Hoover Digest, 2016, No. 1, Winter

8/20/2019 Hoover Digest, 2016, No. 1, Winter

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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 TA N F O R D U N I V E R S I T Y

HOOVER DIGESTRESEARCH + OPINION ON PUBLIC POL ICY

WINTER 2016 NO. 1


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The Hoover Institution on War, Revolution and Peace was established at Stanford Univer-

sity in 1919 by Herbert Hoover, a member of Stanford’s pioneer graduating class of 1895 and the

thirty-first president of the United States. Created as a library and repository of documents,

the Institution approaches its centennial with a dual identity: an active public policy research

center and an internationally recognized library and archives.

The Institution’s overarching goals are to:

» Understand the causes and consequences of economic, political, and social change

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This Institution supports the Constitution of the United States, its Bill of Rights,

and its method of representative government. Both our social and economic sys-

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from its records, to recall the voice of experience against the making of war, and

by the study of these records and their publication to recall man’s endeavors to

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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 TA N F O R D U N I V E R S I T Y

HOOVER DIGESTRESEARCH + OPINION ON PUBLIC POLICY

WINTER 2016 • HOOVERDIGEST.ORG


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The Hoover Digest explores politics, economics, and history, guided by the

scholars and researchers of the Hoover Institution, the public policy research

center at Stanford University.

The opinions expressed in the Hoover Digest are those of the authors and

do not necessarily reflect the opinions of the Hoover Institution, Stanford

University, or their supporters. As a journal for the work of the scholars and

researchers affiliated with the Hoover Institution, the Hoover Digest does not

accept unsolicited manuscripts.

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ON THE COVER

A British poster from World War I highlights

a young woman working in a munitions

factory. Munitions work was indeed highly

dependent on women’s labor, as were many

other civilian jobs in the warring nations.Such jobs gave women a salary, a sense of

purpose—and in some cases chronic health

problems. Some of the so-called “munitio-

nettes” or “canary girls,” so named because

the chemicals in shells turned their skin

orange-yellow, also died in explosions in huge

arms factories. See story, page 196.

HOOVER DIGESTRESEARCH + OPINION ON PUBLIC POLICYWINTER 2016 • HOOVERDIGEST.ORG

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Winter 2016 HOOVER DIGESTTHE ECONOMY

9 Avoiding Greece’s Mistakes—While We Still CanThe United States can avoid the errors that savaged the Greek

economy, but only if Washington makes a concerted effort todo so. By John B. Taylor

13 Too Strong to FailDodd-Frank’s selective scrutiny won’t prevent the next

meltdown. What would? Insisting that financial institutions

hold more capital. By Edward Paul Lazear

16 Where’s the Productivity?Despite predictions, there’s little sign that automation is

making economies more productive. How come? By Michael

Spence

20 A Few Trillion Short

Public employee pensions are in a deeper financial hole thanstates admit—a much, much deeper hole. By Joshua D. Rauh

POLITICS

25 Myths of RedistributionDecrying the “income gap” may make for stirring political

rhetoric, but we don’t need rhetoric. We need growth. By

Allan H. Meltzer

HOOVER DIGEST • WINTER 2016 3


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29 Here’s Mud in Your EyePolitics in democracies have always been rough and tumble,

and we’re better off because of it. By Bruce S. Thornton

REFUGEES

37 The American Way of RefugeOffering sanctuary to Syrian exiles is both compassionate and

wise—and just might give the United States a chance for a

regional “reset.” By Kori N. Schake

HEALTH CARE

41 Rescuing ObamaCareThe best cure? High-deductible plans and health savings

accounts. By Scott W. Atlas and John F. Cogan

INTELLIGENCE AND SECURITY

44 China as an Ally in Cyberspace?How Washington and Beijing could make common cause

toward a secure online world. By Herbert Lin

49 The Future of ViolenceComing to grips with dizzying change and vanishing borders.

By Benjamin Wittes and Gabriella Blum

4 HOOVER DIGEST • WINTER 2016


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55 Foiling the Dirty BombHow to head off the threat of a radiological weapon before it’s

too late. By Sam Nunn and Andrew Bieniawski

EDUCATION

58 Whose Standards?Parents of schoolchildren certainly support standardized

tests; the Common Core, not so much. Highlights of the

latest Education Next poll. By Michael B. Henderson, Paul E.

Peterson, and Martin R. West

70 Fight for the BrightOur highest-achieving students have needs, too—and we’re

failing to meet them. By Chester E. Finn Jr. and Brandon L.

Wright

78 Bad News Is Good News

Low test scores may be unwelcome, but they’re entirelynecessary. Parents shouldn’t shoot the messenger. By Michael

J. Petrilli and Robert Pondiscio

RUSSIA

82 Red Tide Ebbing

Although he may appear to have outmaneuvered Washington, Vladimir Putin has made missteps—and given the United

States a chance to press for a democratic, responsible Russia.

By Michael A. McFaul

GREECE

86 Poorer, Yes. But Wiser?Political regimes in Greece used to be nasty, brutish, and

short-lived. Has the country grown up at last? By Niall

Ferguson



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ISRAEL

89 A Rare Win-WinBy improving the lives of Palestinians, Israelis could improve

their own. By Stephen D. Krasner

IRAN

97 A Chance for Iranian ReformThe Obama administration’s nuclear deal, many Iranians

believe, could encourage changes in Iran itself. By Abbas

Milani and Michael A. McFaul

106 And Now, the FalloutRegardless of what Iran gets out of the nuclear deal, its proxy

Hezbollah clearly gains—and Israel clearly loses. By Peter

Berkowitz

RELIGIOUS FREEDOM111 The Tyranny of Secular Faith

Progressivism marches relentlessly toward its destination: the

one true secular kingdom. By Peter Berkowitz



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CONSCRIPTION

115 Don’t Bring Back the Draft Abolishing military conscription was a great victory for

freedom. Here’s why the volunteer military should remain justthat. By David R. Henderson

CALIFORNIA

120 Beating the Drought, Aussie StyleThe lesson California should learn from Australia: create a

robust market to swap water. By Carson Bruno

INTERVIEW

126 The Exceptional Rupert MurdochThe media mogul reflects on luck, and on making one’s own

luck. By Peter Robinson

IN MEMORIAM: ROBERT CONQUEST

134 The Man Who Was RightThe late Hoover fellow Robert Conquest detailed communist

horrors when nobody believed them, or wanted to believe. By

John B. Dunlop and Norman M. Naimark

144 This Be His Verse As a poet, Robert Conquest could be subtle, blunt, or blue—orall three at once. A brief testament to a great talent. By John

O’Sullivan

HEROISM

151 The Heroic HeartHeroes still walk among us, but no longer must they kill to

win glory. Instead the hero for our time is a healer. By Tod

Lindberg



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161 Heroes and VillainsIf we start pulling down heroes who are imperfect, we should

pull them all down. History is tragedy, and the players always

human. By Victor Davis Hanson

THE COLD WAR

164 “Long Telegram,” Long ShadowSeventy years have passed since diplomat George Kennan

offered his penetrating advice. The story of one of the most

important documents in American history. By Bertrand M.

Patenaude

HISTORY AND CULTURE

181 Sakharov and the Moral Imperative“The truth is never simple,” said the celebrated Soviet

dissident. His was indeed a complex life in complicated times.

By Serge Schmemann

HOOVER ARCHIVES

189 War Is . . . Soccer?Historic posters show how World War I combatants wove

the beautiful game into images, and memories, of a far-from-

beautiful war. By Jean McElwee Cannon

196 On the Cover



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THE ECONOMY

Avoiding Greece’s Mistakes—While

We Still CanThe United States can avoid the errors thatsavaged the Greek economy, but only if

Washington makes a concerted effort to do so.

