Monday, December 22, 2008

Avoiding an Even Broader (Madoff) Ponzi Scheme

America's current domestic public policy shares a lot in common with Bernie Madoff's business plan: Keep growing the pyramid at the bottom to pay for the people at the top. What Madoff did was illegal. What's happening with the government's Ponzi scheme is something we've all agreed to.

In the US Government case, the top of the pyramid are older people and retirees; the bottom of the pyramid are young workers.

Any type of plan that depends on an ever growing base is completely unsustainable over the longer term. At some point, especially because of diminishing natural resources and other population-related issues, you can't grow the bottom of the pyramid enough to pay for the people at the top. With the current financial crisis, the US is building on to a huge pile of debt that will need to be paid by future generations. From an operating perspective, we've also got a hugely disproportionate share of the budget going to the elderly as compared to children and young people.

The reason everybody seems comfortable with this situation (at least, comfortable enough not to do anything about it) is that we haven't faced up to the idea that the underlying premise of continued population growth is fundamentally flawed.

What should be happening is that every generation pay for itself, through taxes that are designed to accommodate the choices a generation makes. If people want a system where you get to retire at 55, then the taxes that are collected during the 30 years between 25 and 55 should be onerous enough to care for the publicly financed programs for the 30+ years that are likely to come after. Same with health care - if people from my generation believe we should be getting knee and hip replacements into our 80s through Medicare, then our taxes now (I'm 48) better be high enough to pay for them later.

No one wants to face up to this reality so what happens is that Medicare expenses are climbing at more than 6% of a year, and are gradually squeezing out a lot of other very worthy programs that benefit people of all ages.

We also need to take a look at the estate tax in this context. Why not tax the estates of elderly people to pay for elderly-related expenses, including Medicare? This would tie the estate tax in a meaningful way to an expense that was incurred by the generation that should have built up an endowment to pay for it. Instead what happens now is that even wealthy people get their medical expenses paid at public expense (which increases the deficit - to be paid by younger generations of taxpayers), with their estates then passing down to their own very fortunate adult children and grandchildren.

In the last several decades, because our population was growing quickly, we were able to mask the problems associated with exploding elder-related expenses. Now, however, it's becoming impossible to dodge the fact that the boomer generation, as we become elderly, are going to be orders of magnitude more expensive than the generations that came before us. And we've done nothing to really prepare for that except hope that the generations coming after us will agree to pay the bills.

This blind faith in future generations might have made sense back in the days when people were routinely having five, six, or more children. (I come from a family of eight.) Now, however, for a variety of reasons the birth rate has slowed, with more and more two-children or fewer families. At the same time, the number of older people with long-lasting chronic health conditions continues to rise. This means that fewer people in their earning years are going to be supporting a much bigger number of elderly people, many of them with hugely expensive medical conditions.

The solution can't lie in encouraging people to have more children, because that just keeps the Ponzi scheme going a bit longer, and creates an even bigger problem for future generations to solve.

Creating a tax system that requires each generation to forecast its public expenses and to fund them fully while still in their earning years would change a lot of things in our society. Younger people would have more of a stake in the decisions that affect their lives, middle aged people would have to confront tough questions about whether they're saving enough, and elderly people would know that the quality of support they're getting from government is directly tied to decisions they made earlier in their lives.

Friday, December 19, 2008

Who Sets the Post-Meltdown Rules?

Hopefully, the current financial crisis will silence forever the people who say that over the long run and without intervention, the markets work and business will always do the right thing for the most people. It's flat out not true.

Business needs "rules of the road." The trust-based systems that the foes of deregulation like to cling to evolved in much smaller communities, where owners, management, workers, and customers were all vested in making sure the system worked over time. If you own and run a grocery store in a small town, your workforce and customers are going to be your neighbors and their kids are going to be attending school with and playing with your kids. Unless you want to live in isolation, you're going to work to earn their respect.

Now, the workforce is global, customers are global, and natural resources are global (though they can be exploited in ways that offer no benefit to local people who will end up paying the consequences), and ownership is so murky that -- as the Madoff case and the broader Wall St. meltdown shows -- even investors have no idea what they own or think they own.

The current financial system operates much like the childhood game of "hot potato," where investment managers are incented to move money around in ways that generate huge financial returns for themselves -- with no one ever asking hard questions unless someone gets hurt because they're holding the potato when the music stops.

Moving forward, it's critical that we figure out how to balance between rules that encourage people to act in ways that ultimately deliver the most good for society and rules that might stifle and ultimately crush innovation.

