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Transcript of Hoover Digest, 2013, No. 4, Fall
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T H E H O O V E R I N S T I T U T I O N S T A N F O R D U N I V E R S I T Y
R E S E A R C H A N D O P I N I O N
O N P U B L I C P O L I C Y
2 0 1 3 N O 4 F A L L
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The Hoover Digestoers inormative writing on politics, economics, and
history by the scholars and researchers o the Hoover Institution, the publicpolicy research center at Stanord University.
The opinions expressed in the Hoover Digestare those o the authors and
do not necessarily relect the opinions o the Hoover Institution, Stanord
University, or their supporters.
The Hoover Digest(ISSN 1088-5161) is published quarterly by the Hoover
Institution on War, Revolution and Peace, Stanord University, Stanord
CA 94305-6010. Periodicals Postage Paid at Palo Alto CA and additional
mailing oices. POSTMASTER: Send address changes to the Hoover
Digest, Hoover Press, Stanord University, Stanord CA 94305-6010. 2013 by the Board o Trustees o the Leland Stanord Junior University
Contact InormationWe welcome your comments and suggestions at digesteditor@stanford.
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On the CoverSeaside villages like this one in an undatedSpanish travel poster suggest not just seasonspast but whole ways o lie changed. Theplacid towns and villages along Spains Pla-
yas de Levante are now, in many cases, brashand bustling resortsdynamos o one o the
worlds biggest tourism industries. Along theway they helped reshape international traveland gave birth to aordable package vacationsor the masses. See story, page 168.
Hoover DigestResearch and Opin ion on Pub ic Po ic
2013 no. 4 fall www.hooverdigest.org
HOOVER DIGEST
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Editor
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Managing Editor
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Managing Editor,Hoover Institution Press
HOOVER INSTITUTION
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Hoover Digest N 2013 No. 4
ContentsHOOVER D IGEST 2013 NO . 4 FALL
THE ECONOmy
9 Failure Isan OptionA Very Good OneHow to let too big to ail banks close up shop, predictably and
airly. Bykenneth e. scott andjohn b. taylor.
14 Debt Is a MillstoneEconomists may make their errors, but theres no mistake about the
ederal debt. Its bad. Bymichael j. boskin.
19 Austerity Versus StimulusEither approach might work. The question is how the private sector
responds. Bycharles wolf jr.
22 Another Uncertainty PrincipleWhy cant economists gaze into the uture the way physicists gaze
into the atom? Because the science o economics is still emerging. By
russell roberts.
27 Bridges to NowhereWhen stimulus spending roars down the highway disguised as inra-
structure spending, its time to hit the brakes. Bypaul r. gregory.
TAxES
32 Many Happier ReturnsHow to mend the ederal tax code. Bygary s. becker.
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36 The Inequality DelusionWhy it isnt the governments job to equalize incomeor to try to
do so by manipulating taxes. Bydavid davenport.
I NTEll IGENCE
39 Lives in the BalanceThe NSAs data-mining eorts seem, in the end, to be a tradeo be-
tween national security and individual privacy thats worth making.
Byroger pilon and richard a. epstein.
42 Watching the DetectivesFree societies can indeed restrain their intelligence agencies, largely
by keeping them honest. Bymark harrison.
50 October SurprisesThe Cuban missile crisis represents an enduring tale o complacency,
ragmented data, and the rantic race to pick signal out o noise. Byamy b. zegart.
56 No Sae Havens?How Barack Obama learned to stop worrying and love the drone. By
kenneth anderson.
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64 A Beautiul FriendshipEuropeans have been claiming, to quote Captain Renault, to be
shocked, shocked about American spying. They should know bet-
ter. Byjosef joffe.
POl IT ICS
68 Another Bad BounceSigns that a political delusion may be about to die at last. By
thomas sowell.
HEAlTH CARE
71 The Coming Rate ShocksSleight o hand makes it appear that ObamaCare means cheaper pre-
miums. Look closer. The savings arent there. Bydaniel p. kessler.
74 No, He CantThe president has no constitutional authority to suspend theemployer mandateor, or that matter, any other law. By
michael w. mcconnell.
77 Medicare on Lie SupportHow desperate does Medicare have to become beore policy makers
act? Byscott w. atlas.
83 Delate the Disability BubbleInlated by broad eligibility and chronic unemployment, this trou-
bled program is due to pop. Bymichael j. boskin.
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SC IENCE
87 Against the GrainThe real mystery behind Oregons patch o mystery wheat is
why we let the USDA suppress biotech crops in the irst place. By
henry i. miller.
EDUCAT ION
93 Private Schools Let BehindCharter schools and online learning are making old-ashioned private
schools look . . . old-ashioned. Bychester e. finn jr.
ImmIGRAT ION
98 The Value o an ImmigrantUntil we clear up what we want rom immigrants, well never clear
up immigration policy. Byedward paul lazear.
I RAq
101 Kurdistan Seizes Its MomentIn the bustling, conident north, the pretense o one Iraq grows
weaker by the day. Byfouad ajami.
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EGyPT
106 Pendulum o PowerInstead o a new political system, Egyptians will get only a new
Nasser. Bysamuel tadros.
THE m IDDlE EAST
111 Taking on IranBetween empty ultimatums and threats o overwhelming orce lies a
diplomatic sweet spot. An interview withabraham d. sofaer.
119 Unholy AllianceAlas or Lebanon. Syria, Iran, and Hezbollah have turned the country
into an arena or their unending proxy wars. Bymarius deeb.
I NTERV IEw
124 We Are Going to Stand on PrincipleSenator Rand Paul on libertarianism and the GOP; the Senate; and
the Constitution. An interview with peter robinson.
VAlUES
134 Still the Essential NationAter a lietime o service to the nation, a relection on Americas role
in the world. Bygeorge p. shultz.
139 Who Speaks or Black Americans?When jurors rejected the racial narrative surrounding the Zimmer-
man trial, they also rejected certain present-day civil rights leaders.
Byshelby steele.
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H ISTORy AND CUlTURE
143 Shermans WayThe Civil War general was a prophet not o total war, as his critics
charge, but oconclusivewar. Byvictor davis hanson.
154 Declaration o DependenceTocqueville admired the independence o the Americans he met.
Their descendants now swaddle themselves in a regulatory state. By
niall ferguson.
HOOVER ARCH IVES
158Windows into HistoryIn seldom-seen treasures rom the Hoover Archives, stories o artists
and their times. Bynicholas siekierski.
168 On the Cover
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Hoover Digest N 2013 No. 4 9
THE ECONOMY
Failure Isan OptionA Very Good One
How to let too big to ail banks close up shop, predictably and
airly. ByKenneth E. Scott
and
John B. Taylor.
It is now three years since the Dodd-Frank Act was enacted to prevent the
possibility that taxpayers would have to bail out too big to ail banks.
Yet there is serious concern that the legislation has not solved the problem.
Many have called or new laws to limit the activities o very large banks or
even, as in the bill introduced last spring by Senators Sherrod Brown andDavid Vitter, to cause them to break up.
In our view, a straightorward reorm o the bankruptcy code would
acilitate the orderly bankruptcy o large ailing inancial institutions and
thereby deal with the bailout problem. The reorm should be enacted
now, whether or not urther actions are taken on big banks.
Under bankruptcy, a ailing irm can go into either liquidation, in
which it goes out o business and is dismantled into pieces that are soldo, or reorganization. In reorganization, assets are assigned a market
Kennethe. Scottis a senior research fellow at the Hoover Institution, a mem-
ber of Hoovers Working Group on Economic Policy, and the Ralph M. Par-
sons Professor of Law and Business (Emeritus) at Stanford University.JohnB.
tayloris the George P. Shultz Senior Fellow in Economics at the Hoover Institu-
tion, the chairman of Hoovers Working Group on Economic Policy and a memberof Hoovers Shultz-Stephenson Task Force on Energy Policy, and the Mary and Rob-
ert Raymond Professor of Economics at Stanford University. They are co-editors of
BankruptcyNotBailout: A Special Chapter 14 (Hoover Institution Press, 2012).
