Health Care and Choice

Shortly before the passage of new health care bill the Washington Post reported a stinging, sustained broadside against health insurance rate increases by President Obama.

A health insurance industry spokesman was quoted as saying “All health plans are in the same situation in trying to deal with the steadily increasing costs in the delivery system, which are not sustainable.” In other words the health insurance industry is only responding to cost increases beyond its control.

To the individuals and families who pay the premiums for insurance, their premiums cover costs that include the delivery system and the burden of supporting separate industry bureaucracies with a separate set of transactions. Outside of the health care industry in other sectors of the economy, bills tend to be a two party transaction between a customer and a vender, but seldom so in health care.

One illness or injury starts a billing shuffle through separate bureaucracies at hospitals, laboratories, clinics, imaging centers, Preferred Provider Organizations(PPOs), Independent Panel Association’s, but also private insurance companies, independent billing agencies and bureaucracies at Medicare, Medicaid, Social Security, workmen’s compensation or the Veterans Administration. Medicare, Medicaid and workmen’s compensation are federal programs with federal bureaucracy, but also administered by the states through 50 separate bureaucracies.

Private insurance companies accept premiums paid into a risk pool that generates a reserve fund to pay losses. Insurance companies analyze actuarial data on accidents, sickness, disability and other risks to construct probability tables that will determine the premiums that will generate reserves to pay future losses.

Otherwise though insurance companies do not provide health care; that is left to doctors, hospitals and medical venders. All those separate entities in medicine have an incentive to bill higher amounts; all the insurance companies have an incentive to pay lower amounts. The two sides maintain bureaucracies with staff to argue and negotiate over the bills from millions of transactions nationwide.

But we can ask our selves what does the insurance industry do that the health care industry cannot do for itself?

The actuarial data for health insurance policies comes from the medical industry so they could employ their own actuaries and do the necessary risk assessment without insurance companies. If the medical venders were organized together as regional or metropolitan entities setting their own premiums to provide their own health care, then millions of transactions would be eliminated, along with the perverse incentives to overcharge and underpay.

If the health care industry was organized with its separate components brought together into comprehensive health care providers, the insurance industry would be unnecessary. It would become a redundant component.

You may recognize the combination I mentioned above as an HMO, or a health maintenance organization, but that is the rub. Many Americans have the idea, aided by the health insurance industry, that health maintenance organizations restrict choice or might deny treatment, even though they have the facility and staff to provide it.

The private insurance industry exists because enough people believe private insurance gives them more choices and better choices. It is a very expensive choice, which is why President Obama is going easy on the health insurance industry when he attacks their increase in premiums. If he was going to get tough he would tell us how we can rid ourselves of the health insurance industry.

Replacement Jobs for Manufacturing

America’s high unemployment rate will come down as total spending picks up and the economy recovers. Some of the unemployment is the result of the recession but some is the result of long term trends. Many know that manufacturing jobs have a downward trend with jobs off 5.4 million since 2000. When the economy comes back manufacturing jobs will not recover much if at all. Other jobs in service industries will replace the jobs lost in manufacturing, but the new jobs we are taking are different from the jobs we are losing.

The 20 year evolution of America’s eating habits is a good illustration of the differences in the new jobs. In the production-marketing chain of food, restaurants help to have more jobs and probably more than most people realize. Start on the farm and let’s count America’s farmers. Next add all the jobs in pesticide, fertilizer and agricultural chemicals, and all of the jobs in agricultural implement manufacturing. Add in the jobs at farm supply wholesalers, and farm raw material wholesalers.

Then move on to food manufacturing. Add all the manufacturing jobs milling, canning, freezing, bottling, refining, slaughtering, baking, brewing, distilling, fermenting and packaging. Add them to grocery store merchant wholesaler jobs and all the jobs at grocery stores, convenience stores, liquor stores and food stores. The total comes to 6.7 million jobs.

There are 9.3 million jobs in the restaurant business including fast food outlets, bars, and caterers. That was for 2009 a recession year, but there was a monthly average of 9.6 million jobs in 2007 and 2008. The total does not include food service workers at school cafeterias, hospitals, retail stores or ball parks, museums and other recreation facilities. Add them to the total and it comes to almost 11.4 million food service jobs.

Worse, jobs from the farm to the supermarket continue to decline due to productivity growth and imports in the global economy. Restaurants are the only part of the food chain Americans can count on for more jobs.

Gambling is another area like restaurants where Americans spend themselves into jobs as gaming dealers, gaming cage workers, slot key persons, and sports book writers and runners. Gambling employment reached a high of 426 thousand in the private gambling industry in 2007, including casino hotels. Gambling jobs dropped 8 percent in the recession, after nearly two decades of rapid growth.

Work in gambling and restaurants is not the high tech and high wage employment the politicians keep promising for the future, but they are becoming the replacement jobs for manufacturing. The 5.4 million jobs lost in manufacturing are up to 4 percent of America’s jobs, but the jobs people are finding pay less and drop faster in recessions than the manufacturing jobs they replace.

The politicians expect more spending to bring more jobs and restore full employment, but they are ignoring the trend to a higher percentage of jobs in restaurants, gambling, fitness centers, pet care, landscaping, temp work, security, prisons, business and personal services that take the place of manufacturing employment and support millions of jobs.

Politicians are good at counting jobs, but they act like the new jobs are as good as the old ones. The next time you hear the unemployment rate went down; remember the trends in replacement jobs and wonder if we are better off.

Banks and Favors

The new credit card rules will make it difficult for banks and credit card processors to be tricksters, which is my word for their erratic and arbitrary fees and penalties. Despite the hostile opinions toward banks reported in the popular media they continue to have their way in financial matters.

Take the student loan program where Congress decides that banks will get special favors to make student loans in the student loan program. Starting the early 1990s, college financial offices have been able to choose between a direct government loan and private lending by banks with a government guarantee against default. Summary reports indicate that private loans are now more than half of student loans. In 18 years private lenders jumped from nothing to more than half of student loans.

For the government to make loans the original principal for the loans has to come from a Department of Education appropriation. However, when the government is the lender they receive the interest and principal payments which can then be recycled as new loans.

With principal and interest returned to the government the student loan program can be a self sustaining program without the need of a yearly appropriation. The interest payments received as students pay their loans can be added to the principal to make more loans, reduce interest rates in the future, or fund grants for especially needy students.

With private sector loans the Federal Government accepts the financial risk of default to private lenders, but the interest payment and principal goes to the bank. That means more than half of student loans can generate losses but no revenue for more student loans.

The Obama administration wants to make student loans a self perpetuating program and eliminate student loan guarantees to private banks. A House bill that would make the switch to direct government lending passed in early 2010 over strong industry and Republican opposition. Industry spokesmen say the bill is a government takeover that would squelch competition, diminish services to students and cost jobs.