The "most good for society" is likely to come from:

- rewarding innovators for their contributions - which encourages them to keep applying their creativity to solve interesting problems
- ensuring that workers are fairly treated - which becomes ever more difficult as the standard of "what's fair" needs to encompass the fact that when jobs can be moved offshore at lower cost, they will be
- ensuring that the environment is protected
- ensuring that consumers' health, safety, and rights are protected
- ensuring that competition will be fair
- ensuring that investors have access to the information they need to make good decisions and that they suffer the consequences when they ignore or encourage behavior that violates "the rules," much as a small business owner in a small community pays the price when he or she violates the community's trust.

A difficult problem now is determining who should establish and enforce the rules of the road. With free trade, the system has gone global and there's no going back. When one country crashes, the fallout is often felt around the world. Clearly, Barack Obama is going to play an activist role. However, even his very powerful voice is just one part of a much broader system that even the "experts" don't fully understand.

We need to develop new systems and new "rules of the road" that reflect the reality of our interconnected, interdependent world, where financial resources, natural resources, and human resources are all intertwined. Greater transparency is an absolute necessity.

Governments will need to figure out new ways to step up - and work together in ways that perhaps could not have been imagined before the greed on Wall Street triggered a financial collapse in Iceland, and before melting icecaps in the Arctic became a key indicator for drought and flooding across the Southern Hemisphere.

Nongovernmental organizations and watchdog groups that can operate across borders also need to play a bigger role. Increasingly, warning bells are going to be sounded by organizations and people that operate from a global perspective, who can see local symptoms, but who understand that those symptoms and their potential solutions must work in a global context.

Thursday, December 18, 2008

When Government Needs to Cut

As governors look to trim state spending, there are always going to be critics who say there's no fat that can be found ANYWHERE. Yesterday I listened to a radio program where one of the guests said there was no reason to eliminate schools anywhere, despite shifting demographics that left some existing schools underattended and some areas without the facilities to accommodate growing school-age populations. In times of tight budgets, I don't know how you can expect to open new schools in areas where they're needed without also looking to close schools in areas where they're not.

It reminded my of my first full-time job after graduation. There was a deep recession going on, and I was fortunate to be one of the few members of my graduating class to get a job in my field - journalism. I had a great title - Publications Editor within the Agricultural Communications Department at a publicly funded university. What I realized shortly after joining the department is that my job didn't really need to be done - not by me, not by anyone. At the time, we were producing short stand-alone publications (the equivalent of a magazine article) on home economics topics. All of the writing was done by University professors.

It was decidedly low-tech and the typesetting and production was done manually in a huge building on campus. This was in the early 1980s - just after the introduction of the IBM PC.

What made my job essentially pointless was that there really wasn't an audience for most of the publications I worked on. I saw first-hand how the publications remained stacked up, unread, in that huge printing building. At the time, I was a magazine junkie, and the women's magazines at the time were full of lively articles that did a better job of communicating about most of the topics our department was supposed to be focused on.

I could believe that years, perhaps decades earlier, a department focused on home economics for farm families absolutely made sense. Extension services and communications around topics such as canning, sewing, and cooking would have been hugely valuable to farm wives, many of whom lived in isolated situations without easy access to important information. Especially in food safety areas like canning and cooking, having authoritative guides on how to do things right would have been enormously helpful and healthful.

But that was then. By the time I came along, there was not enough work to sustain my job and the work I was doing was not very useful. On too many days when I would come in, eager to work, there was literally nothing in my in-basket. Since I was part of a workflow (the publications had to be written before I could edit them), if there was nothing there, I really had no work. Furthermore, my boss was extremely uncomfortable whenever I tried to take on additional assignments because she'd had my job before getting promoted and so the fact that I didn't have enough to do likely meant she hadn't had enough to do either.

What kept it going was tradition, the desire to not give up anything in the budget process, and the need of the university professors to have an outlet for publishing. (At one point that year, I was assigned to edit a new publication on earth-sheltered housing, something that struck me as a bit odd. When I dove in a bit deeper, I found that the publication I was working had already been published by a different author in another state. It was a clear case of plagiarism which I reported at the time. There was fallout and some very quiet disciplinary action, but what really dawned on me was that the professor who did the plagiarizing didn't expect anyone to read the publication either and that's why she thought she could safely turn the piece in as her work.) When things get dysfunctional, they often get wildly dysfunctional.

I left that post after about eight months and moved on to a writing job in the high tech sector.

Wow. The worlds could not have been more different. Where my previous job was all about reaching markets that no longer existed, the new job was all about reaching markets that were growing and changing everyday. I stayed at that next job for three years, enthusiastically working long days, and learning as much I could before taking the next step to work at a growing software company in Redmond, Washington.