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Hoover Digest N 2013 No. 410
value and losses are recognized. The interests o shareholders and
creditors are addressed in the order o priority stipulated by law,
which oten means stockholders are let with little or no own-
ership interest. Creditors, in order o contractual priority,have their debt claims written o, reduced in amount, or
converted into stock. In the end, the irm continues in
business, oten with new managers.
Title II o Dodd-Frank established a very di-
erent process, the Orderly Liquidation
Illustrationb
y
TaylorJones
for
the
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Hoover Digest N 2013 No. 4 11
Authority. The Federal Deposit Insurance Corporation has the authority to
resolve a large inancial irm when it ails. Consistent with the original ral-
lying cry or the legislation, it will wipe out shareholders. But the heart o
the new resolution process is reorganization, and that is where the problem is.The FDIC will transer a selected part o the irms assets and liabilities
to a new bridge institution, with more discretion and less transparency
and judicial oversight than in bankruptcy.
Some creditors claims can receive larger
payments than under a typical bank-
ruptcyeectively a bailoutin the
name o avoiding systemic conse-quences.
This violates the priority struc-
ture that underlies the entire credit
market. It also reduces the risk
incurred by large creditors expect-
ing to be so avored, and thus the
interest rate at which they arewilling to lend the bank money.
The big banks, able to borrow at
a lower cost, are eectively getting
a subsidy$83 billion per year,
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Hoover Digest N 2013 No. 412
according to widely cited Bloomberg estimates based on an International
Monetary Fund study.
The probability that some creditors will be bailed out has the perverse
eect o increasing the likelihood o a banks ailure. Normally the risksa inancial irm might choose to take are constrained by creditors as they
monitor and protect themselves rom losses by demanding collateral or
cutting their exposure. Bailouts give them less reason or concern and
action.
Shareholders in a ailing bank resolved under Dodd-Frank wont be
protected, but creditors said to be systemically important most likely
will be. Who and when? Thats up to political discretion. Hence there isuncertainty about how this process would operate, especially or com-
plex international irms. Some believe that earul policy makers would
ignore it in the heat o a crisis, resorting to taxpayer bailouts as in the
past. In short, too-big-to-ail and government bailouts remain possible
or even likely.
This approach would let a failing financial firm enter bankruptcy without
causing disruptive spillovers.
There is a better wayand it involves adding a chapter to the ed-
eral bankruptcy code speciically or large inancial institutions. A Chap-
ter 14 would apply to all inancial groups with assets over $100 billion.
A specialized panel o judges and court-appointed special masters with
inancial expertise would oversee the proceeding, which would includeall the parents subsidiaries, including insurance and brokerage. (Under
Dodd-Frank, insurance and brokerage services have to be handled sepa-
ratelywhich adds complexitywhile banks and other subsidiaries are
under FDIC jurisdiction.)
A bankruptcy petition could be iled by creditors, as now, but also by
the primary ederal supervisor o the irm or by a management that saw
insolvency looming. The procedure to determine asset values, liabilities,sales o some lines o business, write-downs o claims, and recapitaliza-
tion would take place according to the rule o law. There would be judi-
cial hearings and creditor participation, neither o which is a part o the
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Hoover Digest N 2013 No. 4 13
Dodd-Frank resolution process. The strict priority rules o bankruptcy
would govern (with some modiications or holders o repurchase agree-
ments and swaps to limit their risks).
Chapter 14 would let a ailing inancial irm enter bankruptcy in a pre-dictable, rules-based manner without causing disruptive spillovers in the
economy. It would also permit people to continue to use the irms inan-
cial servicesjust as people lew on American or United planes when
those irms were in bankruptcy. The provisions also make it possible to
create in bankruptcy a newly capitalized entity that would credibly pro-
vide most o the inancial services the ailed irm was providing beore it
got into trouble.Customers would continue to do business with a inancial irm ater a
Chapter 14 iling i they were conident the irm could meet its current
obligations. That conidence would be achieved by giving post-petition
creditors a high priority. In all likelihood, this priority would enable the
irm to continue obtaining ample private inancingso-called debtor-in-
possession inancingto provide liquidity or normal operations.
The managements o the ive largest inancial irms in the UnitedStates control the investment o more than $8 trillion. A credible bank-
ruptcy procedure designed speciically or these and other large inancial
irms would substantially reduce the occasions to use the Dodd-Frank
resolution machinery and thus the concerns about its eects. It would
make creditors exposure much better deined and predictable, and
thereby reduce the likelihood o bailouts and the perverse, unair subsi-
dy they create.Reprinted by permission of the Wall Street Journal. 2013 Dow Jones & Co. All rights reserved.
Available from the Hoover Press is Bankruptcy, Not
Bailout: A Special Chapter 14, edited by Kenneth E. Scott
and John B. Taylor. To order, call 800.935.2882 or visit
www.hooverpress.org.
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Hoover Digest N 2013 No. 414
THE ECONOMY
Debt Is a MillstoneEconomists may make their errors, but theres no mistake about the
ederal debt. Its bad. ByMichael J. Boskin.
The recent controversy over errors in a 2010 paper by the economists Car-
men Reinhart and Kenneth Rogo is a sad commentary on the demands
o the 24/7 news cycle and the politically toxic atmosphere surround-
ing iscal policy in the United States, Europe, and Japan. In their paper,
Growth in a Time o Debt, Reinhart and Rogo estimated large declines
in growth associated with public-debt/GDP ratios above 90 percent. But
it contained coding errors discovered by a University o Massachusettsgraduate student. When corrected, the eect is substantially smaller, but
nonetheless economically consequential.
The Reinhart/Rogo paper is just a small part o a voluminous aca-
demic literature that shows high debt levels to be economically risky. A
more undamental question is causality: the state o the economy certainly
aects the iscal position, just as taxation, spending, deicits, and debt may
aect economic growth.Research errors in economics are not uncommon, but they are usually
caught early, as happened once to me in a prepublication drat. Sometimes
errors are not discovered until later, when they are working papers, as with
Reinhart and Rogo, or ater publication, as with Nobel laureate Ken
Michael J. BoSKin is a senior fellow at the Hoover Institution, a member ofHoovers Shultz-Stephenson Task Force on Energy Policy and Working Group on
Economic Policy, and the T. M. Friedman Professor of Economics at Stanford
University.
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Hoover Digest N 2013 No. 4 15
Arrow, who had to correct a mistake in the proo o his amous impos-
sibility theorem.
Economists use dierent methods to analyze iscal issues: stylized ana-
lytical models; macroeconometric models itted to aggregate data, such asthose used by the Federal Reserve, the European Central Bank, and the
U.S. Congressional Budget Oice (CBO); empirical estimation o key
parameters, such as spending multipliers; vector autoregressions; and his-
torical studies. Each o these approaches has its strengths and weaknesses,
and serious economists and policy makers do not rely on a single study;
rather, they base their judgments on complementary bodies o evidence.
Thus, there is no excuse or the outrage, the exaggerated claims or onepapers inluence, and the attempt to use the error to discredit legitimate
concerns over high levels o debt (let alone to viliy the authors).
T IMING IS IMPORTANT
While large deicits are usually undesirable, sometimes they can be benign
or even desirable, such as in recession, in wartime, or when used to inance
productive public investment. In normal times, deicits crowd out privateinvestment (and perhaps crowd in private saving and/or oreign capital)
and hence reduce uture growth. By contrast, in a deep, long-lasting reces-
sion, with the central banks policy rate at the zero lower bound (ZLB), a
well-timed, sensible iscal response can, in principle, be helpul.
Research errors in economics are not uncommon, but theyre usually
caught early.
But the political process may generate poorly timed or ineective
responsesocused on transers rather than purchases, inra-marginal
tax rebates, and spending that ails cost-beneit teststhat do little good
in the short run and cause substantial harm later. Americas 2008 stimu-
lus barely budged consumption upward, and the 2009 iscal stimulus
cost hundreds o thousands o dollars per job, many times higher thanmedian pay.
We should adopt policies that beneit the economy in the short run
at reasonable long-run cost, and reject those that do not. That sounds
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Hoover Digest N 2013 No. 416
simple, but it is a much higher hurdle than politicians in Europe and the
United States have set or themselves in recent years.
