Reason Magazine - Contributors

The Death of Social Security

info@reason.com (James K. Glassman) info@reason.com (Tyler Cowen) — Fri, 01 Apr 2005 00:00:00 EST

As George W. Bush's second term begins, no item on his agenda is more controversial than Social Security privatization--that is, allowing Americans to divert at least some of their payroll taxes into personal accounts that they can invest in mutual funds or similar instruments. So far, Bush's own plan has been maddeningly vague, but it has opened up a serious debate about transforming a government program that was once so sacrosanct that it was called "the third rail of American politics."

Is privatization necessary? Preferable? Politically viable? In January, with Bush's second inaugural in the offing, Reason invited James K. Glassman, a fellow at the American Enterprise Institute and host of TechCentralStation.com, to discuss and debate the ins and outs of Social Security reform with Tyler Cowen, the Holbert C. Harris professor of economics and director of the Mercatus Center at George Mason University.

Social Security's Fortuitous Crisis

James K. Glassman

This August marks the 70th anniversary of Social Security. If it ever had a reason to exist, it doesn't any more.

Social Security has three big problems, all of which can be solved by allowing Americans to invest--on their own --part of what they are now forced to send to Washington in payroll taxes.

First, Social Security is a blight on liberty. It extracts a big chunk of the pay of working people to benefit the retired. The vast majority of Americans are perfectly able to handle their own retirement savings, just as they buy their own food, clothes, and shelter. Even if we concede that government needs to force all Americans to save today so that taxpayers won't have to chip in to prevent the profligate from starving in their old age, why do we all have to buy the same annuity with the same terms from the same provider--that is, the government itself?

Second, Social Security creates a vast moral hazard. Since its implicit message is "Don't worry--Uncle Sam will protect you in your old age," it's a huge encouragement to spend rather than to save for your own or your family's needs.

Third, Social Security is a terrible retirement system, a Ponzi scheme that was inevitably going to collapse of its own weight. Instead of a conventional retirement account, with real assets accumulated over time, it was constructed as a pay-as-you-go plan: Current workers pay the bills of current retirees. (There's a small amount left over for a so-called trust fund, which predictably has become a piggy bank for the rest of the government.)

The first retirees in the system were big winners. For example, the very first recipient, Ida May Fuller, paid in $44 and collected benefits of $20,934. Times were different then. In the 1930s, 11 workers supported each retiree. The ratio is now 3.3 to 1. Soon it will be 2 to 1 and stay there. In 1929 life expectancy was 57; today it is nearly 80. Americans receive benefits far longer than they did before, and they can start earlier. Meanwhile, work force growth is slowing, and benefits are rising faster than inflation, since they are geared to wages, not prices.

As a result, by 2018, according to current predictions, retiree benefits will exceed workers' taxes paid into the system. Social Security will then present its IOUs to the Treasury for payment. The only way to get the cash will be to raise taxes, cut other government programs (fat chance), or borrow like crazy.

The system has been saved from insolvency in the past mainly by higher taxes. As a result, the actual returns that workers will receive from their contributions are minuscule: an estimated 1.5 percent annually after inflation for a typical person born in the last 30 years. Compare that with the average yearly return since 1926 from an account invested half in a stock index fund and half in Treasury bonds: 5 percent after inflation.

It's not surprising that young people especially have little taste for Social Security and little faith it will survive. The good news is that the impending disaster offers an opportunity to fix Social Security once and for all. The solution should:

� Guarantee the benefits of everyone now getting them, as well as others on the brink (say, those 55 and older).

� Gradually index future benefits to inflation, rather than wages, and increase the retirement age (currently 65 for those born before 1960, 67 for those born afterwards) by another year or two.

� Allow those under 55 to opt out of the current system by investing up to half of the retirement part of their payroll taxes (which totals roughly 10 percent of pay, including both the employee and employer contributions, for middle-income Americans) in an account with mandatory provisions that would restrict investment choices and require phased withdrawals starting perhaps at age 60 or when sufficient funds are acquired. Otherwise, ownership of the account would be unfettered and would belong to the worker and his heirs. It could be used to buy an annuity or simply provide needed income.

� Reduce, accordingly, the Social Security benefits of those opting out.

As the new system proves successful, gradually allow all former Social Security retirement deductions to go to personal investment accounts and broaden choices for those accounts.

Just before the last election, Investors Action, a new advocacy group that I chair, commissioned Public Opinion Strategies to poll likely voters on their willingness to switch to a system like the one I've described above. Among all voters under age 65, a slight plurality wanted to switch, 49 percent to 46 percent. But among those aged 35 to 44, the margin favoring switchers was significant: 61 percent to 33 percent. Among those under 35, some 64 percent wanted to switch.

Despite Social Security's reputation as the "third rail" of politics, intelligent discussion of the issue has been possible. Such congressional advocates as Rep. Jim Kolbe (R-Ariz.) have called for personal accounts repeatedly and have been elected repeatedly. President Bush said during the last campaign that he backed reform, implying that he supported some form of privatization, although he didn't spell out the details (and still hasn't as of this writing).

Bush evidently understands that Social Security reform could transform politics more broadly. Public Opinion Strategies, in another poll we commissioned after the election, found that investors (defined as people owning stocks or bonds, individually or through mutual funds) voted for Bush over Kerry, 52 percent to 46 percent, while noninvestors voted for Kerry over Bush, 54 percent to 45 percent.

What was striking was that the investor-Bush link remained strong at all income and demographic levels. For example, among those making less than $40,000 a year, a Democratic stronghold, investors were almost evenly split, with 47 percent voting Kerry and 46 percent Bush. But noninvestors voted for Kerry massively, 57 percent to 36 percent.

There's a good case to be made that becoming an investor increases a person's stake in free markets. Reforming Social Security using personal accounts would probably increase the proportion of Americans who are investors from about 50 percent today to about 80 percent in a few years.

Can Americans handle this much freedom? More than two-thirds of Americans (and 83 percent of married Americans) have bought a house--a far more difficult and risky investment than funding, over 40 years, a long-term account split roughly evenly, as I would advise, between stocks and bonds. Social Security treats Americans as children, keeping them in a kind of bondage, beholden to government for no good reason. The opportunity has come, at long last, to break the chains.

Cut the Benefits, Hold the Accounts

Tyler Cowen

We can improve Social Security, but let us opt for a sound transition. Unfortunately, some proposals would restrict liberty and responsibility rather than enhancing them.

I agree with James Glassman's first and second suggestions, namely that we should guarantee benefits for the current elderly and gradually index future benefits to inflation. The latter proposal would cause benefits to rise at a slower rate than otherwise, since current benefits are indexed to wages rather than to prices. It also would suffice to bring the system into future fiscal balance.

But here we begin to differ. Glassman proposes new private but government-regulated accounts. My alternative proposal is simple: Keep the limits on benefits but do not create the new system of accounts.

Of course we already have private accounts, which anyone can, if they wish, hold at Merrill Lynch, Bank of America, or Fidelity. Individuals can save in (relatively) unregulated fashion, and in some cases in tax-free or tax-reduced form (e.g., IRAs and 401(k) plans). It runs counter to both liberty and responsibility to set up a new system of "private" accounts with regulated contributions, investments, and withdrawals. We would end up adding to government involvement in the market economy, not diminishing it.

Whether we like it or not, government would come to be seen as offering an implicit guarantee for these accounts. If the stock market were to stay low for 10 or 15 years, retirees would demand that government supplement their returns. Government would feel pressure to cough up additional revenue exactly when the budget would be in the tightest squeeze. The result would be higher taxes in times of recession, exactly the opposite of what is appropriate. (It is true that government does not end up guaranteeing current IRAs, but that is only because we already have Social Security as a backstop.)

The private accounts would function as a kind of forced saving, as Glassman admits. But how much can government really force people to save through this kind of mechanism?

You can make people lock up funds in an account, but they can respond by borrowing more on their credit cards, taking out a bigger mortgage, and in general investing less in their future. The net increase in savings will be much less than the mandated increase. So the government will control more of our lives but without making our old age much safer. In essence we would see substitution from privately initiated saving to government-controlled saving. Is this really a step in the direction of liberty and responsibility?

And what will happen to the efficiency of private capital markets? Glassman already has admitted that investment choices will be "restricted." By whom? According to what standards? Will the government use these regulations to punish unpopular companies? How about companies that (supposedly) break the law? How about companies that supported the other political party? The proposal invites a politicization of investment decisions.

The Glassman proposal also would raise your taxes. Keep in mind that Social Security, whether we like it or not, is structured as a pay-as-you-go system. That means current taxpayers fund current retirees. If we allow current taxpayers to divert funds into private accounts, how do we fund the (constant) benefits to current retirees? It has to be either taxes or borrowing, and the latter means future taxes. Depending on how many people wish to switch to the private accounts, the size of this tax increase could run to the trillions.

In fairness to Glassman's proposal, it can be argued that these taxes would have been coming anyway. When subsequent generations of the elderly retire, we must pay taxes to fund their benefits. So arguably the Glassman reform is simply taking an implicit future liability and making it explicit in the present.

Unfortunately, the reality is grimmer than such logic would suggest. In theory it would work if government raised our taxes today, and then cut our taxes tomorrow as future retirees relied more on their personal accounts. But is that how governments operate? How often do they cut taxes just out of generosity? More likely they would keep the higher levels of taxation (and/or borrowing) in place. The plan would lead to a permanently larger role for government.

Whatever the problems with Glassman's idea, you might object, isn't the current system even worse? The correct comparison is not with the status quo but rather with caps on benefit increases. Those caps would bring fiscal stability to the system without requiring tax increases. Over time Social Security taxes could be cut. Individual saving would be encouraged. We could reap the higher returns available on private investment. At the same time we would not be breaking promises to current or near-term retirees. Even long-term retirees would receive a level of benefits at least as high as today.

And consider how benefit caps would operate in the long term. As benefits are held constant in real terms and the economy grows, the relative size of the Social Security program will shrink. Over time Social Security will become very small, in real terms, relative to the economy as a whole. This requires some patience, but it is the best recipe for privatization we have available. And it does not require additional regulation of savings or investment.

Glassman asks, "Can Americans handle this much freedom?" I think they are ready to handle more liberty than he is proposing.

Proceed With Caution

James K. Glassman

Tyler Cowen would reform Social Security by capping benefits, thus forcing people to save more on their own through existing private mechanisms, including IRAs, 401(k)s and taxable mutual funds, stocks, and bonds.

I am not sure what Cowen means by "caps." The implication is that he would stop increasing benefits, period. If inflation runs 3 percent annually, that would mean that in 24 years retirees would have half the purchasing power from their Social Security payments as retirees today.

Slowing the rise in benefits is part of my own proposal as well. I want to boost payouts to retirees each year according to the consumer price index, not according to the annual rise in wages.

Cowen's notion is only one step removed from the plan Milton Friedman outlined in Free to Choose and earlier writings: repeal payroll taxes immediately, keep doling out benefits to people currently in the system, pay all younger participants off (either in an annuity or in government bonds) for the value of what they have contributed, and let everyone fund his own retirement. Friedman would fund the reform by issuing new federal debt.

"This transition," he writes, "does not add in any way to the true debt of the U.S. government. On the contrary, it reduces that debt by ending promises to future beneficiaries. It simply brings into the open obligations that are now hidden. It funds what is now unfunded."

