The Growth of Government - Cato Institutebook, At the Jazz Band Ball: Sixty Years on the Jazz Scene, published by the University of California Press, Hentoff has just received ...

PRESIDENT CARDOSOBrazil’s failed waron drugs

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CATOPAPERSThe Institute’s new annualresearch collection

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The Growth of Government

n late November 1972, GovernorReagan convened a small group atthe Century Plaza in Los Angeles.In his opening remarks, he observedthat conventional politics, includ-

ing the recent reelection of a Republicanpresident by a large majority, would proba-bly not be sufficient to slow the growth ofgovernment. Several other speakers sum-marized what little we knew about the rea-sons for the growth of government. My ownremarks focused on the erosion of the con-stitutional restraints on the powers of thefederal government, powers that were specif-ically enumerated in Article I, Section 8, ofthe Constitution and specifically circum-scribed by the Tenth Amendment. Gover-nor Reagan then asked us to consider thefeasibility and desirability of a constitution-al limit on the total tax and spending powerof the state.

That meeting was the genesis of the con-temporary tax-limitation movement in theUnited States, a movement whose history isnot yet complete. The group formed in LosAngeles later drafted and promoted the firstmajor proposal for a constitutional limit on

the total tax and spending power of a state,a proposal that was appropriately termed“Proposition 1.” The early record of thismovement was not encouraging. Proposi-tion 1 was defeated in California in 1973,and a similar proposal in Michigan wasdefeated in 1976. The year 1978, however,proved to be a watershed for the tax-limita-tion movement. General limits on state tax-ing authority were approved in Tennesseeand Michigan, and property taxes were sub-

stantially reduced in California and Massa-chusetts. Since that time, general tax limita-tions have been approved in an additionalhalf-dozen states, and the legislatures of 32states have called for a similar amendmentto the federal Constitution.

For state and local governments, a limi-tation on or reduction in taxes can be aneffective limit on government spendingbecause most such governments are con-

BY WILLIAM A. NISKANEN

Continued on page 6

On February 5, 1985, WILLIAM A. NISKANEN, then-acting chairman of the Council of Economic Advisers, presented President RONALD REAGAN with a T-shirt commemorating the annual Economic Report of thePresident. “We'd like to award you honorary membership in the Council of Economic Advisers,” Niskanen toldthe president, “and give you something to chop wood in back at the ranch.”

January/February 2012 Vol. XXXIV No. 1

JOHN ALLISONSpeaks at 29th Annual MonetaryConference

PAGE 17

I

William A. Niskanen, distinguished senior economist and chairman emeritus of the CatoInstitute, passed away on October 26, 2011. This article, the inaugural lecture he gave afterassuming his position at Cato in 1985, firstappeared in the July–August 1985 issue of CatoPolicy Report. It is presented here unchanged,and is still timely.

2 • Cato Policy Report January/February 2012

Editorial

BY DAVID BOAZ

“When you lay out a picnic,you get ants.And today’s federal budget is the biggestpicnic in history.

he optimistic libertarian perspective on OccupyWall Street is that the Occupiers are opposed tocrony capitalism, corporatism, and specialinterests. They see big business and big govern-

ment working hand-in-hand to bail out favored allies,and they don’t like it. And it turns out that the TeaParty dislikes the same thing. So is there potential for across-ideological alliance? Maybe. But the Occupy WallStreet fans need to redirect their protest. The center ofthe problem isn’t Wall Street; it’s Pennsylvania Avenue.

You want to stop crony capitalism, bailouts, andfinancial crises? Occupy Pennsylvania Avenue anddemand a drastic reduction in size, scope, and powerof the federal government. That’s what the specialinterests feed on. That’s where the tax money getschanneled to favored constituencies. That’s what gaveus the housing bubble and the Solyndra boondoggle.

Put the government in charge of handing outmoney, we’re told, and the decisions will be made byhighly trained, public-spirited economists or lawyers,irrespective of political considerations.

But the reality is that people are people. Govern-ment employees are just as self-interested as corporateemployees. And therefore they are susceptible to politi-cal influence, persuasion by interested parties, outrightbribes, and personal preferences.

The libertarian argument for keeping more of soci-ety in the private sector is not that there’s no self-inter-est or corruption in business; it is that the market sys-tem has more competition, more checks and balances,and more incentives to satisfy customers. You canmake money in the private sector by cutting costs; gov-ernment agencies that cut costs find their appropria-tions reduced. Businesses must constantly search forbetter ways to deliver goods and services lest customersmove to their competitors. Government agencies areusually monopolies that forbid competition. With noowners seeking a profit on their investment, no finan-cial reward for doing a good job, no penalty for wast-ing money, government employees have little incentiveto deliver goods and services efficiently.

As Adam Smith suggested with his “invisible hand”metaphor, the competitive market system channelsself-interest in a socially beneficial way—into the searchfor ways to attract customers—while the non-marketsystem actually encourages pure self-interest.

And one aspect of that is lobbying. Big governmentmeans big lobbying. When you lay out a picnic, you getants. And today’s federal budget is the biggest picnic inhistory.

Lobbyists love spending bills. They also love a com-plicated tax system with myriad rates and exemptions.And they especially love complex regulations, whichgenerate demand for consultants who can navigate

the regulatory agencies. Just look at some of the lob-bying stories from 2011: “Desperate to Stop AT&T [inWashington, not in the hearts and minds of con-sumers], Sprint Doubles Lobbying Spend.” “Google,facing an antitrust probe by federal authorities, boost-ed its lobbying expenditures.” “Goldman Sachs flexesits lobbying muscle.”

As Craig Holman of Public Citizen, an organizationfounded by Ralph Nader, told Marketplace Radio aftera report on rising lobbying expenditures during thefinancial crisis, “the amount spent on lobbying . . . isrelated entirely to how much the federal governmentintervenes in the private economy.”

Marketplace’s Ronni Radbill noted then, “In otherwords, the more active the government, the more theprivate sector will spend to have its say. . . .With theWhite House injecting billions of dollars into the econ-omy [in early 2009], lobbyists say interest groups arepaying a lot more attention to Washington than theyhave in a very long time.”

Of course, this is not a new story. As I pointed outin theWall Street Journal in 1983:

If more money can be made by investing inWashington than by drilling another oil well,money will be spent there.

Nobel laureate F. A. Hayek explained theprocess 40 years ago in his prophetic book TheRoad to Serfdom: “As the coercive power of thestate will alone decide who is to have what, theonly power worth having will be a share in theexercise of this directing power.”

Lobbying is one of the costs—not the worst cost, butcertainly a galling one—of a government that is “gener-ous and compassionate,” based on “a progressive visionof our society”; a government that “helps families findjobs at a decent wage, care they can afford, a retirementthat is dignified”; a government that “directs help tothe inspired and the effective,” that will “restore thesecurity of working families” (as leading Democratshave said in various speeches).

If that’s the government you want, then lobbying isan inevitable adjunct. Let’s not forget that analysis fromCraig Holman: “the amount spent on lobbying . . . is relatedentirely to how much the federal government intervenes in theprivate economy.”

If the Occupiers—and the rest of us—want lesscrony capitalism, we have to reduce the power of thefederal government to hand out money, impose tariffsand regulations, and otherwise pick and choosefavored businesses.

”

TOccupy Pennsylvania Avenue

THE LAW OF THE LAND“Forget about BlackBerrys and American-flag lapel pins. The hottest accessory onCapitol Hill is the pocket-sized copy of theConstitution,” Roll Call declared last year.This handsome publication has long beenthe Cato Institute’s most popular, withmore than 5 million copies distributed to date.But the reach of this “diminutive docu-

ment” extends far beyond the halls ofCongress. “Aside from the millions of

copies of the Constitution it has distributed,” they continue, “thethink tank has also printed 12,000 copies of a Spanish translationof the Constitution and 8,000 copies of an Arabic translation.”

JOHN MUELLER JOINS CATOJohn Mueller, a leading scholar in the fields of political science,international relations, and national security, has joined the CatoInstitute as a senior fellow. As the Woody Hayes Chair of NationalSecurity Studies at Ohio State University, Mueller has focused in particular on how policymakers inflate national security threats at home and abroad. “John has taken on the conventional wisdom in the national

security arena with a rare combination of accessible, breezy proseand meticulous cost-benefit analysis,” said Christopher A. Preble,vice president of defense and foreign policy studies at the CatoInstitute.His newest book, Terror, Security, and Money—which he present-

ed at a recent Cato forum with coauthor Mark G. Stewart—exam-ines whether the gains in security over the past decade were worththe funds expended. At the Institute, Mueller will continue his workon the subjects of security, defense, and U.S. foreign policy.