I estimated the impact on GDP o Americas recent and projected debt
increase (in which the explosive growth o public spending on pensionsand health care looms largest) using our alternative estimates o the eect
o debt on growth: a smaller Reinhart/Rogo estimate rom a more recent
paper; a widely used International Monetary Fund study, which inds a
larger impact (and which deals with the potential reverse-causality prob-
lem); a related CBO study; and a simple production unction with govern-
ment debt crowding out tangible capital. The results were quite similar:
unless entitlement costsare brought under control, the resulting rise indebt will cut U.S. living standards by roughly 20 percent in a generation.
Corroborating statistical evidence shows that high deicits and debt
increase long-run interest rates. The eect is greater when modest deicit
and debt levels are exceeded and current-account deicits are large. The
Illustrationb
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TaylorJones
for
the
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Hoover Digest N 2013 No. 4 17
increased interest rates are likely to retard private investment, which low-
ers uture growth in employment and wages.
Numerous studies show that government spending multipliers,
even when large at the ZLB, shrink rapidly, then turn negativeandmay even be negative during economic expansions and when house-
holds expect higher taxes beyond the ZLB period. Permanent tax cuts
and those on marginal rates have proved more likely to increase growth
than spending increases or temporary, inra-marginal tax rebates. Suc-
cessul iscal consolidations have emphasized spending cuts over tax
hikes by a ratio o ive or six to one, and spending cuts have been less
likely than tax increases to cause recessions in OECD countries.
DEBT IS A LONG-TERM DRAG
Some argue that iscal consolidation by gradual permanent reductions
in spending would be expansionary or high-debt countries, as occurred
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Hoover Digest N 2013 No. 418
in some historical episodes. Others maintain that a temporary increase
in spending now would boost growth. Both could be expansionaryor
not, depending on details and circumstances. Because many countries
have been consolidating simultaneously, interest rates are already low;and, or the United States, which accounts or more than 20 percent o
the global economy and issues the global reserve currency, caution in
generalizing rom other iscal episodes is highly advisable.
Unless entitlement costs are brought under control, rising debt will cut
U.S. living standards by roughly 20 percent in a generation.
Nonetheless, the evidence clearly suggests that high debt/GDP ratios
eventually impede long-term growth; iscal consolidation should be
phased in gradually as economies recover; and the consolidation needs to
be primarily on the spending side o the budget. Finally, the notion that
we can wait ten to iteen years to start dealing with deicits and debt, as
economist Paul Krugman has suggested, is beyond irresponsible.
Reprinted by permission of Project Syndicate (www.project-syndicate.org). 2013 Project Syndicate Inc.All rights reserved.
Available from the Hoover Press is Entitlement Spending:
Our Coming Fiscal Tsunami, by David Koitz. To order, call
800.935.2882 or visit www.hooverpress.org.
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Hoover Digest N 2013 No. 4 19
THE ECONOMY
Austerity VersusStimulusEither approach might work. The question is how the private sector
responds. ByCharles Wol Jr.
Why is it that in the United States the stimulus solution to the econ-
omys ills has perormed badly while in Europe the opposite approach,
austerity, has perormed even worse?
The answer is that austerity (deined as substantial reductions in debt-
inanced government spending) or stimulus (deined as high levels odebt-inanced government spending) will promote growth only in some
countries and in some circumstances.
Whether either policy will work depends critically on the responses o
the private sector. What is missing rom consideration today is whether the
private sectors reactions will enhance, retard, or reverse a policy o either
austerity or stimulus. In both the European Union and the United States,
policies would have been more eective i eorts had been made to antici-pate and mitigate the reasons or adverse responses o private businesses.
Four years since the great recession ended in mid2009, and not-
withstanding recent signs o modest improvements, the annual rate o
real U.S. GDP growth has averaged less than 2 percentwhich is 4 per-
centage points, or $600 billion, below the pace o recovery rom prior
deep recessions, such as in 198182. Recorded unemployment is 7.5
charleSWolfJr. is a senior research fellow at the Hoover Institution and a senior
economic adviser and corporate fellow in international economics at the Rand Cor-
poration. He is a professor of policy analysis at the Pardee Rand Graduate School.
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Hoover Digest N 2013 No. 420
percent but is actually twice as high, allowing or involuntary temporary
and part-time employment, as well as discouraged workers who have
stopped looking or work.
The stimulus o 200912 averaged over 6 percent o GDP annuallybetween $1.2 trillion and $1.5 trillion. Yet it has been ineective.
Austerity in the EU has ared even worse. In the euro-currency area,
which includes seventeen o the EUs twenty-seven members, government
spending has been cut in hal, with dire consequences. GDP growth is at a
standstill, and recorded unemployment is 12 percent and rising.
Uncertainty is magnified when stimulus is accompanied by profuse,
costly, and ambiguous regulations.
Yet true believers in either policy, which include Nobel Prize winners
on both sides, discount the results. Stimulus adherents claim that the poor
record simply relects that the recession was so deep that the stimulus
should have been even bigger. Austerity adherents claim that its dismal
record simply relects that it was too severe and imposed too quickly.Both groups are overlooking the crucial role o the private sectors reac-
tions to austerity and stimulus.
In the United States, these reactions are crucial because the private sec-
tor is so largethe majority shareholder, so to speak. Its share o pur-
chased goods and services is approximately quadruple that o government.
Several actors are at work. One is what textbooks reer to as Ricardian
equivalencethat debt-inanced government spending in the presentmay require higher taxes in the uture, thereby motivating companies and
households to save rather than invest or spend.
An indicator o this is the ballooning o cash reserves on corporate bal-
ance sheets to over $2 trillion since 2009, thereby providing a major oset
to the stimulus goal o expanding aggregate demand. Other indicators are
increased household savings rates (by 3 to 4 percent annually) since 2009
and decreased household debt (by 8 percent), thus urther negating theincreased aggregate demand sought by stimulus.
Another impediment is the quandary created or business plans because
o uncertainty about where and how stimulus would aect each irms
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Hoover Digest N 2013 No. 4 21
markets and those o its competitorsuncertainty that is magniied when
stimulus is accompanied by prouse, costly, and ambiguous regulations.
Finally, stimulus in the United States has been undercut by private-
investment decisions to invest abroad. Between the recessions turnaroundin mid2009 and the end o 2012, outward-bound U.S. private direct
investment rose steadily to $1.73 trillion annually rom $1.05 trillion.
This outward-bound investment currently exceeds (by $500 billion) the
outward low preceding the recession in 2007.
Private-sector reactions in Europe have also seriously aected austeritys
results. The EUs private sector is smaller relative to government than in
the United Statesabout three to two versus our to one. Moreover, thedirect involvement o government is more pervasive than in the United
States. For example, European governments are oten part-owners o pri-
vate corporations and sometimes sit on corporate boards.
Austerity in the EU has imposed simultaneous severe spending cuts on
both the government and the private economy, thereby reducing oppor-
tunities or either one to cushion the adverse impact o austerity on the
other. The EUs private businesses also seem less enabling o entrepreneur-ship and innovation that could acilitate adjustment to austerity.
Neither in the United States nor in the EU does the private sector speak
with one voice or necessarily react in a uniorm way. For example, some
venture-capital irms and other wealth-management companies in the Unit-
ed States have reacted less adversely to government policy than others. Still,
the experience to date strongly suggests that the reactions and behavior o
private investors and consumers to stimulus in the United States and auster-ity in the EU critically aected each policys tarnished record. Something or
policy makers to keep in mind when devising economic remedies.
Reprinted by permission of the Wall Street Journal. 2013 Dow Jones & Co. All rights reserved.
Available from the Hoover Press is Looking Backward
and Forward: Policy Issues in the Twenty-First Century,
by Charles Wolf Jr. To order, call 800.935.2882 or visit
www.hooverpress.org.
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Hoover Digest N 2013 No. 422
THE ECONOMY
Another UncertaintyPrincipleWhy cant economists gaze into the uture the way physicists gaze
into the atom? Because the science o economics is still emerging.ByRussell Roberts.
When asked to prove the eectiveness o Keyness prescription o deicit
spending to cure an ailing economy, Keynesians usually point to World
War IIgovernment ran large deicits, GDP surged, and unemployment
disappeared. The economy certainly appeared to be healthy. The militaryindustrial sector grew larger and boosted measured GDP. Conscription
orced unemployment close to zero.