By John B. Taylor

Last summer I addressed the Senate Foreign Relations Subcom-

mittee on Europe and Regional Security Cooperation about the

lessons the United States can learn from the Greek financial

crisis. One obvious lesson is that the United States needs to take

actions to prevent its own federal debt from exploding, as is forecast by the

Congressional Budget Office in its alternative fiscal scenario. But I chose to

emphasize a broader set of economic policy issues.

First, note that while the Greek economy has been performing terribly

recently (real GDP has declined by an average of 5 percent per year for

the past five years), over the longer term economic growth has also been

poor. Real GDP growth averaged only 0.9 percent per year and productivity

growth (on a total factor basis) averaged only 0.1 percent per year since 1981.

John B. Taylor is the George P. Shultz Senior Fellow in Economics at the Hoover

Institution, the chair of Hoover’s Working Group on Economic Policy and a mem-

ber of Hoover’s Shultz-Stephenson Task Force on Energy Policy, and the Mary and

Robert Raymond Professor of Economics at Stanford University.



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Note also that Greece’s economic policies—regulatory, rule of law, bud-

get, taxes—have also been very poor, according to many outside observers.

According to the Heritage Foundation’s Index of Economic Freedom, Greece

ranks 130 among the countries of the world, the worst policy performance

in Europe and on a

par with many poor

sub-Saharan African

countries. According

to the World Bank’s

Doing Business indicator, Greece ranks 61, which is well below Portugal, Italy,

Spain, and Ireland; and on two important pro-growth measures in the Doing

Business indicator it ranks 155 on enforcing contracts and 116 on registering

property. And, according to yet another measure, the Fraser Institute’s Index

of Economic Freedom, Greece ranks 84 in the world.

These factors alone explain much of Greece’s poor economic performance,

and for this reason in its recent report on Greece the IMF concludes that

“to achieve [productivity] growth that is similar to what has been achieved

in other euro area countries, implementation of structural [supply side]

[Taylor Jones—for the Hoover Digest ]

The United States has been slipping on

measures of good economic policy.



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reforms is therefore critical.” No quantitative measure is perfect and there

are exceptions, but there is a general association between these economic

policy measures and economic performance.

Of course, US economic policy scores higher according to these quantita-

tive measures, and one must be careful in drawing analogies and lessons.

Nevertheless there is a problem: the United States has been declining in

recent years on all of these

measures of good economic

policy. On the Fraser index,

the United States ranked

2 in the year 2000 and

it ranks 14 today. On the

Heritage index it ranked 5 in

2008 and it ranks 12 today. On the World Bank’s Doing Business indicator it

ranked 3 in 2008 and it ranks 7 today.

I have also noticed such a deviation from good economic policy in the

United States in recent years and I wrote about it in my book First Principles.

I find a connection between the recent US problem of low economic growth

I find a connection between the

recent US problem of low economic

growth and this deviation from

sound policy.



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and this deviation from sound policy principles. In the United States, adher-

ence to the principles of good economic policy has ebbed and flowed over the

years, creating waves of bad economic times and good economic times.

Of course, there are implications for Greece: the best policy for Greece would be to radically change economic policy in a pro-growth direction. This

would move Greece up in the economic policy indexes and, more important,

start productivity and economic growth.

For the United States, the policy implications are similar, though their

purpose is to accelerate the slow upward pace of the economy—say from a 2

percent growth rate to 4 percent—and avoid another economic crisis, rather

than to stop a precipitous downward drop in the economy and stop an ongo-

ing crisis, as in the case of Greece.

Reprinted from John B. Taylor’s blog Economics One (http://economicsone.

com).

New from the Hoover Institution Press is Puzzles,

Paradoxes, Controversies, and the Global Economy ,

by Charles Wolf Jr. To order, call (800) 888-4741 or visitwww.hooverpress.org.



15/196

THE ECONOMY

Too Strong to FailDodd-Frank’s selective scrutiny won’t prevent

the next meltdown. What would? Insisting that

financial institutions hold more capital.

By Edward Paul Lazear

R

ecently large market declines and increased volatility have

prompted concerns that we may be headed again toward finan-

cial chaos. The 2010 Dodd-Frank law was supposed to prevent

that from happening, but as Milton Friedman cautioned, “the

government solution to a problem is usually as bad as the problem and very

often makes the problem worse.”

Case in point: Dodd-Frank’s Financial Stability Oversight Council has

subjected several US banks and nonbank financial institutions to special

regulatory scrutiny based on the idea that their failure could lead to another

crisis. But the theory behind so-called systemically important financial

institutions, or SIFIs, is fundamentally flawed. Financial crises are patholo-

gies of an entire system, not of a few key firms. Reducing the likelihood of

another panic requires treating the system as a whole, which will provide

greater safety than having the government micromanage a number of private

companies.

The risks to a system are most pronounced when financial institutions bor-

row heavily to finance investments. If the value of the assets falls or becomes

Edward Paul Lazear is the Morris Arnold and Nona Jean Cox Senior Fellow at

the Hoover Institution, co-chair of Hoover’s Conte Initiative on Immigration Re-

form, and the Jack Steele Parker Professor of Human Resources Management and

Economics at Stanford University’s Graduate School of Business.



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highly uncertain, creditors—who include depositors—will rush to pull out

their money. The institution fails when it is unable to find a new source of

funds to meet these obligations.

The collapse of Bear Stearns and the Lehman Brothers bankruptcy are

prime examples. Before the 2008 crisis, some firms had leverage ratios of 25

to 1 or higher, meaning that

for every $26 of investment,

the firm needed to borrow

$25. This required banks

to obtain large amounts

daily to pay off previous creditors. But when the value of their investments

fell—which in the last crisis included a large share of mortgage and other

asset-backed securities—the banks could not borrow and had to raise money

quickly by selling their assets, sometimes at fire-sale prices. This turned

seemingly solvent firms into insolvent ones.

A bank’s inability to pay off its creditors can be transmitted to others. The

mechanism can be direct: the debtor bank defaults, and its creditors cannot

repay their creditors, etc. But the mechanism can be indirect. The suspicion

that similar assets held by other institutions are subject to the same down-

ward pressure can start a run at even an unrelated financial institution.However, this domino effect has less to do with the so-called interconnect-

edness of the financial institutions than with weaknesses in the system itself.

To understand why, consider the contrast between the 2008 financial crisis

and the dot-com crash in the late 1990s and early 2000s.

The bursting of the dot-com bubble and subsequent failure of many

Internet-based companies had serious repercussions for investors, but not

for the financial sector. That’s because the failed firms were financed primar-

ily through equity, not borrowed money. Investors took big losses when the value of tech companies fell precipitously. But there were no runs.

Mutual funds are similar. Many are large and hold assets that may be risky,

but they don’t fail when the value of their assets falls. The liabilities move

one-for-one with the value of the assets because the fund does not promise to

pay off any fixed amount to its investors. There is no reason for a run: getting

money out first serves no purpose to investors nor does withdrawal of funds

cause significant distress. The fund simply sells the assets at the market

price and returns that amount to investors.

These factors suggest that instead of trying to divine which firms are

systemically important, banks should be required to get a larger share of the

funds they invest by selling stock. Bank investment funded by equity avoids

Financial crises are pathologies of an

entire system, not a few key firms.



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the danger of a run: if the value of a bank’s assets falls, so too does the value

of its liabilities. There is no advantage in getting to the bank before others do.

Using higher equity requirements to reduce systemic risk has been sug-

gested by Hoover distinguished visiting fellow Allan Meltzer, and in The

Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It ,

a recent book by Anat Admati and Martin Hellwig that has received much

attention.

