Three Cheers for the Middlemen

Matthew Feeney

On commercials, screaming used car salesmen and wholesalers sometimes promise to “eliminate the middleman.” But what’s wrong with middlemen? Middlemen can help you find a ride or a couch to sleep on, and middlemen have even helped prisoners of war make the best of their circumstances.

In 1942 a British soldier named R.A. Radford was captured in Libya. For years Radford lived in prisoner of war camps, which housed allied soldiers from across the globe. Within a year of his release, Radford wrote a paper on the economy of prison camps, explaining how POWs traded goods and used cigarettes for currency.

Red Cross packets were the principal source of goods, and they included things such as cigarettes, jam, chocolate, biscuits, sugar, and other “foodstuffs.” Because the POWs didn’t like those things equally, they traded these goods with one another.

Amid this trade, Radford notes, middlemen emerged. These middlemen made it their business to facilitate trade by learning who needed a particular good and who had that good for trade. Yet, despite their obvious benefit, middlemen were hardly universally praised in the POW camps, as Radford explains:

Taken as a whole, opinion was hostile to the middleman. His function, and his hard work in bringing buyer and seller together, were ignored; profits were not regarded as a reward for labour, but as a result of sharp practices. Despite the fact that his very existence was proof to the contrary, the middleman was held to be redundant.

Even when everyone had access to food packets and trade was voluntary some still frowned upon those who profited from using information to their advantage. That animosity towards middlemen in the POW camps is remarkable, but it is a common attitude toward middlemen that still exists today. When taxi drivers lit tire fires on the streets of Paris in protest of rideshare companies like Uber, they were protesting middlemen.

Uber and Airbnb do not own cars and hotels. Rather, they are profiting from what they know about consumers and dead capital. Before the rise of Uber there were many people who needed rides but were unable to efficiently contact nearby strangers who would be willing to give them a ride in exchange for a fee. In a similar fashion, Airbnb connects travelers in strange cities to the hundreds of nearby homeowners who have spare bedrooms. Before companies like Airbnb travelers faced significant costs if they wanted to spend their holiday living in a native’s spare room. In almost every circumstance, booking a hotel or hostel room was more cost-effective and reliable. Now, finding people who want to give you a place to sleep is just a few clicks away.

Consequently, Uber and other “sharing economy” companies such as Airbnb have been causing headaches for regulators and competitors across the world. Although Uber and Airbnb are not taxi or hotel companies, traditional market incumbents are facing stiff competition from these new upstarts.

Traditional competitors seeking to halt the growth of the sharing economy will claim that Uber and Airbnb should be governed by the same regulations that oversee taxi companies and hotels. In Paris, a representative from a taxi collective called for the government to “ensure respect for the regulations,” and a protester accused Uber of “economic terrorism.”

What makes the sharing economy so successful is that it allows users to more easily engage in voluntary exchange by dramatically reducing transaction costs (costs that prevent a transaction from taking place).

The protester in Paris was not the first person to allude to terrorism when discussing ridesharing companies. In 2014 the president of the Pennsylvania Taxi Association said, “I try to equate this illegal operation of UberX as a terroristic act like ISIS invading the Middle East.”

These protests provide an opportunity to remind people that sharing economy companies operate much more like Radford’s middlemen than they do radical Islamic fanatics. Like those who disliked Radford’s middlemen, people seem to think that those who only trade information—whether it is who has coffee to trade or who has an extra room—are not adding any actual value.

It might strike many readers as bemusing that companies that merely trade in information can be valued at billions of dollars. Like some POWs critics of middlemen regard Uber’s and Airbnb’s profits not as “reward for labour, but as a result of sharp practices.” Not too long ago a friend of my family remarked that he didn’t understand why Uber was worth so much money when it doesn’t “make anything.”

Unfortunately, many people remain skeptical or ignorant of the fact that the total welfare within a group can dramatically increase without an increase in available goods. All that is needed is voluntary exchange. This won’t come as a surprise to those who are familiar with the “brown bag” experiment.

