Unregulated, lots of good ideas go off the rails

In public life, just as in private ones, people want the benefits of some action but prefer to not pay the costs. A nation may get away with that longer than an individual could in private life, but eventually the piper must be paid. The underlying problem is a political rather than economic one, but the consequences can affect the economy as a whole. Consider a few examples.

It is possible to get more bang for our defense bucks if we contract out support functions where specific military expertise is not essential. Forty years ago, it didn’t seem sensible that the army spent tens of thousands of dollars to put me through infantry and parachute training so I could mow grass and pick up trash at Ft. Bragg.

I was right, and once the end of the draft forced the military to face the marginal cost of uniformed workers, hiring civilians and contracting certain functions out increased. It had existed all along: When I was in Vietnam, RMK-BRJ, a consortium of U.S. engineering firms, built bases and operated such mundane facilities as ice houses.

Ex-Luftwaffe mechanics helped maintain U.S. Air Force cargo planes for the 1948-1949 Berlin Airlift, and an ex-Imperial Japanese Navy admiral piloted U.S. Navy ships in and out of Sasebo Naval Base for decades.

But the substitution of contract for uniformed personnel really took off in support of operations in ex-Yugoslavia in the 1990s and grew even more after 9/11 to include military functions like interrogations, interpreting and security for other government agencies like the State Department.

Some functions can be accomplished more cheaply by contractors. But to do so effectively requires more contract administrators and compliance auditors. We wanted the cost savings, or reduced tasking of uniformed personnel, that contracting out afforded us, but we were not willing to pony up the resources to implement such outsourcing effectively. The result was a series of debacles in facilities construction and services in Iraq.

Another example of not paying the costs is increased trade, including greater imports of consumer goods.

Growing imports of clothing, housewares and electronics from Asia greatly benefited most U.S. households over the past 30 years. But a public health and product safety regulatory system set up to monitor domestic production is not well structured to oversee imports of products made abroad.

As imports grew, we did not increase port-level customs and sanitary inspectors or re-orient domestic health and safety regulation to handle imports. That would have increased budget outlays when demands for lower taxes dominated economic policy-making.

So we got contaminated pet food, lead-painted toys and harmful exotic species like the Emerald Ash Borer along with low-priced goods. On the whole, we gained enormously from increased trade in recent decades, but the fact that we wanted the benefits without paying needed costs has made us less well off than we could have been.

Regulation of financial institutions is a third example. We had a great deal of innovation in financial services in the past 30 years.

The basic idea of securitizing mortgages was a good one that could have benefited households and businesses with cheaper credit. Getting more companies access to borrowing via commercial paper was basically good. Developing new financial instruments to manage risk was, on the whole, an innovation with possible societal benefits.

But history and much economic theory should have taught us that financial markets function most effectively over the long run when there is well-designed, prudent government oversight.

We watched a “shadow banking system” that came to dominate important categories of lending develop without revamping existing regulatory structures. We watched as investment banking and insurance became concentrated in fewer and fewer firms. We watched as these mega-firms churned out new securities that were not only unregulated but also unmonitored by the Securities and Exchange Commission or Commodity Futures Trading Commission.

This was due in part to ideological blindness, the theological devotion of Alan Greenspan to the idea that markets always can regulate themselves and SEC Chair Christopher Cox’s belief that established regulations unnecessarily harmed businesses.

But it was also convenient for Congress to avoid having to spend more money on financial regulators. The decline in SEC compliance staff during the Bush administration was a convenient budget savings

The same has been true at state levels, where state banking and insurance commissioners have not gotten additional budget to deal with the growing complexity of the institutions they regulate.

Wanting the benefit without paying the cost is human nature. But the long-term well-being of our society depends on citizens and their leaders resisting such imprudent impulses.

© 2009 Edward Lotterman
Chanarambie Consulting, Inc.