This reasoning also implies that deposits—the checking and saving

accounts that are bank liabilities—should be invested only in short-maturity

secure assets, like Treasury bills. A bank’s long-term investments, in mort-

gages or stocks, can then experience big losses or even fail. Bad for the bank

and its investors, but not for the financial system or for depositors, whose

deposits are backed by vir-

tually risk-free assets.

The Federal Reserve

seems to be wising up, and

may require higher equity

capital for the SIFIs and place less emphasis on regulation. Fed Chair Janet

Yellen told the Senate Banking Committee last July that she was open to

raising the threshold on the asset level warranting SIFI status and scrutiny. Additionally, the international Financial Stability Board announced last

summer that it would set aside work on designating funds or asset manag-

ers as systemically important to focus instead on whether their activities or

products were systemically important.

Dodd-Frank’s method of protecting the financial system is based on a

misdiagnosis of what led to the 2008 financial crisis. A more rules-based

approach that focuses primarily on equity and leverage would provide better

certainty and a higher cost-benefit ratio than designating firms as SIFIs.

Reprinted by permission of the Wall Street Journal. © 2015 Dow Jones &

Co. All rights reserved.

Available from the Hoover Institution Press is NAFTA

at 20: The North American Free Trade Agreement’s

Achievements and Challenges , edited by Michael J.

Boskin. To order, call (800) 888-4741 or visit www. hooverpress.org.

Bank investment funded by equity

avoids the danger of a run.



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THE ECONOMY

Where’s the Productivity?

Despite predictions, there’s little sign that

automation is making economies moreproductive. How come?

By Michael Spence

It seems obvious that if a business invests in automation, its work-

force—though possibly reduced—will be more productive. So why do

the statistics tell a different story?

In advanced economies, where plenty of sectors have both the money

and the will to invest in automation, growth in productivity (measured by value

added per employee or hours worked) has been low for at least fifteen years.

And, in the years since the 2008 global financial crisis, these countries’ overall

economic growth has been meager, too—just 4 percent or less on average.

One explanation is that the advanced economies had taken on too much

debt and needed to deleverage, contributing to a pattern of public sector

underinvestment and depressing consumption and private investment as

well. But deleveraging is a temporary process, not one that limits growth

indefinitely. In the long term, overall economic growth depends on growth in

the labor force and its productivity.

Michael Spence is a senior fellow at the Hoover Institution, a professor of eco-nomics at New York University’s Stern School of Business, and the Philip H.

Knight Professor Emeritus of Management in the Graduate School of Business at

Stanford University. He was awarded the Nobel Memorial Prize in Economic Sci-

ences in 2001.



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Hence the question on the minds of politicians and economists alike: is the

productivity slowdown a permanent condition and constraint on growth, or

is it a transitional phenomenon?

There is no easy answer, not least because of the wide range of factors

contributing to the trend. Beyond public sector underinvestment, there is

monetary policy, which, whatever its benefits and costs, has shifted corpo-

rate use of cash toward stock buybacks, while real investment has remained

subdued.

Meanwhile, information technology and digital networks have automated

a range of white- and blue-collar jobs. One might have expected this transi-

tion, which reached its pivotal year in the United States in 2000, to cause

unemployment (at least until the economy adjusted), accompanied by a rise

in productivity. But in the years leading up to the 2008 crisis, US data show

that productivity trended downward; and, until the crisis, unemployment did

not rise significantly.

One explanation is that employment in the years before the crisis was

being propped up by credit-fueled demand. Only when the credit bubble

burst—triggering an abrupt

adjustment, rather than the

gradual adaptation of skillsand human capital that would

have occurred in more normal

times—did millions of workers

suddenly find themselves unemployed. The implication is that the economic

logic equating automation with increased productivity has not been invali-

dated; its proof has merely been delayed.

But there is more to the productivity conundrum than the 2008 crisis. In

the two decades that preceded the crisis, the sector of the US economy thatproduces internationally tradable goods and services—one-third of overall

output—failed to generate any increase in jobs, even though it was growing

faster than the nontradable sector in terms of value added.

Most of the job losses in the tradable sector were in manufacturing indus-

tries, especially after the year 2000. Although some of the losses may have

resulted from productivity gains from information technology and digitiza-

tion, many occurred when companies shifted segments of their supply chains

to other parts of the global economy, particularly China.

By contrast, the US nontradable sector—two-thirds of the economy—

recorded large increases in employment in the years before 2008. However,

these jobs, often in domestic services, usually generated lower value added

The pressing question: is the pro-

ductivity slowdown permanent or

transitional?



20/196

than the manufacturing jobs that had disappeared. This is partly because the

tradable sector was shifting toward employees with high levels of skill and

education. In that sense, productivity rose in the tradable sector, although

structural shifts in the global economy were surely as important as employ-

ees becoming more efficient at doing the same things.

Unfortunately for advanced economies, the gains in per capita valueadded in the tradable sector were not large enough to overcome the effect of

moving labor from manufacturing jobs to nontradable service jobs (many of

which existed only because of credit-fueled domestic demand in the halcyon

days before 2008). Hence the muted overall productivity gains.

Meanwhile, as developing economies become richer, they, too, will invest in

technology to cope with rising labor costs, a trend already evident in China.

As a result, the high-water mark for global productivity and GDP growth

may have been reached.

The organizing principle of global supply chains for most of the postwar

period has been to move production toward low-cost pools of labor, because

labor was and is the least mobile of economic factors (labor, capital, and

WORKING SMARTER: People watch an industrial robot at a manufacturingexpo in Weifang, China. As developing economies become richer, they will

invest in technology to cope with rising labor costs, a trend already evident inChina. [Guo Xulei—Xinhua]



21/196

knowledge). That will remain true for high-value-added services that defy

automation. But for capital-intensive digital technologies, the organizing

principle will change: production will move toward final markets, which will

increasingly be found

not just in advanced

countries but also in

emerging economies

as their middle classes

expand.

Martin Baily and James Manyika recently pointed out that we have seen

this movie before. In the 1980s, Robert Solow and Stephen Roach separately

argued that IT investment was showing no impact on productivity. Then the

Internet became generally available, businesses reorganized themselves and

their global supply chains, and productivity accelerated.

The dot-com bubble of the late 1990s was a misestimate of the timing, not

the magnitude, of the digital revolution. Likewise, Manyika and Baily argue

that the much-discussed “Internet of things” is probably some years away

from showing up in aggregate productivity data.

Organizations, businesses, and people all have to adapt to the technologi-

cally driven shifts in our economies’ structure. These transitions will belengthy, rewarding some and forcing difficult adjustments on others, and

their productivity effects will not appear in aggregate data for some time.

But those who move first are likely to benefit the most.

Reprinted by permission of Project Syndicate (www.project-syndicate.

org). © 2015 Project Syndicate Inc. All rights reserved.

The dot-com bubble of the late 1990s

was a misestimate of the timing, not the

magnitude, of the digital revolution.

New from the Hoover Institution Press is Inequality and

Economic Policy: Essays in Memory of Gary Becker,

edited by Tom Church, Chris Miller, and John B. Taylor.

To order, call (800) 888-4741 or visit www.hooverpress.

org.



22/196

THE ECONOMY

A Few Trillion Short

Public employee pensions are in a deeper

financial hole than states admit—a much, muchdeeper hole.

By Joshua D. Rauh

There’s a huge financial hole in state-sponsored retirement plans

for public employees, a hole that states will eventually have to fill

with tax increases and spending cuts.