The use of the word takeover is ironic since the student loan program goes back just over 40 years, but the subsidy for banks was introduced and passed in 1992 with the support of the President Clinton, a democrat. The Obama proposal suggests a take back, but hardly a take over.

Competition in student loans suggests bank offers of discounted interest rates to students to get their business from other banks. Instead, Congress sets the interest rates for both subsidized and unsubsidized student loans with rates reset June 30th of each year. The published interest rate implies a maximum rate, but it serves as a minimum rate.

I say minimum rate because I do not hear of banks offering a rate lower than the published rate. Having one rate and treating it as the rate for student loans eliminates competition that is a normal part of banking. There should be evidence of competition if there is competition.

Judging from the opposition, the subsidy banks want to keep must be larger than I would have guessed. Nearly two years after a banking collapse America has some new rules for credit card users, but nothing else. The media keeps reporting Americans are angry with banks and bankers, but if that is true there is little reform to show for it.

Unemployment

The President and the Congress continue to worry about unemployment and with good reason. The recent unemployment rate had to drop to reach 9.6 percent. Seasonally adjusted unemployment rings in at 14.9 million. However, if we look at labor force and employment trends of the Bureau of Labor Statistics Current Population Survey back to 2000, the employment situation looks even worse.

The civilian labor force drifts upward but at a lower rate than population growth. The adult population keeps growing at annual rates around 1.2 percent while the labor force grows at annual rates around .9 percent. The difference is small for a year or two but gets significant over time.

Those employed and the unemployed who are looking for work are classified as in the labor force. Otherwise people are classified as not in the labor force. The employed are up since 2000, but at much lower growth rate than the labor force; and at a much lower growth rate than those not in the labor force; and at a much lower growth rate than the unemployed.

The unemployed jumped from an average of 7 million in 2007 to 8.9 million in 2008 to 14.3 million in 2009, but those years were recession years. Part of the spike in unemployment results from the recession, but the glacial pace of growth in the employed back to 2000 suggests that some of the unemployed come from longer term decline unrelated to the business cycle.

In the years from 2000 through 2009 the annual growth rate for the employed averaged .24 percent; from 2000 to 2008 it averaged .75 percent; from 2000 to 2007 it averaged .93 percent. The year 2007 had the highest average for employment of any year of published data, but still with slow growth going back to 2000.

Other questionable trends from 2000 to 2009 include the rapid growth of the part-time employed. Part-time employment was up over 4 million from 2000 to 2009, while the full time employed dropped about a million.

Those employed from the ages of 16 to 54 dropped from 2000 to 2009. Those employed for ages over age 55 were up 8.9 million. Those leaving high school and college can’t find jobs partly because there are not enough of them but also because more of their parents continue to work and maybe because they cannot afford to retire or they need health care from a job.

The recession will end and employment will pick up, but the changes of the last decade point to a trend of a rising share of America’s labor force remaining unemployed or out of the labor force.

When America spends its way out of recessions Americans assume there will be jobs for those who need them. If employment lags behind we hear suggestions for a business tax break or two like we have now, or the great cry sounds to “Get some training” but that is about it for policies on jobs.

The 40 hour work week, eight hours a day with time and a half for over time continues to be the federally mandated work week as it has been for nearly 90 years. If someone suggests a 35 hour work week it might spread the work around to some of those now unemployed. Business hates the idea and politicians won’t touch it, but if the ominous trends in employment continue someone will need to have a new idea. Right now that sounds like a revolution.

Maryland and Virginia

First published in the Washington Herald Telegraph

Jobs and the Plight of the Maryland and Virginia Governors

Both of the incumbent governors in Virginia, and Maryland have staked their political plans and reputation on creating more jobs. In Virginia, Governor Robert McConnell has pledged to make jobs his top priority while in Maryland Governor Martin O’Malley is defending his record and priorities on jobs. Given the well published need for jobs their promises are easy to understand, but let’s weigh the prospects for success.

Virginia reached its highest monthly average of 3.76 million establishment jobs in 2008 whereas Maryland reached its highest monthly average in 2007 with 2.61 million jobs. Both had declines for 2009 from their previous average highs. In Virginia, jobs were off by a monthly average of 126,000; for Maryland jobs were off a monthly average of 87,000.

The jobs picture is not improving yet (June 2010). The 2010 monthly average of seasonally adjusted jobs through May dropped another 19,000 in Virginia and by another 16,000 in Maryland. To be fair to the governors though, the last decade has not been a good decade for jobs and both governors face similar problems creating jobs.

Both states have well publicized job losses in manufacturing, but the decline goes back many years. Virginia has a loss of 148 thousand manufacturing jobs since 1990. Maryland is down 80 thousand in the same period. For Virginia manufacturing was 13.4 percent of statewide jobs in 1990, but only 6.6 percent by the end of 2009. In Maryland manufacturing accounted for 9.1 percent of statewide jobs in 1990 but only 4.7 percent now.

Both states need new jobs to replace their lost manufacturing jobs before they can add jobs. That means both states must have faster than average growth in service industry jobs to make up for the decline in manufacturing. Trouble is there are major sectors of the service economy that are not growing at all, or growing too slowly to maintain their share of statewide jobs.

For example, wholesale and retail trade accounted for 383 thousand jobs in Maryland for 1990 but 364 thousand trade jobs in 2009. In Virginia trade jobs were 474 thousand jobs in 1990 and 511 thousand in 2009, but the 2009 total is 14 percent of statewide jobs compared to 16.4 percent in 1990. Both states show a continuously declining share of statewide jobs in trade.

Using computer technology in trade, especially for barcodes and inventory management increases labor productivity. Retail and wholesale sales volumes per work hour are up and sometimes at rates comparable to productivity in manufacturing. Higher productivity limits job growth.

The use of digital technologies and business consolidation has affected labor productivity and jobs in other service industries. In addition to manufacturing and trade Maryland and Virginia have a nearly identical group of service industries that have a twenty year record with a declining percentage of jobs. Include mining, utilities, information services such as publishing, broadcasting, and communications, banking, real estate, and repair and maintenance sectors as service industries losing share in statewide jobs. Maryland’s declining industries lost 10 percent of jobs since 1990. In Virginia the losses are 11.4 percent.

Shares must total 100 percent, which assures a higher percentage of jobs in a shrinking number of other services. These other services are health care especially, along with education and selected professional services, particularly computing. Business support services and restaurant jobs show gradual increases, but they are hardly the services that governors want to promote when they discuss new jobs.

Health care including social services continues to create more jobs month after month in the national economy where it now has 12.5 percent of establishment jobs. The recent expansion of health care insurance passed by Congress will help the states generate new jobs. Virginia lags behind in health care jobs with only 10.1 percent of statewide employment. Maryland health care has 12.7 percent of statewide jobs, slightly above the national average, but both governors will need to support health care expansion and concentrate on producing as much health care within their respective states in order to meet their employment goals.