HENTOFF AND ALL THAT JAZZCato senior fellow Nat Hentoff is best known in the policy world as one of the leading defenders of the First Amendmentand civil liberties. But he also has a longcareer as a writer about jazz. For his latestbook, At the Jazz Band Ball: Sixty Years onthe Jazz Scene, published by the University of California Press, Hentoff has just received

the Deems Taylor Award from the American Society of Composers,Authors and Publishers (ASCAP). As it happens, Deems Taylor was the father of Joan Kennedy Taylor, author of the Cato bookReclaiming the Mainstream: Individualist Feminism Rediscovered.Hentoff and Joan Kennedy Taylor were both commentators on theCato Institute’s Byline radio series in the 1980s.

January/February 2012 Cato Policy Report • 3

Cato News Notes

The larger purpose of higher education is to broaden both theminds and the skills of students. But with college stickerprices reaching new stratospheric highs, the questionremains: Is the Ivory Tower achieving these goals?

At a Cato Institute Conference held in November, a number ofnational experts gathered to examine how well our higher educationsystem is working. One key topic that emerged was how to assess theproductivity of faculty members, including the groundbreaking—and highly controversial—efforts recently undertaken in Texas.

Richard Vedder, founder of theCenter for College Affordability andProductivity, and author of aprovocative report that uncoversastounding levels of inefficiency atthe University of Texas (UT), defend-ed his analysis. He responded to vari-ous criticisms of his data, noting thatthey “had a very modest, almost noeffect, on the conclusions.” Vedderemphasized that the purpose of thereport was to bring productivity intothe higher education debate, not to disparage UT or other postsec-ondary institutions.

Neal McCluskey, associate director of the Cato Institute’s Centerfor Educational Freedom, focused on a somewhat different aspectof the debate. “While I think measuring faculty output is probably agood thing, it will never be allowed to carry meaningful conse-quences if most funding for education comes from third parties,”he said. The burden of financing postsecondary education,McCluskey noted, “has grown ever heavier” on the backs of taxpay-ing citizens. “We need to change that before we can expect anythingelse to really improve,” he said.

In his keynote address, Stephen Joel Trachtenberg, presidentemeritus of George Washington University, presented his vision formaking postsecondary institutions more accountable. As it stands,he argued, colleges are beholden to an array of external influences—noting, for example, that “the most influential person in higher edu-cation” is likely Robert Morse, director of data and research for U.S.News & World Report. “To an unsound degree,” Trachtenberg said,“universities too often allow themselves to be pushed around by therankings.” He concluded with his “modest proposals” for reformingthe system, which included lowering the number of administrativestaff by 20 percent and increasing faculty productivity.

In the end, the conference sparked thought-provoking—andsometimes heated—discussions, and ultimately brought innovativepolicy proposals to the table. “They were an attempt to bring a moreresults-oriented, student-friendly focus to education,” entrepreneurJeff Sandefer said of his reforms, known as the Seven Solutions.“Now, they’ve gotten a life of their own.”

What are we getting from higher education?

Squeezing the Ivory Tower

Stephen Joel Trachtenberg


Even then, however, Bill possessed theseeds of a healthy skepticism. One weekbefore Watergate, he left OMB with a sourtaste in his mouth. “As a group, we made anawful botch of things as party to a rapidgrowth of domestic spending and regula-tion and the implementation of compre-hensive wage and price controls.”

But I’m getting ahead of myself. To trulyunderstand Bill and his work, we must take a deeper look at his foundation, workhabits, and style.

Bill’s foundation was laid by MiltonFriedman at the University of Chicago inthe late 1950s. Friedman was riding high

at the time, and he was known for eschew-ing the fads—the frilly and esoteric tech-niques. He stuck to what was fundamental,simple, robust, and applicable—and it wasthis approach that left an indelible mark on Bill.

“Conjecture and refutation” becameBill’s methodological lodestar. After all, ifyou entered the fray by asserting that yourpolicy prescriptions were theoreticallytrue—yet untestable—how could you everhope to resolve any differences? He soughtto convince people with evidence, not toconvert them to a value system. He consis-tently projected an air of tolerance, a will-

ingness to debate, and a firm belief thatconsensus was possible.

Bill’s work habits were as important to hiscareer as was his Chicago training. The mas-ter craftsman went to his workshop at pre-cisely the same time each day—I could set mywatch to the first bang of his pipe in the ash-tray—and once he arrived, he worked. Bill wasa man of habit and rhythm, one of the secretsbehind his enormous output.

Bill began each day with a careful readingof newspapers—a rare talent in and of itself—and he was always in the watchtower fromthat point on. His persistence made me thinkof James Madison—the only Founding Fatherto attend every hour of the ConstitutionalConvention. Bill’s work style was that of aduck serenely gliding across a pond; below thesurface, two feet were churning away at a fero-cious pace. “Roll up your sleeves and do ityourself” was one of Bill’s mantras.

Style usually reveals a great deal about aman, and that was true in Bill’s case. He iden-tified his management technique in the mid-1960s, as director of economic and political

William A. Niskanen i n m e m o r i a m | b y s t e v e h . h a n k e

n late October, Bill Niskanen met his Maker. Cato lost its chairman emer-

itus and distinguished scholar. I lost a friend and collaborator of 40 years.

I first met Bill in 1971, when he was the assistant director for evalua-

tion at the Office of Management and Budget (OMB). At the time, we both

had the same type of nuts-and-bolts experience. Our mindsets were techno-

cratic—with an optimism about the possibilities for making the government

“efficient” bordering on naïveté.

I


studies at the Institute for Defense Analyses:“I quickly discovered that the secret of beinga good research manager is to hire brightpeople and give them only the most generalguidance.” Bill liked to lead by example, andthat’s what he did.

Bill was laid back. Butwhen he struck, the punchwas lightning fast and on tar-get. In the mid-1970s, whenBill was director of econom-ics at Ford Motor Company,Ford decided that its salva-tion would be the impositionof government restrictionson Japanese auto imports. Bill thought other-wise, and said so with perhaps the cleareststatement on the immorality of corporatewelfare ever written: “A common commit-ment to refrain from special favors serves thesame economic function as a common com-mitment to refrain from stealing.” For this,Bill was sacked—which, of course, didn’t sur-prise him. In fact, he mentioned to me that it was the source of untold nonpecuniary

benefits. Bill loved adhering to principles.Bill arrived at Cato in April 1985, and he

had never found a more perfect match. Hehad always embraced Cato’s commitment toindividual liberty, free markets, limited gov-

ernment, and peace. Butover time Bill had evolvedfrom a technocrat and a pol-icy analyst—skills that henever abandoned—to a poli-tical economist of interna-tional regard. And he wasfinally home.

Bill Niskanen had per-sonality and character. To

the outside world, he perhaps seemed shyand stiff—but he was a learned and thought-ful man, at ease with friends and devoted to his family. Bill Niskanen was a man of liberty—one who was worth knowing. He is missed. n

STEVE H. HANKE is professor of applied economics atthe Johns Hopkins University and a senior fellow at theCato Institute.

Above: At a Cato reception in 1985, Niskanen chats with Sen. Steve Symms (R-ID), ICC Commis-sioner Fred Andre, and Dudley Schadeberg. Below: Niskanen with Alan Greenspan at a celebra-tion of his 70th birthday. A tribute in the F. A. Hayek Auditorium included Nobel laureate JamesM. Buchanan and other distinguished speakers.

The most honest man in D.C.

“ “

—LAWRENCE H. SUMMERS

Bill was the first per-son to ever challengeme on our church’sprayers. This summerwe offered prayers forour elected officials,which we always do,but used a different setof prayers: we prayedthat they may use theirpower and authority to ensure that peopleeverywhere have every-thing they need. Bill stopped me afterthe service and asked if perhaps we were expecting too muchfrom our elected offi-cials if we thought thatit was their responsibil-ity to ensure that every-one have everythingthey need. After all,there was God, and a whole world full ofpeople, to spread thatresponsibility around.

I edited the prayers.

““

—REV. CARA SPACCARELLI,RECTOR, CHRIST CHURCHOFCAPITOLHILL, FUNERAL HOMILY


strained to have a balanced budget on theiroperating accounts. For the federal gov-ernment, however, tax limitation is notsufficient to constrain spending becausethe federal government has, effectively,unlimited authority to borrow. An effec-tive restraint on federal spending, thus,must constrain both taxing authority andborrowing authority.

A proposed amendment to the federalConstitution that would change the votingrules on tax and borrowing authority wasapproved by more than two-thirds of theSenate and by more than a majority of theHouse in 1982 and is being considered inthe Senate again this year. For those of uswho are concerned about the long-termgrowth of the federal government, approvalof this proposed amendment should be thehighest priority.