How big is this government debt owed to public employees? In

July 2015, the Pew Charitable Trusts released its latest issue brief, reporting

that as of 2013, the nation’s state-run retirement systems had a $968 billion

funding gap, not far from the “trillion dollar gap” Pew reported in 2010.

As serious as this sounds, the true magnitude of unfunded pension prom-

ises for the systems tracked by Pew is much larger. The system of measure-

ment and budgeting for public pension promises has fallen prey to one of the

fundamental fallacies in financial economics: undervaluing a risk-free stream

of promised cash flows by assuming that the promises can be met with high,

anticipated returns on smaller pools of risky assets.

WHERE THE NUMBERS WENT WRONG

When I correct the calculations to reflect the expectation of public

employees that these promises will be honored, the market value of

Joshua D. Rauh is a senior fellow at the Hoover Institution and the Ormond

Family Professor of Finance at Stanford University’s Graduate School of Business.



23/196

unfunded liabilities proves to be far larger: $3.28 trillion (as of 2013). More-

over, this figure excludes local government obligations such as those of US

cities and counties.

Pew collects its information from state government disclosures. Its 2013

data suggest that, across 237 state-level pension systems, there were $3.43

trillion in liabilities backed by $2.47 trillion in assets. In other words, this

implies a net gap of around $1 trillion.

These liability measures are far

too low. They are based on state

assumptions of high assumed

returns on risky asset portfolios:

the median assumed return was

7.75 percent (and the liability-

weighted average 7.66 percent).

The funding gap amounts to a mere $1 trillion only if the public plans can

achieve these high compound annualized returns over the horizon during

which these benefits must be paid. Yet governments have promised to pay

the pensions regardless of what happens to the pension investments. As

such, pension promises should be treated like the senior government debt

they are, akin to default-free government bonds.For a proper financial market valuation, the promised pensions should

first be adjusted to reflect only accrued benefits, or retirement payments

that employees would be entitled to receive under their current salary and

years worked. This is not how governments do it today, but my 2011 paper

with Robert Novy-Marx did this recomputation for most of the plans in the

Pew study.

Using the Treasury yield curve and assuming the pension payouts have an

average maturity of fourteen years, the correct fourteen-year discount rate is2.8 percent—implying a whopping

$5.77 trillion in total state pen-

sion liabilities for these accrued

benefits only.

What about the assets backing

these promises? The Pew report

relies on asset values smoothed

over a period of years. To cor-

rect for the artificial smoothing, we collected actual market values for the

majority of the Pew-included plans. The resulting numbers indicated assets

in 2013 were only about 1 percent larger than the smoothed values, still just

States assume they can meet

their promises with high, antici-

pated returns on small pools of

risky assets.

Market interest rates have con-

tinued to fall, raising the cost

of making good on pension

promises.



24/196

under $2.50 trillion. Total unfunded state pension promises using market

values were therefore $3.28 trillion, or the difference between $5.77 trillion in

accrued liabilities versus a little less than $2.50 trillion in assets.

Moreover, state court decisions in California and recently in Illinois sug-

gest that even prospective benefits for current workers are inviolate under

the law of some states. If states cannot even slow the rate of future benefit

accruals, then the true magnitude of the liability to which states have com-

mitted is even larger that the liabilities formally accrued at present.

LACK OF PROGRESS

It’s remarkable that despite strong investment performance over the 2009–13

period, the states’ unfunded pension liabilities have hardly declined. Though

assets have grown, liabilities have continued to move steadily upward, as

plans continue to make new promises faster than they pay off their old




25/196

ones. Public pensions have also had to re-evaluate their assumptions about

longevity. Meanwhile, market interest rates have continued to fall, raising the

cost of making good on these promises. For all of these reasons, unfunded

liabilities on a market-value basis will likely be even larger this year when the

data become available.

The Governmental Accounting Standards Board’s Statement 67 began,

in 2014, to impose some stricter reporting requirements on systems that

project their plans’ net assets to be insufficient for meeting all benefit pay-

ments to current plan members. The trouble is that few states are recogniz-

ing that their assets will be insufficient because they expect to achieve their

high returns on invested assets.

Most systems will therefore



26/196

continue to budget for pensions exactly as they have in the past: by hoping

that good returns on their financial assets will bail them out of trouble and

marking down the value of their liabilities as though such returns were a

certainty.

US governmental accounting standards should be replaced with a more

transparent standard, one that measures the true financial cost of public

pension promises. This would be an important step toward ending the use of

pension systems as a way for state and local governments to run off-balance-

sheet budget deficits.

Special to the Hoover Digest.

Forthcoming from the Hoover Institution Press is

Making Failure Feasible: How Bankruptcy Reform

Can End “Too Big to Fail,” edited by Kenneth E. Scott,

Thomas H. Jackson, and John B. Taylor. To order,

call (800) 888-4741 or visit www.hooverpress.org.



27/196

POLITICS

Myths of Redistribution

Decrying the “income gap” may make for stirring

political rhetoric, but we don’t need rhetoric. Weneed growth.

By Allan H. Meltzer

No topic recurs in political discussions more often than income

distribution. It came up frequently in Alexis de Tocqueville’s

book about our republic’s early years, Democracy in America. And

it was very much in James Madison’s thoughts when he wrote

about “factions” in Federalist No. 10 at the time the Constitution was ratified.

We now refer to “interest groups” instead of Madison’s factions. Madison

believed factions were impotent. Opposing ones, he thought, would cancel

each other out in a democracy. But he was terribly wrong about the power

of interest groups: they dominate our politics. In every election, parties offer

rewards to groups of voters. The Democrats tend to offer benefits to black

voters, young women, and Hispanics. The Republicans, like President George

W. Bush, do so to religious groups.

Voters are often swayed by the benefits offered. Sometimes a majority

choose a leader who eschews redistribution and promises growth in living

standards achieved by lowering tax rates. Dwight Eisenhower and Ronald

Reagan are US examples; Margaret Thatcher is an example from Britain.

Allan H. Meltzer is a distinguished visiting fellow at the Hoover Institution,

chair of Hoover’s Regulation and the Rule of Law Initiative, and a professor of po-

litical economy at Carnegie Mellon University.



28/196

Taking another approach, presidents Franklin Roosevelt and Lyndon John-

son won smashing election victories by offering benefits to selected interest

groups using the rhetoric of redistribution.

PERILS OF THE MINIMUM WAGERedistribution is again a major political issue as we approach the presi-

dential election. One of the most controversial forms of redistribution is a

doubling of the statutory minimum wage to about $15 an hour. Proponents

of this policy do not mention that anyone who earns only the current mini-

mum wage receives the earned-income tax credit. Instead of paying federal

income tax, low-income people who work receive payments to supplement

their earnings. For example, a married worker with three children under

nineteen who earns the current minimum wage receives $6,143 a year if he or

she works all year. That payment drops to $4,726 if the hourly minimum wage

rises to $15. Other government benefits are an additional form of assistance.

The higher minimum wage will reduce employment, especially for unskilled

youth. Although they claim to be friends of the poor, advocates of a higher

minimum wage usually knowingly adopt policies that keep young workers from

finding jobs that will train them in ways that permit them to advance along a

career path. Politicians who approve minimum-wage hikes know that the many who gain will know the source of their gain, while the many who lose will not.

The argument against the minimum wage lies in good economics and com-

mon sense. In a well-functioning market economy, a worker will receive a

wage equal to the value that he or she produces. That will be true on average

over time, but it is rarely true all of the time. Sometimes the wage will be

higher than the value of the worker’s product, sometimes lower. Employers

cannot accurately measure worker productivity. The employer learns about

the relation between wages and productivity by watching what happens to thecompany’s earnings over time. If the employer pays more than the workers

produce, profits fall and firms go out of business. Owners deploy their capital

where it earns the best return. Only then will the business thrive. Only then

will owners be able to compensate their employees well and hire new recruits.