But did government spending on the military stimulate the economy
through the vaunted Keynesian multiplier? Government spending on the
military didnt stimulate private consumptionit crowded it out. Con-
sumers suered.
That doesnt disprove Keynesmaybe a smaller increase would havedone the trick o ixing the economy without reducing private consump-
tion. World War II doesnt prove Keynes was wrong, but it sure doesnt
prove him right either.
A better test came at the end o war. Paul Samuelson, a prominent
Keynesian who later won one o the irst Nobel Prizes, worried that i
the war ended suddenly and government spending contracted quickly, we
ruSSell roBertSis the John and Jean De Nault Research Fellow at the Hoover
Institution.
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would ace the greatest period o unemployment and industrial disloca-
tion which any economy has ever aced.
Federal spending ell by 40 percent in 1946 and ten million service
members were suddenly looking or work. Despite the warnings oSamuelson and others, nothing was done to cushion the expected blow
to the economy. But there was no recessionunemployment stayed
low.
World War II doesnt prove Keynes wrong, but it sure doesnt prove him
right either.
A year later, ederal spending was 60 percent below the 1945 level.
Output grew 7 percent and employment grew 4.8 percent, hitting record
levels. That extraordinary natural experiment could have ended the asci-
nation economists had with the work o Keynes. Instead, the Keynesians
recalibrated their models and looked to the uture.
WHERE D ID THE ST IMULUS GO?The ailure o the Obama stimulus package o 2009 to have the predicted
eects on the unemployment rate didnt change many minds either. In
January 2009, Alan Blinder o Princeton, a highly respected Keynesian,
argued that a $650 billion stimulus package would be big enough to ix
the economy. Instead we spent $820 billion; in return, we have the worst
recovery in modern American economic history.
O course, its possible that large natural experiments like these shouldntbe treated as decisive. The world is a complicated place. Lots o things
happen at once. Correlation is not causation. Maybe actors besides gov-
ernment spending account or the lethargy o the U.S. economy today or
the vitality o the U.S. economy in 1946.
Some economists argue that the stimulus should have been $2
trillion while others, equally illustrious, argue it should have been zero.
That is why I think it isnt just Keynesianism thats in trouble these
days but macroeconomics in general, at least the way journalists and
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politicians expect us to practice it. When Nobel Prize winners argue that
the stimulus should have been $2 trillion while other equally illustrious
economists argue it should have been zeroand both have studies to
back up their claimsone has to wonder how much science there reallyis in economics.
Perhaps our proession should admit that some o the questions people
want us to answer simply cannot be answered.
One o those questions is whether or not $820 billion in additional
ederal spending, using borrowed money, is a good idea. I think its a bad
idea. But my reasons or thinking so are based on logic and philosophy,
not ancy statistical analysis.
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But hasnt the nonpartisan Congressional Budget Oice (CBO) ound
that the stimulus created millions o jobs?
Sort o. At one point in 2011, the CBO estimated that the stimulus
had created between 400,000 and 2.4 million jobs. Not so precise. Worse,its not even an estimate: its simply the orecast the CBO did beore the
stimulus passed, recalculated using the actual amount o money that was
spent.
This is equivalent to sending a space probe to Mars but being unable
to veriy its location. When asked by the president where it is, the sci-
entists assure him that its on Mars. How do they know? Because their
models say so. In modern macroeconomics, we make predictions that
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cannot be conirmed or veriied. I dont know what to call that, but it
isnt science.
STUBBORNLY COMPLEX
Some argue that we havent had enough serious recessions to model them
adequately. Give us twenty or thirty more, they say, and well have enough
data. Im more inclined to side with F. A. Hayek in his 1974 Nobel Prize
address, The Pretense o Knowledge. Hayek argued that the economy
was simply too complex to allow predictions o the precision we expect
rom, say, physics. So while a physicist can tell us where Mars will be on
January 1, 2035, and actually veriy the prediction when the time arrives,we economists will always struggle to identiy the path o the economy six
months rom now.
Economics isnt rocket science; its a lot harder. We should admit as
much and when asked to measure things we cannot measure, we should
admit our ignorance.
Reprinted by permission from the European(www.theeuropean-magazine.com). All rights reserved.
Available from the Hoover Press is Government Policies
and the Delayed Economic Recovery, edited by Lee E.
Ohanian, John B. Taylor, and Ian J. Wright. To order, call
800.935.2882 or visit www.hooverpress.org.
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THE ECONOMY
Bridges to NowhereWhen stimulus spending roars down the highway disguised as
inrastructure spending, its time to hit the brakes. ByPaul R. Gregory.
Big-government advocates seek to substitute inrastructure or the
S-word (stimulus). President Obamas State o the Union address called
or $40 billion to ix the nations roads and bridges and the establishment
o a ederal inrastructure bank. A ew weeks later, the president called or
an additional $4 billion in inrastructure spending. A billion here and a
billion there, and soon youre talking real money.
To persuade a wary public to spend more with trillion-dollar deicits,big-government advocates must gin up a national inrastructure emergen-
cy that threatens saety, jobs, and well-being. Public-spending lobbyists
are ready to oblige with D-plus report cards or aging and unreliable
roads, bridges, and ports. Big-government advocates substitute scare tac-
tics or the acts that our inrastructure is as good as Europes and that we
spend more than the European Union on public investment. I we spend
as much or more and have inerior inrastructure, that is a massive politi-cal ailure or which someone should pay.
Gone are grandiose plans or massive stimulus to boost output and
employment on Keynesian steroids. Instead the president is repackaging
stimulus as inrastructure spending. His Miami speech was timed to the
newly released American Society o Civil Engineers 2013 inrastructure
Paul r. GreGoryis a research fellow at the Hoover Institution. He is the Cullen
Distinguished Professor of Economics at the University of Houston and a research
professor at the German Institute for Economic Research in Berlin.
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report card. Its D-plus rating rang the alarms that our roads, bridges, water
and waste treatment, rail, dams, and airports are crumbling and unsae.
At least the president reminded us in Miami that we have had the good
ortune o our years o enlightened stimulus spending under him:Now, over the last our years, weve done some good work. Construc-
tion crews have built or improved enough roads . . . to circle the globe
ourteen times and upgraded enough [rail] to go coast to coast and back.
Weve repaired or replaced more than twenty thousand bridges. Weve
helped get tens o thousands o construction workers back on the job.
I our roads circled the globe ity times, would we get a B-plus? Teach-ers reserve D-plus or students who make no eort other than to show up.
D-plus brings to mind backwater countries o Latin America and Asia.
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D-plus is a national disgrace or a once-great country! How could we have
let it get so bad?
The American Society o Civil Engineers Failure to Act study oers
a price tag or restoring a irst-world inrastructure. It would take $1.7 tril-lion to correct our current inrastructure deicit and an extra $160 billion a
yearor $1.1 trillion totalto meet our inrastructure needs through 2020.
Our civil engineers do not predict or us the eect o almost $3 trillion in
additional spending on the deicit. Ater all, what is it worth to be able to
drive across bridges without ear o plunging to certain death? (By my calcu-
lations, our bridge ailure rate is one in three hundred and ity thousand.)
Even though we do not have the $1.7 trillion or current needs andthe $1.1 trillion or later, we would be penny wise and pound oolish not
to borrow and
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spend, say the civil engineers. The $160 billion extra over each o the next
seven years would alone raise GDP by $3.1 trillion (a three to one return)
and add 3.5 million jobs, they say. What a bonanza!
We have not seen such optimistic numbers since the young Obamaadministration promised huge returns or the irst stimulus. Should we
again put caution aside? A word o warning: the website o the Ameri-
can Society o Civil Engineers shows it to be a lobbyist or inrastructure
spending. Asking the civil engineers how much inrastructure spending
we need is akin to asking deense contractors how much we should spend
to keep America sae. I doubt the big-government people would like that.
The United States ourteenth-place ranking in the World EconomicForums inrastructure index scarcely bespeaks a national scandal. Lux-
embourg and Canada rank just above the United States, and Austria and
Denmark rank just below. None o these countries is exactly a slouch
in the inrastructure category. Among the twenty largest countries, the
United States ranks second only to Canada. The World Economic Forum
index also shows that U.S. inrastructure beats the European Union aver-
age by a wide margin. How can that be, with the ast trains and the gleam-ing autobahns o the European Unionthe envy o our transportation
bureaucrats?