HOW GOVERNMENT GROWSThe election and reelection of President

Reagan, however, have somewhat defusedthe pressure for more general restraints onthe powers of government, based on a plau-sible belief that the election of the most con-servative president in our lifetime would besufficient to slow the growth of govern-ment. Governor Reagan knew better; real(inflation-adjusted) state spending in Cali-fornia grew more rapidly during his terms asgovernor than during any other equivalentperiod. President Reagan should know bet-ter; real federal spending increased about asrapidly during his first term as president asduring the Carter administration.

Moreover, there is no general evidencethat the growth of government spendingdepends on the party in office. An examina-tion of federal spending during the yearssince World War II, based on some researchthat I completed early this winter, indicatesthe following.

First, real defense spending increasedmore rapidly under Democratic presidents,real domestic spending increased more rap-idly under Republican presidents, but therewas no significant difference in the growthof real total federal spending from one partyto another during this period.

Second, the composition of the growthof federal spending under President Reaganwas significantly different from that underother Republican presidents but was notsignificantly different from that under allthe postwar presidents taken as a group.

Third, the amount and composition ofthe federal spending share of the gross nation-al product can be explained almost entirelyby three conditions: the level of real per capi-ta GNP, the number of U.S. armed forcesoverseas, and the unemployment rate. Con-trolling for these conditions, federal spend-ing was independent of the party of the pres-ident, the party that controlled the House,and the party that controlled the Senate.

A fourth observation bears on two com-peting hypotheses of the relation betweenfederal spending and federal taxes. One view,shared by Milton Friedman and RonaldReagan, is that reducing taxes will reducespending. The contrary view, shared by JamesBuchanan and Herbert Stein, is that reducedtaxes will increase spending by reducing theperceived price of government services. Overthe postwar years, controlling for the threeconditions mentioned earlier, federal spend-ing appears to have been independent offederal tax receipts. In other words, a reduc-tion in federal tax receipts, for a given level ofGNP, increases the deficit by a roughly equalamount.

One interpretation of this evidence isthat our political system is working quitewell, responding to a change of preferences

represented by both parties but independ-ent of the governing party. Another inter-pretation is that our political system is notworking very well, due to common biases inthe behavior of elected officials of both par-ties. For the moment, the available empiricaltests are not sufficient to choose betweenthese contrary perspectives. My own per-spective is that our political system does notserve us very well, a view that has been strong-ly shaped by my own government experi-ence and by the developing contributions ofthe public-choice scholars.

The major biases in our political systemare now more broadly perceived. Most peo-ple have little incentive to invest in informa-tion about government or, for that matter,to vote. Concentrated interests have moreincentive to invest in political activity thanthe broader community of consumers andtaxpayers. The regional basis for representa-tion in Congress elevates regional concernsrelative to more broadly shared nationalconcerns. Elected officials have an unusuallyshort time horizon, given their limited termsof office and the erosion of party control.The incentives of bureaucrats are not consis-tent with either the efficient supply of government services or the optimal level of these services. The elected officials andbureaucrats who set the agenda for subse-quent decisions have unusual power overthe outcomes of these decisions.

These major biases, however, have beeninherent in our political system since thedawn of our republic, and they do not explainwhy the federal share of GNP has increasedfrom 2.5 percent in 1929 to 25 percent in1985. What does explain it is the erosion ofthe constraints on the powers of the federalgovernment, a change in our effective con-stitution without any change in our formalconstitution. This change is the most impor-tant political development in our lifetime.

THE EROSION OF CONSTITUTIONALCONSTRAINTS

James Madison, the primary architect ofthe Constitution, described the powers ofthe federal government in the Federalist No.45 as “few and defined. . .to be exercisedprincipally on external objects, as war, peace,

“The erosion of the constraints on the powers of the federal government, a change in our effec-tive constitution with-out any change in ourformal constitution, isthe most importantpolitical development

in our lifetime.”

Continued from page 1

negotiation, and foreign commerce.” ThomasJefferson, in his first inaugural address,described the powers of the federal govern-ment as limited to “the external and mutu-al relations only of these states.” In 1936,however, the Supreme Court ruled in UnitedStates v. Butler that “the power of Congressto authorize appropriations of public mon-ey for public purposes is not limited bydirect grants of legislative power found inthe Constitution.” The Court, apparently,paid no attention to Madison’s defense ofthe proposed Constitution in the FederalistNo. 41, where he argued that “the idea of anenumeration of particulars which neitherexplain nor qualify the general meaning,and can have no other effect than to con-fuse or to mislead, is an absurdity.” After hisretirement as president, Madison wrotethat the General Welfare clause slipped intothe Constitution as a consequence of “inat-tention to phraseology occasioned doubt-less by its identity with the harmless charac-ter attributed to it in [the Articles of Con-federation] from which it was borrowed.”My own reflections on this issue, summa-rized in an article in 1975, concluded that“at the present time, the enumerated func-tions do not even command lip service. TheU.S. Constitution, in terms of its effective-ness in constraining the functions of thefederal government, is a dead letter.”

Moreover, no coherent theory of the statehas been substituted for the formal consti-tutional restraints. During the 1950s, econ-omists developed a theory of the state, describedas “welfare economics,” based on the provi-sion of public goods and the correction ofexternalities in market transactions. Thistheory—formulated by Arrow, Bator, Bau-mol, Samuelson, and others—provides a sat-isfactory framework for the role of the state,but only if government officials are all-know-ing saints. Welfare economics overlookedthe fundamental insight of our constitu-tional founders: that government should beso structured that the behavior of govern-ment officials in pursuit of their privateinterests also serves the public interest.

In any case, welfare economics did notprovide any effective restraints on the devel-oping functions of government. Many gov-

ernment activities are not public goods.Many government activities create addi-tional externalities. Much of the activity ofthe modern state, like that of imperial Rome,consists of providing various forms of breadand circuses, goods and services that areadequately supplied by the market.

THE ROLE OF THE CATO INSTITUTEFor some of you, this may be your first

exposure to the Cato Institute. What can asmall nonpartisan policy institute, operat-ing in a city fascinated with power, do toaddress these issues? The role of Cato, likethat of similar institutes, is based on thepremise that changes in government policyshould be based on informed consent. Inpursuit of that role, we document the effectsof a wide range of government activitiesand develop alternatives that will betterserve the interests of a free community.Most important, we try to shape the per-spective by which people address policyissues. Does a specific policy increase per-sonal choice? Does it reflect the consent ofthose affected? Does it respect the consider-able diversity of the American community?

As with other institutes, we bring a num-ber of analytic perspectives to bear on theseissues. Some of our resident and adjunctscholars have been influenced especially bythe Austrian economic tradition, best repre-sented in the writings of Mises and Hayek.Others have been more influenced by theneo-classical tradition or the developing

field of public choice.We differ from many other institutes

primarily in our political values. These val-ues have been characterized as “radical con-servative” by the liberal press, as “anarchist”by the conservative press, and sometimes as“libertarian.” I am personally uncomfort-able with any of these labels. We share thevalues of Locke, Smith, and Mill—peoplewho were known as Whigs and, later, as Lib-erals in British political thought. We sharethe values of Jefferson and Madison, theauthors of the leading charters of Americanliberty, people who called themselves bothRepublicans and Democrats. We will differfrom the dominant political traditions pri-marily when they try to use the powers ofthe state to impose their particular valueson the larger community. We will opposecontemporary liberals when they fail to dis-tinguish between a virtue and a require-ment. We will oppose contemporary con-servatives when they fail to distinguishbetween a sin and a crime.

This perspective—libertarian, if you wish—reflects a shared set of political values amongpeople who may have widely different per-sonal values or religious beliefs, a perspec-tive, I contend, that was and is the essence ofthe original and continuing American revo-lution. The terms that are used to describethis perspective are not important. We askyou to read our publications. We will valueany contribution you can make to our fund-ing. Spell our name correctly, and call uswhat you will.

Governor Reagan was prescient in rec-ognizing that the reelection of a Republi-can president by a large majority wouldnot be sufficient to slow the growth ofgovernment. That is still the case. Presi-dent Reagan will earn our support whenthe actions of his administration are con-sistent with his long-held convictions. Hewill deserve our opposition when they arenot. The cause of liberty is not especiallydependent on which party or person iselected to political office. It is more depend-ent on the views shared by both parties onthe importance of limiting the role of thestate to those activities that serve the com-mon defense and the general welfare. n

“We will oppose contemporary

liberals when they fail to distinguish

between a virtue and a requirement. We will oppose contem-porary conservativeswhen they fail to

distinguish between a sin and a crime.”



