To No One's Surprise Detroit Declares Bankruptcy

This past Thursday (July 18, 2013) the city of Detroit, to no one’s surprise, filed for bankruptcy.  With over $18 billion worth of debts the city appears to have had no choice.

However, some bond holders and the city’s two municipal pension funds appear to be prepared to fight to prevent Detroit’s request for bankruptcy being approved.  Ironically, it was the refusal of these bondholders and pension funds to agree to the city’s haircut proposal in which the bondholders and pension funds would have been required to accept cents on the dollar for their holdings, which, according to city officials, forced it to seek bankruptcy protection.

Detroit’s bankruptcy filing is the largest municipal bankruptcy filing in history.  However, not only is the bankruptcy no surprise but it also could have been avoided as warning signs of serious fiscal problems for the city have been popping up as the city has been declining during recent decades.

While there are many factors contributing to Detroit’s decline a major, if not the major factor, is modern liberal welfare state with its emphasis on ever expanding government and its tendency to undertake every project that presents itself regardless of cost.

A March2011 Wall Street Journal article on the 2010 Census figures for Detroit.  The paper reported that the city’s population had declined by 25% between 2000 and 2010.  The 2010 population came in at 713,777.

 

The article quoted Mayor Bing as saying:

If we could go out and identify another 40,000 people that were missed, and it brings us over the threshold of 750,000, that would make a difference from what we can get from the federal and state government…

The fact is that state and federal funding was probably at the root of many of Detroit’s problems. 

To the politicians and bureaucrats these federal and state funds were free money that they did not have to try to extract from the taxpayers.  Unfortunately, these federal and state funds were problems in two ways:

•           First such funds usually come with strings in that they are frequently in the form of seed money to be used to start programs which the city will have to fund in the future or were for programs which the city had to share the cost with the higher level of government.

• ·         Second, taxpaying residents tend to be less concerned with the cost of such programs since they aren’t paying for them directly with their local tax dollars.  Of course, the special interests that benefit directly from the programs love them.

If local government leaders were forced to rely on the tax paying residents of the city they would tend to be more frugal with their spending as increased spending would result in increased taxes.  

Increased taxes tend to get people upset and provide an incentive to either get out and vote the current leaders out or move and avoid the higher taxes.

For years, leaders in Detroit (and many other cities as well – Detroit is just the first big city to hit the wall of reality) have ignored costs and fiscal realities by choosing to rely on financial gimmicks to keep spending.

Borrowing, aid from the State of Michigan and the Federal government, raising taxes and deferring spending for like the maintenance of infrastructure and adequately funding pensions have all been used to enable leaders to charge ahead without regard for cost.  

With few  effective checks on their spending and, as managers lacking any equity interest in the city beyond their pensions which they are theoretically contractually entitled to receive, those who have been running Detroit have been able to ignore fiscal realities and continue business as usual.

The usual reaction of managers is to concentrate on today’s problems and ignore the long term effects of their current actions.  After all, if the predicted financial consequences aren’t expected to occur for another thirty or forty years, then they don’t have to worry as they will be retired and gone before any days of reckoning occur.

Well, the day of reckoning appears to have arrived and, just as in Greece and other failing social welfare states in Europe, many innocent victims are going to pay the price for the decades of fiscal irresponsibility of politicians and bureaucrats who have safely retired someplace else.

Uncoupling Food Stamps from Farm Bill

Last Thursday (July 11, 2013) the House of Representatives voted 216-208 to remove Food Stamp program funding from Farm Bill that the Senate had previously passed and sent to the House.

This is a historic first and, if Republicans (all of the 216 votes for the proposal were from Republicans while the 208 included 12 Republicans with the remainder being Democrats) can get both houses to pass the House version of the bill and the President to sign it this will be a major step in reigning in both programs.

While the odds of passage of the bill are slim, the debate itself will be a start at weakening these two pieces of bad progressive legislation.