Let me be clear: I love the Friedman strategy, but it has two drawbacks. First, it is wildly impractical. There is zero chance that Congress will either shut down Social Security or, in the Cowen version, bleed it to death. Reformers need to be more subtle. Slowing the increase in benefits would, in a less brutal and more gradual way, force Americans to save more and rely on Social Security less.

The second problem is that in the United States we don't let people starve. Some people simply will not save for their own retirement--especially after 70 years of relying on the government. Even Hayek agreed that some form of forced savings is necessary to keep taxpayers from having ultimately to foot the bill for those who don't provide for their own future.

For this reason, and to meet political practicalities, mandatory elements are necessary in any reform plan--at least as a start. As I said in my first piece, these strictures can be phased out later as it becomes clear the plan is a success and as people get used to doing it themselves.

This is a good time to lay out the specific mandatory elements.

People who opt out of Social Security with, say, four percentage points (including the employer's contribution) of the 10 points that now go to the retirement part of payroll taxes must put that money into a personal retirement account (let's call it a PRA). The PRA would be privately managed and administered, but the investment choices would be limited--say, to six funds: two U.S. stock index funds (an S&P 500 fund and a broader, total-market fund), a corporate bond fund, a Treasury bond fund, a money market fund, an international stock fund, and a fund whose assets are split roughly 50-50 between stocks and bonds. A further requirement might be that persons over 50 would have to put all of their new PRA contributions into the last type of fund, to dampen volatility just before retirement. (A portfolio split 50-50 in this way has never lost money in any 10-year period since 1926.)

There would be restrictions on withdrawals from PRAs as well. We could say that, at age 60 (or at the time of the accumulation of at least $1 million in assets), a participant could either purchase an annuity or begin withdrawing 10 percent of the account each year.

I am not happy about this sort of engineering, but I think it is necessary to passing some kind of reform. Also, I agree with Cowen that these protections are not foolproof. Some people might borrow away all their savings.

The counterargument to this compromise plan is that Democrats, who understand that a nation of investors is the death knell for New Dealism (and thus the end of their party as we know it), will oppose Social Security reform in any form, so why not the best? Perhaps, but my strong impression is that many Republicans are squeamish about major changes in a popular system that dates back to FDR. Proceeding cautiously, putting a firm foot in the door, is a better approach.

I'm Not Milton Friedman

Tyler Cowen

We can and should reform Social Security without the mandatory elements postulated by James Glassman. Still, Glassman and I are in more agreement than he has noticed. He writes: "I am not sure what Cowen means by 'caps.' The implication is that he would stop increasing benefits, period." But I did note that "I agree with James Glassman...that we should guarantee benefits for the current elderly and gradually index future benefits to inflation."

So my plan would not create any new problem with starvation. Furthermore, rising real incomes over time will supplement these benefits, so each generation of the elderly will still be better off than the last, even without the government-managed private accounts Glassman calls for.

Glassman compares my ideas to Milton Friedman's plan, but the differences are significant. Most of Glassman's response thus really concerns Friedman, not my own notions of what we should do with Social Security. Some differences I have with Friedman: I don't think we can abolish the payroll tax, or that we can "buy people out" from the system.

To the benefit caps that we really agree on, Glassman wants to add government-regulated personal accounts. The economics here are straightforward, once unbundled from benefit caps. Our government would raise taxes (or borrow) to finance further private investment in equity markets. Furthermore those investments are to be regulated by the government. I expect that Reason readers, once they hear the plan described in these terms, will be suspicious.

Glassman makes two arguments about my proposal. First, he says it is too radical. But his points refer to Friedman's views, not mine. My own plan actually deviates from the status quo less than Glassman's does. We both agree on benefit caps. He wants to add an additional change--regulated personal accounts. I want to leave this choice in private hands. Of course, the mere fact that my plan is less radical does not mean it will be adopted. But a) it is a viable contender, and b) we should first put forward what is best to do.

Glassman's second argument is that my plan would lead to starvation. Again, this is confusing my plan (cap real benefit growth gradually over time) with Friedman's idea to shut down Social Security altogether. Furthermore, this emphasis on "starvation" is further reason to believe that if Glassman's regulated private accounts underperformed, government would step in to fill the gaps. We would end up with the worst of both worlds.

I maintain my suspicion that Glassman's proposed transition will lead to a long-run increase in taxes and the size of government. Yes, we are just trading in implicit for explicit liabilities. But as I argued, taxes and borrowing will go up in the short run under Glassman's plan. I worry about this outcome. I do not trust government to lower future taxes simply because it will not need the money to pay future Social Security benefits.

The First-Best Approach

James K. Glassman

Now that Tyler Cowen has clarified his position, he makes a good argument for a second- or third-best approach to Social Security reform: Slowly squeeze recipients through lower benefits, pressuring them to save more--but do nothing to set up special tax-advantaged retirement accounts. I worry, however, that, rather than promoting more personal responsibility for retirement saving, the Cowen plan would create a powerful constituency for reinstating the current benefit levels and even raising them.

We need to get Americans out of the habit of expecting government will provide them with most of their retirement income (the role Social Security plays for two-thirds of the nation) and instead demonstrate clearly that there is an alternative. My plan, which is probably close to what the Bush administration will propose, also calls for reducing benefits, by indexing them to inflation rather than to wages. But I believe that America's workers should have the choice of putting, to start, up to half of the retirement portion of their payroll taxes (about 5 percent of a middle-income salary) into a personal retirement account. That account, of political and social necessity, would have some restrictions on investment choices and on the timing and amount of payouts. Cowen makes meritorious libertarian arguments against such restrictions, but I am convinced a Social Security reform consisting simply of benefit cuts has no chance of passage--nor does the more sweeping Friedmanesque reform I described.

I reject Cowen's contentions that government would "step in to fill the gaps" if private accounts underperform, and that a scheme like mine will "lead to a long-run increase in taxes." First, government has never stepped in to make shareholders whole in the case of other "regulated" (as Cowen calls them) retirement accounts such as IRAs, 401(k)s, and the Thrift Savings Plan for federal workers, and the chances that such accounts will perform worse than Social Security itself over time are essentially nil, if we judge from history. Second, Cowen's own plan is just as likely to lead to tax increases. Almost certainly, as in the rescue in the 1980s, the formula for keeping the leaky Social Security system afloat will be a combination of higher taxes and lower benefits.

Finally, the establishment of private retirement accounts--even with restrictions--will be a blessing for tens of millions of low- and middle-income Americans who have little or no savings. As we've seen in Chile, when people are introduced to investing in stocks and bonds, they like the experience and want more. The problem today is that payroll taxes are so high that young people especially don't have the cash to save and invest. Reforming Social Security would change that.

Reform also should have a profound effect on the political system, which is why the left so fiercely opposes personal accounts. (The New York Times is almost hysterical on its editorial page.) In the last election, investors across the board preferred Bush over Kerry compared with non-investors. About half of American families hold stocks and bonds, and that ownership appears to change their perspective on capitalism and markets for the better. Imagine if 80 percent of U.S. families owned stocks and bonds. That's what Social Security reform would do.

Yes, Let's Choose the First Best

Tyler Cowen

I've already discussed most of the substantive points Glassman offers. I would like to note two points of terminology:

1) It is unusual to write, "Now that Tyler Cowen has clarified his position..." when I simply repeated what I had already said in my first contribution to this exchange.

2) Second, Glassman still misrepresents my opinion. He writes that my idea would: "slowly squeeze recipients through lower benefits, pressuring them to save more."

But I wrote: "I agree with James Glassman's first and second suggestions, namely that we should guarantee benefits for the current elderly and gradually index future benefits to inflation. The latter proposal would cause benefits to rise at a slower rate than otherwise."

More generally, I'll repeat my core characterization of the Glassman (Bush?) proposal. It suggests that the government should tax/borrow more money so that some American citizens can invest more in stocks. I'll vote no on this idea and hope that something better comes along.

A Sad, Infuriating Tale

info@reason.com (James K. Glassman) — Thu, 24 Jan 2002 00:00:00 EST

This article originally appeared in TechCentralStation.

Some business stories make you angry - like the collapse of Enron. Other business stories make you sad - like the bankruptcy of K-Mart. Still others make you both - like the suit filed yesterday by AOL Time Warner against Microsoft Corp.

AOL was once a proud, entrepreneurial, profitable company. Today, it is a bloated, money-losing behemoth, the largest media conglomerate the world has ever seen. AOL's merger with Time Warner, completed a year ago, has not worked out. AOL stock, which was trading at more than $90 per share before the merger, closed Tuesday at $28.40. It's down by more than half since June. And no wonder: The company has lost an incredible $3 billion in the past 12 months, despite cost-cutting and management changes.

Now, instead of competing in the marketplace - where it's been battered lately - AOL has decided to compete in the courts. The suit serves several purposes: It distracts investors from AOL's business woes, and it adds confusion in an attempt to scuttle a settlement already reached among the U.S. Department of Justice, nine state attorneys general and AOL's arch-rival, Microsoft, to end an antitrust action begun in 1997.

Also, by filing a lawsuit, even one of dubious merit, AOL purchases a low-cost lottery ticket. After all, the company, in league with other Microsoft competitors, got the federal government to file the initial suit, so U.S. taxpayers have borne nearly all the costs of prosecuting the software company. Other unscrupulous companies, please note the technique: Don't bother filing a suit yourself. Get the government to do it. Then piggyback later on its expensive work.

AOL's suit seeks damages for the alleged harm done by Microsoft's business practices to the Netscape browser. AOL wants Microsoft to stop such practices and to pay damages.

It's a strange suit - to put it mildly. After all, it was in 1999 that AOL agreed to purchase Netscape for $10 billion. In other words, the year after the government sued Microsoft for thwarting Netscape, AOL bought the company for a ton of money. Now, more than three years later, AOL decides to sue Microsoft.

If AOL were all that worried about Microsoft's alleged anti-competitive practices in the first place, then why did it buy Netscape? No one forced AOL to shell out $10 billion. And AOL's Steve Case, who is hardly a naïve guy, knew full well that Joel Klein and his colleagues at the Justice Department were claiming that Microsoft was crushing Netscape unfairly.

Clearly, AOL's management believed that it could compete with Microsoft anyway - especially with a massive federal lawsuit preoccupying Microsoft's own management. But just as clearly, AOL was wrong. Netscape turned out to be a poor investment (its market share has plummeted to about 10 percent, compared with nearly 90 percent for Microsoft's Internet Explorer, which, by the way, AOL chose as its online service's own browser).

So AOL has turned to an arena in which it increasingly finds more comfort than the rough-and-tumble marketplace: the courts and the political system.

"Over the next five years," Case told the National Press Club in 1998, "I believe the future of this medium will be determined more by policy choices than by technology choices." Sadly, he may be right. AOL has played a big role in promoting policy (and politics) over technology. Remember that the firm campaigned in 1999 in Congress, state legislatures and city councils to persuade politicians to require cable companies to give "open access" to content providers like AOL at government-mandated terms and prices.

But then, in 2000, AOL made its deal with Time Warner, which had 12.7 million cable subscribers. Suddenly, the shoe was on the other foot, and AOL was trying to prevent the kind of forced access it championed.

The company clearly has still not learned its lesson: Keep the courts and the politicians out of technology. In the end, technologists lose, and consumers lose.

Speaking of consumers, I can't understand how they're hurt by a business strategy that offers browsers for free. Would consumers - who, after all, are the people who are supposed to be protected by antitrust laws - be happier if they had to pay $100 or $200 for a browser? Free software is hardly a new Internet idea; AOL continually offers "upgrades" to its own service for free. Is it unfairly competing?