Education like health care has a 20 year record of steady growth in jobs. Maryland jobs in private and public education are now just over 11 percent of statewide employment, above the national average. Education and health care are both sectors where computer technology and the digital revolution have limited ability to raise labor productivity compared to service sectors like finance and communication. Even though many people write checks and do their financial business with paper, the wider use of digital technology could further erode employment in finance, insurance and communications.

Both states have a third service sector with a continuously higher share of jobs: combined business and professional services. Virginia has the best record here with a 4.4 percent jump in professional service employment from 5.9 to 10.3 percent of statewide jobs from 1990 to 2009. Virginia has been able to attract computing design services, which jumped from 45 thousand jobs in 1990 to 137 thousand jobs by 2009.

Maryland has also done well with professional and business service jobs, which are up to 224 thousand in Maryland for 2009, but only 8.9 percent of statewide jobs. Like Virginia, computer design services have the most jobs in professional services, but 60 thousand jobs compared to 137 thousand for Virginia.

Virginia has also been successful in bringing corporate headquarters to northern Virginia. Jobs in the management of companies reached a high of almost 77 thousand in 2008, an impressive total with 2 percent of statewide employment, higher than the national average. Maryland has 20 thousand jobs in this category.

The professional service part of business and professional services has jobs in law, accounting, architecture, engineering, computer design, management consulting, scientific research, advertising, and veterinary services. The business services part has supporting jobs in administrative and facilities services, employment services, and support services in telemarketing, security, janitorial, landscaping services and a few more.

Professional services have the best chance of any services to be sold in other states and in the global economy. Business support services along with health care, education and so many service industries tend to be local services, whereas professional services give both governors a chance to promote services and jobs the bring money from outside their states to support jobs with exported services.

The reality of shifting jobs within the service industry along with the long term decline in manufacturing limits the options of both governors. If they can generate economic activity and jobs in health care, education, and professional services then these should pull along additional jobs in business support services along with leisure, hospitality, and personal service jobs.

Federal, state and local government jobs in both Maryland and Virginia continue to be the biggest employers in both states. Governments have 19.2 percent of Virginia jobs in 2009 including public education; 19.5 percent of Maryland. Politicians seldom advocate government jobs as a solution to job needs, but neither governor can afford to sit by and let these jobs decline, no matter how unpopular taxes and spending come to be. State and local jobs are spread out geographically and help maintain a core of jobs in many communities. If these jobs decline, other jobs will decline with them.

Both governors will need to maintain construction jobs, but neither can expect there will be enough new construction jobs to help much with statewide job needs. Construction employment in the national economy fluctuates around 5 percent year in and year out. It has not gone above 6 percent in the national economy since the 1940’s.

Both Virginia and Maryland are already doing about as well with construction jobs as any state could expect. Virginia had construction jobs above 6 percent of statewide jobs in some years over the last 20 years and continued above 5 percent even through the recession. Maryland has done quite well also with construction jobs above 5 percent through the last twenty years.

Both governors made promises on jobs that will be difficult to keep. We wish them well and want to remind them they are not alone. There are 27 states showing lower employment in 2009 compared to 2000 but Maryland and Virginia are not among them. If the two governors concentrate on health care, education, and professional services, then new jobs could generate enough new spending to boast employment in the supporting service sectors. They are getting off to a slow start, but we can check their progress at a later date.

Value and Work

Sometimes I hear people say something like “The wealthy worked hard for that money, and free markets determined what they do is of such high value.”

Such statements raise a question for economists. Can value be measured to show that wages reflect individual productive value?

It is an old question that goes back into the 19th century when British and European philosophers and economists applied science reasoning to the craft industries of the day: wheelwrights, blacksmiths, shoemakers and so on.

These economic philosophers suggested that if a shoemaker works 8 hours a day producing 5 pairs of shoes and then sells them at $10.00 each, he produces $50 worth of value.

Then they had the shoemaker hire a helper to specialize in cutting leather while the shoemaker sews and assembles the final product. Together they make 9 pairs of shoes a day.

We can see right away the shoemaker’s shop went from 5 pairs a day to 9 pairs a day so the helper added 4 more pairs to the total produced in a day. His production can be measured in money terms when the product is sold.

Craft industries would be expected to have small local markets so it might be necessary to lower the price to sell 4 more pairs of shoes a day. If the price is lowered to $8 a pair to sell 9 pairs per day instead of 5, then the revenue jumps to $72. With that knowledge we can see the new hire’s work added $22 = $72-$50 of value a day to the firm.

If the hired helper is paid what he is worth to the firm it will be $22. It is a maximum because if pay exceeds $22 the firm’s net revenue will drop below $50 and the shoemaker would do better without the helper. The wage could be less than $22 depending on how many other people apply for the job and how many other shoemakers compete for hired help.

It might be a surprise to learn I have condensed and summarized what continues to be part of current study in economics courses throughout U.S. colleges. It uses the scientific method because only one thing changes, labor time, while everything else remains constant. The additional product of labor can be precisely determined as part of the experiment. Economists continue to use examples like the shoemaker because it applies science to wages and they want people to believe that today’s wages reflect individual productive value as part of science, and not politics or favoritism.

For those who are comfortable transferring the fable of the shoemaker to the wages and incomes in today’s economy, including the wealthy, they will feel comfortable that the wealthy earn what they produce. For some of us though, it is all bluff.

Student Aid and Tuition

The Education Trust, a nonprofit advocacy group, recently released a report and statements titled “Opportunity Adrift” that criticizes the financial aid practices of public universities. The report used data from 2003 to 2007.

The report accused public research universities of increasing the amount of aid to students whose parents make at least $115,000 a year by 28 percent, to $361.4 million. Also it reported that public colleges routinely award as much in financial aid to students whose parents make more than $80,000 a year as to those whose parents make less than $54,000 a year.

Apparently public universities do have authority to favor the neediest students over those who are better off, but if tuition is going up at a faster rate than the maximum in Federal government need based financial aid then students of modest means will be crowded out anyway.

Posted in-state tuition at the University of Virginia in the 2002-2003 academic year was $4,595; in 2008-2009 it was $9,505. That amounts to an annual compounded rate of increase of 12.88 percent.

Virginia is not alone. At the University of Arizona the increase over the same years was 14.23 percent; at University of California-Berkeley it was 10.52 percent; at the University of Colorado-Boulder it was 12.63 percent and so on.

Federal financial aid comes primarily from grants and loans and it is not keeping pace with the inflation in college tuition. Grants are the best form of aid since they do not have to be paid back, but grants and loans have yearly upper limits.

From 2003 to 2007 the top Pell grant award was frozen at $4,050, but went to $4,731 for 2008. It should have been $5,832 by 2008 if it was keeping up with inflation as measured by the Bureau of labor Statistics education price index, one component of the Consumer Price Index.