If we get less bang for our infrastructure buck than Europe does, the problem
would seem to be not too few dollars but too much waste and corruption.
Consider another inconvenient act. OECD inrastructure experts indthat Europe has too great a supply o roads and rail relative to demand. Yes,
there are trains departing every ew minutes, but they are hal empty. And
do Germans really need ive dierent autobahns to drive rom Munich to
Frankurt? The same OECD experts ind that the United States, Canada,
and Australia have built about the amount o inrastructure that its the
demand.
Still, i all else ails, our big-government spenders at least can showthat we spend little on inrastructure relative to countries that have good
inrastructure. Get ready or a surprise. According to OECD statistics, the
United States spends 3.3 percent o its GDP (200611) on inrastruc-
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ture investment, versus the European Unions 3.1 percent. With roughly
equal GDP, the United States actually outspends the European Union,
our model o inrastructure perection.
I we spend as much as or more than the European Union on inra-structure, we should have better or equal results. In both the United States
and Europe, public investment and procurement are political processes
characterized by waste, politics, and corruption. I we get less bang or our
inrastructure buck than do our European colleagues, our problem would
be not too ew dollars but too much waste and corruption.
Asking civil engineers how much infrastructure spending we need is like
asking defense contractors how much to spend on weapons.
In his Miami pitch or more inrastructure spending, the president
stated: Weve got to do it in a way that makes sure taxpayer dollars are
spent wisely. Does he know something the people do not? Could it be
that taxpayer dollars have not been wisely spent? Could the unions, crony
capitalists, and lobbyists have proited at taxpayer expense?That would be as hard to believe as the police chie s surprise that there
was gambling in Casablanca.
Special to the Hoover Digest.
Available from the Hoover Press is Failing Liberty 101:
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Hoover Digest N 2013 No. 432
TAXES
Many Happier ReturnsHow to mend the ederal tax code. ByGary S. Becker.
The ederal tax code is a messit is neither eicient, air, nor clear. A
complete set o suggestions to improve the tax system would take hun-dreds o pages, as did the excellent 2005 Report of the Presidents Advisory
Panel on Federal Tax Reform. I will concentrate on a ew o the changes
needed to stimulate a more eicient, aster-growing American economy.
A major priority is to eliminate taxes on savings and investments.
One reason is that they involve double taxation: personal and corporate
incomes are irst taxed, and then the returns on the savings and investment
out o these incomes are taxed again later. A second, even more important
problem with taxes on savings and investments is that in the long run they
are shited to labor because these taxes lower ater-tax returns, thereby
discouraging investment. A lower rate o investment slows down capital
accumulation, which leads to a lower ratio o capital to labor. Wages are
lower and pretax returns to capital are higher when the capital/labor ratio
is lower.
Moreover, the present system taxes dierent orms o saving and dier-
ent types o investment goods at dierent rates. This distorts the alloca-
tion o investments among investment categories. For example, deprecia-
tion tax rules allow durable capital to be depreciated more slowly than
E
PA/ShawnThew
GaryS. BecKeris the Rose-Marie and Jack R. Anderson Senior Fellow at the
Hoover Institution and a member of Hoovers Working Group on EconomicPolicy and Shultz-Stephenson Task Force on Energy Policy. He is also the Uni-
versity Professor of Economics and Sociology at the University of Chicago. He was
awarded the Nobel Memorial Prize in Economic Sciences in 1992.
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less-durable capital, which lowers the relative tax rate on more-durablecapital. Similarly, savings that enter tax-ree IRA or Roth accounts are
taxed less heavily than other orms o savings.
One way to eliminate taxation o investments is to allow all investments
to be written o immediately as expenses instead o being depreciated over
time. Taxing only earnings would eliminate double taxation o savings.
Expensing investments and taxing earnings moves the income tax
code a long way in the direction o a tax on consumption rather than onincome. The basic eiciency advantage o consumption taxes is that they
do not distort the decision to consume now rather than consume later
since the returns on savings and investments are not taxed. By contrast,
Apple CEO Tim Cook testifies before Congress in May about the companys offshore account-
ing arrangements. We think we should do a comprehensive reform of the tax code, Cook
said in defense of Apples removing of billions of dollars from the IRSs oversight. For
multinationals the right approach would be simplicity. Just gut the code.
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income taxes do distort this decision since they tax the incomes earned on
savings as well as the incomes that led to the savings.
Whether or not one moves to a consumption tax, taxes should be made
simpler and latter because that would reduce the large cost o tax com-pliance and encourage greater investment and work eort. A reasonable
proposal that would maintain progressivity yet have a much latter tax
structure would be to have only two or three tax rates, such as 20 percent,
25 percent, and 30 percent. The tax rate on low labor market earnings
would be even less than 20 percent i the earned-income tax credit on
low earnings were retained. This credit encourages poorer individuals to
enter the labor orce rather than staying out to become eligible or variouswelare beneits, such as ood stamps, unemployment compensation, and
housing subsidies.
Personal and corporate incomes are first taxed, and then the returns on
the savings and investments are taxed again.
The income tax base should be widened not only because that arrange-ment would be more eicient but because a wider base would help main-
tain tax revenue as rates are lattened and taxes on savings and investments
removed. As one step, the deductibility o mortgage interest should be
eliminated because that artiicially encourages investments in home own-
ership relative to investments in other orms o capital. This deduction
also avors higher-income amilies since they are more likely to itemize
deductions and have higher marginal tax rates. I it were too politicallydiicult to eliminate this deduction, a tax credit could be given to all
homeowners equal to a raction o their mortgage interest payments.
There would be an upper bound to the amount o interest payments that
could qualiy or the tax credit.
The exclusion o interest on state and local bonds rom income taxes
should be abolished because that artiicially encourages spending by
these governments relative to spending by households and businesses.Since higher-income individuals hold the vast majority o state and local
bonds, this tax exemption also avors higher-income people in an unde-
sirable way.
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The tax on business cash low (net o investment outlays) should be
aligned with the proposed latter personal income tax structure by lower-
ing corporate and partnership tax rates to the proposed maximum tax rate
on personal income, say 30 percent. Doing this, and taxing business cashlow net o investment deductions, would integrate the business tax into
an overall consumption tax.
Consumption taxes, unlike income taxes, do not distort the decision to
consume now rather than later.
These are the most needed reorms, although others are also desirable.Unortunately, major reorms have little chance o enactment in the pres-
ent political climate, but they are longer-run goals that should appeal to
both Democrats and Republicans.
Reprinted from the Becker-Posner Blog (www.becker-posner-blog.com).
New from the Hoover Press is Constitutional
Conservatism: Liberty, Self-Government, and Political
Moderation, by Peter Berkowitz. To order, call
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TAXES
The InequalityDelusionWhy it isnt the governments job to equalize incomeor to try to do
so by manipulating taxes. ByDavid Davenport.
In his novel Gravitys Rainbow, Thomas Pynchon wrote: I they can
get you asking the wrong questions, they dont have to worry about the
answers. This describes to a T what President Obama has done in seek-
ing to make income inequality, as he put it in one o his speeches, the
deining issue o our time. I that is the question, then higher taxes on thewealthy, a large increase in the minimum wage, and other redistributionist
measures become the answer. But in act, the president is either mistaken
or misleading. Income inequality is not the right question to be asking.
When Obama and his supporters reer to income inequality, they are
taking a complex set o economic and social issues and boiling them down
to a single data point: the size o the dierence between the annual incomes
o top earners and those on the bottom o the income scale. While that is aninteresting issuethough there are problems with it, even as it ishaving it
stand alone as the driving orce or change is a gross oversimpliication that
will lead to bad outcomes. It would be as i we decided to judge baseball
pitchers by the number o walks they issue, not taking into account the vast
array o appropriate measures (wins and losses, earned run average, strike-
outs, hits given up, innings pitched, etc.) that combine to give a uller, more
accurate understanding o a pitchers eectiveness.
DaviD DavenPort is counselor to the director and a research fellow at the
Hoover Institution.
