The relevant county data include population per sq. mi., median family income, share of married households, share of female heads-of-household, as well as shares of white and black households.

    Regression analysis confirms that population density and marriage status explain most of the differences in voting patterns. One might guess that race was a more significant factor, but female heads-of-household and black households were very highly correlated—at .81, where 1.0 is perfect correlation—and female heads-of-household dominated the racial factor.

    Fast forward to 2008 and this is where it gets interesting. We apply this same methodology to recent hotly contested Democratic primaries and what we discover about how different communities voted may surprise those banking on a new post-partisan geography.

    The following table displays the county profiles of three state primaries in Pennsylvania, North Carolina and Indiana compared to the national profile. Amazingly, these 259 counties offer almost a perfect demographic sample for the total set of the nation’s counties, so these three primaries taken together offer a good proxy for the national profile.

    Comparing the primary results for these three states to the election results for the same counties in 2000 and 2004, yields the following results.

    We see that the voters in these three states’ counties voted in a distinct red vs. blue pattern. Counties that voted for Obama align closely with those who voted for Gore and Kerry and those that voted for Clinton align almost perfectly with Bush. But remember, all these voters were Democrats! So partisanship has been taken out of the equation and what we’re left with is political preference based upon lifestyle, economic, and community interests.

    Regression results are a bit more mixed for these votes because of how identity groups voted. For example, black households and female heads-of-household were even more highly correlated (.9), but black women tended to vote for Obama and white women tended to vote for Clinton. In general, exit polls confirmed that urban, black and college-educated voters favored Obama while older women, suburban and rural, working class whites favored Clinton.

    Unless something else changes, the upcoming presidential campaign’s increased ideological rhetoric will likely push voters toward their communal red vs. blue comfort zones. It’s doubtful the personal strengths and campaign strategies of McCain and Obama will be enough to overcome this. Rather, campaign incentives to win at any cost will probably exploit it.

    See more of Michael Harrington’s work at Red State Blue State Movie and his blog at Purple Nation Blog.

  • Three State Primary Profile

  • Comparison of Demographic Means in Presidential Elections

  • County Demographics of Presidential Elections