This piece originally appeared on The Walrus.
The pursuit of economic growth has made us
addicted to risk -- and left us vulnerable to catastrophic disasters
By Bryne Purchase
CAN OUR SOCIETY take pre-emptive action to forestall devastating
climate change? Can it act now to avoid wars over oil and natural gas?
Can it take steps today to avoid economic crises stemming from spiking
oil prices? The answer, unfortunately, is no, no, and no. Our
institutions, public and private, are not designed for prudent action.
They are designed to facilitate risk taking and to address negative
consequences, if they arise, later on. Only in the face of disaster,
when there is a clear and present danger, are we capable of mobilizing
an appropriate response.
The problem is not ignorance; it is not
that we are unaware of the risks we take. Nor do we lack the instruments
to deal with them. The problem, deeply embedded in the architecture of
our decision making, is that in the pursuit of economic growth we
privatize reward and socialize downside risk. To describe this tendency,
economists borrow a term, “moral hazard,” from the insurance industry. A
moral hazard exists whenever decision makers in risky situations reap
the rewards from their decisions without bearing all of the costs. The
ability to pass downside costs on to others encourages imprudent
decision making.
Our society is ridden with moral hazard. Limited
liability is built in to our most important programs and institutions,
and it has clear advantages. It makes our society dynamic; we dare the
future, and that dare has paid handsome dividends. In a mere 200 to 250
years, it has made us wildly rich. Modern market capitalism is how we
engineered our escape from the Malthusian trap, the subsistence living
that has characterized human history, enforced by periodic outbreaks of
war, famine, and disease.
But modern market capitalism has also
exposed us to new orders of potentially catastrophic failure.
Catastrophic, because by the time a potential problem becomes recognized
as a clear and present danger, no action may be sufficient to prevent
social and economic breakdown or, worse, war. In complex systems,
tipping points may produce viral effects. Consider the violence in
countries caught up in the Arab Spring. Think about the riots in
southern Europe after the global economic crisis. Once set in motion,
such events often acquire a momentum of their own and can lead anywhere.
The
financial crisis in the United States illustrates how both private and
public institutions can proceed into an icefield, full steam ahead, with
full knowledge of the risk. Here is what Alan Greenspan, former chair
of the Federal Reserve Board, wrote about sub-prime mortgages in his
memoir, The Age of Turbulence : “A difficult problem is that
much of the dubious financial-market behavior that emerges during the
expansion phase is the result not of ignorance that risk is badly
underpriced, but of the concern that unless firms participate in a
current euphoria, they will irretrievably lose market share.”
Of
course, private companies, and banks in particular, are not supposed to
make reckless bets just because their competitors do, which is why
Greenspan resisted further regulation. But they did, and later it became
obvious why: moral hazard. When the masters of the universe who control
decision making on Wall Street are confronted with enormous short-term
personal rewards and minimal long-term downside risk, then disaster
awaits.
But if you think imprudent decision making is a private
sector phenomenon, think again. Here is Alan Greenspan on the public
sector response before the sub-prime mortgage crisis: “I am also
increasingly persuaded that governments and central banks could not have
importantly altered the course of the boom either. To do so, they would
have had to induce a degree of economic contraction sufficient to nip
the budding euphoria. I have seen no evidence, however, that electorates
in modern democratic societies would tolerate such severity in
macroeconomic policy to combat a prospective problem that might not even
materialize.”
As the ultimate Washington insider, he knew how
governments actually function, as distinct from how we think they do.
Americans at all income levels were benefiting from the housing
boom—although some more than others, to be sure. The very rich were
getting richer, but unemployment was low, inflation was down, and
homeowners everywhere were enjoying increases in their personal net
worth, or spending sprees bankrolled by mortgage refinancing. Woe to any
government that proposed to take away that punch bowl, especially on
the strength of forecasts by the few observers who warned that something
might go wrong.