There are things that government absolutely can and should do. Government plays a critical role in many ways - ensuring access to quality education, setting and enforcing safety standards, protecting natural resources, protecting our national interests, and providing a safety net, to mention a few. Government can and does attract some great people - but it is also vulnerable to a bureaucratic mindset that can strangle innovation and demoralize people who want to find a better, more efficient way of doing things.

Now, with the huge budget cuts being implemented across the country, there are new opportunities for government to reexamine the ways things have been done and try to find new ways of achieving the same or even broader impact by doing them smarter or better. It's not going to be easy. But one of the things that would help is for people who believe that their pet programs should never, ever be cut is to recognize that times and situations change, and that for a lot of reasons, government needs to be more transparent, responsive and proactive about making sure each and every department and job makes sense in the broader context.

Thursday, December 11, 2008

Too Big to Fail?

Today, Republicans in the Senate seem poised to kill the auto industry bailout bill. Without more changes, I'm in agreement with them that the bill shouldn't pass.

What does it mean when a business is "too big to fail"? It seems to me that once you've decided a company is too big to fail, you've lost any chance that that company will ever innovate and be successful again.

Creating and running a successful business is tough and it's getting tougher. The fear of failure - that adrenaline-induced sense that you've got to do everything in your power to help your company succeed - is one of the things that leads to success.

For years, I've watched as the US auto companies have done everything in their power to fight against rules for higher fuel efficiency. What strikes me is that that any one of them could have seen the new standards as an opportunity for innovation yet none of them stepped up.

If the rules had been applied equally across all cars and vehicles sold in the U.S., it would have been the equivalent of a platform shift. In technology, platform shifts always create opportunities for new winners and losers. That's what had the big automakers scared. Why should they subject themselves to competition when by hiring more lobbyists they could protect the status quo?

We're also past the point where a combative relationship between workers (the unions) and management makes any sense. Successful companies today need to find ways to get everyone committed to the same goal of building an innovative, profitable business that can compete in the global economy. I don't understand how you do that when workers are guaranteed a wage and benefits that would put the company at a competitive disadvantage.

There are ways to incent workers so that they share in the success of a company. Stock options or profit sharing are two ways that companies have enlisted employees in feeling an ownership stake. As a investor, I want the people who are making the day-to-day decisions on behalf of a business to share in the company's success. Likewise, if the company is facing tough times, I want the employees to feel that pain too so that they'll work harder to curb expenses and to contribute ideas that can turn a flailing company around.

In the case of the UAW, for way too long, members have worked against the interests of the company by fighting for rules that make no economic sense. It's crazy to think that people should get paid when they're not contributing to the economic well-being of the company. The autoworkers have been so focused on "winning" whatever concessions/benefits they can from the company, and in so doing lost sight of the fact that their companies were losing the war.

The new winners in the automotive industry are going to be the innovators who work to create change. The losers are going to be the ones who are constantly looking backwards, fighting to keep things as they are.

Ultimately, I'm highly doubtful that there's anything anyone in Washington can do to change the underlying culture of businesses that believe they are too big to fail.

Wednesday, December 10, 2008

Orca Whales and Old Growth - Case Studies in Market Failures

In the Pacific Northwest, where I live, we have a long history of consuming natural resources in the name of economic development in ways that negatively impact the public good.

One of the casualties of the consumptive nature of our society is the war that was waged over old growth trees. In simple terms, the Old Growth lost.

When I was growing up in the 60s, a trip from Portland to the Coast took you through huge tracts of forestland, with towering trees. The drive always felt a little wild and dangerous, especially because of the huge number of logging trucks, carrying mammoth trees from forest to mill.

Today, that same drive takes you through suburban sprawl and tree farms, full of short slender trees, all of the same pedigree.

For a time, there were huge battles over Old Growth Trees, the centuries-old tree stands that provide enormous biodiversity. The argument for cutting the last of Old Growth went something like this: Jobs will be lost if we don't cut them down. Let's cut them down.

As a child, I couldn't understand how, if we were down to the last 5% of Old Growth Trees, there could be any sane argument for continuing the carnage. Surely, it wouldn't make a long-term difference to stop at 95% destruction instead of 100%.

To the mill owners and loggers, any suggestion that we stop short of cutting down all the Old Growth trees was an attack on their livelihood. Never mind the longer-term consequences of eliminating a natural resource that offered much greater benefits to society at large if protected.

What no one seemed to understand is that the loggers and mill owners were of course only going to look after their short-term economic interests. They weren't going to focus on what was going to happen after the Old Growth Trees were all gone because that would be a different battle - and the only battle they could focus on was the one they were engaged in every day to just keep cutting and keep the mills open.

That's the nature of capitalism here in the U.S. We have no concept of the long view and few effective ways to manage resources that will be consumed if business interests are left unchecked.