But the price index comparison doesn’t measure the short fall of funding in the years 2002-2008. In the 2002-2003 academic year at the University of Virginia a Pell grant covered all but $545 = $4,595-$4,040 of tuition. In 2008 the gap of funding was up to $9,505-$4,731 = $4,774.

The more grants in aid fall below tuition the more difficult it will be for prospective students from moderate income households to finance their education. In the period from 2003-2007 wages were not keeping up with inflation either. Federal student loans have limits and Congress raised interest rates during the years of the study.

In this way we shouldn’t be surprised that State Universities are channeling more financial aid money to higher income applicants because we suspect they have fewer lower income applicants who can afford to fund the rest of their tuition. It also suggests that the Federal Financial Aid program is the problem more than the state universities.

There is reason for optimism because the Obama administration has increased the Pell Grant maximum $5,350. Of course we shouldn’t ignore the policies of state universities in directing their Financial Aid, but the first place to look for problems is at Federal Financial Aid.

The Big Short

Michael Lewis, The Big Short: Inside the Doomsday Machine, (New York, NY: W.W. Norton & Co. 2010), 266 pages, $27.95

The Big Short tells the story of the 2008 financial crash by following a small cast of characters who saw it coming. In a brief prologue, titled Poltergeist, Lewis recounts his experience on Wall Street in the 1980’s by summarizing the period as a time when a great nation lost its financial mind. He told that story in his first book on Wall Street, Liar’s Poker, published in 1989. That book is still relevant and makes a good preamble for The Big Short.

Back in 1989 Lewis had hope the finance sector would improve. Now he is disgusted that nothing has changed, but he wants to set the record straight by telling the story of the people who not only saw it coming but also had the nerve to bet on the outcome.

The story begins when we meet the first in a cast of characters: Steve Eisman. Eisman got a chance to operate his own hedge fund, Front Point Partners, after some years working at Oppenheimer securities. He invited several other like minded colleagues to help: Vincent Daniel, the numbers guy, and Danny Moses, the trader. Before long Daniels began to notice a high rate of defaults on manufactured housing sold with sub prime mortgages. It was the first in a long list of evidence showing the sub prime mortgage bonds had no real earnings.

In Chapter 2 we meet Michael Burry, who was finishing medical school and starting his medical internship, but found time to pursue his fascination with stock and bonds. He started his own hedge fund: Scion Capital. Mike Burry found he could earn good returns as a contrarian who bet against popular trends, the perfect approach for the sub prime mortgage market.

After we meet Michael Burry but before we meet the partners of Cornwall Capital, the third of the three hedge funds that Lewis features, we meet Greg Lippmann. Lippmann is a Deutsche Bank bond trader who is the wild card of the sub prime mortgage meltdown: an oddball among oddballs. He not only decided that vast numbers of home mortgages were certain to default as soon as home prices stopped rising, he developed a 42 page presentation to promote and sell the idea. The presentation was titled “Shorting Home Equity Mezzanine Tranches.”

To make money the Lippmann way required buying Credit Default Swaps on the worst sub prime mortgage bonds. The Credit Default Swap is a contract sold as an insurance policy against the risk of bond default. A buyer pays periodic premiums over the years of the contract to insure against the loss of principal in a default.

Credit default swaps are not regulated as insurance so it is up to the buyer to discuss the seller’s reserves, or ability to pay if there is a default, but the hedge fund does not need to be insuring against a debt they own. They can enter into a contract to buy a credit default swap because they expect, or hope, a bond will go to default and they will get a payoff.

Markets with buyers of credit default swaps need sellers of default swaps, which turned out to be the insurance giant AIG. They were willing to sell billions of credit default swaps. Beginning on page 72 and going to page 77 we learn more details. We learn that Front Point Partners and Scion Capital were not the only ones buying Credit Default Swaps, Goldman Sachs was also buying them. That put Goldman Sachs in the position of selling bonds to customers while betting on them to default.

There is more however, because Goldman Sachs apparently reasoned that Credit Default Swaps generated a cash flow from premiums payments that was similar to the cash that bond holders get from bond interest. From this idea Goldman Sachs began selling a bond called a synthetic CDO where the buyer received the amount of the credit default swap insurance premium as long as the underlying bond did not default.

To sell these so-called bonds they had to pay what Lewis calls “fat fees” to Moody’s and Standard and Poor’s to falsely rate their synthetics with a triple A rating. In a footnote on page 77 Lewis tells readers they get a gold star if they followed the story so far. I may not deserve a gold star, but readers should be warned I read these pages several times to understand whatever I understand.

By chapter 5 we learn 13,675 hedge funds reporting results and that despite the hard sell of blunt talking Greg Lippmann only 10, or perhaps as many as 20, of these hedge funds are actively bet against sub prime mortgage market.

Chapter 5 is also where we meet the managers of Cornwall Capital, the final hedge fund the Lewis describes. The founders, if that is the word, were two thirty year old guys with a $100,000 Schwab account: Jamie Mai and Charlie Ledley. Later they brought in their neighbor Ben Hockett who had Deutsche Bank experience.

They started by turning a $26,000 purchase of Long Term Equity AnticiPation Securities(LEAPS) into $526,000. LEAP’s we learn are a contract to buy a stock at a fixed price in the future. Eventually Cornwall Capital bought Credit Default Swaps that ended up as millions when the crash came.

The remainder of the book’s narrative follows the trials and troubles of the managers of the three featured hedge funds as they cope with the rest of the financial sector. Even after Cornwall Capital has amassed $30 million we read how they cannot get the “bigshots” of structured finance to take them seriously. We go with them to a Las Vegas conference in January 2007 where Steve Eisman stands up and tells the featured speaker he is wrong and a fool.

Over more than a hundred pages readers learn the personal burdens of predicting a crash. Running a hedge fund full of credit default swaps requires spending money on insurance premiums with nothing coming in until a default and the payoff. The delay of more than two years before the crash took its toll as nervous hedge fund investors questioned the whole strategy. The crash came and the payoffs were millions, but the winners Lewis interviewed sounded depressed more than vindicated. Realizing the financial sector was really out of its mind was not something they wanted to celebrate.

The book ends with an epilogue where Lewis has lunch with his former boss from the 1980’s, John Gutfreund. Recounting the lunch conversation helps tie the recent abuses to their beginning, which Lewis puts at 1985.

In the end the losers lost little because the federal government stepped in to save the bankrupt firms of Wall Street and their CEO’s who gambled with other people’s money and lost. Lewis reminds readers that Congress appropriated funds intended for Secretary Henry Paulson to buy sub prime mortgages from banks, but apparently the money was handed over to Morgan Stanley, Goldman Sachs and others with no strings attached.