It's no coincidence that AOL's dramatic lawsuit comes just as a federal judge is deciding whether to bless a hard-won settlement, reached by nearly all the parties in the massive anti-trust suit against Microsoft. Nine attorneys general, among them America's top publicity-seekers, remain holdouts. They have asked, among other things, that Microsoft be forced to give away the Explorer source code.

But AOL Time Warner itself will have to tread in a gingerly fashion to avoid anti-trust crusaders. Its sheer size alone makes it a tempting target. As an Internet Service Provider, AOL at last count had 29 million subscribers; by contrast, Microsoft, at number-two, had just 5 million. AOL also owns Turner Broadcasting, the leading revenue producer in cable, with such networks as CNN, Turner Classic Movies, TBS and the cartoon channel; 60 magazines, including Time, People and Sports Illustrated; Warner Bros. Pictures and television; Warner Music Group; plus the cable properties.

Yet the company, which just announced a new CEO, hasn't been able to put all the pieces together. Revenue, according to the Value Line Investment Survey, is "lackluster" and "subscription revenues are softening." The research service concludes, "Investors should be cautious? Issues of performance and integration still need to be resolved. In addition, there is a risk that the company may have to either raise debt or dilute its stock." Debt, by the way, already stands at $20 billion - a lot of money, even for a company with $38 billion in sales.

Instead of straightening out its business problems, AOL has decided to spend its time and effort filing lawsuits against tough competitors - a petty, distracting pursuit that won't help AOL or, for that matter, the U.S. economy, which depends on firms like Microsoft for the innovation necessary to bring about a technology revival.

After the Sept. 11 Attacks

info@reason.com (James K. Glassman) — Wed, 28 Nov 2001 00:00:00 EST

The Sept. 11 terror attacks have spawned a new cliché. The media establishment is saying, over and over, that Americans love big government again.

R.W. Apple Jr.'s "White House Letter" in Friday's New York Times carried a typical headline: "Big Government is Back in Style." The headline on a Christian Science Monitor op-ed by Daniel Schorr was, "Government's Back, Big Time"; on a Los Angeles Times piece by Ronald Brownstein, "The Government, Once Scorned, Becomes Savior."

This is wishful thinking by the punditocracy. Yes, the public trusts government to fight terrorism, and it's willing to give the military and domestic-safety agencies more money and power. But Americans are not going to hand Congress and the president a blank check to expand the welfare state.

In fact, the result of the terror attacks may be to reduce government. Two prominent vestiges of a command-and-control vision of the U.S. economy are now - because of the war - is serious jeopardy. As institutions protected and subsidized by taxpayers, the U.S. Postal Service (USPS) and Amtrak - at least as we now know them - may be on their last legs.

Postal Service: Postal workers have been victims of bioterrorism, and they deserve praise for their courage. But the attacks have also prompted Americans to ask how much traditional postal service they really need.

It all reminds me of a 1997 episode of "Seinfeld," where Kramer gets fed up with the mail service and goes to the post office to cancel delivery permanently.

"What about your bills?" asks Newman, the postal clerk.

"The bank can pay 'em," says Kramer.

"The bank.... What about your cards and letters?"

"E-mail, telephones, fax machines, Fed Ex, telex, telegrams, holograms...."

"All right," says Newman. "It's true! Of course, nobody needs mail. What do you think? You're so clever for figuring that out?"

It may be inertia that has kept Americans from using the technology to improve on the absurd practice of writing things on pieces of paper, addressing them, stamping them, walking a few blocks to stick them in a box, having the box emptied and the envelope brought across the country by plane, truck and foot, etc., etc.

Now, it seems, bioterror may trump inertia. What to do about the mail service? First, end the U.S. Postal Service monopoly on first-class letters; second, end the USPS monopoly on the use of the letter slot (yes - by law, the feds own the slot in your own door, and companies like Federal Express are prohibited from using it); and, third, end all government subsidies for the USPS and make it compete on an equal footing with UPS, Fed Ex and others.

Amtrak: A scathing report, issued by the Amtrak Reform Council (set up under a 1997 act that kept the railroad alive for five years) stated Nov. 14 that "Amtrak has made no significant progress toward self-sufficiency" and concluded, "America has a critically flawed rail passenger company."

Amtrak is losing about $1 billion a year, but, worse, as ridership and revenues rise, so do losses. Amtrak, like the USPS, survives because of its political connections. The USPS has far more employees (798,000 vs. 25,000), but Amtrak's crazy route structure runs through 45 states. Members of Congress talk tough, but they always give Amtrak - which has never made an operating profit in 30 years - more money, to keep a tiny group of constituents happy.

A well-run private service could serve constituents, too - and probably better. Again, there is a simple solution, laid out in Derailed, an excellent book by Joseph Vranich, former director of the National Association of Railroad Passengers. Following a model used in Britain, Japan and other countries, the government should auction off selected routes to the private firms that require the smallest subsidies. Other routes should be shut down. The Northeast Corridor should be a goldmine, but Amtrak can't make it pay.

Ending subsidized mail and rail government monopolies fits well with new public attitudes since the attacks. Americans, now more serious, have less patience for programs that don't work. When the pundits talk about a return to big government, what they really mean is a return to more government spending on national security. That's nothing new. It goes back to Hobbes and Locke: government's first and most important job is national defense and domestic safety.

Increased spending on antidotes to bioterrorism, the creation of a new Office of Homeland Security, federalizing airport security guards, emergency funds for New York, even providing grants and loans to the airline industry (and not, say, to the hotel industry) - all of these steps were taken to improve security of Americans in a time of danger.

The Sept. 11 attacks put pressure on our institutions. Some, including the White House and the military, have risen to the challenge. Others have not. A Gallup Poll, taken Nov. 8 to 11, found that 89 percent of those surveyed approved of President Bush's performance in the crisis, and only 8 percent disapproved. But for the news media, only 43 percent approved and 54 disapproved.

There's not much that can be done about the media, but it's unlikely Americans will tolerate the continuing poor performance of the postal service and passenger rail. Both need free-market therapy, and this is the time to provide it.

Bonn Climate Meeting Is Crucial for U.S.

info@reason.com (James K. Glassman) — Thu, 19 Jul 2001 00:00:00 EDT

BONN, Germany, July 19, 2001 -- Delegates representing the 178 nations here at the big conference on global warming appear resigned , at last, to the fact that the United States is not going to change its position on the Kyoto Protocol. President Bush rejected the agreement in March, calling it "fatally flawed."

Paula Dobriansky, the new undersecretary of state for global affairs, said earlier this week at the U.S. will not be putting compromise proposals on the table at this continuation of the Sixth Conference of the Parties to the United Nations Convention on Climate Change (COP-6) "We very much appreciate that others are reaching out to the United States and are thinking of ways of engaging us, but we do truly believe the protocol is fundamentally flawed," she said, echoing President Bush. "We will not be coming back to the protocol."

In an editorial today, the New York Times described Dobriansksy as having "the unfortunate distinction of being the first American climate change negotiator with no negotiating position." In fact, she has a clear position: It is that the U.S. has rejected Kyoto as an extreme and expensive solution to a problem that has still not been confirmed by science. What is needed, the president has said, is more research.

Even die-hard Kyoto enthusiasts like Jurgen Trittin, the German environmental minister, are getting the message. Trittin said that "it would be unreasonable to infer that Washington would change it position," the German newspaper Frankfurter Allgemeine reported today.

So what is the point of this meeting? For the pro-Kyoto contingent, it is hard to say. After talks broke down at the original COP-6 at the Hague, a Bonn follow-up was scheduled. It was put off for two months, but supporters did not want to cancel it -- even though another COP, this one in Morocco, is set for late October.

But for the U.S., this Bonn meeting is crucial: It provides an important opportunity to put the final nail in Kyoto's coffin and to demonstrate the new president's resolve in foreign affairs in general.

The U.S. is cast in the role of a parent that has told a child "no." The child, not surprisingly, continually tests the parent: "Are you sure?" "Won't you change your mind?" In this case, the parent -- both here in Bonn and in the G8 meeting of world leaders that starts tomorrow in Genoa, Italy -- is simply reaffirming the decision -- mainly as a matter of substance but also for the child to know that the parent's word should be taken seriously.

As a result, compared with the excitement at the Hague last fall -- when Europeans were negotiating with Americans on ways to implement Kyoto -- Bonn is boring and, for Kyoto advocates, deeply dispiriting. Demonstators are few (the floating party of Euro anarchists prefers Genoa by the sea, and why not?), and the American delegation is low-key and inconspicuous. In contrast to the Hague, when Senators like Chuck Hagel (R-Neb) and Represenatives like James Sensenbrenner (R-Wis) were in constant evidence, not a single member of Congress is here.

While there are 34 Americans on the official list of participants, that's not a big number as these international meetings go. The Dutch have sent 43 government delegates here; the French, 47; and the hosting Germans, 106.

Even Greenpeace, the hard-core environmental organization whose young delegates dominated the halls at the Hague conference, is barely visible. Early this morning, three Greenpeace students debated three American students from an anti-Kyoto group before a crowd of about 100. Such balance would have been unthinkable at past global environmental meetings.

Kyoto opponents, including the students, were pleasantly surprised by an article that appeared on page 3 of the highly regarded German newspaper Die Welt yesterday featuring Ulrich Berner, a Hannover scientist whose research, like that of Sallie Baliunas of Harvard, indicates that cycles of solar intensity, rather than build-ups of carbon dioxide, are the main cause of surface heating on earth.

In fact, one of the major changes since the Hague is that opponents of Kyoto, encouraged by the official U.S. position, are not afraid to speak out. A delegate from Canada, for example, speaking at a press conference this morning, insisted that the country's emissions-reduction target be met in large degree through the use of "sinks" -- forests and farmland that suck up carbon dioxide.

Kyoto requires enormous reductions in greenhouse gases for developed countries, especially the United States. A study by the Energy Department during the Clinton Administration estimated that implementing the treaty would reduce U.S. output by three to four percentage points annually -- a cost of $3,000 to $4,000 per American family. Other economists have said that the ripple effects from slow or no growth in the U.S. would severely damage developing countries.

At the Hague, the U.S. attempted to clarify how it could use other means, including sinks and emissions trading, to meet its targets, but Europeans took a hard line, dooming any chance for American ratification. By a vote of 95-0, the U.S. Senate passed a resolution in August 1997 opposing any climate-change agreement that excluded developing countries from its strictures and that would result in serious economic harm to the U.S. Partly as a result, the Clinton administration never submitted the treaty for ratification, but it delegates in the Hague, led by Frank Loy (who eventually got a pie in his face from enviro-activitsts) tried hard to get the Europeans to compromise, but to no avail.

Now, the only question is whether Kyoto will proceed without the Americans. That prospect, too, seems unlikely. Much of the early attention here has focused on Japan, which has been ambivalent -- and generally lukewarm -- about ratification. The nation's new prime minister, Junichiro Koizumi, said flatly on Sunday, "We will not be able to reach an agreement in Bonn." Koizumi, like Bush, was only stating the obvious, but, at U.N. conferences, such candor is exceptional -- and difficult for delegates and bureaucrats to absorb.

The Japanese also indicated that it was unlikely that they would ratify Kyoto unless the Americans do so. Yoriko Kawaguchi, Japan's environmental minister, said that "partcipation of the U.S. is critically important." Together, the U.S. and Japan are responsible for 42 percent of greenhouse emissions by developed countries (as of 1990, the base year); the treaty requires 55 countries with total developed-nation emissions of 55 percent for enactment.