Farm Price Supports Have a Long History

A revolution in agricultural production accompanied the Industrial Revolution.  Like the Industrial Revolution in which technology and innovation moved to make industrial workers more efficient, so too did the Agricultural Revolution make farming more efficient and less labor intensive.  

The result of these advances in agricultural output was to increase agricultural output while reducing the number of people needed in agriculture.  At the time of the American Revolution when we became an independent nation, over 90% of the population was directly involved in farming.  Today less than 10% of the population is directly involved in raising or growing food.

The transition from a predominantly rural agricultural society to an urban industrial society is never easy or painless and this transition in the United States was no exception.  

Many farmers sought to preserve their traditional life and occupation by turning to politics.  Beginning in the late 19th and early 20th centuries the Federal and state governments began enacting legislation aimed at helping to preserve the traditional family farm through various regulations and subsidy programs.

Bundled Corn Stalks on New York Farm following harvest in 1930s (photo copyright 1936, 2013 by Estate of Charles Nugent Sr.)

By the 1930s, Franklin Roosevelt's New Deal was very active in creating agricultural cartels, enacting tariffs and quotas on agricultural imports as well as taking more direct action toward reducing the supply of agricultural output by placing quotas on how much each farmer could produce and paying farmers to keep part of their cropland out of production.

Eventually the government began determining what price farmers needed from the sale of various produce in order to continue as profitable operations.  The government then entered the market and, using tax dollars, purchased and stored large amounts of produce before it reached the market.  This, of course, reduced the supply of that produce causing the market price to increase to what was deemed necessary to keep farmers in business.

During the Great Depression of the 1930s Franklin Roosevelt's New Deal Administration began  to experiment with limited distribution of wheat and other commodities to the unemployed and poor. The program was gradually expanded but, while helping the poor was a political selling point, the program was focused and driven by the political need to help maintain farm incomes.

In 1939 an experimental food stamp program was initiated in which unemployed and poor could purchase orange stamps from the government at face value and, in turn, receive blue stamps equal to half the value of orange stamps purchased.  The stamps could then be used to purchase food.

This program was popular with both retailers, who saw larger sales, and farmers.  The program ended in 1943.

Following World War II new food stamp programs were initiated and expanded over the years.  As before the primary goal was to raise farm incomes.

President Ronald Reagan, during his term in the 1980s tried to kill the food stamp program.  This was not only a period of prosperity and growth with low unemployment as a result of his domestic programs, but also a period of rising farm income due to increase world demand for U.S. agricultural output.

In addition to being a popular conservative Republican president, Reagan had a Republican majority in the Senate and strong support in the House.  He had a very good chance of eliminating the Food Stamp Program and probably would have except for the fact that the opposition to eliminating food stamps was led by the conservative Republican Senate Majority Leader, Senator Robert Dole from the farm state of Kansas.

Leading a coalition of farm state conservatives and urban liberals, Senator Dole was able to thwart President Reagan's attempt to eliminate the food stamp program.  

Dole realized that farmers alone no longer had the numbers to maintain the political clout that had given them their victories in the past.  

The family farm had long since been replaced by giant corporate agribusiness and so called hobby farms - farms owned by wealthy urban dwellers as rural retreats.  Though they didn't needed and couldn't justify the subsidies and other financial support from the Federal Government, these two groups were still the beneficiaries of millions of dollars of Federal aid.

Food stamps not only helped to keep prices of farm produce high but, more importantly, provided urban political support for the continuation of farm programs.  By keeping both food stamps and the various farm support programs in one Farm Bill the two programs had the support both needed to survive.  

As separate pieces of legislation the future of both farm subsidies and food stamps the odds of both of these programs continuing could be in doubt.

Why Wages Remain Low for Unskilled Work

My spring semester Introduction to MacroEconomics course has started.  Income distribution is covered in the first assigned chapter and a number of students had questions concerning the low wages of unskilled workers.