REP. RON PAUL (R-TX): I’ve thought about theFederal Reserve for a long time now. Ibecame fascinated with the monetary issuein the 1960s—having come across Ludwigvon Mises and F. A. Hayek—and was veryimpressed when their predictions cametrue a decade later on August 15, 1971. I’vealways worked under the assumption thatthe regime that replaced the BrettonWoods system would be much worse. Well,the handwriting is on the wall.

We are currently dealing with a mone-tary system that is not viable—one that islittle more than a deception. It’s sort of likea drug—you get some benefits if you keepusing it—you run up and monetize debt,run up inflation, and make a bigger bub-ble. But when the drug is taken away, youhave to go through withdrawal. Ultimately,continuing to expand the Fed’s balancesheet risks killing the patient—which inthis case is the worldwide economy.

Confidence in the dollar is plummeting,confidence in the euro has been shatteredby the European bond crisis, and belea-guered consumers and investors are slowlybut surely awakening to the fact that gov-ernment-issued currencies do not holdtheir value. The Federal Reserve is a facilita-tor of the current state of affairs—provid-ing us with temporary benefits that arevery detrimental in the long-term.

Politicians continue to fiddle aroundthe edges as the country burns. We need todecide on the appropriate path forward,rather than continuing to paper over ourmonetary problems. I believe in a shortperiod of time we will be forced into mak-

ing those decisions.I have supported a balanced approach

to the Federal Reserve, even as far back asthe 1980s Gold Commission. You can’tclose the Fed down in one day. Rather, I’dstart by denationalizing money, taking thetaxes off of silver and gold, legalizing com-

petition in currencies, and allowing the freemarket to work in banking. This to me isthe most important step we can take. But,at a higher level, we as a people ought to beasking a larger question: What role shouldgovernment play in our society? Ultimately,if we defend the Constitution, restore theprinciples of liberty, and allow free marketsto work, we would go a long way towardsanswering these fundamental issues.

BENN STEIL, Council on Foreign Relations:The financial crisis that began unfurling in2008 has placed central banks at the fore-front of the rescue and recovery effort. It isa fundamental postulate of today’s domi-nant paradigm of Keynesian macroeco-nomics that all demand is created equal.Government spending is interchangeablewith consumer spending, the logic goes—and this is itself interchangeable with busi-ness investment. I’d like to offer an analogyin response.

Imagine you get into the shower, turnon the water, and nothing comes out. Youcall the plumber. He tells you there’s a holein the pipes, and that it will cost you athousand dollars to repair it. You tell himjust to turn up the water pressure instead.

Sound sensible? Well, this is the logicbehind the Fed’s strategy of flooding themoney pipes until credit starts flowingfreely again from banks to businesses. Youwouldn’t expect this to work in your show-er, and there’s little reason to expect it towork in the commercial lending market.

The credit transmission mechanism inthe United States has been seriously dam-aged since 2007. There is a hole in the pipes.Small- and medium-sized businesses inthis country are dependent on small- andmedium-sized banks for access to vitalcredit, yet too many of these banks remainthe walking dead—they are unable to lendbecause their balance sheets are litteredwith bad commercial and real-estate loansmade during the boom years. Whereas theFed has driven its short-term lending ratedown to zero, most banks will only lend onvastly greater collateral and at much higher

P O L I C Y F O R U M

Monetary Reform in the Wake of Crisis

Over the past few years, the Federal Reserve has acquired an increas-ingly powerful position in both the U.S. and global economies, rais-ing many critical questions. What is the best way to reform the glob-

al fiat money system? What monetary policies are needed to create a “free bank-ing” regime? What are the limits of those policies? At the 29th Annual MonetaryConference, an all-day event held on November 16 in Washington, D.C., expertsweighed in on these questions with their prescriptions for fundamental reform.Panelists offering various perspectives ranged from Austrian economists to thepresident of the World Bank.

Rep. Ron Paul (R-TX)

“I’d start by denationalizingmoney, taking thetaxes off silver andgold, legalizing com-petition in currencies,and allowing the free market to work

in banking.”


real interest rates than before the bust. Sothe Fed plows on with the cheap and easymacroeconomic option: flood the pipesand see what comes out.

We’ve already seen the liquidity intendedto boost domestic bank lending instead spillout through the cracks into markets asdiverse as agricultural commodities, metals,and poor country debt. Those bubbles willburst, as they always do, but more will doubt-less be created through the tried and trou-bled methods of modern central banking.

ALLAN H. MELTZER, Carnegie Mellon University:Over-response to short-run events and neg-lect of longer-term consequences of itsactions is one of the main errors that theFederal Reserve makes repeatedly. The cur-rent recession offers many examples ofactions that some characterize as bold andinnovative. I regard many of these actions asinappropriate for an allegedly independentcentral bank because they involve creditallocation, fill the Fed’s portfolio with anunprecedented volume of long-term assets,evade or neglect the dual mandate, and dis-tort the credit markets.

Purchasing more than $1 trillion oflong-term mortgages is credit allocation.How can the mortgage-related securities besold later when inflation rises, while thehousing market remains troubled? The Fedhas no plan. Selling Treasury securities tofinance mortgage or other purchases is afiscal operation. Money doesn’t change,and the purchase reduces the interest pay-ment made to the Treasury. Selling two-year Treasuries to finance purchases oflonger-term bonds also doesn’t changereserves or money. It is debt managementand should be left to the Treasury.

Bailing out Bear Stearns and accepting$30 billion of low-quality assets in March2008 is high on the list of mistaken actionsin this recession. That reminded financialmarkets that “too big to fail” (TBTF) notonly remained part of operating policy, butthat the policy now included non-banksand medium-sized financial firms. Thebailout policy kept in place, and evenextended support for, banks and othersthat earned high returns on risky assets butshifted many of the losses to taxpayers.

Without warning, the Fed and theTreasury changed TBTF policy in October,allowing Lehman Brothers to fail. That pol-icy did not continue. Days later, the Fedbailed out American International Groupby investing $180 billion in the failing com-pany. These shifts in policy greatly increaseduncertainty about what would happennext. Financial firms and others respondedby greatly increasing the demand for cash.The Fed responded appropriately by actingas lender of last resort to financial marketsat home and abroad by increasing the sup-ply of cash assets.

What occurred next is a model of what awell-run central bank should not do. TheFed explained that the increase in cash assetswas almost entirely short-term assets. Thesewould decline over time and would be with-drawn. That didn’t happen. The Fedreplaced the short-term assets with longer-

term assets and undertook credit allocationto stimulate the housing market by buyingmortgage-related securities. It explainedthat these holdings would decline over timeas borrowers paid interest and some princi-pal. Again, that didn’t happen. The Fed pur-chased long-dated Treasury securities to pre-vent its balance sheet from shrinking.

The most recent Fed action is theattempt to “twist the yield curve” by buyinglong-term debt and selling short-term.Reserves and money do not change. This isnot a monetary action. The Fed is againengaging in debt management or credit-market policy that is the province of theTreasury. The Fed responded again to thefinancial-market soothsayers who warnedof another recession. We know that waswildly wrong. The preliminary estimate ofthird quarter growth is 2.5 percent, dou-ble the second quarter rate. Of course, inadvance of the Fed’s announcement, themarket again lowered bond yields, sosome nimble speculators gained. Howdoes that help the economy or the unem-ployed? It is a mistake that the currentFed keeps making.

LAWRENCE H. WHITE, George Mason University:Suppose for the sake of argument that weall agree to the following proposition: If wecould change the monetary regime merelyby snapping our fingers, we would preferthe United States to be on a standard dif-ferent from the present fiat dollar. To bespecific, let’s suppose that we would preferto be on a gold standard—a system inwhich gold defines the unit of account andserves as the ultimate medium of redemp-tion. Currency notes, checks, and electron-ic funds transfers are all denominated ingold and are redeemable claims to gold.How do we get there from here? Whatwould be the most cost-effective way forthe United States to make the transition tothis new standard?

Two paths suggest themselves. One pathis to let a parallel gold standard grow upalongside the current fiat dollar. The moreconventional path—as followed after thesuspension of the gold standard during theCivil War—is to set a date after which thedollar would be defined as so many grams of

Allan H. Meltzer

“Over-response to short-run eventsand neglect of longer-term consequences of its actions is one of the main errors that the FederalReserve makes repeatedly.

”


pure gold. Today that implies converting theFederal Reserve System’s dollar liabilitiesinto gold-redeemable claims.