What makes the sharing economy so successful is that it allows users to more easily engage in voluntary exchange by dramatically reducing transaction costs (costs that prevent a transaction from taking place). Uber isn’t producing new cars, but it’s providing car owners with a way to find people willing to pay for rides.

It would be a mistake to regulate Uber as if it were a taxi company. Uber is a technology company that connects drivers with passengers. It’s not a taxi company

True, in many jurisdictions taxi drivers have had to invest time and money into securing the opportunity to do business. Clearly, it’s frustrating to have diligently complied with taxi regulations and then to have Uber arrive on the scene without having dealt with the same regulatory hurdles.

Nevertheless, instead of regulating Uber and Airbnb as if they were taxi companies and hotels lawmakers should deregulate the taxi and hotel industry, thereby allowing taxis and hotels to compete on a level playing field. But why stop there?

There are many industries where middlemen are needed but are held back. You’d think in 2016 it wouldn’t be too much to ask for alcohol to be delivered to your doorstep or for you to be able to invite people into your home for a meal without risking running afoul of the law.

The alcohol delivery service Klink can deliver to those lucky enough to live in the nation’s capital. But, thanks in part to alcohol regulations, Virginia residents like myself don’t have access to its services. This is regrettable considering that I’d gladly pay for a liquor store driver to deliver booze to my front door. The problem is I don’t have a cost-effective way of finding those drivers without Klink, In other words, I need a middleman, but regulators are preventing me from finding one.

There are also so-called “underground supper clubs,” which might sound nefarious, but are really just places for people to gather to eat. Granted, sometimes these “clubs” are operated out of someone’s home and are not inspected like restaurants, but that shouldn’t prevent entrepreneurs from openly and freely connecting talented amateur chefs to hungry mouths to feed.

Duke University’s Michael Munger foresees the growth of a “middleman economy,” which he describes as the “third entrepreneurial revolution.” Clearly, people are willing to pay for lowered transaction costs, and we should expect that trend to continue and for more companies to seize the kind of opportunities the founders of Uber and Airbnb saw years ago. But it shouldn’t be a surprise if suspicion of middlemen as well as anti-competitive market incumbents hamper the spread of this revolution, if only temporarily.

But unfortunately, the hatred of middlemen is eternal, whether it is in POW camps or anti-Uber protests.

Matthew Feeney is a policy analyst at the Cato Institute.

Trump and Smart Foreign Policy: Both Missing From the GOP Debate

Emma Ashford

Former Defense Secretary Bob Gates accurately described the state of foreign affairs discourse during prior Republican debates, when he noted “either they really believe what they’re saying, or they’re cynical and opportunistic, and, in a way, you hope it’s the latter, because God forbid they actually believe some of the things that they’re saying.” Thursday night’s debate, the last before the Iowa Caucasus, was no exception. All the candidates talked tough—sometimes taking it to quite ridiculous extremes—but most were either unwilling or unable to offer any specific foreign policy proposals, or to deviate from clearly planned talking points.

Certainly, with Donald Trump absent, the average foreign policy knowledge among the candidates was several notches higher than usual. But to borrow a phrase from foreign policy guru Ben Carson, if Russia is a one-horse economy, some of those on last night’s debate stage in Iowa were one-horse candidates. Chris Christie answered every question by promising to prosecute terrorists and Hillary Clinton. Marco Rubio answered questions about the liberty movement and immigration with responses on ISIS. The questions were generally high quality, but many of the candidates effectively refused to answer them, choosing instead to pivot to the issues they were most comfortable with.

A number of common misconceptions reappeared. As Gates noted, we simply don’t know if the candidates actually believe these factoids, or if they are simply using half-truths for political expediency. We were again told by several candidates that America’s military is in decline. Ted Cruz described declining numbers of planes (8,000 to 4,000) and ships (529 to 272). But not only were these numbers inexplicably wrong, but comparing today’s military to that required during the Cold War is disingenuous at best. Nor do such numbers take any notice of factors like improvements in technology. Marco Rubio noted that he will rebuild “the U.S. military because the world is a safer and better place when America is the strongest military in the world.” No mention was made of the fact that U.S. military spending already eclipses its closest seven rivals.