FOREVER UNEQUAL, FOREVER UNFAIR?

What about certain candidates’ claims that “fairness” requires higher tax rates

for the highest earners to finance bigger transfers to the poorest? Like the efforts

to redistribute income by raising the minimum wage, that claim is wrong.

First, since the War on Poverty began fifty years ago, many billions of dol-

lars have been redistributed from taxpayers to those who receive transfers.



29/196

There has been no evidence of reduced poverty rates. Nor has there been

evidence that people now believe the system is fairer. “Fair” is a subjective

notion based on a term that cannot be defined objectively.

Has the constant appeal to fairness worked to benefit the disadvantaged?

For the first time in the postwar years, we have young working-age people

leaving the labor force to live on the benefits they receive from the welfare

system supplemented by occasional earnings in the underground economy.

The unfortunate long-term consequence is that these workers never develop

job skills and never receive the on-the-job training that increases their

productivity and wages. They will remain unskilled and the rest of us will not

benefit from their increased productivity.

The Obama administration’s efforts to increase corporate regulation and

income redistribution have produced large negative consequences. For the

first time in the postwar years, median income fell during the recovery.

Median households earned $54,059 in 2009 but only $51,939 in 2013. (Later

years are not available.) We know that the top income earners gained income,

so the losses were borne by the rest of us.

Second, we are suf-

fering from government

policies that reducedproductivity and ignored

its costs. Instead of

helping people get better

jobs, regulation raises

business costs and discourages expansion. A massive increase in the regula-

tion of industry discourages business investment. The recovery that began

in 2009 has had the lowest rate of business investment of any recovery since

World War II. One consequence is that productivity growth has remained lowin this recovery. Low productivity growth prevents wage growth for workers.

Workers who do not produce more cannot permanently earn more. Compa-

nies cannot permanently raise wages for middle-income workers unless those

workers earn higher wages by increasing their productivity. More investment

brings new methods that require additional training. That’s a major source of

productivity growth that is largely absent in this recovery.

The clamor on the left about the widening difference between the top 1

percent or 5 percent of income earners and the rest of the population almost

always compares earnings before the incomes of the top earners are taxed

and that money transferred to the bottom earners. When these adjustments

are made, as they should always be, the difference narrows.

Billions have already been transferred

from the wealthy to the poor, but cries

of “unfair” continue. Fairness, it seems,

can’t be defined.



30/196

HARD WORK AND INNOVATION

Another major oversight is the role of recent policy. The Federal Reserve has

held interest rates at very low levels. This has pushed up asset prices, includ-

ing prices of most common stocks and bonds, adding greatly to the income ofthe top 1 percent and 5 percent of income recipients. This increases incomes

at the top and expands the

difference between top

earners and everyone else.

Of course, the rise in stock

prices adds to the value

of worker pensions, but we do not count that as income when we compare

earned incomes.Still another omission is the threat of higher tax rates on high incomes. The

best research shows that tax increases reduce innovation, investment, and

productivity growth. A pro-growth policy of reduced regulation and lower tax

rates, if enacted, would eventually increase productivity and therefore reduce

the gap between the highest earned incomes and the rest.

Americans did not become wealthy by redistributing income. They became

wealthy by innovating, learning, and working hard. Most of the immigrants who

came to the United States were unskilled. So, too, were the workers who came

from the farms to industry. They began at the bottom, learned by doing on-the-

job training, and earned higher wages. This model seems to be breaking down.

Politicians can promise to narrow the income gap. They can pass legisla-

tion that redistributes more. But they cannot permanently reduce the spread

between the top and the rest unless they adopt policies that encourage

growth, innovation, learning, and productivity. There is no other way.

Reprinted from Defining Ideas (www.hoover.org/publications/defining-

ideas), a Hoover Institution journal. © 2015 by the Board of Trustees of

the Leland Stanford Junior University. All rights reserved.

Workers who do not produce more

cannot permanently earn more.

Available from the Hoover Institution Press is Ronald

Reagan: Decisions of Greatness , by Martin and

Annelise Anderson. To order, call (800) 888-4741 or

visit www.hooverpress.org.



31/196

POLITICS

Here’s Mud inYour EyePolitics in democracies have always been rough

and tumble, and we’re better off because of it.

By Bruce S. Thornton

The presidential campaign started with a bang. Donald Trump

accused Mexico of sending “rapists” and other criminals to the

United States and denied that Senator John McCain is a war

hero. Senator Ted Cruz, on the floor of the Senate, accused Sen-

ate Majority Leader Mitch McConnell of telling “a simple lie” regarding legis-

lation renewing the Export-Import Bank. Mike Huckabee accused President

Obama of signing a deal with Iran that would “march [Israelis] to the door of

the oven.” And the president accused Republicans who opposed the deal with

Iran of making common cause with the Iranian “hard-liners chanting ‘death

to America.’ ”

Such comments elicited the usual condemnations of the “incivility” that

presumably degrades the political process. Washington Post pundit Dana

Milbank attributed it to “the growing polarization of both parties” and to the

“obvious reality” that the “Republican Party has gone particularly bonkers.”

Milbank’s comments, with their own uncivil name-calling and partisan

scapegoating of Republicans, remind us that the calls for civility and bipar-

tisanship, usually linked to some imagined political golden age of bipartisan

Bruce S. Thornton is a research fellow at the Hoover Institution, a member of

Hoover’s Working Group on the Role of Military History in Contemporary Conflict,

and a professor of classics and humanities at California State University, Fresno.



32/196

comity and cooperation, are often rhetorical tactics for gaining partisan

advantage and delegitimizing opposition.

They also reflect a belief that the purpose of the federal government is

primarily what the organization No Labels, dedicated to restoring civility to

government, vaguely calls “the business of solving the problems facing the

nation,” a duty compromised by “all the petty infighting, party-first agendas,

and hyper-partisan wheel-spinning.”

Rather than reflecting some recent decline in political decorum, however,

the “incivility” these comments lament is as old as the ideological conflicts

that have defined democracy since its origins in ancient Athens. A dislike of

political rancor is at heart a dislike of democracy, and a misunderstanding of

the constitutional structure and its purpose.

CUT ’EM DOWN TO SIZE

Starting in ancient Athens, democracy has given the vote and equal par-

ticipation in policy deliberation to citizens regardless of wealth, status, or



33/196

knowledge. Given the wide variety of conflicting interests, ideologies, and

character among the citizenry, the public deliberation at the heart of demo-

cratic policy making has always been rough, vulgar, and insulting, often at a

level far beyond what we today call the “politics of personal destruction.”

In Athens, politicians were publicly insulted and humiliated, on the comic

stage or in public speeches delivered in the assembly, the equivalent of our

Congress. As classicist K. J. Dover writes of comedy in the fifth and fourth

centuries BC, just about every Athenian politician we know of was accused

of being “ugly, diseased, prostituted perverts, the sons of whores by foreign-

ers who bribed their way into citizenship.” Political debate in the Athenian

assembly was not much better. Sordid sexual practices, disreputable parent-

age, and taking foreign bribes were standard charges.