Wages are the price of labor and, like other prices, wages are determined by supply and demand.  While there is still demand for unskilled labor in the United States, supply has been shrinking and this should cause wages to increase.

One reason why wages for unskilled labor do not  increase very much is the fact that output per worker is low.  Thus, when wages begin to increase due to declining supply, companies tend to either invest in and begin substituting capital for labor or move production overseas to a place where such labor is cheap and plentiful.

However, another reason is that the role of the price mechanism is to attract resources to areas of scarcity.  So whenever the supply of something decreases its price increases and this increase in price (and the potential profit from meeting this shortfall) results in efforts to increase the supply.

In the case of unskilled labor an increase in wages results in an immediate increase in supply.  

Unskilled workers, due to lack of training and education, have nothing to offer employers beyond time and muscle.  The fact is that any able bodied individual can provide muscle power.  As to time, if the wage rate is high enough, the opportunity cost of such jobs is generally greater than using their time working in their skilled job.

Because the supply of unskilled labor is so elastic, noticeable increases in unskilled worker wages results in the supply increasing and driving the wages back down.

Skilled jobs require training which takes an investment of time and money.  This tends to set skilled workers apart and limits the supply to only those with the necessary skills.  

So, while an unskilled worker can never compete with a skilled worker for a skilled job without first making the necessary investment of time and money to acquire the skills, a skilled worker can easily compete for unskilled positions.  Skilled workers generally don’t compete for unskilled jobs, but if the wage is high enough, they can quickly move into that market, thereby increasing the supply of available workers.

B to B Bartering - A Tool for Small Businesses

Barter is an ancient form of exchange in which a person traded something he owned for something that someone else had and he wanted or needed.

A major problem with a barter system is the fact that one has to spend time searching for another person who both has what one wants and is willing to trade it for what you have to offer. 

The introduction of money removed this inefficiency as money is a universal good that everyone wants and thus be traded for anything anyone is willing to sell.

However, while the use of barter has for the most part been replaced by the use of money it still comes in handy on occasion.

In a previous article, Bartering Pepsi Cola for Vodka and Tanker Ships, I described how Pepsi Corporation got around the problem of repatriating profits from the production and sale of Pepsi Cola in the old Soviet Union by basically accepting vodka and tanker ships in exchange the cash it earned in the Soviet Union.

Currency controls and lack of foreign exchange in some countries make it difficult for foreign companies to do business in these nations.  In these cases, barter may be a solution.  In essence the company selling its product in the country accepts goods produced in the country in lieu of cash.  It then brings the bartered goods to its home nation where it sells the bartered goods for the cash it would have earned in dealing with the nation which either forbid the export of currency or lacked hard currency reserves to make the payment.

Small businesses, especially those starting out often lack the funds to obtain the supplies they need to produce their product.  Barter can be a solution in these cases as one small business can trade the goods or services it has to offer for goods or services it needs from other small businesses.  However, searching for such matches is inefficient.

Enter barter exchanges.  These are organizations that enable small businesses to trade their services without having to spend time searching for those  both offering the good or service the business needs and also wanting what the seeking business has to offer.

With a barter exchange, a business simply provides its good or service to a business seeking that good or service and receives a credit to its account with the exchange for the value of what it provided.  The selling business can then use the credit to purchase a good or service it needs from another participating member. 

For example a motel (most of which, despite bearing the name of a national or global chain are actually franchises and thus operate as a small local business) may need some computer work done.  Rather than searching for a small business providing tech services, the motel owners simple look in the local barter directory for a tech company and call to have the work done. 

The motel pays for the work by transferring barter credits (either by writing a check against its barter account or transferring them electronically) from its account with the exchange to the tech company's account.  The credits are equal to the dollar value of the services it received. 