In the first scenario, the fiat dollar wouldlose little market share to gold so long as theFederal Reserve keeps its inflation rate low.However, the benefit from using gold-denominated money in a fiat dollar econo-my increases with the dollar’s inflation rateand its uncertainty. Should the U.S. inflationrate return to double digits, consumerswould find it very helpful to have an alterna-tive currency network available. Potentialcompetition might even help incentivize theFed to keep inflation low.

As such, if an uncoordinated piecemealswitchover to a superior standard wouldnot occur except during a painful period ofhigh inflation, there is a strong case foravoiding that pain through a coordinatedswitchover.

Establishing a new gold definition forthe U.S. dollar would require two steps.First, withdraw most of the $1.6 trillion innon-required reserves that banks have accu-mulated since September 2009. This wouldbe achieved by eliminating interest onreserves and selling the mortgage-backedsecurities that the Fed acquired in QE1, plusenough Treasuries to bring total bankreserves down to the current value of theU.S. government gold stock. Second,redeem Federal Reserve liabilities with theU.S. government’s gold at the then-currentmarket price.

Because the nation’s stock of moneybecomes endogenous, no monetary policy isneeded under a gold standard. Retaining acentral bank committee to “manage” thegold standard undermines its automaticoperation and thus does more harm thangood. A central bank inevitably faces politi-cal pressures to pursue monetary policiesinconsistent with redemption for gold at afixed rate, can endanger or suspend redemp-tion with legal impunity, and faces no com-petitive pressure to maintain its reputation.

Going back to the gold standard by re-establishing a dollar-gold parity requirestoday what it has always required: first, asufficient real gold stock, which the U.S.government has on hand; and second, thepolitical will to do so. Developing a parallel

gold standard, using present-day technolo-gies for money transfer, is probably easiertoday than it has ever been.

GERALD P. O’DRISCOLL, JR., Cato Institute: Idon’t know what is politically possible, nordo most economists. There is nothing in thetraining of economists that provides thatexpertise. I do know that economic freedomand political freedom are systematically

related. To maintain the classical liberalorder requires the monetary arrangementscongruent with that order. That system isthe classical gold standard.

There are many moving parts in mone-tary reform. Ultimately, as many thinkers inthe 1930s realized, monetary reform requiresreform of the banking and financial system.But my argument is that monetary reformcomes first. The classical gold standard has

worked with a variety of different bankingsystems—though not equally well.

In Britain, the gold standard operatedwith a central bank. The Bank of Englandwas founded in 1694 and the gold stan-dard adopted only much later. The Bank ofEngland dominated the system. Therewere many commercial banks in bothEngland and Scotland, some of them sub-stantial in size.

The United States adopted gold in the1870s, but had no central bank until 1913.The banking system was highly fragmentedwith numerous small institutions. Branchingwas highly constrained if not forbidden.Nationally chartered banks issued notes.

In Canada, there emerged a system of asmall number of nationally branchedbanks with some other financial institu-tions (such as trust companies). The banksissued the currency and there was no cen-tral bank until 1934.

My argument is not that the structure ofthe banking system does not matter. Quitethe opposite. But adoption of the gold stan-dard is a key for restoring monetary disci-pline and a free monetary order. Restoring acommodity standard is a necessary, but nota sufficient, condition for monetary reform.

The argument for gold is not that it is aperfect monetary system. There is no suchthing. The most basic argument for a com-modity standard is a public choice one: itconstrains the ability of the fiscal authorityto spend. If there is a central bank, it preventsthe kind of wholesale monetization of gov-ernment debt that is now occurring in devel-oped countries.

A few intellectual efforts have been madetoward restoration of the gold standard. It isunlikely to come about through internation-al agreement, but it did not do so in the 19thcentury, either. Britain’s adoption was astrong impetus to its gradual adoption bycountries that saw it in their self-interest todo so. It emerged as a global monetary sys-tem in an unplanned fashion.

Simply put, the restoration of the goldcommodity standard must be on the agendafor those wanting to restore a classical liberalorder. Doing so undoubtedly requires great-ly downsizing government—which, ofcourse, is its own imperative. By constraining

P O L I C Y F O R U M

Robert Zoellick

“In observing mar-kets over the past several decades, I’venoticed that the priceof gold has started to reflect some lack of confidence in

national policies andcentral bankers.”


central banks, a gold standard would helplimit the growth of government. It wouldalso open up the possibility of a movetoward some form of free banking.

ROBERT ZOELLICK, JR., World Bank: By andlarge, it’s important for countries to haveflexible exchange rates independent of cen-tral banks. As developed economies withsophisticated financial systems, the Groupof 7 (G-7) countries should have a normsaying that you’ll allow the exchange ratesto adjust—but with an exception. If a situa-tion occurs in which one country is out ofsync, the G-7 would agree on some poten-tial form of intervention.

With respect to emerging markets, theidea is that over time you want to move thesecountries towards flexible exchange ratesindependent of central banks as well. But

you need to recognize that some of them arenot quite ready yet.

I personally believe that the dollar willremain the principal reserve currency. But asthe dollar loses some of its dominance in theface of economic reality, you could move to amultiple reserve currency system—though alot of this depends on what happens withthe euro in the future. Over time, if Chinamoves to an open capital account, I think theyuan can play a role; and also the yen and thepound at a certain point.

How would countries manage such a sys-tem? My view is that the IMF could serve asa referee. It would be able to blow a whistle,but it wouldn’t necessarily have a penalty toimpose. In effect, they would at the very leastbe able to try to prod countries into recog-nizing the risks of certain policy actions.

In observing markets over the past sever-

al decades, I’ve noticed that the price of goldhas started to reflect some lack of confi-dence in national policies and centralbankers. I do not mean to suggest a goldstandard—in reality, I’m talking about flex-ible exchange rates. Therefore, I believe thatgold should be used as an indicator, aninformation tool. It shouldn’t be consid-ered a formal anchor, but as a way of beinga check on the checkers.

Obviously, scholars have long pointed tothe problems with the gold standard duringthe Great Depression. But sometimes theythen overreact against the idea that goldcould ever play a role. I’m being very prag-matic. What has my experience taught me?Sometimes scholars become captives to theirown past analysis. They get so wedded to thebeauty of their ideas that they ignore mar-kets. I believe that is a mistake. n

Cato’s outstanding policy studies publications offer authoritative interpretation of a wide range of

critical issues. Every study offers a sharplyfocused look behind and inside the topic covered. Available at Cato.org, these incisivepublications form the heart of Cato’s important work.

RECENT CATO STUDIES INCLUDEl Social Security, Ponzi Schemes, and theNeed for ReformlUndermining Mexico’s Dangerous DrugCartelslThe Case Against President Obama’sHealth Care Reform: A Primer forNonlawyerslAnswering the Critics of ComprehensiveImmigration ReformlAbolish the Department of HomelandSecurityl Publication Practices for TransparentGovernment

Studiesfromthe


Conference lays bare the devastation of prohibition

Although prohibition has manifestlyfailed to stem the use of narcotics, ithas generated enormous costs andled to perverse outcomes. In the

United States, the war on drugs is produc-ing alarming violations of civil liberties,weakening the rule of law, and compromis-ing law-enforcement efforts.

Such unintended consequences, howev-er, extend well beyond the U.S. borders. At aCato Institute Conference held in Novem-ber, international leaders and prominentscholars from around the world cametogether to review the global impact of drugprohibition and introduce practical alter-natives.

In his opening address, Jorge Castañe-da, former minister of foreign affairs inMexico, looked at the initiation of the waron drugs in his country. “The war wasdeclared on false premises,” he said—adding that fears of increased violence andrising consumption were overblown. Pro-hibition has done little to reverse these mis-steps, he noted. “If the premises were falsethen, they’re still false now,” Castañedadeclared, concluding that Mexico “shouldmake advocacy of legalization in the U.S.its main task in foreign policy.”

Tim Lynch, director of Cato’s Project onCriminal Justice, gave a “brief tour” of theU.S. system of law, focusing in particularon the ways in which the drug war haseroded America’s bedrock legal principles.At the same time, he acknowledged the“palpable sense that the momentum hasshifted” from the warriors to the reform-ers—due, in part, to what he calls “drug warexhaustion.”