The questions were generally high quality, but many of the candidates effectively refused to answer them, choosing instead to pivot to the issues they were most comfortable with.

Ted Cruz could certainly use some further education on the uses and effectiveness of air power, after he again repeated his call for the use of carpet bombing against ISIS. First, his statements are inaccurate. The Gulf War did not involve the use of carpet bombing, but in fact some of the earliest successes in precision bombing. Second, the statements also lead one to believe that it is only the Obama administration’s caprice which prevents the U.S. from engaging in carpet bombing today. In fact, most experts agree that carpet bombing is not a useful strategy; there is no need to engage in such a practice inside Iraq or Syria where the risk of civilian casualties is high. Indiscriminate bombing of the type Cruz calls for is also generally considered a war crime. We might almost prefer to assume that Cruz doesn’t believe what he’s saying.

And even where the moderators provided an opening for nuance on various foreign policy issues, the candidates were typically unable to answer with any statement more complicated than their talking points. A nuanced question involving America’s NATO treaty obligations to the Baltic States was posed to Ben Carson, who proved unable to answer in any coherent fashion. In response to a question designed to get candidates to address the dichotomy between their stated intentions to ‘rip up’ the Iranian nuclear deal, and the fact that the deal will be largely concluded by the time any of them takes office, Marco Rubio retreated to his familiar—if  confusing—refrain about Iran’s apocalyptic theology.

Some candidates did perform better in this debate. John Kasich was able to provide nuance on the issue of sanctions, explaining why unilateral sanctions are often less effective than multilateral ones. His calls for coalition building and against a permanent U.S. role as a global policeman were realistic, and a welcome retreat from his absurd assertion in another recent debate that he “would punch Russia in the nose.” Rand Paul also seems to have tired of trying to disguise himself as a hawk, making strong and coherent statements in support of a more restrained foreign policy.

But overall, whether the result of poor knowledge, poor advising or political expediency, the candidates remain generally weak on foreign policy, especially when it strays from the hot button topic of ISIS. Even on that topic, when pressed by moderators, many candidates fell back on policies not dissimilar to those currently being pursued by the Obama administration, such as building a global coalition to combat ISIS. That’s not necessarily a bad thing—there are almost no good alternatives to the administration’s current policies—but it does illustrate the stark divide between the tough rhetoric the candidates repeatedly toss around and their actual proposed solutions, which are often superficial and unrealistic.

Unfortunately, the question posed by Gates—whether the candidates are ill-informed or simply cynical—remains a relevant one. These debates are adding little to our understanding of how the candidates might actually pursue foreign policymaking as president. Nor are debate moderators free of blame on this issue, as many questions repeat from debate to debate while other key foreign policy issues—how the U.S. should deal with China, for example—go largely unaddressed. Ultimately, it might be another quote from Gates that sums up the debate best: “The level of dialogue on national security issues would embarrass a middle schooler.”

Emma Ashford is a Visiting Fellow in Defense and Foreign Policy Studies at the Cato Institute. Follow her on twitter: @emmamashford.

What America’s Military Spending Debate Is Missing

Christopher A. Preble

While many in Washington believe that we don’t spend nearly enough money on our military, no one disputes that we are spending a lot. The central issue pertains to whether we are getting less than we used to for what we spend today, and whether our security is imperiled as a result.

In a recent commentary posted at the National Interest online, the Heritage Foundation’s Justin Johnson makes the case for spending more on the military. Americans, he says, “have every reason to be concerned about the state of the U.S. military.” But is more money the answer? The United States could, instead, seek to get more bang for its buck by reforming the way the Pentagon does business, and by revisiting the military’s roles and missions.

