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Monday, July 5, 2010

California chicken

On Friday, California governor Arnold Schwarzenegger threw down the gauntlet, threatening to cut the pay of 200, 000 state workers to minimum wage until the state legislature passed a balanced state budget. This story has actually received remarkably little press. My own local paper picked up an AP piece, which appeared to be identical to what appeared in the Washington Post. I could not find anything in the NYT.

I browsed through some of the comments on the Yahoo news and Huffington Post. They tended to comment on the fact this was unfair, should be blamed on one political party or another (democrats - profligate spending; republicans - hindering adequate tax collection), blamed on public employee unions, blamed on immigrant demands on resources....the list goes on forever. I suspect they are all correct to some degree.

As luck would have it, I just finished reading Burton Folsom's book, "New Deal or Raw Deal". It is a re-examination of FDR's first two terms in office and how his politics changed the political landscape of the country. FDR developed a remarkable political machine based upon patronage on a scale never seen before. Yes, the leaders of major cities used these same tools for a hundred years before FDR deployed them but they did not have access to even a fraction of the financial resources which FDR could muster.

FDR basically ventured into virgin territory when it came to tapping into revenue streams which could be exploited and redirected into political patronage. He and his brain trust were remarkably good at this, as were subsequent politicians such as Lyndon Johnson and Richard Nixon. Folsom points out that in fact, even ideologically contrary George W. Bush took a page out on of FDR's playbook in the passage of the Medicare Prescription Drug benefit. Tax many who may not notice the incremental cost and bestow benefit on the few who you hope are beholden in the next election.

How does all relate to California? There is an endgame. This approach is not sustainable. Economics is the study of allocation of scarce resources. There are many possible approaches to the allocation problem. Ideally the one that should be optimal is one that expands the pool of resources the most over the largest segment of time. As I have written here repeatedly, I am a major proponent of market based allocation approaches. They are decentralized, allow individuals to allocate their resources where they believe they will provide the most return, and history supports this approach provides the biggest pie for distribution.

California state and local governments has absorbed a larger and larger share of dollars generated and has created an environment hostile to business, the very entities which create wealth. This has created a two-fold problem. First, it has not been compatible with growing the pool of resources. Second, it has converted a decentralized process (where resources reside in the hands of many small players) into a centralized process. The centralization of resources is good for those who want to use them to divvy up political patronage, but it runs into a problem. This approach causes the pool of resources to shrink while simultaneously creating an infinite demand for those same resources. Furthermore, as political competition for the shrinking pool of resources intensifies, the flaws of using a political approach to allocation become all too apparent.

Political allocation does not allocate resources where they can be used most effectively. It rewards those who are willing to be most ruthless in furthering their own ends. It does not allow one to hedge their bets and is prone to huge swings based upon changes in the statehouse or executive branch.  What we are seeing in California (as well as other states such as New York), is the endgame. As the beast seeks more and more money, its actions result in shrinking resources. Individual players (teachers, prison guards, administrators, health care workers) who have successfully fed off this passionately defend their stakes. The short term winners in each of these political fights is the group who plays the game of chicken with the most nerve. Short term wins are confused with actual success and durable systems. This is how political allocation schemes work. Over the longer haul, you end up with Greece, California, and similar bankrupt states. They make promises about the future financed by unworkable schemes that will be revealed after those who made the promises can be held accountable. Beyond this, when calamity falls, there is rarely sufficient memory to link the mistakes of the past to the event of the present.

At this point it appears that Arnold has some leverage, He has gotten a hold on those soft and tender parts and he is squeezing. The courts have supported him. My question is, does he know what to ask for?

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