Political debate in early America seldom reached Athenian sexual coarse-

ness but still was brutal, reflecting a similar diversity of interests and




34/196

religious beliefs in the thirteen colonies. Particularly when political parties

began to coalesce in the second term of George Washington, political rhetoric

was as personal and insulting as the comments we decry today. John Adams,

a Federalist suspected of scheming to concentrate power in the federal

government, was called “His Rotundity” by his antifederalist rivals, mocking

both his alleged aristocratic pretensions and his ample girth. James Madison,

calling on the class-warfare rhetoric many decry today, accused Adams’s

party of being “partial to the opulent,” seeking to rule by “the pageantry of

rank [and] the influence of money and emoluments,” and desiring power so

that the government is “narrowed into fewer hands, and approximated to an

hereditary form.”

The Federalists responded in kind, one edito-

rial writer calling the Democratic-Republican

clubs, incubators of Madisonian-Jeffersonian



35/196

democracy, “that horrible sink of treason, that hateful synagogue of anarchy,

that odious conclave of tumult, that hellish school of rebellion.” Indeed, the

charge that Thomas Jefferson fathered children by his slave Sally Hemings

began as a political smear in the 1800 election.

The tumultuous decades leading up to the Civil War saw an explosion of

such invective, sparked by the intense conflict over slavery. In 1851 Represen-

tative Preston Brooks stormed the Senate floor to cane and seriously injure

Charles Sumner, who had characterized anti-abolitionist fellow senator Ste-

phen Douglas as a “noisome, squat, and nameless animal.” Later, Abraham

Lincoln was called the “missing link” and the “original gorilla.” The New York

Times’s Paris correspondent called for an embargo on portraits of Lincoln,

for “the person represented in these pictures looks so much like a man

condemned to the gallows, that large numbers of them have been imposed on



36/196

the people here by the shopkeepers as Dumollard, the famous murderer of

servant girls, lately guillotined near Lyons.” And the Times was a supporter

of Lincoln.

Every decade of American history has been filled with political speech

of the sort we now decry. Jingles about Warren G. Harding’s illegitimate

daughter, rumors that FDR was scheming to become a dictator, caricatures

of “Tricky Dick” Nixon as a

used-car salesman, Ron-

ald Reagan mocked as an

amiable dunce, Bill Clinton

nicknamed “Slick Willy,”

George W. Bush slandered

as “Bushitler”—American

political speech has always

used insult and personal attacks in partisan disputes over power and policy.

This fierce verbal combat would not have surprised the founders. As

James Madison wrote in Federalist No. 10, citizens are motivated not by the

rational study of ideas, empirical evidence, and cool debate over the issues

but by “interests and passions,” the former comprising property, the latter

religion. Out of these arise the conflicting “factions” and “parties,” each seek-ing to protect and advance its interests, and all “inflamed . . . with mutual

animosity, and rendered . . . much more disposed to vex and oppress each

other, than to cooperate for their common good.”

Assuming that these phenomena reflected permanent flaws “sown in the

nature of man,” the architects of the Constitution sought not to eliminate

such factional struggle but to limit the excessive power of any faction by

dividing the federal govern-

ment into three powers,each checking and balanc-

ing the other, and empower-

ing the state governments

to counterbalance the

federal government. The primary aim was to protect freedom and autonomy

by keeping any ambitious factional power from growing strong enough to tyr-

annize the people. Thus “solving the problems facing the nation” was not as

important as protecting political freedom and the sovereignty of the states.

As for the tone and quality of public discourse, if the citizenry comprises

multiple factions free to seek their interests and express their passions,

one would expect political speech to be spirited, angry, and brutal, for

“That horrible sink of treason, that

hateful synagogue of anarchy, that

odious conclave of tumult, that hell-

ish school of rebellion.”

The public heart of democratic policy

making has always been rough, vul-

gar, and insulting.



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38/196

well as drawing the federal government farther from its republican origins

and closer to the direct democracy that the founders feared.

So we shouldn’t be surprised that the level of discourse in both houses

is, with some exceptions, more on a par with that of the citizens. But in the

end, that is not as important as maintaining the constitutional mechanisms

for protecting individual

freedom from the encroach-

ing power of a hypertro-

phied federal government.

In this context, trying to

moderate or police, based on

some subjective notions of

“civility” or decorum, the clashing expressions of passionate beliefs often is

an attempt to limit the freedom to express those beliefs, and a way to benefit

one faction at the expense of others.

As Craig Shirley, biographer of Ronald Reagan, said recently, “The last

thing we need in American politics is more civility.” Civility is often the cam-

ouflage for hiding challenges to the big-government faction and concealing

the collusion of bipartisan elites that has created the redistributionist entitle-

ment state. After all, the First Amendment does not protect merely decorousor genteel speech, but as the political rhetoric of American history shows, all

manner of speech no matter how rude or uncivil. That’s because our politi-

cal ancestors knew something we should never forget—that as the Athenian

Sophocles said, “free men have free tongues.”

Reprinted from Defining Ideas (www.hoover.org/publications/defining-

ideas), a Hoover Institution journal. © 2015 by the Board of Trustees of

the Leland Stanford Junior University. All rights reserved.

In the end, calls for “civility” or deco-

rum to police clashing beliefs often

try to limit the freedom to express

those beliefs.

Available from the Hoover Institution Press is The New

Deal and Modern American Conservatism: A Defining

Rivalry , by Gordon Lloyd and David Davenport. To order,

call (800) 888-4741 or visit www.hooverpress.org.



39/196

REFUGEES

The AmericanWay of RefugeOffering sanctuary to Syrian exiles is both

compassionate and wise—and just might give theUnited States a chance for a regional “reset.”

By Kori N. Schake

Americans are mere spectators to the drama of Syria’s refugees

teeming into Europe. We are taking no responsibility for our

part in the tragedy. Worse yet, we are missing an opportunity

to reset our relations with the peoples of the Middle East by

showcasing one of our core values, which is also one of our great domestic and

international advantages: we are a country of, and welcoming to, refugees.

Americans pride ourselves on being a sanctuary for people fleeing vio-

lence, injustice, and political and religious persecution. We have a proud

history of sheltering those who fear remaining in their homelands, and it

has strengthened our country in myriad ways—bringing us immigrants

courageous enough to start anew in a foreign land; testing and rewarding

our tolerance; reinforcing our sense of ourselves as a community devoted

to opportunity and individual liberty; infusing our culture with new influ-

ences and the malleability that comes from accommodating them; and

creating a “brand” that gives us competitive advantages in the global

competition for talent.

Kori N. Schake is a research fellow at the Hoover Institution and a member of

Hoover’s Working Group on the Role of Military History in Contemporary Conflict.



40/196

We are so accommodating that Fidel Castro included thousands of prison

inmates among the Cuban refugees of the 1980 Mariel boatlift to spite our

harboring of people fleeing his despotism. But our history has also had sad

failures to admit the desperate. When we have averted our eyes, it is typically

either the result of overt racism (prohibitions on Asian immigrants in the late

nineteenth and early twentieth centuries), our fear of being drawn into an

ongoing war (denying Jews admission in the 1930s), our inability to distin-

guish between refugees and “economic migrants” (interdicting Haitian boats

teeming with people fleeing first the Duvalier butchery then the junta that

came after in the 1990s), or our alarm at a sudden rush of would-be immi-

grants (Central Americans fleeing murderous violence in 2014).

None of these conditions applies in the case of the Syrian refugees clawing

their way to Europe. The only remotely applicable reason for reluctance is

the notion that we might be drawn into a war, but Bashar al-Assad’s Syria is

not the great power Hitler’s Germany was. Moreover, as the past four bloody

years of Syria’s agony demonstrate, we can choose not to fight in Syria.

Which makes the dilatory response of our government to the plight of Syria’s

suffering all the more shameful.