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Asking about the gap between high and low earners is at best an incom-
plete question. It tells us nothing about why the gap may be growing or
shrinking. For example, it may be the case, as is shown in recent studies,
that incomes at both the top and bottom have grown, but incomes at thetop grew aster. But even that isnt enough to know, because you would
want to understand whythe top is growing aster. Is it at the expense o
those at the bottom? Actually no, since theirs is growing also, but it is due
to greater investment income at the top. Do we then want to penalize Bill
Gates and Steve Jobs or creating wildly successul companies, along with
the people who invested in them?
Pointing out the gap between high and low earners tells us nothing about
why the gap may be growing or shrinking.
A urther problem is that most o the data collected on this phenom-
enon ocuses on pretax income, so it doesnt take into account the eects
o our progressive tax system. But that prompts an even deeper ques-
tion: is it the role o government, and its system o taxation, to equalizeincome among citizens? The United States already has one o the most
progressive tax systems in the world, so absent this red-herring question
about income inequality, taxing the wealthy would be an even tougher
case to make.
A more relevant question would be whether there is mobility among
the various income levels. In an equality-o-opportunity society such as
the United States, income inequality should be a problem only i an indi-viduals income is static. A Treasury Department study looked at income
mobility rom 1996 to 2005 and concluded that during the study period,
more than hal o taxpayers moved to a dierent income quintile. Approx-
imately hal o taxpayers in the bottom income quintile had moved to a
higher income group, and only 25 percent o those in the top quintile had
remained there. With people moving up and down the income distribu-
tion scale, there would appear to be equality o opportunity, i not equal-ity o outcome. And nearly everyone agrees that the impetus or more
mobility is education, not income redistribution. Education is where the
policy emphasis should be.
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Legendary ootball coach John Madden was asked to comment when a
team signing a notoriously laky quarterback announced that he was the
answer. Maddens response was, i he is the answer, I guess I dont know
what the question is. I income inequality is the answer, the question isnot how to have an equality-o-opportunity society. Instead, it is the much
more Machiavellian question o how to build a case or income redistribu-
tion, which is altogether the wrong question to be asking in a ree society.
A more relevant question: is there mobility among the various income
levels? It seems there is.
Unortunately, I conclude that President Obama wants to ask that very
questionhow we can redistribute income in a way that he thinks creates
greater equalitybut knowing how controversial that would be, he has
masked it in the cloak o income inequality. Lets hope Congress and the
American people see through his redistributionist cloak.
Special to the Hoover Digest.
New from the Hoover Press is The New Deal and
Modern American Conservatism: A Defining Rivalry,
by Gordon Lloyd and David Davenport.To order, call
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INTELLIGENCE
Lives in the BalanceThe NSAs data-mining eorts seem, in the end, to be a tradeo
between national security and individual privacy thats worth making.
ByRoger PilonandRichard A. Epstein.
Ater the news broke that the National Security Agency had been collect-
ing metadata about Americans phone calls and some oreign online com-
munications, President Obama was attacked or stating the obvious: no
amount o government ingenuity will guarantee the American people 100
percent security, 100 percent privacy, and zero inconvenience.
Legally, the president remains on secure ooting under the Patriot Act,which Congress passed shortly ater 9/11 and has since reauthorized by
large bipartisan majorities. As he stressed, the program has enjoyed the
continued support o all three branches o the ederal government. It has
been ree o political abuse since its inception. And, as he rightly added,
this nation has real problems i its people cant trust the combined actions
o the executive branch and Congress, backstopped by ederal judges
sworn to protect our individual liberties secured by the Bill o Rights.In asking or our trust, Obama would have been on stronger ground i
the NSA controversy had not ollowed hard on the heels o the Benghazi,
IRS, and AP/Fox News scandalsto say nothing o Attorney General
roGerPilonis vice president for legal affairs at the Cato Institute and director
of Catos Center for Constitutional Studies. richarD a. ePStein is the Peter
and Kirsten Bedford Senior Fellow at the Hoover Institution and a member ofHoovers John and Jean De Nault Task Force on Property Rights, Freedom, and
Prosperity. He is also the Laurence A. Tisch Professor of Law at New York Uni-
versity Law School and a senior lecturer at the University of Chicago.
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Eric Holders problems. But give the president due credit: we can recall no
other instance in which he announced publicly that the responsibilities o
his oice had changed his mind. And or the betterheres why.
In domestic and oreign aairs, the basic unction o government isto protect our liberty, without unnecessarily violating that liberty in the
process. The text o the Fourth Amendment grasps that essential trade-
o by allowing searches, but not unreasonable ones. That instructive,
albeit vague, accommodation has led courts to crat legal rules that irst
deine what a search is and then indicate the circumstances under which
one is justiied. In the realm o oreign intelligence gathering, recogniz-
ing the need or secrecy and their own limitations, judges have shown anacute awareness o the strength o the public interest in national security.
They have rightly deerred to Congress and the executive branch, allow-
ing executive agencies to engage in the limited surveillance that lies at the
opposite pole rom ransacking a single persons sensitive papers or politi-
cal purposes.
That deerence is especially appropriate now that Congress, through
the Patriot Act, has set a delicate balance that enables the executive branchto carry out its basic duty to protect us rom another 9/11 while respect-
ing our privacy as much as possible. Obviously, reasonable people can
have reasonable dierences over how that balance is struck. But on this
question, political deliberation has done its job, because everyone on both
sides o the aisle is seeking the right constitutional balance.
This nation has real problems if its people cant trust the combined
actions of the executive branch and Congress, backstopped by federal
judges sworn to protect our individual liberties.
In 1979, in Smith v. Maryland, the U.S. Supreme Court addressed that
balance when it held that using a pen register to track telephone numbers
did not count as an invasion o privacy, even in ordinary criminal cases.Thats just what the government has done here on a grand scale. The
metadata it examines in its eort to uncover suspicious patterns enables it
to learn the numbers called, the locations o the parties, and the lengths
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o the calls. The government does not knowas some have charged
whether youve called your psychiatrist, lawyer, or lover. The names linked
to the phone numbers are not available to the government beore a court
grants a warrant on proo o probable cause, just as the Fourth Amend-ment requires. Indeed, once that warrant is granted to examine content,
the content can be used only or national security issues, not even ordi-
nary police work.
Political deliberation has done its job. Everyone on both sides of the aisle
is seeking the right constitutional balance.
As the president said, the process involves some necessary loss o pri-
vacy. But its trivial, certainly in comparison to the losses that would have
arisen i the government had ailed to discern the pattern that let it thwart
the 2009 New York subway bombing plot by Colorado airport shuttle
driver Najibullah Zazi, an Aghan-American, who was prosecuted and
ultimately pleaded guilty.
The critics miss the orest or the trees. Yes, government oicials mightconceivably misuse some o the trillions o bits o metadata they examine
using sophisticated algorithms. But one abuse is not a pattern o abuses.
And even one abuse is not likely to happen given the saeguards in place.
The cumulative weight o the evidence attests to the soundness o the
program. The critics would be more credible i they could identiy a pat-
tern o government abuses. But ater twelve years o continuous practice,
they cant cite even a single case. We should be thankul that here, at least,government has done its job and done it well.
Reprinted by permission of the Chicago Tribune. 2013 Chicago Tribune. All rights reserved.
Available from the Hoover Press is The Case Against the
Employee Free Choice Act, by Richard A. Epstein. To
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INTELLIGENCE
Watching theDetectivesFree societies can indeed restrain their intelligence agencies, largely
by keeping them honest. ByMark Harrison.
Natural questions arise rom news reports about mass surveillance in
Western societies. Are our liberties at risk, along with our privacy? Are we
moving in the wrong direction along the spectrum that runs rom a ree
and democratic society to a totalitarian police state?
To help answer such questions, it would seem only sensible to ask howsurveillance works in real totalitarian police states. The answer might give us a
reality check. Here I will point out some important similarities between what
the U.S. National Security Agency (and others) are up to and the unctions
o the secret police under communist rule. I also will show some dierences.