First, the facts. U.S. military spending today, as it is dictated by the bipartisan Budget Control Act (BCA), is comprised of the Pentagon’s base budget excluding the cost of recent wars. This spending is approaching historic highs. In inflation-adjusted dollars, U.S. taxpayers will spend more on the military in each of the next five years ($510 billion) than was spent, on average, during the Cold War ($460 billion). And, again, that spending gap doesn’t take into consideration today’s war costs.

Now, some will object that comparing inflation-adjusted military expenditures is insufficient. Johnson chose to focus instead on military spending as a share of GDP, the military’s share of total federal expenditures and the U.S. share of global military spending.

Let’s examine what the U.S. military truly must do in order to keep Americans safe, and how much that will cost.

Military spending as a share of GDP has been declining for the past several decades, and falling as a share of total federal spending since 2008. It is projected that the interest on the national debt will eclipse military spending within the next ten years. And the United States, which once accounted for 48 percent of global military expenditures, now accounts for 38 percent. Still, Johnson does not dispute that America is spending more in absolute terms.

Why spending levels matter, meanwhile, is distinctly subjective. Citing a Heritage Foundation study, Johnson claims that calls to cut military spending are dangerous because the global threat level is “elevated,” and “America’s ability to defend itself and its interests” is “only ‘marginal.’”

Is that really so? Would any other country on the planet trade places with Uncle Sam today? Are Americans today less safe than those living during the Cold War? Or World War II?

To be sure, the U.S. military is indeed smaller today than it was six years ago, or during the Cold War. Consider it just in terms of the number of men and women serving on active duty. In 1952, at the height of the Korean War, active-duty end strength peaked at 3.6 million. During the Vietnam War, the number of active duty personnel reached 3.5 million. The high point in the post–Cold War era came in 2010, when active duty end strength peaked at 1.5 million, less than half the number in uniform at the time of those earlier wars. And yet total Pentagon spending was higher in 2010 than in either 1952 or 1968 — 35 percent higher than in 1952, and 32 percent higher than in 1968.

A similar story could be told with respect to ships at sea, or planes in the air. The platforms we are buying today are more costly than those fielded a generation ago. We spend more, and we get less.

Or do we? Is spending itself necessarily correlated with effectiveness? Does a larger budget for the Department of Education lead to better education for our kids? Does higher health care spending ensure that we will all live healthier lives?

We should ask similar questions with respect to the Pentagon’s budget. The military of my parents’ generation was comprised primarily of conscripts: men obligated by law to serve, often against their will. They were poorly paid and received minimal training because it would have been foolish to invest time and money in those who were unlikely to remain in uniform for more than a few years. They executed their missions, often heroically, and under harsh conditions. But they were, by and large, temporary soldiers, anxious to return to their civilian lives when the wars were over, or when their obligated term of service was up.

With no disrespect intended to the generations who fought in World War II, or Korea, or Vietnam, I would argue that today’s military is superior — truly the finest fighting force in our nation’s history — because it consists entirely of dedicated professionals who have volunteered to serve.

In light of this choice, taxpayers are willing to pay service members well, relative to their comparably skilled peers. The entire package of salary and benefits must be competitive with the private sector in order to attract and retain the very best talent. It’s about more than just pay, however. We are willing to invest heavily in training military personnel because such an investment is so widely believed to yield dividends.

So, yes, we spend a lot. But the cost effectiveness of our defense spending is debatable — a worthy debate, at that.

Notwithstanding Johnson’s efforts, then, it isn’t obvious that a more costly force is needed to preserve U.S. security and protect vital U.S. interests. That we are spending less as a share of GDP than at some points in U.S. history does not necessarily mean that we should spend more. It could also be true that we are spending less and getting more, or that we could safely get by with less. Once we get beyond the confusion over different ways to measure our spending, let’s examine what the U.S. military truly must do in order to keep Americans safe, and how much that will cost.

Christopher A. Preble is vice president for defense and foreign policy studies at the Cato Institute.