Lewis avoids suggestions for reform, even something as simple as a 90 percent tax bracket for the income over several million dollars. I am reminded of a comment of Will Rogers speaking about the scandals of the 1920’s and the Harding Administration. He said it is hard to convince a jury of corruption in these lush times because the jurors secretly admire the people who get away with it. We will hope those sentiments have changed, but it is hard to tell even after reading a book like the Big Short.

Jobs and Deficits

I clipped a news article way back on August 11, 2005 when the Associated Press reported President Bush’s comments on a new transportation-spending bill. “President Bush calls the massive $286.4 billion transportation spending bill he signed into law Wednesday a job creator.”

The article goes on to describe the bill that will pay for 6,000 favored projects in the districts of nearly every member of Congress. Even though the legislation is $30 billion more than the President recommended he is quoted as “proud to sign it.” Remember too that 2005 was a year when the government reported a Federal deficit of $418.3 billion.

We have to admire President Bush’s candor in this matter because few politicians are prepared to emphasize that transportation projects are for creating jobs instead of transportation.

The effort of President Bush to create jobs sounds very nearly the same as President Obama’s economic stimulus plan. If President Bush recognizes the job creating potential of government spending shouldn’t all the politicians around the country recognize these same intentions in the Obama stimulus plan?

The current worries about the growing Federal deficit could make us forget that deficits are part of government spending. The deficit in 2008 reported by the government’s Bureau of Economic Analysis jumped to $933.6 billion, which was part of the $5.025 trillion of Federal expenditures. Eliminating $933.6 billion of deficit funded Federal Expenditures will eliminate $933.6 billion pumped into the spending stream; spending that both President Bush and President Obama agree helps to create jobs.

If America has less government spending then private sector spending will have to make up the difference. The country needs more spending to create jobs, but we are a country with 10 percent unemployed, and 43 million jobs paying less than $25,000 a year.(1)

We are also a country with a growing inequality of income where entertainers, sports figures and corporate chiefs are paid tens of millions of dollars. Recently NBC announced entertainer Conan O’Brien will get a $33 million dollar salary even though he is leaving his job. If his $33 million salary was divided into $50 thousand dollar pieces it would be $50,000 salaries for 660 families.

Those 660 families might buy 660 cell phones, but we have to doubt Mr. O’Brien will buy that many cell phones. Those 660 families might go to restaurants a couple of times a month. That would be 15,840 (2x12x660) restaurant meals a year, but we have to doubt Mr. O’Brien will eat out that much or create many restaurant jobs. Maybe those 660 families will go to the movies twice a month, and so on?

Working Americans have wages too low and taxes too high to keep us employed with their spending, but the wealthy are not making up the difference in spending or in taxes. If the politicians want to lower the deficit and create jobs in combination they will have to lower taxes on working Americans and raise taxes on the Conan O’Brien’s of the country. It no longer matters who thinks it fair or unfair. When it comes to jobs and deficits, distribution matters.

(1) Occupational Employment Survey, U.S. Bureau of Labor Statistics

Can They Do That?

Lewis Maltby, Can They Do that? Retaking our Fundamental Rights in the Workplace (New York: Portfolio, Penguin Group (USA) Inc., 2009) 248 pages, plus 6 short appendix.

Lewis Maltby writes in the preface of his book that “Learning how to run a productive, profitable company without violating employees’ human rights became the focus of my life.” The focus of his life took shape after law school, a period as a criminal defense lawyer, board member of the Pennsylvania ACLU, followed by corporate lawyer for a new company and then Head of the Department of Human Resources. The focus of his life is also the focus of the book.

Readers start with an introduction that has examples of the doctrine of employment at will: a legal doctrine of work without due process rights. First, there is a woman who was fired for having a John Kerry bumper sticker. Jobs in America come without freedom of speech. Second, jobs come with surveillance where employers can legally monitor and judge email, cell phones, arrest records, medical histories, credit histories, driving records, and demand drug tests, personality tests and psychological evaluation. Jobs in America come without rights of privacy.

The first eight chapters from a total of sixteen chapters cover the varied issues of free speech and privacy in more detail. Readers learn of the origins of employment at will and how it has been applied over many years, and more recently with the evolution of surveillance technologies. Maltby believes many of these policies are unnecessary and fail as well, but there are many practical examples and legal cases to illustrate these points and help job weary Americans protect themselves. These chapters introduce periodic appeals to get active and help change the system; appeals that are sprinkled throughout book.

In Chapter 4 we meet Roger Boisjoly, an engineer at Morton Thiokol, who warned his higher ups that the company’s O-rings on the Challenger space shuttle were likely to fail in the freezing weather at the Florida launch pad. They did fail and he got fired for being right because due process of law does not apply to America’s jobs. American’s can lose a job for any reason or no reason.

In Chapter 7 we meet Becky Thompson who lost her job in a drug test even though she did not use drugs. That is common because companies sometimes contract with sloppy labs that find many false positive tests. Congress decided to require lab certification for all companies doing government funded drug testing, but nothing for people like Becky Thompson who still have no rights because Congress does nothing about the doctrine of employment at will. Many of the same issues apply to dismissals for medical conditions and gene testing; other issues where Congress has been weak or evasive.

The focus changes from Chapter 9 through Chapter 14. Chapter 9 covers plant closings. Federal legislation passed during the Reagan administration requires 60 days notice for dismissing employees, but then readers learn why so many companies ignore the law. Most are bankrupt and without money to pay and a majority have fewer than a hundred employees, which exempts them from the law.

The next five chapters take the reader through labor law and the rights we do have. Chapter 10 has labor law for union organizing and contract negotiations, which means the National Labor Relations Law and amendments. There is discussion of the trials and troubles for labor organizers and the weaknesses of labor law, but also a reminder that unions help secure labor rights by negotiating labor contracts for members, contracts that courts do enforce. Chapter 11 is titled “The Judge Is Not Your Friend” so we can tell what to expect. Narrative here gives a summary of some major labor law cases, especially appellate court review before the Supreme Court. The chapter that follows has a fairly detailed guide to arbitration applied in labor disputes.

Chapter 13 covers the legislated exceptions to employment at will; those dismissed for reasons of race, creed, color, religion, gender, age, nationality and lately genes have some rights. Enforcement to protect these rights can be expensive and difficult even with some help available through the Federal government’s Equal Opportunity Employment Commission. This chapter includes discussion of the Fair Labor Standards Act and what to expect from America’s minimum wage and overtime rules. Also there is brief mention of defamation by employers.

The fifth chapter of the labor rights chapters shifts to international labor rights in the global economy. Free trade agreements like the North American Free Trade Agreement (NAFTA) usually include minimum standards for labor rights for countries to be eligible for free trade, but alas readers learn they are weak and poorly enforced. Reforms are suggested.

The final two chapters leave specific issues for general and gentle persuasion. Chapter 15, Capitalism and Freedom, argues that capitalism and economic growth do not conflict with human rights. The book ends with a wrap up and suggestions for taking back our rights, meaning taking back human rights on the job.