My conclusion? We are a long, long way rom mass surveillance in the
style o the Soviet KGB or Chinas Public Security Bureau. But that should
not be completely reassuring.Here are the similarities that seem important:
Mass surveillance. American counterintelligence is in the business o
mass surveillance. Theyre looking at everyone. Jeremy Bash, chie o sta
to ormer CIA director and deense secretary Leon Panetta, is quoted in
the New York Timesas saying:
MarK harriSonis a research fellow at the Hoover Institution, a professor of
economics at the University of Warwick, and an associate of Warwicks Centre
for Competitive Advantage in the Global Economy.
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I youre looking or a needle in the haystack, you need a haystack.
That haystack is the millions and billions o bits o our data that are
being gathered. Mass surveillance was also the business o the KGB, as
it is the business o the secret police under any dictator. In act, coun-terintelligence everywhere has an unquenchable thirst or personal acts.
Every secret policeman knows that the most dangerous enemy is the one
you dont have on ile. You can keep tabs on the ones already in the Rolo-
dexbut what about the sleepers, the new recruits, the ones that are out
there and completely invisible to you? Its what you dont know that can
kill you. So, in the interests o staying alive, you can never know enough.
Detection relies on big data. How do you ind the enemy you dont
know? By using data and looking or patterns in the data. This is what
the KGB did. It looked or several kinds o patterns. KGB agents were
pioneers o proiling, or example. They igured that many disloyal people
had markers in common, although exactly what mattered changed rom
one period to another. In one period it was your social origins: upper
class (which meant the regime had taken your property) or poor. In otherperiods it was whether you had amily members who had led abroad, or
you spoke a oreign language, or you had stayed behind when the war
came and tried to live quietly under German occupation. So the agency
looked or people with those markers. Another thing the KGB looked or
was who knew whom or was related to whom. When agents put a person
under surveillance, they obsessively tracked riends and amily members,
telephone callers, letter writers, and so on.A third thing was just to look or unusual patterns o activity in the street
and at work. To know what was unusual, agents had irst to know what
was usual, and this in itsel required data collection on a massive scale. The
abnormal would stand out only against the normal. Qualitatively, this isnt
dierent rom what the FBI or the NSA are doing. They too are mainly just
looking or anomalies, or patterns o interest in the data.
The goal is prevention. The ultimate goal o surveillance is preven-
tion. Exactly what is being prevented may vary. Most Western intelligence
agencies today are trying to prevent another 9/11 or its London equiva-
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lent, another 7/7. They are also trying to prevent the public rom inding
out exactly how they are doing this, because that knowledge might help
their targets pass under the radar.
Chinas Public Security Bureau has a wider set o goals: to prevent publicdisorder, to prevent open criticism o Chinas leaders and political order,
and to prevent everyone rom getting the idea that open opposition could
ever be normal and go unpunished. The KGBs goals were pretty similar.
To do any o these things you have to be ready to react instantly to
signals that something is up. Sometimes you receive a signal, and you can
wait and see how it develops. Sometimes you have to react and nip it in
the bud even beore you know what it might be. To prevent the bad stuyou have to review all situations that look as i they have a potential or
going bad, and consider all people who look as i they have a potential to
become enemies. Identiying potential enemies is always and everywhere
a judgment call.
Risk of type I errors. So much o this work consists o judgment calls,
in act, that errors are inevitable. Some are what statisticians would calltype I errors and some are the opposite: type II. You make a type I error
when you see a pattern in randomness: or example, a person has a random
resemblance to a terrorist by having the wrong appearance and being in
the wrong place at the wrong time, and suddenly you have him on a plane
to Guantnamo Bay. To explain this another way, when youre looking
or a needle in a haystack, and its important to avoid missing it, its inevi-
table that you will turn up lots o things that might be needles becausethey look quite like needles and in act you might have even stuck one in
the pincushion beore you realized that its just a shiny thorn . . . and now
you cant be bothered to retrieve it. Yes, and that means that where there
is scope or error there is also scope or abuse, because secret policemen are
not all dedicated proessionals; among them will be those that are too lazy,
or too ambitious, or too much in love with power to correct a mistake.
A type II error is when you miss a pattern or overlook a real spy or ter-rorist. In most situations, Western societies show a preerence or type II
errors: wed rather leave a criminal at liberty than imprison an innocent
person. Thats not so hard when were talking about shopliting; its harder
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by orders o magnitude when the criminal at liberty has the potential to
behead a bystander or ly a passenger jet into a shopping mall.
Those are the ways in which Western counterintelligence looks very
much the same as counterintelligence under totalitarian rule. But there arealso some key dierences. Here they are:
Governed by law, and openly contested. Most obvious is the existence o
a legal ramework. It was not always like this but in both Britain and America
the intelligence services operate within the law, subject to both legislative and
judicial oversight. The law permits some things and not others. The NSA can
ind out that X sent e-mail to Y, but it cant read your e-mail without a courtorder that names you and convinces a judge o probable cause.
This ramework may well look unsatisactory, and may indeed be
unsatisactory; Im not a lawyer and dont pretend to know. At the same
time, we also have a ree press and intrepid journalists who have strong
incentives to ind scoops and dig out scandals. As a result, the scope o
secrecy and surveillance is law-governed (although imperectly), open to
ree discussion (to the extent that we know o it), and contested (vigor-ously and continually). I you dont like the law you can take the contest
to the polls and toss out the lawmakers. Or you can take a personal stand,
break the law, and answer or it in the courts.
The contrast with the situation in countries under communist rule
could not be more stark. There the KGB responded only to the instruc-
tions o the ruling party (and the same no doubt holds in China, Cuba,
North Korea, and Vietnam); there was and is no answerability to theparliament, the courts, or the press. What is more, the merest mention
o secrecy and surveillance was completely suppressed; the existence o
secrets was a well-policed secret.
A much bigger haystack. Americas haystack is o unimaginably vast
dimensions. Its so big that, according to Edward Luce in the Financial
Times, it employs a data-intelligence complex with a sta o nearly a mil-lion and a budget o $80 billion.
The KGBs haystack was pretty large in its time. It was put together rom
many individual straws: agent reports o gossip rom canteen queues and stu-
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dent dormitories, surveillance reports, inormation gathered rom micro-
phones, phone taps, opening the mail, and so orth. In orty years the archive
o KGB counterintelligence in Soviet Lithuania (a country o around 3
million people) accu-mulated at
Illustrationb
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TaylorJones
for
the
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least a million pages o documents. On that basis, the total paperwork
o the entire Soviet KGB archive (or seventy years and a country o 200
million people and more) ought to exceed that o Soviet Lithuania by at
least two orders o magnitude. And this was in a society with one landlinesystem and one mail service, without networked computers or mobile
phones, where no one even had ree access to a photocopier. When even
intercity phone calls had to be booked through an operator in a city
exchange, it was relatively easy or the KGB to monitor anyones personal
network. So the size o Americas haystack must be thousands o times
larger than this, and probably tens or hundreds o times larger than even
Chinas haystack.This observation, at irst alarming, is testimony to the act that we
live in a ree society in which communication is unettered and o
negligible cost by historical standards. We, the citizens, are the ones
who make the haystack so large by our abundant use o the reedom
to communicate.
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Many fewer needles. The problem o inding needles in this vast hay-
stack is magniied by the act that Western societies do not appear system-
atically to produce needlescertainly not on the scale o more repressive
societies. As the sociologists Alex Inkeles and Raymond A. Bauer reported(in The Soviet Citizen, 1959) rom the irst wave o the Harvard Inter-
view Project, the Soviet system o repression was apparently based on the
assumption that everyone had a reason to hold a grudge against the com-
munist rulers somewhere in the past. A parent had lost property, a brother
had been arrested, a husband shot, a cousins amily resettled in the remote
interior. As time passed the salience o such historical events might recede,
yet or some reason each new generation o Soviet-educated citizens kepton throwing up new kinds o nonconormity and outright disloyalty that
had to be monitored and checked.
In contrast, Western societies are not governed by dictators who have
systematically expropriated property and penalized wide social classes and
ethnic groups; they also provide multiple channels or citizens to express
discontent and resentment and organize or social and political change.
Despite this, there are still needles: enemies o openness and tolerance.But they are ar ewer in number than the hostile orces that repressive
regimes cannot help but produce and reproduce continually.
More type I errors. Put a much bigger haystack together with ar ewer
needles and the implication is unmistakable. When the haystack is small
and needles are many, the chances o making type I errors are reduced.
