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The Bear's Lair: Sovietizing the economy

By
MARTIN HUTCHINSON, UPI Business and Economics Editor

WASHINGTON, Aug. 25 (UPI) -- The United States economy has changed significantly since the September 11 attacks, in a thoroughly unpleasant direction. While Gross Domestic Product has risen by 4.6 percent (in real terms) from the third quarter of 2001, government consumption has risen by 8.2 percent, while private fixed asset investment has declined. As always, disaster has tended to "Sovietize" the economy, increasing the share of output absorbed by products and services that nobody wants.

The pre-1989 Soviet economy and those of Soviet satellites scored quite well on measures of Gross Domestic Product per capita, but the catch was that much of the measured output consisted of goods that were either hopelessly mis-priced or of no value to the country's citizens. My "Economist" desk diary for 1991, for example, stated that in 1989, East Germany was richer per capita than the United Kingdom. As any East German of that era could have told you this was nonsense. The East German economy might produce as much measured output per capita as that of the United Kingdom but the living standards of its citizens were hopelessly lower.

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That is why, when the Berlin Wall came down and the Soviet satellite economies were able to produce according to market demands, measured GDP per capita dropped so sharply, by more than 50 percent in many cases. While there was considerable disruption at the time of economic change, such a huge drop was in no way reflected in the living standards of ex-Comecon citizens; their living standards dropped, to be sure, but by only a modest percentage, representing the disruption of transition, while their purchasing power in terms of internationally traded goods and services may even have increased. As with my discussion of "Gross Private Product" three weeks ago, GDP did not adequately capture the true output of the economy, that which brought utility to the country's citizens.

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The September 11 attacks brought a major re-orientation to the U.S. economy. Some of it was reflected in public spending. Airport security was federalized, a new Department of Homeland Security was created, military reserves were called up, defense spending rose, and an airline bailout fund was created (the last being off-balance-sheet as far as the federal government was concerned.)

Other diversions of resources occurred in the private sector. Property insurance premiums rose, for the same or lesser amount of coverage. Airline charges rose, to cover the new security costs. New "security construction" was undertaken to make businesses more secure against terrorist attacks.

Still further costs of the attacks are not reflected in economic data at all. As anyone who has flown in the last year will tell you, the average check-in time for flights originating in the U.S. has lengthened by 30-60 minutes. For passengers, this is completely lost time, accompanied by a considerable amount of aggravation, yet it is not reflected in published data.

The Immigration and Naturalization Services has tightened up its controls, and introduced many new procedures, requiring students coming to the U.S., for example, to file a new application annually, rather than simply one for the course of study as a whole. As a consequence of this, and of tightened enforcement, students validly attempting to attend U.S. colleges are being sent back to their home country, at enormous deadweight cost to them and their families. Again this is not reflected in official economic statistics -- INS inefficiency, and that of the colleges, of course greatly increases this cost burden.

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In all three ways, therefore, the disaster of September 11 has diverted resources to items people don't want. This is not the same as diverting them to the public sector. A Medicare prescription drug provision, for example, would provide senior citizens with goods they undoubtedly do want -- prescription drugs -- albeit in a manner that may be inefficient and economically damaging. Conversely, higher insurance premiums do not provide customers with any services they are not already getting, they merely increase the costs of those services. Disasters thus reduce the efficiency of the economy; they increase expenditure on services and goods that provide no additional value to their consumers, while apparently increasing economic activity.

To a modest extent (so far), the economy has moved away from the free market model, in which items purchased have genuine value to the purchasers, and towards the Soviet model, in which items are produced according to the dictates of people who are not themselves the purchasers. In the Soviet case, production decisions were made by the central planners of Gosplan; in the current case, the additional goods are forced on consumers either by legislation or by the economically damaging activities of the terrorists.

There are a number of other activities besides terrorism that tend to Sovietize the economy. Restrictive legislation, such as the CAFÉ fuel economy standards for automobiles, forces consumers to modify their consumption patterns in ways that are to them sub-optimal -- one man's SUV is another man's Moskvich.

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Crime, like terrorism, forces people to invest in security equipment that is of no direct value to them; my friends in London, for example, have been forced by the enormous rise in crime in the last 25 years to invest in expensive home security systems and car alarms that are both expensive and annoying; both their living standards and their quality of life have been compromised.

Rising population forces people, usually through government legislation, to spend more on environmental protection, spending billions of dollars to combat global warming that would not be necessary if the world's population had been checked at a lower level. It also compels them to spend more on housing than they normally would, or face agonizingly long and inefficient commutes, such as the commuter train in England two weeks ago that set off for London at 9.15 am and arrived at London's Waterloo station at 6.20 pm -- not much of a working day was possible for THOSE commuters!

Government spending, to the extent that it increases as a percentage of GDP, removes purchasing decisions from those actually benefiting from goods and services, and thereby increases the loss of optimality in the system.

There is an important factor in common between all these examples: they are all increasing. Far from growing in a healthy manner, as the crude GDP statistics would suggest, the U.S. public's actual purchasing power, in terms of goods and services that actually provide a benefit to it, has barely increased since the 1970s and is now once again on the decline (living standards have increased modestly, but only because of higher workforce participation and longer working hours.) In continental Europe, public discontent at the lack of economic progress is well founded; "real" living standards are actually declining and have been since about 1975. Only in Asia, where the terrorist threat is modest and government is both small and largely unable to enforce damaging regulation, is there any continuing rise in living standards.

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The economic cost of terrorism, and of crime, in terms of people's living standards, is thus a large multiple of the out of pocket costs of the activity itself, even when the out of pocket costs are as large as they were from the September 11 attacks. Conventional economic statistics fail to measure this, and thus lead to policies that deal with the problem inadequately. Forced consumption is a major problem of our time, that will if it is allowed to increase strangle economic growth and reduce welfare both in the U.S. and globally.

Policies that address the problem of forced consumption, and reduce it to pre-2001 levels, are urgently needed. Economic benefits from increased international movement of population may indeed be chimerical, when its full economic costs, and the difficulty of controlling "bad guys" while letting in "good guys" are taken into account. High concentration of economic activity in major centers, vulnerable to disruption, imposes negative externalities on the system that are not properly captured. Political correctness, for example in refusing to discriminate at the airport between a young male Saudi and an elderly Ghanaian grandmother, may itself impose huge unnecessary costs. And softness on crime, and on its perpetrators, is the most regressive of all policies, because it increases the costs of criminal activity for those lower income citizens who cannot afford home security systems.

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Without a policy rethink, the non-market sector of our economy is destined to increase inexorably, and the misery of the hopeless Soviet system to draw ever closer.


(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

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