But, if the Europeans are so enthusiastic about Kyoto, why don't they proceed, whether they get the requisite 55 percent or not. So far, however, not a single European country except Romania has ratified the treaty, which was signed nearly four years ago, nor have the Europeans taken the natural step of modifying treaty terms to lure the U.S. back into the fold. Why not?

In an article posted online by the New Republic earlier this week, Gregg Easterbrook, a respected writer on environmental issues, raised the specter of continental hyprocrisy. "When Euros say" they back Kyoto, Easterbrook wrote, "they mean it with the same deep, sincere conviction that members of Congress used when they said they backed campaign finance reform, confident it had no chance of passage. European Union states can now thump their chests about how badly they want Kyoto because they are confident it has absolutely no chance of going into force."

Easterbrook also notes that, not only has no E.U. country ratified Kyoto, but "the European Commission, the E.U.'s executive body, has proposed no meaningful anti-greenhouse measures; of European states, only Denmark and Norway have taken domestic action, and of the token variety."

If the Europeans were serious about enacting Kyoto, this theory goes, they would simply relax their position, get support from Japan, Canada and Australia and go ahead without the United States.

Still, judging from the morose faces here in Bonn, I find it hard to agree that the Europeans -- not to mention their allies in developing nations, who are required to do absolutely nothing under the treaty -- are truly overjoyed at the firmness of the U.S. opposition.

But, then again, lumping all Europeans together may be misleading. It is Europe's enviros -- mainly the Green Party politicians who control environmental ministries -- who are represented here. The cynics are back home -- or in Genoa.

Hell's Bells

info@reason.com (James K. Glassman) — Sun, 01 Apr 2001 00:00:00 EST

The Telecommunications Act of 1996 was supposed to open up the local phone loop and end the so-called Baby Bells' monopolies. Instead, the Bells filed lawsuits to protect their privileges, then dragged their feet; now they're appealing to politicians for help. The result: more monopolies. In 1996, there were eight local companies -- the seven Baby Bells plus GTE. Now there are only four. Verizon -- a combination of BellAtlantic, Nynex, and GTE -- had $65 billion in revenues in 2000, up from $13 billion in 1996. SBC Communications -- formed from Southwestern Bell, PacTel, and Ameritech (the Bell of the Midwest) -- has a market capitalization of more than $160 billion, twice that of AT&T.

These companies monopolize the last mile of telecommunications into the home, a status protected by state regulators. As a result, they have steadily increased their returns. Even Bell South, a relative laggard, had a 26 percent return on equity in 1999, compared with 13 percent as recently as 1993.

Further evidence that the Bells are winning a war of attrition came after Thanksgiving weekend. Covad Communications Group, one of the largest upstarts to enter the high-speed Internet data transmission market, announced not only that it was laying off 400 workers, but also that it would stop building out its DSL network. Analysts are predicting that data communications will grow at an annual rate of 70 percent over the next few years, and the high-speed service Covad provides seems like just what people want. Yet the one-time darling of investors has seen its stock plunge 93 percent in the past year. In an attempt to stay in business, it has sold a 6 percent stake to SBC. Covad isn't the only company to cut back an expansion plan and seek a partnership with a Bell: NorthPoint, for example, will soon merge into Verizon.

In theory, the Telecom Act required the Bells to unbundle their networks and sell components to competitors at discounted rates. The carrot was that when there was sufficient competition, they'd be allowed into the long-distance business. But the Bells have sidestepped those rules. And now, with breathtaking audacity, they're trying to gut the Telecom Act's requirements. The Internet Freedom and Broadband Deployment Act -- a true misnomer -- would let the Bells immediately enter the long-distance data business and, soon after, the rest of long-distance services. The law would do so without opening local service to competition.

Meanwhile, the Bells are creating a thicket of new problems for their biggest potential competitor, the cable television industry. Arcane restrictions already make it impossible for cable companies to provide phone service to anywhere near the percentage of households that the Bells do. The Bells propose to hobble them some more, funding campaigns to force cable companies to open their lines to all Internet service providers.

The local monopoly lives -- and grows. Without firm action, the Telecom Act's 5-year-old promise of greater choice will instead come down to this: the Bells, the Bells, only the Bells.

Liberate Supply

info@reason.com (James K. Glassman) — Wed, 28 Mar 2001 00:00:00 EST

Committee on Financial Services of the United States House of Representatives At a hearing entitled "Beyond the Tax Cut: Unleashing the Economy"

Mr. Chairman, Members of the Committee:

My name is James K. Glassman. I am a resident fellow at the American Enterprise Institute for Public Policy Research in Washington, D.C., and host of www.TechCentralStation.com, which concentrates on issues of technology and public policy. I am also a senior consultant and chief columnist to Folio(fn), a financial services company that packages and markets portfolios for investors. My writing on financial and economic matters appears regularly in the Wall Street Journal, International Herald Tribune and other media, and I am co-author of Dow 36,000, a book on stock valuation. For six years, I was a columnist for the Washington Post. Prior to that, I was editor of Roll Call, the twice-weekly newspaper that covers this institution; publisher of two public affairs magazines, the New Republic and the Atlantic Monthly; and host of two television series, "Capital Gang Sunday" on CNN and "TechnoPolitics" on PBS.

My main area of academic interest is the nexus among technology, finance and public policy.

The message I bring you today is that the U.S. economy has slowed and that tax cuts and monetary easing are necessary but not sufficient to restore the rate of growth we experienced in the late 1990s. What is critical is that changes are made in regulatory policy to encourage a liberation of supply -- a resurgence of output. I will give specific recommendations on how this can be accomplished. First, however, I will briefly review the state of the economy; offer observations on why it has slowed; and present an analysis on why it has grown with such strength over the past decades.

State of the Economy

The United States economy has slowed significantly in recent months. The growth in Gross Domestic Product (GDP), the nation's output of goods and services, fell from 5.6 percent in the second quarter to 2.2 percent in third quarter to 1.1 percent in the fourth. Retail sales and job growth are flat, unemployment is rising, the critical Purchasing Managers Index has dropped by one-fourth in the past year, a majority of banks has tightened credit requirements for businesses, and industrial production has dropped for five straight months.

The high-technology sector has been hit especially hard. For example, Cisco Systems, the giant Internet infrastructure provider, was increasing its revenues at a 70 percent pace as recently as November. But by February, sales were actually down from the previous year. "This is important," writes economist Brian Wesbury of Griffin, Kubik, Stephens & Thompson, Inc., who then quotes Alan Greenspan, the Fed chairman, as saying on March 27: "High-tech goods -- semiconductors, computers, and LAN equipment...contributed two-thirds of the increase in manufacturing output between 1995 and 2000." Overall, electronic goods orders are off 4 percent over the past year. Meanwhile, the authors of a new study estimate that 80 percent of the remaining dot-com companies in the San Francisco Bay will collapse in the next year. Profit expectations for the companies of the tech-heavy Nasdaq have fallen 75 percent. We may already be living through the beginning of the first recession in 10 years; we will know for sure when the statistics are published in a few weeks.

The 1990-91 recession, which ran for nine months, was considered mild by historic standards. At its depth, the economy's output declined only 1.5 percent. Still, it is important to remember that even short and shallow recessions hurt. In the last recession, the unemployment rate rose from 5.4 percent to 7.8 percent (by the summer of 1992, after the recession had officially ended). It was not until December 1994 that unemployment returned to its pre-recession level. If we have a typical recession, three million Americans will lose their jobs. Also, even if we are not in a recession today, it feels like one. GDP growth has dropped from an average of about 4 percent to about 1 percent. That is roughly the equivalent of a decline from a GDP increase of 2 percent to a GDP decline of 2 percent.

Causes of the Slowdown

Today's slowdown has no single cause. These are the major culprits: Fed rate hikes. The Federal Reserve began raising interest rates in June 1999 with little sign of inflation. Instead, the central bank appeared to be reacting to high growth and to a buoyant stock market. The real, after-inflation, rate on federal funds, the overnight loans that the Fed targets, reached a peak of 5.1 percent in October 2000, the highest rate since September 1989 -- a year before the last recession -- constricting the flow of capital.

Tripling of oil prices. Eight of the nine post-World War II recessions, including the last four, have been preceded by an oil shock. It is the rising oil price plus tighter Fed policy that tends to cause recessions, and this double whammy is present today as well.

The drag of high taxes and a gigantic surplus. Federal tax revenues as a percentage of GDP last year were 20.6 percent -- a level exceeded only twice in U.S. history, in 1944 and 1945. The surplus itself is a reflection of these high revenues flowing into Washington. Cash that could have been used for consumption or new private investment is instead being used to retire the bonds of investors who typically use the proceeds to buy more bonds. Retiring debt -- especially with debt at such low levels (about one-third of GDP) is no way to spur an economy. (I respectfully refer the committee to my article, "The Joy of Debt" in the March 26, 2001, issue of The Weekly Standard.)

The end of the high-tech "enterprise zone." The past year, especially, has seen increased government intervention in the economy, especially in the high-technology sector and federal and state mismanagement of the planned deregulation of telecommunications. A year ago, I argued that this change in political approach to high tech threatened a "regulatory recession." We may be in it. It is no coincidence that high-tech stock prices began their 60 percent slide at almost the same moment that the Justice Department asked a federal court to break up Microsoft Corp., the software company that is credited with igniting the computer revolution in the early 1980s. While the antitrust suit against Microsoft was instigated by its competitors, the result has been to damage the capital-raising ability of nearly every high-tech firm -- and to encourage further interventions at federal, state and local levels, threatening to end the status of high tech as a kind of "enterprise zone," free from high taxes and onerous regulation. In telecommunications, the persistence of monopoly power in local markets has greatly deterred the rollout of broadband technology and deferred indefinitely much of the promise of the Internet.

Why the Economy Boomed

Before getting to the question of what must be done to reverse the slowdown, we need to examine why the economy has been so successful up to now. The U.S. is in the tenth year of an unprecedented expansion. Even if the recession did start in January, the economy will have grown a full year longer -- without respite -- than in any period since reliable statistics began to be gathered in the 1870s. The third-longest expansion (and the second-longest during peacetime) was the period that immediately preceded the brief 1990-91 recession. In other words, since July 1982, the GDP has increased consistently, with a nine-month exception. No economy in the world has seen such a boom in output and accumulation of wealth in so short a period.

Since World War II, there have been nine recessions in 56 years, but in the past 18 years there has been just one. Has the business cycle been repealed? That cycle works like this: Low unemployment and prosperity raise the demand for goods and services. This rising demand inevitably bumps up against supply, gets tangled in bottlenecks. With supply constrained, prices rise, and general inflation ensues. The Fed, whose job it is to prevent the depreciation of the dollar and to maintain financial stability, raises interest rates to whack down inflation. The economy slows and frequently goes into recession. Interest rates fall, the economy revives, and the cycle begins all over again. But in the 1980s and 1990s, this pattern did not hold. Strong growth -- at times more than twice the post-war average -- was accompanied not by rising inflation but by relatively stable prices.

Why?

The reason is that the U.S. has been undergoing what I call a "liberation of supply." When demand rose, it did not bump up against supply constraints, so prices remained tame. In a broader sense, capital and the other tools necessary for an entrepreneurial expansion were all in place, so the economy boomed. What were the factors that liberated supply? Here are the primary ones:

The spread of free trade. When bottlenecks occurred in this country, goods from other countries took up the slack. In addition, the U.S. has been helped by immigration (free trade in people, especially in high technology) so that labor shortages were milder than usual. And, at the same time, a financial revolution helped liberate capital and spread it around the world, with investors seeking the best place to deploy their funds -- often, the United States, with its relatively accommodating business environment.