Luis Alberto Lacalle Pou, Speaker of theHouse of Deputies in Uruguay, andRomesh Bhattacharji, former narcoticscommissioner of India, explained how thehemispheric battle has played out in vari-ous regions of the world, includingUruguay, Pakistan, and Afghanistan.Enrique Gómez Hurtado, former senatorin Colombia, reflected on the 1995 assassi-nation of his brother, political leader Alvaro

1. JORGE CASTAÑEDA, Mexico’s former minister of foreign affairs, discussed the impact of and alternatives tothe war on drugs in his country. 2. FERNANDO HENRIQUE CARDOSO, former president of Brazil, offered “a morehumane approach” to the battle. 3. Former secretary of state GEORGE SHULTZ addressed the audience in apre-taped video. 4. LUIS ALBERTO LACALLE POU, speaker of the House of Deputies in Uruguay, explained thefutility of trying to eradicate drugs. 5. BETO O’ROURKE, a former El Paso city councilman, argued for an end tothe prohibition of marijuana.

C A T O E V E N T S

Ending the Global War on Drugs

1. 2.

3.

4. 5.

Gómez Hurtado, at the hand of drug traf-fickers. This tragedy, he said, has given him“a deeper understanding of how traffickersoperate in the political arena” and the futileefforts to stop them. “We press on,” he said,“but are making no ground.”

Other speakers at the conference includ-ed Fernando Henrique Cardoso, formerpresident of Brazil; Peter Hakim, presidentemeritus of the Inter-American Dialogue;and columnist Glenn Greenwald, who fol-lowed up on his 2008 Cato study, “Drug

Decriminalization in Portugal.” Formersecretary of state George Shultz and formerMexican president Vicente Fox addressedthe conference in pre-taped videos.

Ethan Nadelmann, executive director ofthe Drug Policy Alliance, discussed hisattempts to “reduce the role of criminaliza-tion in drug control.” The most optimisticsign of progress, he noted, is “the transfor-mation of public opinion towards marijua-na.” According to Gallup, the number ofpeople in favor of legalization increased

from 16 percent in 1970 to 50 percent lastOctober—the highest number recorded todate. Ordinary citizens are thinking aboutthese issues as never before.

And they’re not the only ones. By thetime the conference had ended, the WhiteHouse’s Office of National Drug ControlPolicy had responded with more than adozen messages on Twitter.

The war on drugs marches on. But thedebate, at the very least, certainly seems tobe resonating. n


More than 250 people attended “Ending the War on Drugs,” a Cato conference held in Washington on November 15. Former Mexican foreign minister Jorge Castañeda(above) gave the keynote address, and the event closed with an address by Fernando Henrique Cardoso, former president of Brazil, who suggested a “paradigm shift” inthe current battle—offering a way forward “from just repression to a more humane and comprehensive approach.”

C A T O E V E N T S


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OCTOBER 5: The Oregon HealthInsurance Experiment and Evidence-Based Health Reform

OCTOBER 14: Is Islam Compatible withthe Free Market?

OCTOBER 14: Frédéric Bastiat:Campaigner for Free Trade, PoliticalEconomist, and Politician in a Time ofRevolution

OCTOBER 18: Mexico and the War onDrugs: Time to Legalize

OCTOBER 19: ECPA at 25: How toModernize the Law to Better ProtectElectronic Privacy

OCTOBER 19: James Madison

OCTOBER 24: How Much HomelandSecurity Is Enough?

OCTOBER 27: How Much Ivory DoesThis Tower Need?

OCTOBER 27: Engineering the FinancialCrisis: Systemic Risk and the Failure ofRegulation

OCTOBER 27: Is Liberty Losing Groundin America?

OCTOBER 28: Cato Institute PolicyPerspectives 2011

OCTOBER 31: The Relationship betweenIntelligence and Policy

NOVEMBER 8: Cato Club Naples: TheEuropean Fiscal Crisis and Lessons for America

NOVEMBER 15: Ending the Global Waron Drugs

NOVEMBER 16: 29th Annual MonetaryConference

NOVEMBER 17: Borderless Economics:Chinese Sea Turtles, Indian Fridges,and the New Fruits of Global Capitalism

NOVEMBER 17: Capital Inadequacies:The Dismal Failure of the Basel BankCapital Standards

NOVEMBER 18: Squeezing the Tower:Are We Getting All We Can fromHigher Education?

NOVEMBER 29: Trendy or Green: AreOur Environmental Policies Helping?

NOVEMBER 29: The Market for Law

NOVEMBER 30: Cato Institute PolicyPerspectives 2011

NOVEMBER 30: Left Turn: How LiberalMedia Bias Distorts the American Mind

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CatoCalendar24TH ANNUAL BENEFACTOR SUMMITPalm Beach l The BreakersFebruary 23–26, 2012Speakers include Gov. Rick Scott and P. J. O’Rourke.

MILTON FRIEDMAN PRIZEPRESENTATION DINNER AND GRAND OPENING WEEKENDWashington l May 4, 2012

CATO CLUB 200 RETREATAsheville, NC l Inn on Biltmore EstateSeptember 27–30, 2012

25TH ANNUAL BENEFACTOR SUMMITScottsdale, AZ l Four Seasons ResortFebruary 21–24, 2013

Audio and video for all Cato events dating back to1999, and many events before that, can be found onthe Cato Institute website at www.cato.org/events. Youcan also find write-ups of Cato events in Ed Crane’sbimonthly memo for Cato Sponsors.


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C A T O P U B L I C A T I O N S

A new annual publication of original research

In an era of sound bites and microblogs,scholarly analysis is more critical thanever. This November marked the inaugural

release of Cato Papers on Public Policy, anannual volume of innovative, original arti-cles on critical economic policy issues. Theoverarching goal of the publication is toprovide in-depth, imaginative new researchfrom nationally recognized experts in dif-ferent fields. “In a nutshell, the papers willaim to produce research that employs mod-ern economic methodology but that isfirmly focused on what policies are benefi-cial for the economy and society,” writes Jef-frey Miron, director of undergraduate eco-nomics studies at Harvard University, aCato senior fellow, and editor of the Papers.

In the first article, J. Mark Ramseyer ofHarvard University and Eric B. Rasmusenof Indiana University examine a high-pro-file case of selective tax relief through exec-utive decree in the takeover of GeneralMotors. The move involved a “highlyarcane” corner of the tax code, allowing thepresident to manufacture a deduction forhis political supporters at General Motors.The authors explore the intricacies of thetax break involved before consideringreforms that might prevent a similar movein the future. “Ordinarily, if an administra-tion wildly misstates the cost of its policiesor routes public funds to its friends, thepress notices and complains,” they write.“In this case, it did not.”

In “Free to Punish? The American

Dream and the Harsh Treatment of Crimi-nals,” Rafael Di Tella of Harvard BusinessSchool and Juan Dubra of Universidad deMontevideo, Uruguay, describe the evolu-tion of punishment in the United Statesover the last several decades. What accountsfor the country’s astronomical incarcera-tion rate? The answer, they suggest, is that“beliefs concerning economic opportuni-ties cause desired punishment levels.”When income is perceived as being closelytied to effort, it is considered legitimate toimpose stricter punitive measures on crimi-nals. “In brief,” the authors write, “we arguethat harsh punishment is caused by theAmerican dream.”

What is the role that patents play—or do not play—in fostering technologicalprogress? In “Competition and Innova-tion,” economists Michele Boldrin, JuanCorrea Allamand, David K. Levine, andCarmine Ornaghi review the empirical evi-dence. The authors find that the receivedwisdom—namely, that patent protectionadvances innovation—has little support.“There are no objective reasons whatsoeverto strengthen patents any further than wehave already done,” they conclude.

In “Labor Market Dysfunction duringthe Great Recession,” Kyle F. Herkenhoffand Lee E. Ohanian of the University ofCalifornia–Los Angeles, analyze the recenteconomic downturn in an attempt tounderstand why unemployment hasremained high for so long. By analyzing theimpact of mortgage-modification pro-

grams, they conclude that these programschange “the incentives for workers to relo-cate from relatively poor labor markets tobetter labor markets”—thus adding to theslow recovery reflected in recent unemploy-ment figures.

The Institute is pleased to add CatoPapers on Public Policy to its collection oftimely, in-depth research publications. n

Visit www.cato.org/store or call 800-767-1241 to order Cato Papers on Public Policy today.

The Institute Unveils Cato Papers on Public Policy


S ince the financial panic of 2008, calls to implement long-term executive compensation schemes have grown increas-ingly louder. In the latest issue of Regulation, James C. Spindler argues that these reforms may not do what theiradvocates promise. Ike Brannon and Sam Batkins discuss a new approach to curtailing administrative overreach by

“regulating the regulators,” while Richard J. Pierce, Jr. looks at the impact of administrative law judges on the Social SecurityAdministration and, ultimately, the federal deficit.Ahmad Faruqui and Jennifer Palmer consider the potential benefits from dynamic pricing of electricity, and William L. Anderson

and Patrick Moffitt examine the politicization of environmental science. In addition, the Fall 2011 issue includes an analysis ofthe long-term impact of land-use decisions and a feature on lead-paint-abatement laws, as well as reviews of books on the finan-cial crisis, fair trade, and energy innovation.