There are six appendixes: an employee bill of rights, a model corporate privacy policy, sample letters and a National Workrights Membership Application. The book does not have a bibliography and virtually no footnotes or footnote references.

Maltby uses an easy to read conversational style intended for a broad audience. He does not cover job issues related to immigration, nor job issues related to ex-cons who have served time. He avoids partisan politics even though labor and human rights permeate America’s politics. The only exception comes at the end when he lists the labor legislation that gives some protection for employee rights with a reminder that all were passed by Democratic votes and the opposition of the Republican Party.

In my experience people who press to make and enforce more rules in employment, or otherwise, do so with an agenda of control. More rules like drug testing give controlling types of people more opportunities to assert authority and tell others what to do. Evidence that drug testing does not work or leads to unfair results will not persuade controller types, they press forward in relentless determination. Too often people looking for jobs find employers who act like they do us a favor to offer a job. Can They Do That will help you remind these people a job in America is a requirement that should be part of your rights.

The Estate Tax

Some national politicians continue to support abolishing the estate tax, a tax on the value of assets at death before ownership is transferred to heirs. The Estate tax has been subject to similar pressures and changes as the federal income tax. Up to 1981 estate tax rates up to 70 percent were applied to the entire value of an estate with only a $50,000 exemption.

Since the early 1980’s Congress has repeatedly reduced the number of estates subject to the estate tax, mostly by raising the exemption. By 2001 the exemption was $1 million and the top tax rate 55%, but 2001 was also the year the Congress agreed to a 10 year phase out of the Estate tax. It is a 10 year phase out because next year, the tenth year, the estate tax is eliminated, but only for one year. The Bush era revisions to the estate tax expire in 2011.

Under the rules that remain for 2009 the first $3.5 million of an estate is exempted from estate taxation and the article reported that only around 100 estates will be subject to any tax, which would bring in $266 billion of revenue despite the small numbers.

At a time of colossal federal deficits the Congress has to make up its collective mind and decide if it wants to amend the current law to avoid losing that much revenue for 2010, when the tax will be zero. The decision for 2010 only applies to one year and only a small amount of revenue, but estate taxes have important social repercussions overtime.

Citizens are not citizens just because they live in the same country and share the same geography. Citizens need to share some common experience to understand each other and cooperate politically and socially. One of those common experiences is the need to finish school and find self supporting work.

If the heirs of the 100 people mentioned above receive $266 billion dollars they have no need to work, ever. They can afford household servants, private tutors, and lavish lifestyles without working and without understanding what other people have to do. They also have enough money to influence media and political agendas and perpetuate their status.

As the matter stands the estate tax of 2011 will be restored to the estate tax of 2001 unless the Congress can agree on new legislation. That was as far as Congress could get toward eliminating the estate tax in the early days of the Bush administration.

Critics in Congress keep pushing to permanently eliminate the estate tax. Eliminating the estate tax will begin building a small class of families with extraordinary wealth that can be diversified around a global economy and permanently protected from market forces.

The term “banana republic” describes a pattern of inequality, usually in Latin American countries, where a few dozen land holders have 90 percent or more of the wealth and the rest live on whatever is left. Despite a well documented increase in income inequality the United States distribution of income and wealth is still a long way from that, but abolishing the Estate tax is a step in that direction.

Financial Reform

More than a year after the 2008 financial collapse Senate Banking Chair Christopher Dodd of Connecticut made a formal release of a proposed financial reform bill. Senator Dodd directed his Banking Committee staff to up load an Acrobat summary of the bill, which is 12 pages and titled “Restoring American Financial Stability.”

The bill intends to create three new independent agencies: the Consumer Financial Protection Agency, the Agency for Financial Stability, the Financial Institutions Regulatory Administration.

It intends to create a new Office of National Insurance at the Department of the Treasury and a new Office of Credit Rating and an Office of Investor Advocate at the Securities and Exchange Commission.

Many of the duties and authorities of the agencies are combined from other existing offices and agencies, especially the Federal Reserve Bank. Under the new bill the Federal Reserve Bank would continue to manage monetary policy and be the lender of last resort, but it would lose many of its consumer and bank regulatory duties.

New duties for the new agencies include authority for the Securities and Exchange Commission (SEC) to regulate derivatives and hedge funds. New SEC duties give authority to examine credit rating agencies, disclose their methodologies and track record and deregister an agency. There are new proposals to regulate municipal securities advisors and dealers with enforcement through the SEC.

The bill provides for an annual assessment of the Securities and Exchange Commission, an apparent attempt to regulate the regulators, where an Investment Advisory Committee will watch over SEC practices and priorities along with a new Office of Investor Advocate.

There are more changes in corporate governance and shareholder rights and a page with the caption “Ending Too Big to Fail” describing new requirements for “limiting large, complex companies and preventing future bailouts.”

Back in 1998 the director of the Commodities Futures Trading Commission, a women named Brooksley Born, argued derivatives should be regulated because banks were taking risks lending money to hedge funds to buy derivatives. To shut her off Congress passed legislation prohibiting the Commodity Futures Trading Commission from writing new rules to regulate derivatives.

A review article [“What went Wrong” Washington Post, 10/15/2008] from last fall quotes former Federal Reserve Chair Alan Greenspan: “Regulation of derivative transactions that are privately negotiated by professionals is unnecessary.”

Apparently Congress agreed with Alan Greenspan that professionals are infallible, but that was in 1998. Now they think they are greedy and irrational and need to be controlled with new agencies and regulations.

Truth is that nothing has changed from the 1990’s or the 1930’s. Financial crises occur because banks only hold a fraction of deposit liabilities in reserve to pay for checks. If banks make enough risky loans for things like derivatives that default they will not be able to clear checks for account holders who need to make payments. Unless there is a bailout, business transactions will halt and the economy will collapse.

Back in the 1930’s there were many gamblers who took risks and bought stocks with borrowed money. After many banks failed Congress passed the National Banking Act of 1933 and the Securities and Exchange Act of 1934, which included Federal Reserve authority to set Margin Requirements: requirements that limit the percentage of borrowed funds to buy financial assets.

Margin requirements are still available for use as they have been since the 1930’s. If Congress thinks derivatives are not covered by Margin Requirements a sentence or two of revision in the regulations would take care of it.

Perhaps a 1,100 page bill reflects a Congressional mania for grandiose solutions, but I have to wonder about their motivation. Do they really want to regulate their friends on Wall Street? We will see.

Jobs and Surplus

The caption in the Washington Post reads “Obama calls for White House summit on job creation.” [WP 11/13/09] The article reports the summit will be an attempt to signal his concern about the growing ranks of the unemployed and to focus on longer term strategies to improve the job market.