Lower tax rates and new regulatory policies. Before Ronald Reagan's election in 1980, the top rate on income was 70 percent. It was cut 28 percent, but, even at today's top rate of 39.6 percent (which applies to nearly all decent-sized private proprietorships and partnerships), it is far lower than in the 1970s (though still too high). Low taxes encourage more work and investment -- that is, more supply. At the same time, the government began a series of deregulatory measures, beginning with transportation in the Carter Administration and extending to energy and telecommunications. This work is far from done, but the change helped remove supply constraints.

Better monetary policy. The Fed has learned a lot since the 1930s, when three successive chairmen presided over tight-money policies that exacerbated the Depression. Paul Volcker, with the backing of President Reagan, had the courage to ring inflation out of the economy, and Alan Greenspan has continued those policies. The next Fed chairman can be expected to do the same, keeping interest rates low and encouraging investment and the liberation of supply.

The high-tech revolution. The advent of inexpensive, powerful networked computers has boosted productivity -- the main component of economic growth. From a rate of less than 1 percent in the 1970s, productivity averaged 1.7 percent between 1982 and 1995, and a remarkable 2. 9 percent over the past five years. Very simply, productivity means more output for the same input -- that is, more supply. Why? Greenspan's own major contribution has been to recognize that information technology not only enhances the knowledge of businesses, it also reduces uncertainty -- so that companies do not have to maintain redundancies in their workforce, inventories or plant and equipment, thus reducing inputs. As he said in a speech at Boston College on March 6, 2000:

Before the quantum jump in information availability, most business decisions were hampered by a fog of uncertainty. Businesses had limited and lagging knowledge of customers' needs and of the location of inventories and materials flowing through complex production systems. In that environment, doubling up on materials and people was essential as a backup to the inevitable misjudgments of the real-time state of play in a company.... [Now,] fewer goods and worker hours are involved in activities that, although perceived as necessary insurance to sustain valued output, in the end produced nothing of value.

What Is to Be Done?

Tax Cuts and Rate Cuts

But lately, the liberation of supply has stalled. New bottlenecks and shortages have developed that threaten not simply to reduce growth but to raise prices as well, raising the specter of stagflation for the first time since the 1970s.

Two obvious steps are now being taken.

First, the Federal Reserve's Open Market Committee has reduced its target for the fed funds rate -- from 6.5 percent to 5 percent. The Fed is likely to continue cutting through the spring and early summer, and a typical easing cycle would bring the rate to 3.5 percent, which should be enough to revive the economy eventually -- though, as Milton Friedman long ago recognized, it takes six to nine months for rate changes, in either direction, to flow through the economy. It was not until last fall that we began to feel the impact of the rate hikes that started in 1999.

Second, Congress has begun action on President Bush's plan to cut taxes a total of $1.6 trillion over ten years. While this hearing is titled, "Beyond the Tax Cut: Unleashing the Economy," I want to emphasize the importance of significant tax relief. A short-term cut of $60 billion, as was recently proposed by some Senators, will give the economy little stimulus. Current GDP is $10 trillion. If half of the one-time tax rebate is consumed and the rest saved (a decent assumption), then increased consumption will represent just 0.3 percent of GDP. Or think of it this way: The CBO expects that tax revenues in fiscal 2001 will total $2.2 trillion. A rebate of $60 billion amounts to less than 3 percent of that figure. Even after such a rebate, tax revenues will still rise -- assuming that the relief occurs wholly within the fiscal year -- by some $41 billion for 2001, applying more drag to a declining economy.

If fiscal policy is to be used for short-term stimulus, then it must be far more aggressive. The surplus is expected to be $281 billion for fiscal 2001. A tax rebate of half that amount, retroactive to the first of the year and starting immediately, would have some sort of impact.

But such measures are diversionary and even counter-productive. Far more important for the long-term strength of the economy would be comprehensive relief in the form of reductions of marginal tax rates, across all brackets, as President Bush has proposed. Even if these reductions took place over time, they would immediately signal an important change to investors and consumers and would likely lead to more savings and investment and perhaps consumption as well. Also, in substance, cutting rates would spur entrepreneurship and investment by lowering the marginal cost of those activities.

A tax cut is the only sensible way to reduce the mounting surpluses, which will create a crisis of another sort by the year 2006, when the Congressional Budget Office forecasts that the federal government will accumulate $3 trillion in "uncommitted funds" -- money that can't be used to pay down the debt because there will be no debt to pay down. Greenspan worries that these funds will be used to purchase private-company stocks and bonds -- thus making the government a major player in the private markets and in corporate governance. Or the $3 trillion could, of course, be spent -- since, judging from the budgets of the past two years, surpluses have loosened constraints on Congress and the White House.

Surpluses, in fact, are dangerous in times like these. My colleague at the American Enterprise Institute, the economist Kevin Hassett, pointed out in testimony Feb. 13 before the Ways and Means Committee that "the last time we approached a slowdown with restrictive fiscal policy, the economy responded to high surpluses and a general weakening in consumer demand by posting the steepest decline in real GDP in postwar history, dropping a whopping 10.3 percent (annual rate) in the first quarter of 1958. At the time, the surplus was about 1 percent of GDP." Currently, it is forecast to be three times as high.

Regulatory Reform to Spur High-Tech Supply

But resuscitation will require more than interest-rate cuts and tax-rate cuts -- though they are absolutely necessary. It will require regulatory changes that liberate supply once again. Specifically, these steps should be taken:

The U.S. needs to formulate a clear energy policy that concentrates on encouraging supply. Currently, supply is being severely hampered by excessive environmental barriers to increased exploration for energy and by policies, such as "new source review," that discourage the renovation of old refineries and utility plants and the building of new ones. We have neglected supply for ten years and are just now beginning to suffer the consequences. High technology requires energy, but supply constraints are putting the supply of energy in jeopardy. I recently returned from California, the heart of the nation's high-tech economy, where rolling blackouts are wreaking havoc with production. The rest of the nation may follow this summer.

The antitrust policy of the later years of the Clinton Administration should be changed to take into account the realities of high technology. I am referring especially to two phenomena: that monopolies and near-monopolies tend to be short-lived since barriers to entry for competitors are low and information about new software and other innovations spreads quickly, and that high-tech monopolists and near-monopolists, with low (often no) marginal costs, have an incentive to increase production rather than restrict it, as monopolists of the past did. The antitrust suit against Microsoft was the seminal event that changed the relationship between government and high technology and frightened investors. The decision by the Justice Department to go after a breakup of Microsoft coincided almost precisely with the peak of the Nasdaq and the beginning of its decline of nearly two-thirds in value. As George Bittlingmayer recently concluded after a historical study in a paper titled "Regulatory Uncertainty and Investment: Evidence From Antitrust Enforcement" in The Cato Journal (vol. 20, no. 3): "The low investment of the late 1950s and early 1960s was due at least in part to a resurgence of aggressive antitrust and related initiatives interpretable as 'anti-business.' Some of the low investment of the 1970s may have had a similar origin." Much the same is happening now to the high-tech sector. Congress and the new administration have a chance to return to the course of the 1980s and most of the 1990s.

The bottlenecks that are restricting the spread of broadband technology must be forced open. The main problem is the lack of enforcement of the main piece of deregulatory legislation, the Telecommunications Act of 1996, which required the Bell monopolies to open up their systems to local competition as a condition for being allowed into long distance. But so far, after five years, in only four states have the Bells opened up enough to qualify. Meanwhile, mergers have produced a re-monopolization -- the eight regional monopolies that control 95 percent of the local telephone business (the "last mile") are now just four. Because the Bells won't cooperate in opening their networks (preferring to use the courts and politicians to foster delays), competitors called CLECs, or competitive local exchange carriers, are cutting back their service or are going bankrupt. Rates for consumers are high -- the opposite of the condition that prevails in competitive long distance. It's not a pretty picture. To bust the bottleneck, the Telecom Act must be taken seriously and, at the same time, state public utilities commissions should be encouraged to force "structural separation" on the Bells, requiring them to split into independent wholesale and retail units, so that competitors will get a fair shake. It sounds technical but it is the only answer to liberating telecommunications supply, allowing interactive businesses (many of which are now going under for lack of broadband) to prosper, and spreading the benefits of fast Internet connections to consumers.

Wireless, too, is being hurt by a lack of supply. Regulators should get out of the business of allocating bandwidth to the politically powerful and instead let market forces determine who gets space on the spectrum. Congress should auction the spectrum that it gave for free to the TV broadcasters in return for a promise -- unlikely to be met -- of a timely buildout of digital, high-definition television. And the Defense Department must stop hogging bandwidth. The Federal Communications Commission has been sitting on loads of spectrum in the 700-megahertz frequency band. Liberate it.

These four simple changes are for starters. Clearly, the federal Air Traffic Control system is another constraint on supply -- in this case, the supply of fast consumer and freight transportation -- that needs to be eliminated and replaced by a private, market-oriented ATC, with government oversight for safety only. Occupational regulations reduce output by raising costs for businesses. All such rules must be reviewed verify that their benefits exceed their costs. And state governments must reduce the threats -- especially to technology and energy -- inherent in the collusion between state attorneys general and trial lawyers, especially those hired on a contingency basis.

Conclusion

The U.S. economy has shown that, when supply is liberated, growth rates of 4 or 5 percent -- roughly double the post-World War II average -- are possible, without inflation. With tax cuts, interest-rate cuts, a supply-oriented energy policy and sensible regulations, we can revive a prosperity that will improve the lives of even more Americans than the boom of the 1980s and 1990s.

Stock Market: Reasons for Hope and Worry

info@reason.com (James K. Glassman) — Tue, 20 Mar 2001 00:00:00 EST

The date was Dec. 5, 1996. The scene was the ballroom of the Washington Hilton Hotel. The speaker was Alan Greenspan, the chairman of the Federal Reserve Board, keeper of the nation's money. He had been droning on for 45 minutes with an address on the 83-year history of the Fed, and much of the audience of 2,000, at this annual dinner of the American Enterprise Institute, was starting to nod off. Then, suddenly, out of the blue, Greenspan said that he was worried about "irrational exuberance" in the stock market. A few people caught it; most (me, included) did not.

But the markets did. The next day, the Dow Jones Industrial Average opened 200 points lower. It quickly recovered, however, and resumed its upward climb.

Only a few weeks before Greenspan gave that speech, two Ivy League economists, Robert Shiller of Yale and John Campbell of Harvard, told the Fed in a confidential session that they were worried that stocks were vastly overvalued and would fall by 50 percent or more. At the time, the Dow stood at 6,437. If you had heeded the warnings of Campbell and Shiller and Greenspan, you would have missed an increase of about 70 percent, including dividends -- despite the decline in the Dow in recent weeks.

It was the Greenspan speech that got me thinking: If Alan Greenspan believes that the only reason the market has been rising is that investors are "irrational," then I needed to get to work. There must be a more sensible way to explain why the Dow had climbed from 777 in 1982 to a level which at that time was nearly 10 times as high and that today is more than 12 times as high -- an increase of a factor of 20, including dividends.

So, with my colleague Kevin Hassett, an economist at AEI, I got to work. In March 1998, Kevin and I published our initial findings. A book, "Dow 36,000," followed late in 1999. We argued in our book that stocks were undervalued, that the rise in the market since the early 1980s was completely rational and that it would continue until the Dow got to around 36,000 -- about four times its level at the time we wrote the book. At that point, stocks would at last be fully valued and returns would level off.