What the tech company receives is not motel services but the dollar value of these services.  It can then use those credits to purchase some other good or service it needs such as tools or replacement parts for computers or services such as marketing, printing, meals at a restaurant, etc.  However, somewhere along the line some other member, who has never provided services to the motel may need a motel for a meeting or workshop will use its credits from other trades for the room at the motel.

Generally the barter exchange will charge small membership and exchange fees which have to be paid in cash but these are small compared to the value of services being exchanged.  Also, the dollar value (which is what is credited to a member's account when trades occur) is reported to the IRS for income tax purposes.

The best way to become involved with barter is to join an exchange or use a service like Craigslist.  Links for some large exchanges are listed below.

IMS Barter Exchange Network

Barter Exchange Network

Superbiz

Trouble Ahead for Social Security Recipients

As I described in a previous, December 11, 2012 post, a stock of productive capital is needed to generate the output and associated income needed to support people in retirement.

In other words, current workers need sufficient capital to enable them to produce enough goods and services to not only support themselves and their families but also current retirees.

The economy is like a pie in that the larger the pie, the more people it will feed and what retirees need is an economic pie that is large enough to feed them along with everyone else even though they are no longer working and producing.

The U.S. Social Security System has always been a risky bet at best, being basically a ponzi type system in which current investors (eg., workers) payments are used as payouts to existing retirees rather than being invested for their own retirement.

Like any ponzi type scheme, the system worked initially as the number of working people was more than enough to support existing retirees.

By having large families, the post war generation of workers ensured that the system would take care of them despite the fact that their life expectancy ended being considerably longer than that of the first generation of retirees under the system.

However, the post World War II Boomer Generation (of which I am a member) is not going to be so lucky.

First of all, this generation tended to postpone marriage and having children until later in life with the result that the generation immediately behind them is small.  As the boomers approached their forties, they did start having children and, on net, have a generation as large as their own behind them.

However, most of this generation was born late and is just now entering the workforce at the same time their parents are beginning to retire.

Second, the prolonged 2008 recession has resulted in double digit unemployment for the new generation just as they begin their careers.  Not only is this high unemployment among youth keeping any of them from working and paying Social Security taxes now, the late start in the labor force will impact their future wages which will further reduce money available for benefits.

Finally, the recession has also resulted in many members of the boomer generation losing their jobs and having to take Social Security early putting further pressure on the system.

Many people may be surprised to learn that Social Security is not a pension plan in the sense that benefits are paid out of earnings on the investments made with their tax payments.  Instead, the program has always been a simple transfer of income from current workers to retirees.

For the Social Security System to work as planned for the boomer generation, the U.S. will need a quick end to the current recession as well as strong economic growth.

Given what is happening in Greece and other places where Social Security type systems are breaking down, it is probably a good strategy for current recent retirees and those near retirement to have a back-up plan for possible cuts in the system.

I doubt that the system will disappear completely, especially for older retirees.  However, at a minimum the cost of living adjustment (which was not a part of the original law but an amendment added during the inflation of the late 1960s and early 70s) will be adjusted or eliminated completely.

There is also talk about means testing for benefits which means that benefits would be reduced or eliminated for those with other sources of income (pensions, IRAs, 401(k)s, part-time jobs or other household income.

As mentioned above, Social Security is not a pension plan but basically a welfare program designed to transfer income from those with wage incomes to those retired and not receiving a wage income.

While I doubt that the Social Security program will be eliminated completely (as retirees plus those who have been paying Social Security taxes for a number of years probably outnumber, in terms of votes, those who are just entering the labor force and have no real financial stake in the system, as either long time tax payers or recipients) but I will not be surprised if cuts and restrictions are enacted in the foreseeable future.

I elaborated these concerns about Social Security cuts and arguments supporting my concern (including links to Supreme Court cases stating that Social Security is not a pension system but a welfare plan which Congress can change at any time) in a HubPage article entitled The Social Security System's Achilles Heel. 

In a third and final post I will explain potential problems with employer administered defined benefit pension plans.