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15 January 2009

Double Standard or Double-Sided Mirror?

The irony of the intractable conflict between Jewish Israelis and Palestinian Arabs is that both sides rationalize their actions by diverting blame from the real author of their dilemma. It was Western (not Arab) anti-Semitism that drove the Zionists to claim a homeland in their long-abandoned Holy Land. It was the West and the USSR (and not the Zionist movement) who used their power to impose a Jewish state on the beleaguered Palestinian people and to secure U.N. endorsement of that action.

Neither the Israeli state nor the governing Palestinian entities are willing to jeopardize the sponsorship of their respective supporters in the West by taking America or Europe to task for having created the maelstrom of conflict in the Middle East. On the contrary, Israel plays on the guilty conscience of the West to obtain sympathy even for its citizens’ sleeplessness under Hamas’s rocket attacks. And the Gazans appeal subliminally to latent anti-Semitism in the West in highlighting the horror caused by the IDF’s retaliatory bombings.

The asymmetrical conflict between Hamas and Israel pits a densely populated strip of land ruled by a nearly incompetent terrorist organization armed with rudimentary weapons against an argumentative and life-treasuring society with a highly sophisticated military. The two of them are locked into a bubble that the rest of the world would rather see float up and away. In answer to Rabbi Marvin Hier’s OpEd in the January 8, 2009, Wall Street Journal, Israel does indeed not enjoy the same right to self-defense as other countries when it is really defending the freedom of the West to expiate a great fault by displacing the innocent contemporaneous inhabitants of a historic piece of land.

Nor do Hamas or other Palestinian groups have the right to terrorize the Israelis, or anyone else for that matter, in retaliation for losing their territory. They and their sponsors in the Arab world certainly have the economic leverage to attempt to pressure the West to force an accommodation on Israel. The risk of a military confrontation with the West, however, may be more than they are willing to take. So, in the end, an interminable stand-off is the best situation that any state in the region can hope to achieve.

Non-state actors, like Al Qaeda, may have other outcomes in mind. Opposition to their anarchical solution to the Middle East dilemma may ultimately lead to reconciliation of the Israeli-Palestinian conflict, as the two sides realize their common interest in collaborating to establish peace and order.

12 January 2009

Perverse Incentives Distort Public Policy

Motivating managers, in finance, energy--across industry lines-- commonly involves incentives that must at once be meaningful to them personally and consistent with the goals of their organizations. When those organizations are private sector corporations, another set of incentives enters the picture: those that motivate shareholders to invest in them.

The usual ways to reconcile the potentially competing interests of shareholders and managers include tying executive compensation to the company’s P& L performance or to changes in its market capitalization. However, these gauges can be contradictory (cf. the Internet Bubble). They can also overlook the community’s long-term goals, like reduced carbon emissions or stable sources of mortgage and consumer credit.

Perverse incentives often result from relying on convenient shortcuts to measure success, such as using the calculation of short-term VaR (Value at Risk) to measure long-term investment quality (cf. Joe Nocera’s article in the January 4, 2009, New York Times Magazine, “Risk Mismanagement”), or a company’s stock market value to measure its worth to the community. A liberal democracy or an enlightened autocrat may decide to enforce a community goal, such as reduced carbon emissions, through tax policy or maybe a “cap-and-trade” system. However, the irresistible temptation would always exist to game any government regulation imposed to achieve a policy goal, just as happened to financial institutions with VaR, according to Mr. Nocera.

The market is a terrible tool for pursuing long-term community objectives. It is the ultimate short-term assessor. Public policy cannot be made there, liberal democracies should not model themselves on the marketplace, and our leaders and executives will not serve the community’s long-term interests if their reward for professional accomplishment depends on daily trading results.