When it did, governments stepped in to rescue the
banks, because, according to conventional wisdom, they were “too big to
fail.” The collateral social and economic costs were considered too
massive to contemplate. Then, realizing that they were creating a
further moral hazard, proponents of the bailouts felt compelled to
increase regulation. But rules do not facilitate innovation. Nor do they
necessarily make society safer. Aggressive innovators are always ahead
of their regulators, who often succumb to groupthink, coming to share
the perspectives of those they govern. And sometimes the authorities are
suborned, turning a blind eye to malfeasance. Indeed, one could argue
that more regulation is a bad idea, because it encourages the belief
that the powers that be are standing guard when in truth they may not
be.
The sub-prime mortgage crisis exposed a deep ideological fault
line in society. On one side are people who quite logically oppose
regulation as both counterproductive to the economy and a violation of
individual rights. On the other side, an almost equal number who, again
quite logically, believe bailouts and other forms of social insurance
are necessary, both to contain collateral damage and to show compassion.
What to do? The answer is obvious: split the difference. Forgo
regulation to get the party going; and then, when it comes crashing
down, bail out and otherwise pump up the most important partygoers. In
such a society, however, there is only one gear: fast forward.
One
can make the case that finance is an exception. It is, in the sense
that it can rip apart the socio-economic and political order of
things—witness southern Europe. While debt serves as the lubricant of
market capitalism, using other people’s money to pursue one’s own
purposes carries an implicit moral hazard. The buildup of debt relative
to income in society is like the buildup of methane in a mine: all it
needs is a spark to set it off. Alas, higher debt levels are an almost
inevitable outcome of greater income inequality. The very rich, who
cannot possibly consume all of their wealth, must lend an
ever-increasing share of it to finance not only capital investment but
also consumption. Without mass consumption, the awesome productive
capacity of capitalism falters, leading to economic recession, even
depression. That was the enduring lesson of the Depression of the 1930s.
Spiking
energy prices, which provided the spark that touched off the global
financial market meltdown, are highly destructive. As we have seen so
often in the past forty years, rising energy prices depress consumption
among low- and moderate-income households. The result, exacerbated by
high personal debt levels, is a severe negative impact on national
income and employment. Technological innovation gets more attention, but
growth in per capita income also depends on access to energy. Without
it, tools are useless. Imagine yourself in the world’s most
sophisticated city with no electricity. Nothing works. GDP measures our
ability to use tools to alter our environment to suit our tastes. An
individual’s income is simply a reflection of his or her control over
energy (including food, which is just energy fit for human consumption),
meaning the poor are virtually powerless.
More than 80 percent of
the world’s primary energy comes from fossil fuels, which are already
priced in global markets, in the case of oil, or soon will be in the
case of natural gas and coal. So fossil fuels bring with them the
potential for repeated and dramatic price spikes related to resource
depletion and war on the one hand, and on the other the issue of climate
change, with its promise of increasingly intense natural disasters. No
one thinks consumers or private corporations will deal with these
issues. They will continue to do what consumers and corporations do,
which is to take whatever actions are necessary to ensure their own
short-term benefit or survival. Most of us will proceed on the
assumption that if a problem arises in the future, our governments will
deal with it.
And we will be wrong, because political decision
making processes are also fundamentally flawed. The political
marketplace is a study in dysfunction, starting with the incentive
structure confronting electorates. Voters are for the most part ignorant
about the complex details of public policy; in a representative
democracy, it is the leaders they elect who make the important choices
about competing public policies. So instead of focusing on policy, the
public focuses on character. A politician’s character is thought to be
important in decision making, and character, in this case, goes not just
to what is known of a politician’s personal behaviour, but to his or
her avowed political beliefs, or ideology.
It is no surprise,
then, that competition in the political marketplace emphasizes character
assassination and branding. Character assassination discredits everyone
in the process, and branding requires huge expenditures on advertising,
which is increasingly paid for by private interests with political and
economic agendas. This undermines the public trust. In the US, which has
a rigid system of checks and balances, it also produces political
paralysis—except in times of crisis. These negative outcomes are only
exacerbated by the fact that political rhetoric today is designed to
appeal to voters’ emotions rather than their intellects. Modern
psychology and neuroscience may be even more influential in political
versus consumer marketing, because the purpose of political speech is
simply to persuade the voter to take a small personal risk—not, as in
the consumer marketplace, to override his or her vested interest in
getting a product that actually works as advertised.