It is a worthy goal but reducing the unemployment rate and the number of unemployed is not the same as creating more jobs. That is because a majority of Americans live in families that make job decisions that depend on their spouse and the circumstance of other family members.

Economists often act as though individuals make independent decisions when it is time to enter the labor force and become part of the labor supply. Instead one person losing their job will often mean that two people start looking for work.

To see why suppose the mister in the Smith family has a job as a tool and die maker working in manufacturing. Tool and die maker is one of America’s better paid production occupations with a median wage reported at $22.32 an hour or $46,430 a year for 2008, and a 90th percentile wage of $34.76 an hour or $72,300 a year. As a family they might earn $60 to $80 thousand dollars.

The Bureau of Labor Statistics reports jobs as tool and die maker in decline every year since the late 1990’s. With a broad base of manufacturing also in decline it is easy to imagine a layoff for Mr. Smith. Economists argue and predict people will work less at lower wages and work more at higher wages so unless Mr. Smith can find work at his tool and die maker wage economists expect him to work less after a layoff than before.

Economists do not base their predictions on interviews, observation or data. Instead they rely on conjecture about preferences. Leisure they argue is valuable and will be traded for work in the personal preferences of individuals. Therefore, at higher wages leisure time is more expensive because it means giving up those higher wages, and people with standard preferences want less of what is more expensive. Conversely, at lower wages leisure time is less expensive because it means giving up lower wages, and people will devote more to leisure when it’s less expensive.

Those less devoted to the economist’s way think the Smith’s will do whatever they can to pay the bills and maintain their economic status. Mr. Smith will take a job in maintenance or construction or whatever he can find at lower wages if necessary, and a second job working evenings or weekends, but we can expect that Mrs. Smith will also enter the workforce looking for work. Together the Smith’s work more hours at lower wages to keep up, just as they might work less if their wage was higher. People like the Smiths assure that lower wages add to the surplus of labor.

Business owners and economists will be invited to the above mentioned summit. Too often job summits end up sounding the great cry: get some training. We will hope they recognize that low pay helps create a surplus of labor that makes more jobs a necessary but not sufficient condition to ease America’s employment problems. Recognizing something new is a lot to hope, but it’s a start.

Skills and Wages

I have heard people say that the director, the general manager, the CEO, or the boss should make more money, have a higher salary, than the people he or she manages. It may not be a universal thought but in America high wages carry prestige, which many agree brings authority.

Economists commonly reject any idea that a wage depends on prestige or confers authority. In the economists tool chest wages depend on productivity. High productivity means high wages and vice versa.

Take doctors where productivity equals important skills that can only be learned over a long period of time: typically 10 years. The years of medical training are a personal investment, not only because Americans pay their medical school tuition and finance their own education, but because the skills belong to the individual and can be transferred between employers.

A personnel investment is different than a personal investment. Personnel investment is training paid for by an employer. Training typically runs for weeks or months with orientation to specific employer needs. Employers are reluctant to pay for long term, general training because the skills and benefits belong to the individual that can be moved to other employers.

In a society where individuals pay for their own post-secondary education wages must reflect the time and money for investment if we expect people to have skills. We don’t want doctors to be paid low wages because they would not have the ability or willingness to make the investment to learn what we want them to learn.

Late last spring I clipped an article where wages do not reflect the skills Americans expect. The caption was “Panel on Fatal Crash Looks at Pilots’ Pay, Commutes.” [Washington Post, May 14, 2009]

The article detailed the efforts of executives at Colgan Air to defend the low pay of their pilots following the worst airline accident in 7 years. The co-pilot, aged 24, earned “about $16,200” and commuted by air from Seattle to Newark, New Jersey to go to work.

Colgan officials justified the low salary and long commute by saying “Pilots are told what the pay scales are. Our pay scales are within the industry standard.”

The Bureau of Labor Statistics reports a median national wage of $111,680 for an occupation titled Airline Pilots, Co-pilots, and Flight Engineers.

There was a time, not too long ago, when airline pilots were almost universally trained by the military at public expense. When pilots left military service to find commercial jobs as pilots, the airlines knew they were hiring thoroughly trained pilots.

The time has passed when airlines can rely on finding applicants trained by the military, but if airlines pay for military style pilot training they know their pilots can leave and go elsewhere. The weak financial incentive for airlines to pay for pilot training puts the burden on individuals who now find it necessary to pay for their own training.

Much of the incentive for individuals depends on the wage they can earn. Going beyond the minimum to be a well trained pilot requires an early investment of time, money and lost wages. A salary of $16,200 will not pay for that investment.

We want pilots to make more the $16,200, but not because we want them to have prestige. We want them to make more because our safety depends on it.

Do it Yourself and Taxation

One of the seldom discussed advantages of owning a home compared to renting an apartment is the do-it-yourself opportunities it allows. Homeowners can pick a few, or many, of the maintenance and repair chores to do themselves. Where renters pay rent it must cover the full cost of commercial maintenance and repair; homeowners can provide untaxed labor that reduces their need for cash flow and income.

I am unaware that Congress or the state legislatures consider the do-it-yourself effects of their policies and taxes. Mostly they do the opposite because the U.S. economy depends on the volume of spending. To keep the economy going our governments would rather pressure us to work like demons and spend like maniacs.

Back in the great depression farmers produced a cash crop for market, but cash earnings were only part of their income. Fruits, vegetables, maple sugar and a high percentage of everything put on the family's table could be produced on the farm. Do-it-yourself production does not require a transaction but it means consumption and supports a family's standard of living in the same way dollar income producing on the job supports consumption.

In today’s economy we can drop our magazine subscriptions, our cable TV and the health club, but notice the recent “Cash for Clunkers” and tax breaks for first time home buyers provide help for spending and spenders, but not for those out of work and looking for ways to save. Policies of aid give aid to those with cash to pump up spending.

For the unemployed homeowner, or those with periods of unemployment, the pressure to pay property taxes continues without relief. America’s property tax system pressures people to keep their property in use or sell it to someone who will. If the United States was a country without property taxes, it would give those who owned homes a better opportunity to withdraw from the market place and turn more to do-it-yourself work.

America primarily uses a combination of income taxes, property taxes and sales, use and consumption taxes that demands a relentless tide of cash. As long as our politicians want us to spend our way out of recessions that is not likely to change.

A tax system that reduces income, payroll and property taxes in exchange for more emphasis on sales and consumption taxes would increase cash flow from wages and permit people to keep more of their interest earnings from saving. Higher consumption taxes on goods and services raise more revenue from those with the income and preference to spend, but lets others choose more do-it-yourself opportunities.

Recently I was speaking with someone who grew up on a farm in the 1930’s. He told me his father was required to grade and maintain the county road that went along their property as were all the farmers in the district. Well of course, it makes sense with farmers short of cash but time and equipment to exchange for taxes. It sure beats eviction.