So, how can we correct these incongruous incentives? First, payments to a liberal democratic government, taxes, ought to be made equivalent to dividends; i.e. the community must be treated like other shareholders in the corporation. One component of this approach would be to reduce the importance of tax avoidance in commercial practice. This ritual is enshrined in the definition of business cash flow as EBITDA (earnings before interest, taxes, depreciation and amortization), which makes taxes one of the principle costs of doing business that corporations are expected to minimize. Change in this behavior would result, formally, in reduced net corporate revenues. However, making the almost religious commitment to share a portion of business income with the community at large will institutionalize corporate citizenship.

In reality, overall profits from business enterprise will not change. Here’s why: During the 2008 financial crisis, the U.S. government has been forced to take an ownership position in several large private corporations in order to stabilize international markets. As a result, the community shares an equity interest with stockholders in the recovery and profitability of those enterprises. It is not much of a stretch to include taxes in the ROI of all private companies. This accounting rule change would bring shareholder dividends and corporate tax payments to the society as a whole into equivalence. If the political process achieves fair and progressive government fiscal policy, shareholders would also benefit paripassu from those tax payments. Moreover, shareholders should receive a proportional credit for corporate tax payments against their personal income taxes. This tax credit would help to reconcile the amassing of commercial fortune with civic responsibility.

A second reform strategy is for the community to enlist private industry to be the motive force behind the tide of globalization instead of being its flotsam. The privatization of many erstwhile functions of government not only takes advantage of individuals’ creative impulses, but also offers entrepreneurs the incentive to profit from managing what has traditionally been considered to be overhead in running the country. These tasks include, for example, national defense, policing the streets, educating the young, regulating the design and construction of living spaces, and moderating the destructive effects of using energy.

The information technology revolution has made it conceivable that private enterprise can carry out public policy initiatives without government. Just as IT has enabled the creation of virtual corporations, it is tempting to think that the national community can self-regulate through interactive communications. Whether or not that “virtual government” serves the community’s long-term best interests, including sustainable energy use, depends on how compelling a case is made that the success, if not the survival, of each individual or enterprise is unbreakably linked to that of the entire global community.

There is no simple resolution of the conflict between personal and community goals. The fundamental question is whether the cyclical swings between satisfaction of one set of goals and the other will ultimately be sustainable, or whether each swing brings us closer to self-destruction. Specifically, will the private exploitation of the planet’s energy resources harm the welfare of the community at large? Rewarding long-term foresight in the immediate present has always been a challenge; but the consequences of not doing so are potentially more threatening to the health and wealth of the planet than ever before.

It is the function of government to anticipate a danger to public security and enforce measures to deal with it. This is not a function that the market does well, if at all. Nor will incentives tied primarily to the market motivate business leaders to act in the long-term interests of the community. The free-enterprise ideal, in the end, will not be preserved without violating its dominion through authoritative and enlightened political action.

03 January 2009

Bolton’s Bad News

What upsets John Bolton in his in the January 2, 2009 Wall Street Journal OpEd essay, only puts me more at ease. The bluster of the North Koreans and Iranians on their nuclear weapons capabilities is really irrelevant. Even if they did agree to muster down, the U.S. and the West would still have to enforce disarmament and be ready to intervene in the case of their deception.

It is not America’s mission to create Western freedom for North Koreans or Iranians. Our government’s duty is first and foremost to protect our security. Letting the Boltons of the world continue to bluster in their own way, on the other hand, does in fact serve our best interests, if only because the constant threat that someone in power might listen to them hangs like Damocles’ Sword over “rogue” states.

In the meantime, who cares whether Pyongyang and Tehran play for legitimacy on the world stage? It is really worthless compared to strong vigilance by the West. If “rogue” states achieve this objective through diplomacy, so what? For example, that success is better than the consequences of our relying on a surrogate, Israel, to strike Iran’s infrastructure and alienate the liberal but historically hesitant and patient Persian upper class. In the end, we will never escape the specter of nuclear (or terrorist) proliferation—reasonable men must always lead us to manage it, and to keep dogs of war like John Bolton barking behind locked gates.

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