As you can imagine, this theory was very controversial when it first appeared and is probably even more controversial today. Still, Kevin and I have not wavered in our belief that stocks are cheap and that investors -- if they do the right thing -- should profit handsomely.

Doing the right thing means buying diversified portfolios of stocks in excellent companies with solid track records and holding them for the long term (five years or more). In our book, we highlighted 15 such companies (there are hundreds more), and they have, in general, performed very well. Our poster child for Dow 36,000 was Tootsie Roll Industries, maker of those chewy chocolate logs (as well as Junior Mints, etc.) which has risen more than 40 percent. But diversification is key, and we urged readers not to load up on technology stocks but to buy financials, utilities, energy and consumer goods as well -- using such vehicles as mutual funds and new instruments like Folios, which are packages of stocks put together by professionals but managed by investors themselves.

History shows that stocks return twice as much as bonds but carry the same level of risk -- when both are held for the long term. In the short run, stocks are extremely risky, but in the long run that risk, or volatility, drops off sharply. For example, the worst 20-year period in history for stocks produced a gain of more than 20 percent, after accounting for inflation. The worst 20-year period for bonds produced a loss, after inflation, of more than 60 percent.

Investors have been waking up to this truth about stocks. Far from being irrational, they have become more rational. Even Greenspan himself has changed his mind. In speeches over the past year he has recognized the crux of our book -- the decline of what is called the equity risk premium -- as the primary reason for the 20-fold increase in share values.

But there is a wild card -- one that, frankly, we did not take into account in our book. It is that politicians, after decades of reducing their involvement in the free-market activity of business, would begin aggressively to intervene again. That is what began to happen in the closing years of the Clinton administration.

For a long time, high technology had been a kind of enterprise zone -- in Jack Kemp's excellent phrase. It was an area of low taxes and low regulation, pretty much beyond the radar range of politicians. That's changed. The key event was the Justice Department's antitrust suit against Microsoft -- and, more important, its decision last year to seek a breakup of the company.

Microsoft is the symbol and substance of the high-tech revolution -- a process that in 10 years has brought the price of a computer, adjusted for quality, down by 90 percent. Computers have become cheaper than TV sets, and a majority of Americans now use the Internet, to their benefit. But the Clinton Administration's attack on Microsoft, instigated by the company's competitors, had a depressive effect not only on that company but on high technology in general. It was no coincidence that the Nasdaq began its 60 percent decline just when the government moved for a Microsoft breakup.

Around the same time, local governments intervened on behalf of content providers that demanded that it fix rates and conditions for their access to cable Internet connections. The local Bell operating companies then tried to get government to take action to thwart their feisty broadband competitors. Governors and big retailers teamed up to try to tax Internet transactions. Plaintiffs' lawyers, with help from attorneys general, focused on high tech as their next target of opportunity -- after tobacco and handguns. And self-styled consumer groups, also with government help, began to go after online firms for privacy encroachments.

All of these steps dampened the enthusiasm of investors for e-commerce, and no wonder. Coupled with tripling oil prices, aggressive rate increases by the Fed, these government interventions are helping produce what I have called a "regulatory recession."

How bad is it?

Bad. But will it last? I don't think so. It is my belief that the Microsoft judgment will be overturned. Politicians will come to their senses. Taxes on the Internet will be postponed. Competition will blossom in telecommunications again. The economy will pick up.

The economy has been awfully consistent since the end of World War II, rising at a pace of about 2.5 percent a year, after inflation. In our book, Kevin and I assume that this average will continue. In fact, if the political sector would get out of the way of the private sector, 2.5 percent growth would prove to be far too low. Our economy can increase at 4 percent a year without inflation. If it does, then Dow 36,000 is a figure that could easily triple.

In the meantime, this is cold comfort for typical investors. For them, I have this advice:

First, review your portfolio. If you own good companies and if you have good diversification, then there is no reason to make changes -- again, as long as you can hold your shares for five years or more. Otherwise, you have no business owning stocks in the first place.

Secondly, take the political attacks on high technology seriously. For the economy -- and your investment portfolio -- to reach its true potential, Washington, Sacramento and every other government jurisdiction needs to get out of the way of the entrepreneurship that created this amazing revolution in the first place.

As for Dow 36,000: Our book did not offer a specific timetable. "It could take10 years or 10 weeks," Kevin and I wrote. We also warned: "Stocks, of course, will not go straight up. They never do. There will be dips, possibly even brief bear markets along the way. Those declines will provide great buying opportunities."

We have one of those opportunities now -- but only if politicians will get out of the way.

Bush Administration Must Say No To Jane And Kyoto

info@reason.com (James K. Glassman) — Thu, 08 Mar 2001 00:00:00 EST

Treasury Secretary Paul O'Neill is fond of telling the story of meeting Jane Fonda a few years ago. While CEO of Alcoa, he was invited to a White House briefing on global warming and found himself seated next to the actress and peace protester. She turned to him and said, "I'm a friend of the greens. What in the world are you doing here?"

Mr. O'Neill was startled and offended by the remark. "The assumption," he said later, "is you must not be a friend of the environment or the children ... if you are an industrialist."

If he met up with Ms. Fonda today, however, she would undoubtedly be less belligerent. Mr. O'Neill seems to be emerging as an aggressive advocate of action on global warming -- a strange role not just for a former industrialist but also for a top official in the administration of George W. Bush, who, like 97 members of the U.S. Senate, opposed the 1997 Kyoto Protocol, which calls on industrialized nations to make drastic cuts in emissions of carbon dioxide. Even Clinton administration studies estimate that implementing Kyoto would cut the rate of U.S. growth by one half -- and hurt poor nations more than rich.

At the first meeting of the president's cabinet, Mr. O'Neill passed out copies of a speech he gave at a trade association meeting in 1998 in which he said that there were two issues that transcend all others: "One is nuclear holocaust. . . . The second is environmental: specifically, the issue of global climate change and the potential of global warming."

In the speech, Mr. O'Neill criticized Kyoto -- not because it's too tough but because it's too timid. "I believe the real danger to civilization," he said, "is that, as a consequence of this 'brilliant' political process, we don't do anything for 10 years. That would not be a good idea."

Don't feel too relieved that climate change is outside Mr. O'Neill's ambit. Listen to what Christine Todd Whitman, the new chief of the Environmental Protection Agency, has been saying lately. Last week, she said the administration is considering putting limits on carbon-dioxide emissions as part of a "multi-pollutant strategy." In other words, the Clean Air Act would be amended to add restrictions on carbon dioxide, the most prominent of the greenhouse gases, to a list of chemicals that now includes sulfur dioxide and lead. Even though Al Gore liked the idea of calling carbon dioxide a pollutant, not even the Clinton administration had the nerve to push it this way.

Most likely a multi-pollutant strategy would mean a heavy carbon tax on just about every fuel -- except nuclear. (I'm assuming that the carbon dioxide expelled from the lungs of humans in the process of breathing would be excluded.)

A multi-pollutant strategy would help realize the objective of many greens. As the late Aaron Wildavsky, professor of political science at the University of California at Berkeley, wrote, "Warming (and warming alone), through its primary antidote of withdrawing carbon from production and consumption, is capable of realizing the environmentalist's dream of an egalitarian society based on the rejection of economic growth in favor of a smaller population's eating lower on the food chain, consuming a lot less, and sharing a much lower level of resources much more equally."

In an interview on CNN's "Crossfire," Robert Novak asked Ms. Whitman, "So, governor, the poor deluded voters who voted for George Bush thinking that he was different from Al Gore on the question of global warming, they made a sorry mistake?"

"Well," Ms. Whitman replied, "maybe they didn't listen closely enough, but he was very clear about that during the campaign." But, she added, "there are ways that we can get to a multi-pollutant strategy on energy that would allow for energy and still meet some of these demands and the needs we need to meet on global warming."

Actually, during the campaign, Mr. Bush had sensible things to say about global warming. He said that he opposed any policies that "would drastically increase the cost of gasoline, home heating oil, natural gas and electricity" and that any climate-related actions by the U.S. would have to include "market-based mechanisms."

The U.S. desire for extensive use of those mechanisms -- such as trading pollution credits or establishing carbon "sinks" (forests and farms that suck carbon dioxide out of the air) -- was the issue on which the post-Kyoto talks last November in The Hague foundered.

Follow-up talks are being scheduled in Bonn for June or July, and the administration urgently needs a clear policy. It's hard to see what the U.S. has to gain from ratifying the treaty, and accepting the Kyoto regime would cancel the benefits of any imaginable tax cuts.

As recently as December, Ms. Whitman didn't have a clue about climate change. When asked about the "state of the science" on global warming, she replied, "Clearly, there's a hole in the ozone, but I saw a study the other day that showed that that was closing." Whoops. The ozone hole is another matter entirely, and besides that issue is so '80s!

Mr. O'Neill is actually more promising. While his rhetoric sounds alarmist, he also expresses an admirable skepticism. In his 1998 speech, he said we really have just "one-and-a-half facts" -- that carbon dioxide concentrations have risen and that global temperatures seem to be up over the past century by half a degree Celsius. Beyond that, "we really need to do much more on R&D."

We do. But advocates of drastic action are pumping up the hysteria. An ideologically slanted summary recently distorted serious work by scientists of the Intergovernmental Panel on Climate Change (IPCC), contending that global warming will soon be causing malaria epidemics and floods. The latest is that -- even though the past November and December were the coldest such months in U.S. history -- the snowcap on Mount Kilimanjaro is melting (glaciers have been melting since the last ice age) and a professor at Iowa State University has concluded that global warming "could yield up to 24,000 more homicides and assaults in the United States."

In fact, says John Christy, professor of atmospheric science at the University of Alabama and one of the lead authors of the IPCC report, "Hurricanes are not increasing. Tornadoes are not increasing. Storms and droughts do not show any pattern of increasing or decreasing. ... Variations of climate have always occurred, even when humans could not have had any impact."

Beyond Mr. O'Neill's one-and-a-half facts, Richard Lindzen, professor of meteorology at MIT, told me, "there is very little consensus" among experts in the field. We don't know whether temperatures will continue to rise, whether human intervention has anything to do with the increase, and whether cutting greenhouse emissions will significantly cut temperatures.

What we do know, says Mr. Lindzen, "is the temperature is always changing for the Earth -- going up or going down. It has done both, and that doesn't say that it's due to carbon dioxide."

Since we know so little, Mr. Lindzen says, "the Kyoto Treaty is absurd. ... The U.S. has signed on to something that agrees to the precautionary principle" -- the idea that, "even if you don't have the data, if you don't have the science, if somebody proposes a problem, you're supposed to act on it."

Ms. Whitman says that "the president is very sensitive to the issue of global warming." Sensitivity is fine, but getting the facts is even better. Adopting Kyoto or branding carbon dioxide a pollutant would be disastrous to the world economy. Sorry, but sometimes Jane Fonda needs to be grossed out.

Bill's And Larry's Continued Political Misadventures

info@reason.com (James K. Glassman) — Mon, 26 Feb 2001 00:00:00 EST

Oral arguments in the federal government's antitrust case against Microsoft began on Monday. Anyone reading the two new books about the battle would have to conclude that the case never would have been brought without the political intervention of some powerful Silicon Valley companies that chose the political, rather than the business, arena to fight a tough competitor. Prominent among these complainers were Netscape (now part of AOL-Time Warner), Sun Microsystems and Oracle Corp.