In the San Juan Islands, where I live part-time, the Southern Resident Orca Whales who frequent the islands each Spring and Summer, are in a fight for their very survival. They're starving. And yet, in some sense, the whales are subject to the same consumptive behavior that destroyed the Old Growth.

For 12 or more hours a day, the whales are chased by whale watching boats. Until recently, there were no laws preventing whale watching boats from chasing them at very close distance. You'd think that the whale watch operators would look at the whales as a resource that needs to be protected over the long term. But what actually happens is that the whale watch operators act like mill owners - it's in their economic self-interest to chase the whales, and the fact that the whales are dying doesn't change the whale watching boat owners' behavior. For a while, they claimed they could be self-regulating, but they were lying to themselves and to everyone else. As a group, the whale watch operators protected their own - not once did they ever turn in one of their own for violating the whale watching guielines. In fact, their own marketing brochures would show them with boats perched right on top of the whales even while they claimed to regulators that they voluntarily complied with guidelines that said boats shouldn't approach closer than 100 yards.

Very recently, because the Southern Resident Orcas were officially listed as an Endangered Species, new laws went into effect requiring all boats to stay more than a hundred yards away. But the laws have few teeth, and enforcement is practically nonexistent. Moreover, the damage that's already been done is likely irreversible. This year alone, almost 10% of the remaining whales died and they are slipping below the tipping point where they can replenish their population.

The whale watch operators will argue that they're not the only cause behind the demise of the Southern Residents. And they're right - toxins and and food shortages are also playing a role. But what's interesting is that in the face of almost certain extinction of the species that is critical to their livelihood, no one from the whale watching industry stepped forward to say, "The fact that we're hounding the whales may not be the ONLY threat to the whales, but because they're facing a critical tipping point, we need to be conservative and assume that the noise from our boats (which sounds like a pack of Harleys underwater) is causing the whales harm. We will voluntarily back off for a period of time to give the whales time to recover."

The only thing that could have stopped the whale watch operators' destructive behavior earlier was public pressure and regulation. But the whale watch operators were effective lobbyists and worked hard to keep any restrictions on their behavior from becoming law. Not until the regulations were in the pipeline and almost certain to be adopted did they claim to have been in support of them the whole time.

This is a clear case where capitalism failed and government couldn't keep up. The loss of the whales will cause the whale watch operators' business to disappear. The whale watch operators will sell their boats and move on to some other business. And future generations will never get a chance to see and hear the magic of the whales feeding off the shores of San Juan Island.

Tuesday, December 9, 2008

Capitalism Do Over - What's Needed Now

Capitalism needs a reboot. Too many people - many of them economists who live in an abstract, theoretical world-- think in terms of absolutes that don't reflect the realities of our increasingly interdependent world. We need a new perspective on capitalism - one that recognizes the crucial role business plays not just as an economic engine, but in all aspects of our lives. What business does, how it behaves, what rules it follows, what social norms it pays attention to has an enormous impact on our quality of life.

Capitalism needs to work better for people, for society, and for the environment. The old system - where the only role of business is to make money - is unsustainable. Why? Because business is amoral and amoral entities do not operate for the public good.

This doesn't mean people who operate businesses are amoral. Some are, some aren't. The key is understanding that there's nothing inherently good or bad about business. People who argue that business will do the right thing naturally don't understand how business works - or they do understand and they want to mislead people.

Business doesn't exist to solve social problems. It exists to make money. And if, along the way, it damages our society in ways that are catastrophic, well, it's just business. Unless reined in, business is going to kill whales, it's going to destroy fisheries, it's going to consume every last bit of old growth trees, it's going to pour toxic waste into our seas and our air, and it's going to throw people out of work.

Business needs checks and balances. It needs scrutiny. It needs watchdogs. It needs regulation. Most importantly, it needs to get better.

We're facing a crisis even bigger than is being described on the news everyday because no one has gotten their arms around the fact that government can't keep up to curb the excesses of business. The pace of change in business and society is just too fast. And yet, if we don't get better at this, if we don't find a new path, we're going to lurch from one crisis to another. Economic crises, environmental crises, social crises.

We're at a critical juncture. We have the opportunity to make things better. It's possible for business to create economic growth and create a positive return for society. It's possible for us all to incent good business behavior and punish behavior that has a negative cost to society. But in order for that to happen, we need to be clear-eyed about what is and isn't working with the current system.

Why am I writing about this?

Because I'm a businesswoman who's concerned about the lack of understanding of business among policymakers, among economists, among media, and among the general public. And also, because I believe that we can expect more from business and from the people who make business decisions everyday.

Business is a powerful driver of change in our society. It's up to us to make sure that business operates in ways that will enhance our quality of life. We need to get off the sidelines by working to create the incentives and disincentives to make business work better for all of us.