Americans have millions of people short of cash like the hard pressed farmers of the 1930’s. America can give them better choices than the have now.

Public Debt and Private Debt

The United States Treasury will lose borrowing authority when the national debt reaches the legislated ceiling passed by Congress. Treasury Secretary Geithner will have to ask for an increase, which the Congress will grant, but he is bracing for the usual politics. Many in Congress use the opportunity to make government debt their number one worry in order to attach conditions eliminating programs they don’t support.

It is common for them to make comparisons between Government debt and personal debt. “My constituents pay their debts and keep their house in order and it’s time for the government to do the same.” That one is a favorite, but most of the announcements from members of Congress play on constituent anxiety and bias about their personal debts.

When people think of their private debts they worry they won’t be able to pay, but that is not the problem with public debt. The public debt must be managed as part of every administration’s duty to manage the economy. Federal Reserve Bank monetary and interest rate policy gets lots of attention, but without mention that it is also debt management.

When the Federal Reserve wants to lower interest rates to expand the economy, it begins buying outstanding Federal Bills, Notes and Bonds. Payments are by check and when the checks are deposited into bank accounts or converted to cash they become part of America’s money supply.

Buying Federal Bills, Notes and Bonds converts outstanding Federal debt to money and the government and Federal Reserve Bank can do that at anytime and in any amount.

Because the government and Federal Reserve Bank have money in any amount officials could retire the entire federal debt at anytime. They don’t do that because the increase in the money supply would generate inflation and retiring the debt is not a goal of economic policy.

The Federal Government also owns assets and has taxing authority and Federal officials could double or triple taxes and begin selling off its land and other assets to pay off the federal debt. They don’t do that either because it would depress the economy and cause deflation and retiring the debt is not a goal of economic policy.

The British government has done some of its borrowing using a bond called the British Consol, which has no maturity, but is sold in perpetuity. The owner gets periodic interest and can sell their Consol to someone else, but the government has no obligation to pay the principal, ever.

America does not have any equivalent to the British Consol. That’s because Americans think of debt as a symbol of excess that should be retired and they want a date when that will occur. They regard public debt as the equivalent of private debt.
Truth is America’s debt will never be retired, but will go up and down as meets the needs of economic policy. The politicians know this and they will raise the debt ceiling, but in the meantime we will have to listen to their excess.

Transportation and Free Enterprise

Shortly after taking office President Obama announced plans for government spending that calls for “billions of dollars to rebuild roads and bridges, modernize public schools, and construct wind farms and other alternative sources of energy.”

He didn’t say much about railroads but it is common to ignore the differences between America’s highways and railroads. With highways everyone has equal access. Anyone can start a trucking company and be ready to haul freight and pay fuel taxes by using Federal highways and the interstate highway system. The trucking companies are private enterprise, but the roads are public enterprise so truck transportation becomes a joint partnership of business and government.

Railroads are private companies that build and maintain their right of way and they own their locomotives and rolling stock. America’s rail routes go back to the 19th century when the Federal government provided land grants to investors who built the lines.

Suppose for the last 50 or 100 years that anyone who invested in a locomotive and freight cars had the right to use the entire rail network as long as they paid fuel taxes just like truckers do for the highways. That way new shippers and new investors could decide trucks or rail without the need to spend billions building and maintaining their own railroads.

Think of a big shipper like United Parcel Service that started way back in 1907. Now they operate their own airplanes and their own trucks, but using the rails means an additional set of transactions with railroads. Shipping rates must cover the cost of fuel, locomotives and freight cars, but also the cost of capital and profit for the railroads.

When it’s time to decide rail or truck, the decision depends on different financial considerations rather than the best way to move freight. Since rail is not available with just the expense of locomotives, freight cars, fuel and fuel tax like it is for trucks, decisions favor trucks.

A whole highway, street and bridge construction industry has grown up from America’s system of interest free and pay as we go fuel tax finance for highways but not railroads. Railroads have to resort to risky private funding and fluctuating interest rates.

We can only speculate how much more rail transportation America would have if the rails and roads had equal access to financing, but even more important, if shippers could use the rails like they use the highways.

During the presidential campaign the Republicans pulled out their favorite bogeyman and called Mr. Obama a Socialist. The terms capitalism and socialism have special definitions in American politics. Socialists are bad guys in political campaigns, but socialist projects like the Interstate Highway System get funded anyway. We can also see that capitalism and socialism are not really the issue; it’s the rules and the finance that make the difference.

Retail Costs and Manufacturing

The decline of the American Textile industry is well documented. In 1990 there were 928 thousand working in just the apparel industry; by 2008 it was down to 198 thousand. The decline is more than double the jobs lost in the automobile industry.

Most of us see our clothes marked "Made in China" or some far eastern country. In the debate over free trade economists have offered excuses for the made in China label. They said textiles and the cut and sew clothing industry are labor intensive and American labor is too expensive to compete with the Chinese.

News coverage on the global clothing industry often includes a picture of Asian women lined up in long rows at sewing machines suggesting another excuse: low cost needs large scale.

Large firms are common in manufacturing because manufacturing industries typically starts out with many companies that gradually consolidate into a few large scale producers. The automobile industry started out with hundreds of firms at the beginning of the last century. Gradually they combined into fewer, but bigger producers, until only three American companies survive in a small group of global auto companies.

The cut and sew clothing industry was never like the automobile industry, but large firms produced clothing to be sold and shipped to other firms in the wholesale and retail parts of the marketing chain.

Lately though creative retailers are finding small scale clothing production can be cost competitive when it is combined with their own retail operations. Retailers that produce on site in their own space capture the entire marketing margin; that is the sales price above their manufacturing costs.

Producing on site eliminates the wholesaler and has the potential to cut inventory and transportation costs. Clothing sales have seasonal fluctuations with peak sales in late summer and again in December. Staff doing cut and sew in off peak periods can be moved to retail selling in peak sales periods making more intensive use of staff and raising labor productivity and lowering costs.

Shipping charges from the Far East are eliminated with local production. Freight charges from China to Long Beach are only part of the expense to import clothing. There are Long Beach handling charges, warehouse in and out fees, forklift fees, customs entry fees, and customs duties, but the clothing shipment is still in Long Beach. Add the shipping fee from Long Beach to wherever, and when it is all added up shipping charges are not insignificant in the costs for importing clothing.

It is unusual for an industry to transform itself from a few dominate firms to many small firms in competition. It can happen though. For many years IBM dominated the computer industry. Then the microprocessor chip transformed the industry allowing hundreds of new firms to enter the hardware and software industry. The PC revolution created many jobs with firms only a fraction of IBM.

In the combined textile and apparel industries more than a million jobs are gone, but that should not mean it was inevitable as economist’s like to say. What looks inevitable may not be. America needs jobs and new ideas; maybe a smaller scale, fully integrated clothing industry is one place to look.