Oracle's interest in bringing the full weight of the government down on Microsoft isn't surprising. As I wrote on TechCentralStation last July: "Larry Ellison and Oracle sell very expensive database software products. Bill Gates and Microsoft sell very inexpensive database software products. This looks like trouble to Larry Ellison, so rather than using guts and creativity to respond in the marketplace, he whines to the government that his company is being victimized by Microsoft."

But he went further. Press reports in June revealed that in 1999, Oracle hired Investigative Group International, the Washington, D.C., private investigation firm that had earlier helped the tobacco industry and President Clinton with its hardball tactics. IGI, as The Wall Street Journal reported, "promptly went trash-hunting" - literally prowling through dumpsters containing the garbage of trade associations and other groups friendly to Microsoft.

Ellison's response to this sleaze: "I feel very good about what we did," he told the press. "All we did was to try to take information that was hidden and bring it into the light. I don't think that's arrogance. That's public service."

This sordid history came to mind last week when Bill Clinton -- who, in quite another sense, has done some dumpster-diving on his own -- gave a speech Feb. 19 at an Oracle applications conference in New Orleans. Clinton and Ellison are made for each other.

The president received an estimated $100,000 for his appearance, and it had to be a welcome honorarium. It put Clinton back into the speaking game after a disastrous start.

Clinton, of course, has been in the spotlight lately for some controversial pardons, primarily of Marc Rich, who fled the United States 17 years ago to avoid federal charges, including racketeering and tax evasion. Clinton also pardoned a cocaine trafficker and a notorious fraud artist, at the recommendation of his brother in law.

The former president's first outing on the lecture circuit did not go well. When word got out that he would be appearing for $100,000 at a Morgan Stanley Dean Witter high-yield bond conference in Florida, many of the firm's clients were outraged. A few days after the talk, Philip Purcell, the MSDW chief executive, apologized to his customers. Then, two weeks ago, UBS Warburg, a division of the Swiss financial firm UBS, AG, cancelled a speech by Clinton for fear of similar controversy.

But Ellison, undoubtedly grateful for the Clinton administration's aggressive action against his arch-enemy Microsoft, stood firm. Ellison had earlier hired Joe Lockhardt, the presidential press secretary, as an Oracle executive.

Does all of this look a little sleazy? It does to me.

Thomas A. Schatz, president of Citizens Against Government Waste, put it well: "The government's case against Microsoft has been about favoring individual competitors rather than impartial application of the law. At the very least, this speech creates the appearance of impropriety and further illustrates the former president's tin ear for ethics."

The former president has one tin ear; Larry Ellison has the other.

In fact, Oracle's stock fell to $22 in late November, then rallied to $33 in January but then fell again to $22. Oracle's peak, last September, was $46.

Milton Friedman said two years ago that Silicon Valley companies would "rue the day" they brought the government in to solve their problems with Microsoft. Judging from their stock performance, I would say that was an accurate prediction. My guess is that the higher court will rule in Microsoft's favor. That's what I would like to see: the software company defeating a dangerously flawed view of antitrust law on the merits, rather than calling on the Bush administration to do it a favor.

Bill Gates and George W. Bush can teach Larry Ellison and Bill Clinton a thing or two about class and integrity.

How Tauzin Can Keep His Word And Stop Telecom "Remonopolization"

info@reason.com (James K. Glassman) — Tue, 20 Feb 2001 00:00:00 EST

Go to the official website of U.S. Rep. Billy Tauzin, the new chairman of the broad and powerful House Committee on Energy and Commerce. There's a big, bold, italic headline that says, "Je suis fier de representer le troisieme district de la Louisiane," above a picture of this proud representative of the third district of Louisiana in camouflage hunting gear, standing in a boat and holding up two huge fish (to my untutored eye, they look like tarpon). Meet Billy Tauzin.

He is the latest in a long line of Louisiana politicians to gain national prominence: Huey and Russell Long, Hale Boggs, F. Edward Hebert and Bob Livingston (who nearly went higher than any of them). Tauzin, however, took a circuitous route. He was first a Democrat, then switched. He claims to be the only member of Congress ever to serve in the leadership of both parties.

I lived in Louisiana from 1972 to 1979, where I founded and edited a weekly newspaper in New Orleans. I have known Tauzin a long time. We have shared similar political passions, and he appeared several times as an outspoken guest on my television series on PBS, "TechnoPolitics." We've talked about difficult personal matters, too, and we like each other.

Tauzin's basic instincts on public policy are good. He is truly one of us – a free-market zealot. But sometimes his enthusiasm sends him off into remote bayous. He became wildly enthusiastic about replacing the current tax code with a national retail sales tax – an idea that's sound theoretically (a simple system that taxes only consumption) but that would be impossible to enforce. Hardly anyone takes the idea seriously, and the co-author of his legislation to change the tax law is Rep. Jim Traficant, D-Ohio, the most flamboyant and probably least respected member of the House.

In 1999, Tauzin became concerned about the lagging dissemination of high-speed broadband Internet services to American consumers and small businesses. The Telecommunications Act of 1996 – signed into law five years ago this month – had promised better and cheaper telecommunications through competition and choice. But on broadband, at least, it has not delivered.

On the problem, Tauzin was right, just as he had been right on the tax problem. But, to complete the analogy, I think he was wrong in both cases on the solution.

Tauzin introduced a bill called the Internet Freedom and Broadband Deployment Act that would solve the problem, he believed, by allowing the Regional Bell Operating Companies, or RBOCs -- the local monopoly phone companies that had been created through the breakup of AT&T in 1984 – to get into the long-distance data services (that is, broadband) business immediately.

For a supporter of the original 1996 law, it was a weird, inexplicable try at a solution.

On Feb. 12, at a panel discussion held in the Cannon Caucus Room on Capitol Hill, I asked Tauzin about his bill, called H.R. 2420. The format of the session, sponsored by a new group called TechIssues.net, was that each of us seven panelists – five civilians plus Tauzin and Rep. Silvestre Reyes, D-Texas – could make a three-minute statement. Then the five could each ask a question of one or both of the two members. The topic was simply "Broadband," and the moderator was former Rep. Jack Fields of Texas, a key member of the Commerce Committee when he was in the House.

My own statement (which you can find in full here) also decried the slow rollout of broadband but argued that "gutting the act is no solution – neither, by the way, is it instant deregulation, as so many contend."

The 1996 law, I said, was based on an important idea – that the way to deregulate telecommunications (the goal everyone at the table professed to desire) was to give the local Bells, which controlled the "last mile" into the homes of just about every American, a big incentive. They could get into the long-distance business, which had already been deregulated, as soon as they opened up their local networks to competition. They were required to allow interconnection with their systems and to sell local service wholesale to competitors at reasonable rates.

But the Bells dragged their feet. Competitors were burdened with high wholesale costs and a lack of cooperation. Many are now going out of business. An editorial cited "legal roadblocks," "delays," and "hardball tactics." Meanwhile, as wireless and long-distances prices have plummeted, local-service prices have risen 10 percent since 1996.

"Incredibly," I said, "some in Congress [led by my friend Billy Tauzin] want to get rid of the only incentive the Bells have to open up to competition – the lure of being able to get into the long-distance business. Bills have been introduced [including H.R. 2420] that would let the Bells into the data part of long-distance (the largest part now, and very profitable) immediately – in order to spread broadband."

In other words, Tauzin wants to remove the carrot.

When my time came to question him, I asked how such a change in the law could possibly inspire the Bells to open up their local connections. Currently, they have a stranglehold on local service (97 percent of consumers and small businesses get their service from a Bell). Why would they give it up if they could get straight into data.

Tauzin answered that voice long-distance remained an incentive. Really? Has he looked at the stock prices of long-distance companies lately? The competition is fierce, and voice is dropping sharply as a proportion of total long-distance service.

He also said that the 1996 act was intended to deal with voice, not data, since broadband was in its infancy. Really? Then, why not call it the "Voice Act of 1996." The truth is that nothing in the law excludes broadband from the interconnection requirement. And, even if the act did not foresee broadband, then the advent of data simply provides an even stronger incentive for the Bells to open up.

I also raised the issue of "remonopolization" – the original seven Bells plus GTE, eight companies holding local monopolies, are now down to just four. This was the last thing Congress wanted when it passed the Telecom Act of 1996. Legislators expected more competition, not less.

Tauzin, in his response, was sympathetic. He had quoted earlier from an article I wrote on remonopolization and that appeared on the op-ed pages of the Dec. 27 Washington Times, "For Whom the Bells Toll: Death of Telecom Competition." And he said now that he would "insist that remonopolization does not happen" – though it seems that H.R. 2420 would enhance the power of the four firms (and, who knows, maybe they will soon be down to two or three?).

Just read the statement on his site about his "Internet Freedom" legislation: "H.R. 2420 frees the Regional Bell Operating Companies (RBOCs) to 'build out' and offer high speed Internet data and backbone hub services on a level playing field in competition with cable companies and current backbone providers. Do the cable and backbone companies want that to happen? Of course not! It's competition."

Tauzin, though well-meaning, has it exactly backwards. His bill, which has scores of co-sponsors, including the top Democrat on the Commerce Committee, would freeze local monopolies in place and allow the Bells to leverage their hold on the last mile into dominance in broadband as well.

As the discussion ended last Monday, I had the impression that Tauzin, a thoughtful guy, was beginning to have doubts about his own approach. I hope so. As I said in the Cannon Caucus Room, the authors of the Telecom Act had a great idea. The reason it is not working is that the act simply hasn't been enforced. Why reject it without trying it?

Consumers, Wake Up! Middlemen Are Ripping You Off

info@reason.com (James K. Glassman) — Mon, 12 Feb 2001 00:00:00 EST

For a year now at TechCentralStation.com, we have been warning of a menace we call “the revenge of the middleman.”

The Internet gives consumers the ability to buy directly from producers. That’s one of the great gifts of technology. Go straight to www.palm.com for your Palm Vx. Or go to a retailer, online or otherwise. Decide on the basis of price, convenience, service. The choice is yours.

All should have the opportunity to bypass agents, dealers and retailers – if that’s our wish. These intermediaries can certainly add value to a purchase (by giving us good advice, for example), but if we want to go it alone we shouldn’t find government standing at the side of middleman gatekeepers, ordering consumers to pay a toll in higher prices.

That, however, is exactly what is happening. Middlemen, organized in groups with lobbying skill, are getting laws passed that stop consumers from exercising a right that’s nearly as important as free speech – the right to buy from whom you choose, using new technology that saves money and time.

Just recently, the Progressive Policy Institute -- a Washington think tank affiliated with the Democratic Leadership Council, an organization started by centrist Democrats -- issued a comprehensive policy paper called “The Revenge of the Disintermediated,” laying out some of the most outrageous examples of this phenomenon.

If you’re baffled by the term, Robert D. Atkinson, author of the paper, can help: “Disintermediation can be defined as the reduction or elimination of the role of retailers, distributors, brokers or other middlemen in transactions between the producer and the consumer.”

He goes on with an example: “Consumers could buy books online directly from publishers who would ship the books directly from their printing plants. But even publishers and printers might be disintermediated if authors were to sell ‘e-books’ directly to the consumer, as mystery writer Stephen King has attempted to do.”

Imagine publishers going to their state legislators to bar King from selling his own works online. As crazy as it sounds, that is precisely what other industries are doing. The cost to the consumer, says Atkinson, is $15 billion a year.