Regulation is available by subscription or online at www.cato.org/regulation.

Executive Pay, Dynamic Pricing, and Lead Paint


Cato’s 29th Annual Monetary Conference

“The only adequate guarantee forthe uniform and stable value ofa paper currency is its convert-ibility into specie,” James Madi-

son wrote in 1831. Based on this principle, thefather of the Constitution sought to ensurethat the political class would not attempt touse the central bank as an instrument of fis-cal policy. At the Cato Institute’s 29th AnnualMonetary Conference, experts came togetherto examine the current monetary regime,question the role of government in the mone-tary order, and restore the spirit that animat-ed the founding generation.

The conference, “Monetary Reform in theWake of Crisis,” was directed by Cato vicepresident for academic affairs James A. Dorn.In discussing the global fiat money system,scholars focused on how we got here andwhy the status quo needs to be replaced by arules-based system in which the dollar isredefined in terms of specie.

In his keynote address, Rep. Ron Paul (R-TX), chairman of the House Subcommitteeon Domestic Monetary Policy, attacked thepresent discretionary regime, arguinginstead for currency competition and ulti-mately a return to the gold standard. Thecurrent monetary system is “little more thana deception,” he said—adding that it’s “like adrug. You get some benefits if you keepusing it.” But when the drug is taken away,you have to go through withdrawal. Ulti-mately, continuing to expand the Fed’s bal-ance sheet risks killing the patient—which,in this case, “is the worldwide economy.”

Jeffrey Lacker, president of the FederalReserve Bank of Richmond, discussed ingreater detail the perils of delegating fiscalauthority to central banks, emphasizing that“some measure of antagonism is an under-standable consequence of the Fed’s owncredit policy initiatives.” “While it mightsound extreme, I believe that a regime inwhich the Fed is restricted to hold only U.S.Treasury securities purchased on the openmarket is worthy of consideration,” he said.

Kevin Dowd, author of Money and the Mar-ket and a Cato adjunct scholar, warned thatunless the present financial system—which is

highly leveraged and based on fiat money—isended, we can expect “monetary chaos” thatincludes high inflation and a loss of freedom.He noted that the Fed “has no exit strategyto safely deflate the bond market”—to whichhe responded with concrete steps that wouldhelp transition the country to a more viablefree banking model.

Other speakers included Robert Zoellick,president of the World Bank; Allan H.Meltzer of Carnegie Mellon University; BennSteil, coauthor of Money, Markets, and Sover-eignty; Lawrence H. White of George MasonUniversity; and Gerald P. O’Driscoll, Jr., sen-ior fellow at the Cato Institute (see page 8).

In his closing address, John Allison gave a

rousing talk about the importance of soundmoney in a free society. As former chairmanand CEO of BB&T, Allison offered “a differ-ent perspective,” speaking from four decadesof experience in an industry that “definitelyreports to regulators.” The reason the Feder-al Reserve has hampered the market system,he said, is that its experts are guilty of what F. A. Hayek called “the fatal conceit.” “I don’tcare how smart you are,” Allison said, “youcannot integrate the economic activity of 7 billion people.” n

The papers presented at the conference will be included in an upcoming issue of the CatoJournal. Video and audio of the conference isavailable at www.cato.org.

The Problems with a Pure Fiat Regime

1. JEFFREY M. LACKER (at podium), president of the Federal Reserve Bank of Richmond, held that the centralbank’s balance sheet should be limited to U.S. Treasurys. Other panelists included ROGER GARRISON (left) andGEORGE SELGIN. 2. JUDY SHELTON, author of Money Meltdown, argued for a new global monetary structure. 3. Cato’s ALAN REYNOLDS listened as JAMES GRANT, editor of Grant’s Interest Rate Observer, addressed thedysfunction of financial regulation.

1.

2. 3.


C A T O S T U D I E S

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Randy E. Barnett......................................................Senior FellowVladimir Bukovsky..................................................Senior FellowTucker Carlson.........................................................Senior FellowLawrence Gasman.............Senior Fellow in TelecommunicationsRonald Hamowy....................................Fellow in Social ThoughtSteve H. Hanke........................................................Senior FellowJohn Hasnas............................................................ Senior FellowPenn Jillette........................................Mencken Research FellowDavid B. Kopel.......................................Associate Policy AnalystChristopher Layne.............Visiting Fellow, Foreign Policy StudiesPatrick J. Michaels.....Senior Fellow in Environmental StudiesJeffrey Miron............................................................Senior FellowP. J. O’Rourke .....................................Mencken Research FellowWilliam Poole...........................................................Senior FellowGerald P. O’Driscoll Jr............................................Senior FellowJim Powell...............................................................Senior FellowRichard W. Rahn..................................................... Senior FellowRonald Rotunda................Senior Fellow, Constitutional StudiesTeller.....................................................Mencken Research FellowCathy Young....................................................Research Associate

“In December 1919, Carlo‘Charles’ Ponzi approached agroup of friends and acquain-tances in Boston with a new

investment opportunity,” Cato senior fel-low Michael Tanner writes. What followedhas become immortalized as one of themost infamous investment scams in histo-ry. In “Social Security, Ponzi Schemes,and the Need for Reform” (Policy Analy-sis no. 689), Tanner considers recent callscomparing this fraudulent operation withthe current U.S. social insurance program.The two programs, he says, have several sim-ilarities. Social Security, for instance, “doesnot actually save or invest any of a partici-pant’s payments”—relying instead oninflows from future contributors to financethe system. This, in turn, provides “a wind-fall to the first participants, but decliningreturns to subsequent joiners”—also similarin operation to a Ponzi scheme. Finally,Social Security is “a system that worked wellwhen demographics were favorable,” yet it’s“facing insolvency as the ratio of recipientsto contributors increases.” Despite these

similarities, there is in the end one cru-cial distinction bet-ween the two. “SocialSecurity is not aPonzi scheme,” Tan-ner concludes, “be-cause Charles Ponzididn’t have a gun.” Assuch, the debate over

epithets obscures a much deeper issue:Social Security is unable to pay promisedbenefits with current levels of taxation. “Inshort,” Tanner writes, “the program is facinginsolvency without fundamental reform.”

Drug Violence Flaring in MexicoIn December 2006, President FelipeCalderón of Mexico launched a military-ledoffensive against his country’s increasinglyviolent narcotics trade. In “UnderminingMexico’s Dangerous Drug Cartels”(Policy Analysis no. 688), Cato senior fellowTed Galen Carpenter argues that this cam-paign is not simply ineffective: “It is a futile,utopian crusade that has produced an array

of ugly, bloody side effects,” he writes. Manyare now questioning whether Mexico is onits way to becoming a “failed state.” WhileCarpenter determines that these fears areoverblown, he nevertheless acknowledgesthat “the overall trend is troubling.” By thesame token, he notes that the extent of aspillover of violence and corruption into theUnited States has been limited—yet the pos-sibility of turf battles becoming proxy warsis “a harbinger of deterioration of the secu-rity situation on our southern border.” Byexamining several alternatives to the cur-rent approach, Carpenter finds that onestands out above the rest. “The most feasi-ble and effective strategy to counter themounting turmoil in Mexico is to drastical-ly reduce the potential revenue flows to thetrafficking organizations,” he writes. Thishinges on abandoning the prohibitionistmodel in favor of full legalization. “The fireof drug-related violence is flaring to analarming extent in Mexico,” he concludes.Restricting the damage will require swiftaction, “before that fire consumes ourneighbor’s home and threatens our own.”

U.S. Social Security: Ponzi’s Got a Gun

War and the Practice of PoliticsArticle I of the United States Constitutionvests the power to “declare War” in Congress,leaving to the executive the power to “repelsudden attacks.” But in the years since theCold War, the practice of initiating limitedconflicts has blurred these constitutional dis-tinctions. In“Congress Surrenders the WarPowers: Libya, the United Nations, andthe Constitution” (Policy Analysis no. 687),John Samples, director of Cato’s Center forRepresentative Government, examines anumber of smaller wars—namely, those inBosnia, Somalia, Kosovo, Iraq, and mostrecently, Libya—and reaches several conclu-sions. First, the president has arrogated“largely unfettered powers” to launch warsthat are “half-made”—conflicts he feels “areessential to fight and yet beyond constitu-tional propriety.” Second, while sometimescritical, Congress tends to defer to presiden-tial command when these wars are both briefand popular. Third, Congress’s active “investi-gations and criticisms can affect the conductof a limited war but not its inception.” On theother hand, while the public is often skepticalthat limited conflicts are worth the cost, their“desire for congressional authorization ofsuch wars goes unfulfilled.” Finally, Samplesfinds that, in Libya in particular, an incre-mental transfer of these powers to interna-tional institutions—also known as weak inter-nationalism—“contravenes values central toAmerican republicanism.” As such, he con-cludes, “law becomes over time a function of,not a constraint on, the practice of politics.”