Under communist rule, i it pricked like a needle and it looked like a
needle, there was at least a good chance that it was a needle. Any Westernintelligence agency trying to ind those ew needles in todays mega-hay-
stack has a greatly reduced chance o coming up with real needles com-
pared with its communist counterpart, and a correspondingly heightened
chance o alse positives.
The act that so many people are looking or the ew needles, that the
number o big-data analysts must exceed the probable number o real ter-
rorists by a actor o one hundred or even ten thousand, just makes it
much, much worse. So you want to make a career as an analyst. How can
you distinguish yoursel i you never identiy a threat? How can you end
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o boredom i you never reach the point o saying this is someone we
should look at more closely? So you do it, and you make a mistake. Well,
you say, it was worth looking into.
And that is most unortunate, because as a society we want to live insaety but we also hate type I errors. We intensely dislike the idea that an
incidental bystander might get investigated, or even detained, because o
an intelligence error. So intelligence errors sow cynicism and mistrust.
NSA versus KGB: is there good or bad news in the comparison? To me
the news looks mostly good. Compared with the KGB, the NSA appears
quite benign. But there is also a warning, which lows rom the observa-
tion that there is no limit on what our guardians would like to knowabout us. The more they know, the better inormed they are. But the more
resources they have, the greater is the scope or overambition, the abuse o
power, and the alse positives that we rightly ear.
How much is enough? The purpose o national security is not to su-
ocate us with cotton wool. It is to enable us to be the people we would
like to be and to protect the rule o law that we would like to have. In a
ree, open society the limits o security are something we, the citizens,should always debate, contest, and, i necessary, push back.
Special to the Hoover Digest. Adapted from Mark Harrisons blog (https://blogs.warwick.ac.uk/markharrison).
Published by the Yale-Hoover Series on Stalin, Stalinism,
and the Cold War is Guns and Rubles: The Defense
Industry in the Stalinist State, edited by Mark Harrison.
To order, call 800.405.1619 or visit http://yalepress.yale.edu/yupbooks/order.asp.
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INTELLIGENCE
October SurprisesThe Cuban missile crisis represents an enduring tale o complacency,
ragmented data, and the rantic race to pick signal out o noise. By
Amy B. Zegart.
In September 1962, CIA Director John McCone was honeymooning in
Europe but couldnt take his eyes o Cuba. Convinced the Soviets were
secretly deploying nuclear missiles ninety miles rom Florida, McCone
repeatedly cabled Washington with his concerns. Nobody believed him.
McCone was operating on a hunch, without solid evidence.
When the CIA issued a Special National Intelligence Estimateabout the Soviet arms buildup in Cuba on September 19, it disregard-
ed the directors views entirely. That estimate, like the previous three,
concluded the Soviets would not dare put nuclear missiles in Cuba.
A month later, U-2 spy planes snapped photographs that conirmed
McCones worst ears and ushered in the most dangerous thirteen days
in history.
The Cuban missile crisis o ity-one years ago stands as the most stud-ied event o the nuclear age. Academics have written so much about that
eyeball-to-eyeball moment that there are articles about why we should
stop writing articles about it. But there is at least one key lesson yet to be
learned. Generations o scholars and practitioners have insisted on calling
the crisis an intelligence successwhen there is much more to be learned by
calling it afailure.
aMy B. ZeGart is a senior fellow at the Hoover Institution and an affiliated
faculty member at the Center for International Security and Cooperation at Stan-
ford University.
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The success narrative says the CIA discovered Soviet missiles beore
they became operational, enabling President Kennedy to seize the initia-
tive and save the day. But the beginning o the story is just as impor-
tant and more oten orgotten: the CIA ailed to anticipatethe presenceo Soviet missiles despite widespread knowledge that Soviet arms ship-
ments were escalating dramatically that summer. All our intelligence
estimates on Cuba published in 1962 had a reassuring quality, highlight-
ing evidence that the Soviets sought to deend the island with conven-
tional arms, not deploy nuclear missiles there. Instead o inoculating the
Kennedy administration against the horrors o a possible Soviet missile
surprise, the intelligence estimates made the surprise even more suddenand shocking.
The bottom line: we got lucky.
It is comorting to think that we avoided nuclear Armageddon
through artul diplomacy, steely nerves, and timely intelligence. But
the truth is we got lucky. During the height o the crisis, a previouslyscheduled test simulating a missile attack rom Cuba was mistakenly
identiied as a real incoming strike, giving the North American Air
Deense Command just minutes to determine what to do. In a 2002
missile crisis anniversary conerence (yes, there are these things), schol-
ars learned or the irst time that one Soviet submarine captain actually
did order preparations to launch a nuclear-tipped torpedo o the U.S.
coast on October 27. Were it not or a man named Vasili Arkhipov,who persuaded the captain to wait or urther instructions rom Mos-
cow even as they were being bombarded by U.S. Navy depth charges
and running out o air, events could easily have taken a tragic turn.
Other terriying examples abound, showing just how close the edge o
disaster really was.
Calling something a success or ailure is not just an exercise in tweedy
semantics. It shits the ocus rom what went right to what went so wrong.And what went wrong ity-one years ago is still going wrong today: two
lingering questions rom 1962 suggest the deadly eects o organizational
pathologies in intelligence.
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MOMENT OF CRISIS: Five days after President Kennedy signed the Cuba
weapons embargo on October 23, 1962, Soviet leaders agreed to disman-
tle nuclear missiles there. Before the crisis, however, all four intelligence
estimates on Cuba published that year had reassured Washington that the
Soviets would defend the island with only conventional arms, not nuclear
missiles.
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1. Why did analysts miss the signals of Khrushchevs true intentions?
Sherman Kent, who led the CIAs estimating shop during the crisis,
argued that intelligence estimates missed the mark mostly because Khrush-
chev was nutty. There is no blinking the act that we came down on thewrong side, he admitted in 1964. But Kent added, no estimating pro-
cess can be expected to divine exactly when the enemy is about to make a
dramatically wrong decision. In other words, lets blame Khrushchev and
hope or more-predictable adversaries in the uture.
The more important and overlooked lesson here is that the struc-
ture o the U.S. intelligence system made a tough job nearly impossible.
Although the CIA was created in 1947 to prevent another Pearl Harbor,the agency has never really been central. Intelligence agencies in the
State, War, Navy, and Justice departments hobbled the CIA rom its
earliest days to protect their own tur. As a result, in 1962 intelligence
reporting and analysis about Cuba was handled by hal a dozen agencies
with dierent missions, specialties, incentives, security clearance levels,
access to inormation, and no common boss with the power to knock
bureaucratic heads together short o the president. In this bureaucraticjungle, signals o Khrushchevs true intentionsand there were sever-
algot dispersed and isolated instead o consolidated and ampliied to
sound the alarm.
Sound amiliar? Beore 9/11, this same ragmentation kept U.S. intelli-
gence agencies rom seizing twenty-three dierent opportunities to disrupt
the terrorist plot. In each instance, someone in an intelligence agency noticed
something important: a string o jihadist light school students in Arizona, asuspicious extremist at a Minnesota light school, two suspected Al-Qaeda
operatives with U.S. visas in their passports. These and other signals were not
drowned out by all the noise. They were ound, an incredible eat. And then,
just as incredibly, each signal got lost in the bureaucratic sprawl.
2. Why, despite new evidence of a dramatically escalating Soviet build-
up, did intelligence analysts continue to draw the same old conclusions?
In August and September 1962, intelligence showed a dramatic uptick
in Soviet personnel and weapons deployments to Cuba. Nevertheless, the
September 19 intelligence estimate concluded nothing had changed. The
Soviets were ramping up all right, but to deend Cuba.WhiteHouse
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Sherman Kent took a lot o heat or that estimate. Nearly all o it cen-
tered on mirror imaging, the tendency or analysts to assume an enemy
will behave as they would. For psychologists, cognitive limits in the Cuban
missile crisis have been the git that keeps on giving. But I am convinced
that organizational pressures were also at work.The thing to know about National Intelligence Estimates is that they
are collective products. No single person or agency writes them. Instead,
estimates require intense negotiation among many agencies to reach con-
THE DANGER PASSES: A U.S. surveillance aircraft (its shadow visible at lower right) flies