We alerted you first to the outrageous example of laws (now in 49 states) that prevent consumers from buying automobiles directly from manufacturers over the Internet. Ford Motor Co. opened a website in Texas that allowed customers to bid on used cars returned to the manufacturer by drivers whose leases were up. The car would be transported from a Ford warehouse to the dealer of the customer’s choice, where it could be test-driven and purchased, with Ford paying the dealer a commission. Good idea, all-around, right?

Unfortunately, the arrangement violated Texas law. Acting on a complaint from dealers, a state official ruled that Ford was “acting in the capacity of a dealer by selling and offering to sell motor vehicles directly to the retail public via the Internet.” That’s illegal in Texas and, now, in nearly every other state. Ford quickly closed the site and took the case to court. But in November of last year, an administrative law judge ordered a $1.7 million fine for the company.

Meanwhile, Arizona, a state that in many other respects has a proud libertarian tradition, recently passed an absurd law that prohibits car manufacturers from selling even insurance, parts and auto-financing over the Internet. This law, too, is being challenged in court, but the damage is being done right now.

The Progressive Policy Institute paper provides more detail on the auto outrage. It also lays out examples in such areas as music, travel, contact lenses and medicine.

New technology, writes Atkinson, allows X-rays and other types of medical imaging to be easily transmitted digitally. So the images of a broken leg in Kansas City can be sent online to a radiology specialist in New York. But “practitioners in some states have pressured legislatures to make it illegal for radiologists not licensed in the state where the image is taken to read the image and make the diagnosis. In fact, the medical profession in many states is attempting to pass laws restricting the practice of all forms of telemedicine.”

For wine lovers, the Internet seems the perfect technology. Scores of small, remote American wineries, which in the past could not afford to market their specialties, can develop websites with all sorts of descriptive material and simple ordering forms. But, again, the middlemen won’t let them.

Recently, the Wine Wholesalers Association successfully lobbied Congress to pass a law that lets them sue out-of-state wineries that ship directly to consumers in states that have prohibited sales of wine via the Internet. Atkinson says that 30 states now have such prohibitions, and in six of them Internet sales of wine are a felony. Why? One reason is that the disintermediaries in the business of selling alcohol are especially powerful politically.

In fact, the attack on consumer choice by the wholesalers isn’t limited to just the Internet. Recently, one of the largest liquor distributorships in the Midwest dispatched armies of lobbyists to the state capitol in Illinois to pass “wholesaler protection” legislation that would make it next to impossible for suppliers to fire their wholesalers for any reason. After spending more than $1 million on what was panned in the media as the worst sort of special interest legislation, the monopoly wholesalers won – but only temporarily. The bill, which was signed into law by Gov. George Ryan in 1999, led to higher prices and created havoc on the marketplace. Consumers and the press were outraged, and a court challenge led to an injunction, still in effect, against its implementation.

It’s an old story. “The resistance which comes from interests threatened by an innovation in the productive process is not likely to die out as long as the capitalist order persists,” wrote the great economist Joseph Schumpeter, quoted by Atkinson. And, as Business Week recently pointed out, in the 1920s, the Horse Association of America “campaigned to limit the use of trucks and automobile parking on public roads.” The difference is that Internet technology threatens nearly every middleman who does not truly add value, not just blacksmiths and buggy-whip makers.

But the real question is not why threatened middlemen squeal, but why politicians heed them. Sure, they have clout, usually in the form of campaign contributions. But don’t consumers have even more clout? They would if they were organized, or if they knew what’s happening to limit their Internet freedoms. But they aren’t organized, and they don’t know.

While the PPI paper is sound, the recommendations it makes to solve the problem are questionable. Their focus – as, I guess, you might expect from an organization of Democrats – is on government action.

PPI wants, first of all, for the Bush administration to create “the position of e-commerce ombudsman to serve as an advocate for e-commerce competitors.” But the last thing e-commerce needs is a new official who’ll build a techno-bureaucracy. Consumer action, not federal action, is what’s needed.

PPI also wants to get the federal authorities to “increase efforts to prevent retailers” from colluding to retaliate against companies that attempt to sell directly to consumers. This is a big problem – Levi Strauss, for example, shut down its e-commerce site in 1999, “mainly because of a backlash from retailers,” writes Atkinson. Certainly, antitrust violations caused by collusion should be punished, but, otherwise, this is another area where government should not play a role. Producers (including the auto manufacturers) are going to have to work out their own compromises with dealer networks.

The think tank also wants to develop “.” No, again! Government licensing of hairdressers, optometrists, plumbers and practically everything else is simply a method for perpetuating cartels of professionals and wannabe professionals – to keep competitors out. Yes, such licensing rules at the state level create barriers to trade on the Internet, but the answer is not federal licensing. The answer is federal laws that prohibit the use of state licensing to restrict interstate commerce on the Internet – as restrictions like the one against radiologists clearly do.

I agree, however, with PPI’s recommendation that the Justice Department and Federal Trade Commission “take a more tolerant position if producers act collectively to sell goods or services online, as long as they are not colluding.” Absolutely. And I would amend that recommendation to say “sell or buy.” Alliances of all sorts are one of the great benefits the New Economy has spawned. Keep them coming.

And the think tank’s call for Congress to consider “national licensing requirements for industries and companies that now need to be licensed by the state” is fine, too – but only as a spotlight on state regulations that ought to be removed. Federal licensing would merely perpetuate many of the cartels of professionals and wannabe professionals that want competitors kept out. The goal ought to be to prohibit the use of state licensing to restrict interstate commerce – as restrictions like the one against radiologists clearly do.

The glare of publicity might energize consumers to organize against the barriers to the Internet disintermediated middlemen try to erect.

A new study by three economists from the National Bureau of Economic Research looked at 2 million referrals from the website Autobytel.com to auto dealers and found that “buyers who use” such a service “save about 2 percent on their average new car purchase.” Not bad: saving $600 on a $30,000 car. But imagine the savings if the Internet could be home, not merely to referral services, but to manufacturers selling direct. Two percent would look puny.

Consumers: get angry and get together.

The Telecom Act, Five Years Later: Deregulation or Remonopolization?

info@reason.com (James K. Glassman) — Mon, 05 Feb 2001 00:00:00 EST

On Feb. 8, 1996, President Clinton signed a sweeping revision of the laws governing telecommunications services -- the first major overhaul since the early days of Franklin Roosevelt's administration. Now, five years later, it's time to assess it.

The most revolutionary change in the Telecommunications Act of 1996 came in Title I, which presented a way to provide broad competition by breaking down the barriers between local and long-distance telephone service -- which, of course, also means Internet service.

After the consent decree of 1982 that broke up American Telephone & Telegraph Co., a monopoly that had been nurtured and protected by regulation for a century, seven Regional Bell Operating Companies (RBOCs) were created for local service in 1984 while AT&T was designated for long-distance. Soon, long-distance became fiercely competitive as MCI, Sprint and other companies drove down prices. The price of a call dropped from more than a dollar a minute to just a few pennies.

The focus of the Telecom Act of 1996 was to bring deregulation to the local level by holding out a deal to the RBOCs: If they sufficiently opened their exchanges to competitors, they would receive certification that would let them into long distance. The law specifically required the RBOCs to interconnect their facilities with competitors at "any technically feasible point and on just, reasonable, and non-discriminatory terms," to unbundled their services and make them available to competitors on similar terms, and, likewise, to provide for the resale of their services to competitors.

It was an excellent idea -- a worthy compromise to produce true deregulation in telecommunications. But why not simply let the RBOCs into long distance immediately? Wouldn't that be a better way to deregulate?

Not at all, Congress and the president decided -- and I agree. The problem was that the RBOCs owned the "last mile" -- the wires that run from broader telecom networks into virtually every home and office in America. And the RBOCs came to own that last mile through government intervention and protection. The last mile, in effect, was a moat, keeping competitors out.

Yes, the moat could possibly be breached with new technologies like wireless or satellite, and coaxial cables, which carry TV signals, could be upgraded for telephone. But those technologies would take a long time to implement broadly. The only way to breach the moat was to drain it -- to take the barrier away. That's what the Telecom Act tried to do, by offering the RBOCs a clear incentive -- the ability to get into long-distance -- in return for draining the moat.

But five years after the act became law, the moats are still there. In some ways, they are broader than ever.

First, in only two states -- New York and Texas -- have the RBOCs been certified for long distance. In the other 48, they have failed to open up sufficiently to competitors -- not a great record.

Second, the RBOCs have grown more powerful. At the start there were seven of them, plus GTE, a regional company that, thanks to grandfathering, could offer both local and long-distance service. Today, through mergers, there are just four companies that handle 95 percent of the local monopoly telecom business: Verizon, SBC, Bell South and Qwest. It is highly unlikely that this "remonopolization" was what the framers of the Telecom Act of 1996 had in mind.

Third, the new companies that sprang up with the passage of the Telecom Act -- companies called CLECs, or Competitive Local Exchange Carriers -- are, in the words of an article in Fortune last November, "flaming out." Why? Most CLECs "blame the Bells for failing to open their networks to competitors."

In just three years, 144 CLECs went public, raising more than $25 billion. Tens of billions of dollars more were pumped into their networks. But now, the CLECs are dying. Major bankruptcies include NorthPoint, Digital Broadband Communications, ICG, Picus and GST. Other firms have been forced into mergers. Adelphia, Covad, Teligent, FairPoint and many others have cut back their expansion plans or services. Teligent cut personnel by 25 percent in November. Covad has announced two separate job cuts. Jato laid off 350 workers; ICG, 500. The devastation is broad and intense.

The result is that local telecom pricing remains high, and the promised rollout of broadband technology that would speed the Internet to homes and businesses hasn't materialized. Companies that were started to take advantage of a speedy Internet are going out of business.

Now, on the heels of these clear failures, the local telephone companies are proposing to remove the incentive to drain their moats -- to promote the competition that is, as always, the only hope for lower prices and better quality. A bill in Congress with strong backing from the new chairman of the telecom subcommittee, Rep. Billy Tauzin, R-La., would allow the locals to get into the fast-growing data part of the long-distance business immediately -- without meeting the certification requirements of the original act. So, the only incentive for opening the local switch would be a desire to get into the vicious free-for-all competition over voice long distance. Not much incentive.

The RBOCs and their political supporters say that all they want is "deregulation." But deregulation comes in many varieties. The Telecommunications Act of 1996 offered the most sensible idea, one that was endorsed by all the parties. Sloppy deregulation -- of the sort embodied in the Tauzin-Dingell bill, H.R. 2420 -- is worse than no deregulation, as the citizens of California have learned in the electricity debacle they are now undergoing.

The Telecom Act is not producing the desired results, but that doesn't mean it should be changed. Instead, it should be reaffirmed. If the Bells think the law will be changed, they have no incentive at all to open their exchanges. Why make that sacrifice if you will be allowed in a few months to retain the advantages of local monopoly plus entry into long-distance data? Also, Congress should hold hearings to examine the demise and suffering of so many CLECs. If it is true that the Bells are killing them off by not allowing them access -- as required by the act -- then clearly the act needs toughening.

There is a paradox here: The best route to complete deregulation is through tough but fair enforcement -- for a period of transition. The worst route is to gut the Telecom Act. If that happens, then five years from now we will still see the Bells (now, maybe down to just one or two companies instead of four) holding onto their local monopolies while dominating data as well. In a world like that -- virtually without competition -- Americans will be suffering from high prices and low quality. Don't let it happen.