Keep it Lean

The size of government tends to grow naturally if not checked. There are many reasons for keeping the government lean and mean (a distant memory, but still a good standard)—personal liberty, personal responsibility and the moral qualities it fosters, economic dynamism, progress and efficiency, and the list goes on. Government bureaucrats, however public spirited and well meaning, are simply not driven by the spirit that animates the private competitive entrepreneur and those he or she manages. Both the
public sector and the private sector respond to the incentives they face. One of the government’s more effective tools for “regulating” the private sector is to fashion laws and regulations that create incentives for private sector behavior that serves the long run public interest. That is what Adam Smith’s invisible hand of self interest and competition do quite well on their own most of the time but there can be gaps (externalities) the government can sometimes fill.

It is difficult to get the incentives right in the public sector. Political leaders may have the public interest at heart but getting reelected must come first and their constituency may have special interests other than the national interest. Bureaucrats rarely advance their careers by standing up or standing out. When government interference with and involvement in economic activity exceed the essentials, it often starts us down a slippery
slop of catering to special interests that is increasingly hard to resist. Three recent examples, illustrate this point.

In the area of financial sector supervision, some have charged that the government has not regulated bank and financial sector behavior tightly enough thus contributing to, if not causing, the financial sector crisis of last year and the recession of last year into this one. While “appropriate” supervision is desirable, America’s financial supervisors (just for banks this included the Federal Reserve, Office of the Comptroller of the Currency, FDIC, Office of Thrift Supervision, and fifty state supervisors) suffer a number of weaknesses typical of government.

Banking supervisors did not foreseeing the housing and financial crisis any better than anyone else (how could they!!). “In May 2006, the nation’s fourth-largest bank, Wachovia, signed a deal to buy Golden West, one of the largest mortgage lenders in California….  The next month the board [of Governors of the Federal Reserve] unanimously approved the deal. The Fed wrote in its approval that it had “carefully considered” the warnings about Golden West and concluded that Wachovia had sufficient capital to absorb losses and effective systems for assessing and managing risks…. Two years after Wachovia closed its
deal for Golden West, regulators told the company it could no longer survive on its own. A hasty sale to Wells Fargo was arranged with the help of billions of dollars in federal tax breaks.”[1] The Federal Reserve and other banking supervisors did not lack adequate
supervisory authority in this instance. The problem was that they did not use the authority they had satisfactorily. New powers (though a few may be useful) would not over come these weaknesses.

Regulators rightly work closely with those they regulate, but are too easily captured by the perspective and interests of the regulated. In the extreme, regulars can fail to use regulatory tools and measure available or even mandated. The FDIC is required by law to intervene when a banks capital falls to less than 2 percent of its risk weighted assets. The fact that the FDIC’s deposit insurance fund is in danger of running out is proof that it has
failed to fulfill this mandate. [2]

A quit different example comes from the area of military procurement. Obviously we need a strong military and get a much better deal for the taxpayer by developing and buying military systems and hardware from the private sector. But consider how difficult it is for the government to judge objectively what is needed and who can prove it best.  I already commented on Lockheed Martin’s attempt to keep the unwanted and unneeded F-22 in the military budget The Defense Department finally won on this one with the passage of the defense appropriation bill Dec 20th without the F-22. The battle for the new U.S. Air Force tanker plane contract rages on (again) between Boeing’s and Northrop Grumman’s offerings. It is a brave Congressman who considers the
national interest over the jobs impact in his congressional district. Boeing, for example, once produced almost all of its airplanes and their parts in the Seattle Washington area. The move of its headquarters to Chicago and the scattering of its manufacturing and assemble plants to as many locations around the country as possible was certainly not motivated by economic efficiency.