The Ivory Tower’s Burden“If you follow higher education—or just livenear a college or university—you’ve probablyheard the complaint: government keepsaxing higher education funding,” writes NealMcCluskey, associate director of Cato’sCenter for Educational Freedom, in “HowMuch Ivory Does This Tower Need?What We Spend on, and Get from,Higher Education” (Policy Analysis no.686). The problem is that there is little evi-dence to support this claim. While most ana-lysts rely on public funding as a share of over-all school revenues, McCluskey examines theburden of postsecondary education borne by

taxpayers—the most direct measure of publicsupport—and one that is “typically ignoredin anecdote-driven media stories.” What dothese numbers suggest? “No matter how youslice it, the burden of funding the IvoryTower has grown heavier on the backs of tax-

paying citizens,” hewrites. In fact, the bur-den on the individualtaxpayer has risenfrom $426 in 1995 to$532 in 2010, a 25-percent increase. Butthis is only part of thehigher-educationstory. The real ques-

tion is whether human capital has expandedalong with this increased investment.McCluskey finds that the increased flow ofdollars has “underwritten poor academicresults, rampant price inflation, and consid-erable college inefficiencies.” “The moneytaken from taxpayers,” he concludes, “to‘invest’ in higher education has been on therise, and it appears to be hurting both tax-payers individually and society as a whole.”

Malpractice Caps Hurt PatientsSupporters of capping court awards for med-ical malpractice argue that such caps willmake health care more affordable. But is thisnecessarily the case? In “Could MandatoryCaps on Medical Malpractice DamagesHarm Consumers?” (Policy Analysis no.685), economist Shirley Svorny of CaliforniaState University, an adjunct scholar at theCato Institute, says that it may not be so sim-ple. In reviewing the structure of the medicalliability insurance industry, Svorny begins byoffering a key insight. “The decades-old con-ventional wisdom holds that medical mal-practice insurers rarely adjust premiums toreflect an individual physician’s risk,” shewrites. This assumption, however, is mis-placed. As Svorny illustrates, the industry hasdeveloped a complex, “interdependent sys-tem of physician evaluation, penalties, andoversight”—all of which is based upon thethreat of legal liability for negligence.Patients, in turn, derive protections from thisoversight. In short, she writes, “the evidencepresented here shows that physicians pay the

price for putting patients at risk.” Svornydraws on interviews with underwriters andbrokers, published sources, and an extensiveanalysis of state insurance company rate fil-ings to make her case—showing that premi-ums “act as signals that steer physicianstoward higher-quality care.” As such, theimplication is clear. “Capping court awards,all else equal, will reduce the resources allo-cated to medical professional liability under-writing and oversight,” she argues, “andmake many patients worse off.” The studygenerated a lively online discussion at theManhattan Institute’s PointofLaw website.

Lessons from Deepwater HorizonOn April 20, 2010, an explosion on theDeepwater Horizon offshore drilling unit ledto the largest accidental oil spill in the historyof the petroleum industry. What lessons haveemerged in the year since the well has beendeclared “effectively dead”? Richard L.Gordon, professor emeritus of mineral eco-nomics at Pennsylvania State University andan adjunct scholar at the Cato Institute,argues in “The Gulf Oil Spill: Lessons forPublic Policy” (Policy Analysis no. 684) thatthe resulting political backlash uncovers long-standing issues with the attempt to regulatecommercial activities. “The underlying prob-lem is a mythology that holds that publiclands are precious resources needing carefulgovernment management,” he writes. Thisisn’t the case. By examining the politicalresponse—particularly the Waxman-Markeybill—he underscores the real issue. “The failurewas in fact due to the impotence of the verypolicy initiatives that the Obama administra-tion wishes to expand,” he writes. Gordoncarefully deconstructs the “tangential cam-paigns” against foreign oil imports, oil con-sumption, and climate change—making itclear that “the only thing these concerns havein common is their invalidity.” The ideal solu-tion, he contends, is privatization of federallands. In the interim, Gordon demonstratesthat the Gulf oil spill reflects the problemsassociated not only with our command- and-control energy strategy, but with governmentoversight in general. “The real lesson of the oilspill,” he concludes, “is the familiar point thatbad policies beget bad consequences.” n


YES, I HAVE KEYNESIANISM, WILSONIAN-ISM, GOVERNMENT MOTORS, AND THEWAR ON POVERTYHave any lefty relics gathering dust inyour closet?—Fundraising e-mail from The Nation,October 28, 2011

TAKING AN AX TO GOVERNMENTGov. Robert F. McDonnell announcedTuesday that he is recommending elim-inating two state agencies, cutting 19boards and commissions and de-regu-lating three professions.

It’s part of his ongoing effort toreshape and shrink state government—one of his signature campaign promises.

McDonnell (R) made the recommen-dations to the General Assembly. TheDepartment of Planning and Budgetestimates the proposals will save at least$2 million per year.—Washington Post,November 30, 2011

THE HORNS OF A DILEMMALesser evil: crony capitalism or bad policy?

Energy Secretary Steven Chu isabout to find out when he testifiesbefore a House panel on Thursdayabout the $535 million loan guaranteehis department awarded to Solyndra,the now-bankrupt solar-energy compa-ny that was, before its demise, the posterchild for America’s renewable-energyindustry and President Obama’s 2009Recovery Act.

The White House and the EnergyDepartment say the influence of politi-cal donors such as Oklahoma oil billion-aire George Kaiser, whose venture-capital firm was the major investor in

Solyndra, did not sway any of the admin-istration’s decisions on Solyndra’s loanguarantee, which was funded from thestimulus package.

By denying politics was involved, theadministration is saying that its topofficials genuinely and continuouslythought Solyndra was a good bet—despite numerous warnings raised bothinside and outside of the administra-tion.—National Journal Daily,November 17, 2011

SURPRISE! ECONOMIC PROJECTIONSFLAWEDThe Arlington County–funded arts cen-ter [Artisphere], which opened October10 last year in the Newseum’s formerspace, projected it would have 300,000visitors in its first year. As of the end oflast month, it had hosted about 90,000.And the venue for art, theater, film,music and more, whose build-out cost$6.7 million, had to request an addition-al $800,000 to supplement the $3 mil-lion appropriated for its first annualoperating budget.

“Our original business plan had veryaggressive projections,” says ExecutiveDirector Jose Ortiz. “In terms of thoseexpectations, no, we didn’t make those.”

“One of the projections was thatevery performance was going to be atcapacity,” he says.—Washington Post, October 7, 2011

KEYNES HAD HIS GOOD POINTSAs the Depression proceeded, and someof Keynes’s colleagues and studentsturned to Communism, Keynes declaredthe theory of Marxism to be “complicat-ed hocus pocus.” When Beatrice and

Sidney Webb, the Fabian grandees, wentto Russia and returned proclaimingStalinism to be the way of the future,Keynes was, as [Sylvia] Nasar recounts,aghast. Asked to contribute to an essaycollection for Beatrice’s eightieth birth-day, he said the only sentence that cameto him was “Mrs. Webb, not being aSoviet politician, has managed to sur-vive to the age of eighty.”—New Yorker,October 10, 2011

GUESS WHAT “IDIOSYNCRATIC” MEANS ATTHE NEW YORK TIMESWyoming’s way—always idiosyncratic inthe windblown, rural grain that mixesmind-your-own-business cowboy liber-tarianism and fiscal penny-pinching—isgetting its moment in the spotlight.—New York Times,November 25, 2011

THE NEW YORK TIMES ON GOVERNMENTENTERPRISES“Two things in particular routinely irri-tate me [about Amtrak],” writes NewYork Times reporter Matt Bai. “One isthat there is no accountability. Second, asyou might expect from any bureaucraticmonopoly, the customer service agentsare just routinely contemptuous. I had anagent a few weeks ago, when I tried tochange a ticket, who pretended not tohear me because she was annoyed that Ihad asked her to confirm that the nexttrain was full, even though my travelagent said it was open. ‘If you had anycommon sense, you’d have heard me thefirst time,’ is what she said. I expect thisat the DMV, but I don’t need to be berat-ed by someone to whom I’ve just paidnorth of 300 bucks.”—Politico, October 26, 2011

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