Our policies have fueled the conflict in Syria in at least six ways: being

apologists for Assad (recall Hillary Clinton saying that he was a reformer);creating the expectation we would usher him from power (recall President

Obama saying Assad must go); fecklessly arming and training “moderate”

Syrian rebels; permitting Iran’s direct involvement to prop up Assad; draw-

ing but not enforcing the “red line” on chemical weapons use by Assad—a

practice he has

continued; and

now watching as

Russia escalates itsinvolvement. And

let’s not forget the State Department’s disgraceful “hashtag diplomacy,” a

futile social-media gesture that added insult to injury. Our government’s cal-

lousness is buying us generations of resentment.

And where are the Republican hopefuls, those calling for a better Ameri-

can foreign policy? Carly Fiorina thinks America has already done its “fair

share.” Jeb Bush, who speaks so movingly about immigration in other

contexts, and Marco Rubio, whose family members are Cuban refugees, both

agreed in principle that the United States should accept some Syrians, but

couched their vague support in the context of preventing jihadis. Neither

spoke up until Donald Trump made news saying, “They’re living in hell, and

We have a proud history of sheltering those

who fear staying in their homelands.



41/196

something has to be done.” John Kasich’s faith may drive his views on Medi-

care expansion, but Syrian refugees are evidently Europe’s problem. Mike

Huckabee and Ted Cruz, so strident in their proclamations of faith, have no

room at the inn. Conservatives need to do some soul-searching.

The United States of America is failing at the central tenet of leadership:

that of setting an example for others to follow. We have given money—$4 billion at last count—much of it to assist Turkey and Jordan, neighboring

countries that are amazingly and nobly helping the four million displaced

Syrians. But checkbook diplomacy is no substitute for solutions, as we so

often tell other countries.

Jordan’s central political dilemma since 1945 has been devising a balance

to accommodate the two million Palestinian refugees it accepted with the

creation of the state of Israel; yet it has still admitted at least 650,000 Syrian

refugees (and more likely double that, since many have been absorbed into

Jordanian cities). The fourth-largest city in the country is the Zaatari refugee

camp. Germany expected to receive 800,000 asylum-seekers in 2015, open-

ing its borders while Hungary’s government verged on xenophobia. Sweden

ON THE MOVE: Syrian refugees crowd a fence at the main rail station of Buda- pest, Hungary, last September. Tens of thousands of Syrian migrants continueto seek shelter in Europe and North America amid the ongoing violence and

chaos in their homeland. [Mstyslav Chernov—Creative Commons]



42/196

admitted 80,000 refugees in 2014—and it is a more homogenous country than

the United States, so its difficulties will likely be greater in fostering civic

cohesion in this new mix. If the United States met the standard by population

that Sweden has set, we would admit two million Syrians. We have admitted

1,500 since the war began, and the additional 10,000 that President Obama

promised last fall to take in would be but a drop in the bucket.

Do Syrian refugees have economic reasons to emigrate? Of course they do—

their country is a bombed-out wreck. But economics are not what put families

with small children perilously to sea.

Are we at risk of jihadis slipping in

among the refugees to threaten our

societies? Of course we are, but they

are slipping into our countries even

without the cover of a torrent of refugees. In fact, we are likelier to have coop-

eration in finding and managing threats from people grateful to be resettled

here (as has proved the case with the more than 100,000 Iraqis admitted since

2003 and 20,000 Afghans since 2001).

True, countries accepting refugees from the Syrian war are creating long-

term problems for themselves: problems of assimilation, problems of employ-

ment, and problems of political backlash. But they are also gaining the tra-ditional advantages America has long benefited from, both domestically and

internationally. Most important of those advantages is the justifiable pride at

looking difficulties in the face and choosing to be a society that lifts its lantern

to the tired, the poor, and the huddled masses yearning to breathe free.

Reprinted by permission of Foreign Policy (www.foreignpolicy.com). ©

2015 Foreign Policy Group LLC. All rights reserved.

Checkbook diplomacy is no

substitute for solutions.

Available from the Hoover Institution Press is State of

Disrepair: Fixing the Culture and Practices of the State

Department , by Kori N. Schake. To order, call (800)

888-4741 or visit www.hooverpress.org.



43/196

HEALTH CARE

RescuingObamaCareThe best cure? High-deductible plans and health

savings accounts.

By Scott W. Atlas and John F. Cogan

With the end of the Obama administration on the horizon,

Republican presidential candidates—and members of

Congress—are proposing ways to replace or repair the

Affordable Care Act. Undoing the damage of ObamaCare

may finally become a realistic possibility.

For now, Americans are experiencing the law’s natural consequences: rising

health insurance premiums and limitations on individuals’ choice of physicians

and hospitals. Further consolidation in the insurance industry and among

providers will probably drive health care costs even higher. To reverse these

trends, any replacement for ObamaCare should include two essential elements:

high-deductible insurance coverage and health savings accounts.

Well-designed high-deductible insurance—in which the individual pays a

few thousand dollars for most health care services before the plan kicks in

to cover claims—restores the fundamental purpose of health insurance: to

reduce the financial risk of large and unanticipated medical expenses. Health

Scott W. Atlas, MD, is the David and Joan Traitel Senior Fellow at the Hoover

Institution. John F. Cogan is the Leonard and Shirley Ely Senior Fellow at the

Hoover Institution and a member of the Shultz-Stephenson Task Force on Energy

Policy and Hoover’s working group on economic policy.



44/196

savings accounts, or HSAs, allow individuals to set aside money tax-free for

out-of-pocket expenses, including routine care. These accounts are owned by

individuals and are not dependent on their place of employment.

When consumers pay directly for their care, as they would from HSAs,

they have an incentive to choose wisely, and to demand that the prices

charged by providers become visible. A study by Carnegie Mellon Univer-

sity’s Amelia Haviland and colleagues, published in July by the National

Bureau of Economic Research, confirmed previous research by these authors

(and others) showing that

high-deductible plans signif-

icantly reduce health spend-

ing without later increases

in emergency-room visits or

hospitalizations. When these

high-deductible plans were

paired with HSAs, health

care spending reductions averaged at least 15 percent annually.

High-deductible plans and HSAs continue to grow despite the restrictions

in the Affordable Care Act. In 2014, according to Devenir Research, the num-

ber of HSAs increased 29 percent and reached a record high of 14.5 millionas of mid-2015. Nearly one-third of all employers (31 percent) now offer some

type of HSA, up from 4 percent in 2005. HSA account holders deposited $21

billion in 2014. HSA assets increased by 34 percent over one year and, as of

June 30, 2015, averaged $14,654 per account. By increasingly choosing HSAs,

American consumers are approving their value.

Consumer-empowering shifts toward high-deductible coverage and HSAs

are crucial to making health care more affordable while maintaining health

care excellence and innovation. According to a 2012 study in Health Affairs,annual health expenditures would fall by an estimated $57 billion if only half

of those Americans with employer-sponsored insurance enrolled in consum-

er-directed plans with deductibles as low as $1,000. Additional evidence from

studies of MRI and outpatient surgery show that introducing price visibility

and defined-contribution benefits—where the employer provides an amount

of money and the employee chooses how to use it—induces patients to shop.

The issue now is how to increase the number of people who would choose

to buy HSAs in combination with high-deductible plans. Some steps should

be taken immediately. For example, the maximum allowable annual contribu-

tion should be raised from $3,350 to at least equal an individual’s maximum

annual IRA contribution ($5,500 if you are under age fifty, $6,500 if you are

Well-designed high-deductible

coverage restores the fundamen-

tal purpose of health insurance: to

reduce the risk of large, unanticipat-

ed expenses.



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age fifty or older). The health care services and products that can be pur-

chased with HSAs should be expanded to include scientifically therapeutic

over-the-counter medications. Money remaining in HSAs should be allowed

to roll over to surviving family members.