These obvious challenges to efficient government have now hit a new low. “Insurance giant Mutual of Omaha will see less of a hit from a $10 billion-a-year industry-wide tax on health insurance providers, under the terms of a deal worked out between Senate Democratic leaders and Sen. Ben Nelson (D., Neb.).[3] This was part of the price Senate Majority Leader Harry Reid arranged for us taxpayers to pay in order to buy Senator Nelson’s vote for the Healthcare bill now almost sure to pass the Senate (Nelson was the 60th vote needed to block a filibuster). “Reid was buying the votes of senators whose understanding of the duties of representation does not rise above looting the nation for local benefits.”[4] Richard Cohn, who supports the bill, noted that “The bill has turned out to be a mosh pit of selfishness.”[5]  “Reid didn’t even attempt to offer a reason why Medicaid in Nebraska should be treated differently from, say, Medicaid across the Missouri River in Iowa. The majority leader bought a vote with someone else’s money….  Why doesn’t every Democratic senator demand the same treatment for his or her
state? Eventually, they will.”[6] “As news of the agreements proliferated, Republican senators went to the floor to protest. “This will not stand the test of the Constitution, I hope, because the deals that have been made to get votes from specific states’ senators
cannot be considered equal protection under the law,” argued Sen. Kay Bailey Hutchison (Tex.).  Her Texas colleague, Sen. John Cornyn, took issue with White House strategist David Axelrod‘s claim that such deals are “the way it will always be.”[7]

The problem is hardly limited to health care “reform.” Despite promises not to interfere with the business decisions of GM after the government took over its ownership, Congress could not restrain itself from forcing GM to keep open some of the dealerships GM wanted to close. “One United Bank in Massachusetts got aid after Rep. Barney Frank (D-Mass.) inserted language into the bailout bill that effectively directed Treasury to give the
bank special consideration.”[8] “Reid said when asked about the fairness of it all. ‘So this legislation is no different than the defense bill we just spent $600 billion on.’ That would be the bill with more than 1,700 pet-project earmarks. ‘It’s no different than
other pieces of legislation,’ Reid continued.”[9]

Sadly he is right. Obama the candidate promised to end earmarks. Under Obama
the President they have gotten worse. There is only one way to roll back and
keep such abuses in check, which threaten to bleed us to death from a thousand
little cuts, and that is to keep the government lean and mean—keep it out of as
much of the economy and our private lives as possible. And eternal vigilance.

[2] While it is
common for banks reporting capital of 2 percent to actually have negative
capital once intervened and the fuller picture is known, all the evidence is
that the FDIC has been negligent.

[3] Martin
Vaughan, Dow Jones Newswires, December 19, 2009.

[4] George F.
Will, “Dubious
‘Wins’ in Copenhagen and Congress”
, The Washington Post, December 22, 2009. Page A19.

[5] Richard
Cohn, “An
Imperfect Ray of Hope”
, The
Washington Post
, December 22, 2009, Page A19.

[6] Michael
Gerson, “For
sale: One senator (D-Neb.). No principles, low price.”
The Washington Post, December 23, 2009,
Page A19.

[7] Dana
Milbank, “Looking
out for number one”
Washington Post
, December 22, 2009, Page A2

[8] Binyamin
Appelbaum, “More
Bailed-out Community Banks Failing to Pay U.S. Dividends”
, The Washington Post, December 22, 2009,
Page A15.

[9] Ibid.


Author: Warren Coats

I specialize in advising central banks on monetary policy and the development of the capacity to formulate and implement monetary policy.  I joined the International Monetary Fund in 1975 from which I retired in 2003 as Assistant Director of the Monetary and Financial Systems Department. While at the IMF I led or participated in missions to the central banks of over twenty countries (including Afghanistan, Bosnia, Croatia, Egypt, Iraq, Israel, Kazakhstan, Kenya, Kosovo, Kyrgystan, Moldova, Serbia, Turkey, West Bank and Gaza Strip, and Zimbabwe) and was seconded as a visiting economist to the Board of Governors of the Federal Reserve System (1979-80), and to the World Bank's World Development Report team in 1989.  After retirement from the IMF I was a member of the Board of the Cayman Islands Monetary Authority from 2003-10 and of the editorial board of the Cayman Financial Review from 2010-2017.  Prior to joining the IMF I was Assistant Prof of Economics at UVa from 1970-75.  I am currently a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  In March 2019 Central Banking Journal awarded me for my “Outstanding Contribution for Capacity Building.”  My recent books are One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina; My Travels in the Former Soviet Union; My Travels to Afghanistan; My Travels to Jerusalem; and My Travels to Baghdad. I have a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago. My dissertation committee was chaired by Milton Friedman and included Robert J. Gordon.

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