All of this
emboldens candidates to act opportunistically in the pursuit of what
matters most to them: winning the next election, which tends to loom in
the immediate future. The greatest risk in this dysfunctional process is
to policies that impose an immediate cost in return for a long-term
benefit. Case in point: the run-up to the global financial crisis, in
which electorates were disinclined to support restraint as a means of
avoiding something that might or might not go wrong at some unknowable
time in the future. There are always politicians willing to offer the
policy option with the least short-term cost or the greatest short-term
benefit, because once they leave office they are no longer accountable.
In this context, all political competitors have a powerful incentive to
punt tough choices into the future. And they are often abetted by public
accounting processes that would make Enron look virtuous. The net
result of these factors is to make governments incapable of taking
action unless and until they face a widely recognized, clear and present
danger—although by then there is always a chance that it may be too
late.
Our inability to consider the long-term consequences of our
public policy decisions is compounded by the growth in income and wealth
inequality. Economists debate the appropriate social discount to be
applied for damages done to future societies by climate change thirty,
fifty, and 100 years from now. But for the growing numbers of poor and
near-poor who live paycheque to paycheque in today’s societies, thinking
about the future is a luxury. Burdened with debt and highly vulnerable
to such adverse contingencies as job loss, illness, divorce, and
unplanned pregnancies, they cannot afford to contemplate the idea of
deliberately raising the price of carbon energy now to avoid some future
cost or problem. Energy, including food, already takes up far too large
a portion of their household budgets, which is what makes the economy
so vulnerable to rising energy prices.
Every politician knows
this: that when it comes to energy, we are all trapped, because the poor
and near-poor are trapped. Some will argue that revenue raised from a
carbon tax could be used to reduce income inequality and thus mitigate
the net negative impact on employment and economic growth. However, this
ignores the fact that, while North America is second only to China in
fossil energy output, its production is concentrated in just a few
provinces and states—and the voters in those provinces and states are
unlikely to stand by as central governments redistribute their income
and wealth, no matter the merits. In Canada, regional differences have
made a national energy policy based on carbon pricing a political
non-starter; the federal government does what it has to do anyway, which
is follow the US.
If America were to adopt an aggressive policy
on climate change, Canada would have to follow. But that is not going to
happen. The power of regional interests in the US is nowhere more
apparent than in the Senate, in which two seats are allotted to each
state, regardless of population. To prevent minority interests from
delaying or even killing legislation by prolonging debate, three-fifths
of the sitting senators (usually sixty out of 100) can force closure.
Even more problematic is the rule that requires two-thirds of senators
to allow ratification of an international treaty; in the absence of such
an agreement, no real progress will be made in addressing global
warming. In the recent US elections, climate change was seldom
mentioned, even though the man who was re-elected president is on record
as saying he believes it is an issue.
Sadly, we have no capacity
to change our institutions from within, because our willingness to
privatize reward and socialize downside risk is protected by powerful
constituencies on both sides of the political spectrum. A fully insured
society should also be a heavily regulated society. We have chosen
social insurance with only light regulation. It may be a fatally flawed
predisposition, but it has made us rich, and so we will stick with it
until it is overridden by events, and evident to the vast majority. At
that point, we might be open to a new social architecture.
But
what would it look like? In my mind, it would restore individual
responsibility in both our private and public lives. No politician, for
example, would be deemed successful just because he or she had won a few
elections; the new metric for political success would be a demonstrated
concern for the future of society, notwithstanding the near-term costs.
Our politics would be less about marketing and more about facts and
reason. There would be greater recognition of the roles randomness and
chance play in individual achievement. Equal opportunity, in all of its
deep complexity, would be a social priority. There would also be less
debt and, it follows, less income inequality. As for energy, a prudent
society would spend vastly more on research and development to help
prepare us for a future that, in every eventuality, requires a reliable
energy supply that is not a Trojan Horse.
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