ObamaCare’s current legal requirement that an individual or family have

coverage with government-specified deductibles in order to open an HSA

is counterproductive. It eliminates the possibility of HSAs with other, more

tailored plans that could cover necessary care subject to a lower deductible

for particular services and medicines, especially for chronically ill people.

ObamaCare restrictions on eligibility for high-deductible plans and broad

coverage mandates should also be eliminated to allow individuals greater

flexibility to purchase high-deductible plans that best suit their needs.

Health savings accounts and well-designed high-deductible health plans

are also important reforms for Medicare and Medicaid. A Census Bureau

study notes that four million Americans reach age sixty-five every year and,

after age sixty-five, live 25 percent longer than in 1972. Today’s seniors need

to save money for decades, not years, of future health care.

Our analysis of actuarial data from HealthView Services, which indicates

a tripling of health expenses for a sixty-five-year-old by 2030, makes HSAs

even more important. The current ban on HSA participation by seniors onMedicare should be abolished. States should be encouraged to experiment

with plans that allow Medicaid enrollees to opt for HSA contributions, as

Michigan and Indiana have done, and high-deductible coverage.

Expanded health savings accounts and high-deductible plans alone are not

necessarily a panacea for the country’s health care system. But they are criti-

cally important and necessary steps.

Reprinted by permission of the Wall Street Journal. © 2015 Dow Jones &Co. All rights reserved.

Available from the Hoover Institution Press is In

Excellent Health: Setting the Record Straight on

America’s Health Care , by Scott W. Atlas. To order, call

(800) 888-4741 or visit www.hooverpress.org.



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INTELLIGENCE AND SECURITY

China as an Ally in Cyberspace?

How Washington and Beijing could make common

cause toward a secure online world.

By Herbert Lin

Now that Presidents Xi and Obama have had their summit, it’s

fair to ask what is different now regarding the China-US rela-

tionship in cyberspace.

Perhaps the most important outcome is what did not hap-

pen—the summit did not break down in mutual recriminations regarding

cyberspace. Indeed, China’s president Xi Jinping was willing to say things,

in Chinese and for the record, that the Chinese government has never said

before. For example, Xinhua, the Chinese news agency, printed a statement

from the summit saying that “China and the United States agree that neither

country’s government will conduct or knowingly support cyber-enabled theft

of intellectual property, including trade secrets or other confidential business

information, with the intent of providing competitive advantages to com-

panies or commercial sectors.” This language perfectly mirrors the White

House formulation on its fact sheet about the summit.

Of course, these are just words, and many skeptics about Chinese behavior in

cyberspace will continue to call for a more forceful retaliation to show the Chi-

nese that the United States won’t allow cost-free hacking against its interests.

Herbert Lin is a research fellow at the Hoover Institution and a senior research

scholar for cyber policy and security at Stanford University’s Center for Interna-

tional Security and Cooperation (CISAC).



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The China-US relationship has both cooperative and confrontational

aspects. Retaliation against Chinese interests stresses the confrontational

aspects, and making such a decision requires answering three questions.

First, who should be the target of the retaliation? Second, what action does

the retaliation entail? Finally, what do we expect to be the Chinese reaction

to such an action?

WHERE, AND HOW, TO STRIKE BACK

The first question is the well-known problem of attribution in cyberspace.

Many people believe such attribution is impossible. This belief is rooted in

the idea that a careful attacker could erase all the clues that might identify

him, and any ostensible clues found by an investigator could have been delib-

erately planted by the attacker in order to mislead the investigator.

While not entirely wrong, this belief ignores a number of realities. Many

attackers are not as careful as they should be, and often they do leave behind

useful identifying clues. Also, attribution judgments are based not only on

information found on the attacked computer but also on other sources, such

as human agents, monitored phone calls, previous attacks, and so forth.

Although some of these sources are secret and thus may not be revealed

publicly, information from secret sources can be helpful for a governmentmaking attribution judgments. Taken together, information from all these

sources often adds up to sufficient and reasonable confidence in attribution

judgments.

What action should be taken to retaliate? One course would be retalia-

tion in kind. But the United States is today surely conducting cyber espio-

nage operations against China. Indeed, Director of National Intelligence

James Clapper expressed grudging admiration for the hack, revealed last

year, on the Office of Personnel Management, saying “you have to kindof salute the Chinese for

what they did” and further

acknowledged that “if we

had the opportunity to do

that, I don’t think we’d hes-

itate for a minute.” What

US policy does not do is allow espionage, cyber or otherwise, for the pur-

pose of benefiting US companies—and almost no one in Congress or the

executive branch wants to change that policy any time soon. So “responses

in kind” amount to a continuation of the US policy status quo—hardly a

way to impose further costs.

Indicting a handful of government-

employed hackers didn’t seem to

inflict any pain at all on China.



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In May 2014, the United States indicted five officers in the People’s Libera-

tion Army for industrial cyber espionage against US corporations. In retro-

spect, it is hard to see how the indictment of these individuals might haveimposed a significant cost on China. Nothing seems to indicate they were

special to China in any way. Mainland Chinese often note that “even if you are

one in a million, there are 1,500 more just like you.” So even if these individu-

als were permanently removed from the playing field, it’s pretty clear that

others would step in to take their places.

The administration is also considering imposing economic sanctions against

Chinese companies that benefit from industrial cyber espionage. Since there

are not a huge number of successful Chinese companies, sanctions on such

companies could really begin to impose serious costs on the Chinese economy.

This leads to the last question—how would China react to the imposition

of sanctions on its companies? Some supporters of sanctions dismiss the

BLURRED LINES: Retired general Keith B. Alexander, the first head of the USCyber Command and former chief of the National Security Agency, talks to

an expert audience at the International Security Conference in Beijing last September. [Li Xin—Xinhua]



49/196

possibility that China might act against US companies seeking to do busi-

ness in China, apparently believing that Chinese discrimination against US

companies is already so great that there is not much left to lose. On this

last point, they are almost

certainly wrong—no matter

how bad things are today,

there is always a way to

make them worse tomor-

row. Punitive fees and

tariffs could be imposed

on individual US companies. Sensitive personal information made available

from other hacks, such as the Ashley Madison incident, could be used to

cause personal discomfort to officials from US companies. Those officials

also could be subject to arbitrary detention when traveling in China. China

could further devalue its currency to the detriment of the US economy. And

all such moves would lead those affected to pressure the US government to

desist from such actions.

THE PATH O F COOP ERATION

Retaliation has the best chance of working if the United States is willing togo to the mat. It would require the United States to regard the cyber issue

as more important than all other aspects of the US-China relationship and

to be willing to endure the additional pain that would inevitably follow from

a Chinese reaction, at least in the short term. But given the many important

US-Chinese interests, going to the mat is highly implausible.

That leaves two other possibilities for making progress. In the short term,

the United States may find a way to respond strongly enough—in cyberspace

or elsewhere—to imposesignificant costs on

China but not so strongly

that it leads to a painful

Chinese response. But in

the long term, placing more emphasis on the cooperative aspects of the US-

China relationship may well prove more valuable.

For example, both nations have a common interest in maintaining the

stability of the international financial system against hostile activity in

cyberspace originated by a malevolent third party. And there are many

other common interests: fighting cyber-enabled financial crime, de-esca-

lating a cyber conflict amidst hostilities, or assisting one another in the

Tracking down the originator of a cyber

attack may not be as hard as it seems.

In the long term, placing more

emphasis on the cooperative aspects

of the US-China relationship may

prove the most valuable course.



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event of a cyber disaster or a high-consequence cyber atta

Hoover Digest, 2016, No. 1, Winter

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