Economic Headwinds: Big Players, Regime Uncertainty and the Misery Index

Steve H. Hanke

Before we delve into the economic prospects for 2016, let’s take a look at the economies in the Americas, Asia, Europe and the Middle East/Africa to see how they fared in the 2014-15 period. A clear metric for doing this is the misery index. For any country, a misery index score is simply the sum of the unemployment, inflation, and bank lending rates, minus the percentage change in real GDP per capita. A higher misery index score reflects higher levels of “misery.”

For purposes of consistency, I have used data from the Economist Intelligence Unit. Only countries with current data for 2015 are included in the accompanying tables.

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A review of these tables indicates a clear rogue’s gallery. It includes the following countries with misery index scores of 40 or above: Venezuela, Brazil, Argentina, Ukraine, and South Africa. The only region not contributing to that gallery is Asia. But, that’s not the end of the story. All countries with scores over 20 are seriously deficient. These countries are ripe for reform.

Turning to 2016, it started with a bang. The world’s major stock markets are volatile and in negative territory. Commodity markets, led by oil, continue to plunge, and so has the value of most emerging market currencies against the U.S. dollar. Combined public and private debt levels relative to GDP have soared, and are well over the ratios that existed during the top of the last credit cycle in 2007. With this debt binge, the level of non-performing loans on banks’ books has soared, too. And if that’s not enough, the Institute of International Finance has just increased its estimate of net capital outflows from emerging markets in 2015 to $735 billion, with $676 billion of capital flight coming from China alone. Talk about a carry trade unwind.

The World Bank and the International Monetary Fund (IMF) have been revising downward their forecasts for global GDP growth. At present, the World Bank forecast for global GDP growth in 2016 is a paltry 2.9 percent, while the IMF’s 2016 forecast of 3.4 percent isn’t much better. It’s becoming clear that the global economy will face headwinds in 2016. It’s no surprise, therefore, that many are in a state of high anxiety and that a spiral of pessimism is developing.

One of the major sources of the storm is ironically what statists and interventionists around the world (read: “The Establishment”) think will save us — namely, big governments. More specifically, the academic literature has dubbed them “Big Players.” While there is a budding and serious academic literature on Big Players, or what could be termed Market Disrupters, there is virtually no mention in the financial press that the Big Players might just bury us. Perhaps this is because the valuable insights provided by the rigorous, and what is at times quite technical, analysis of Big Players is very contra-establishment. Indeed, instead of stabilizing markets, the Big Players disrupt them. They are the purveyors of instability. For those who wish to grapple with the technical literature, I recommend: Roger Koppl. Big Players and the Economic Theory of Expectations. New York: Palgrave Macmillan, 2002.

Big Players have three defining characteristics. Firstly, they are big — big enough to influence markets. Secondly, they are largely insensitive to the discipline of profits and losses — in short, immune from competitive pressures. Thirdly, they act with a large degree of discretion in the sense that their actions are not governed by a prescribed set of rules.

With these characteristics, Big Players are hard to predict. In consequence, they can disrupt. Among other things, they divert entrepreneurial attention away from the assessment of strictly economic market fundamentals — the present value of prospective cash flows and services generated — toward the actions of the Big Players. These are inherently political, and subject to unpredictable change. This reduces the reliability of expectations, with skill becoming devalued and luck counting for more.

The Big Players’ discretionary interventions render most market signals about fundamentals unreliable. They create environments that are ripe for herding and bandwagon effects, as well as noise trading, which is subject to fads and fashions. This explains, in part, why investment groups are spending big bucks to create a thinking, learning, and trading computer — a search for a super-algorithm. Never mind. Big Players increase volatility and create bubbles. They are the disrupters of the universe.

Closely related to the Big Players problem is a strand of innovative analysis pioneered by Robert Higgs of the Independent Institute. It concerns what Higgs calls “regime uncertainty.” Regime uncertainty relates to the likelihood that investors’ private property in their capital and the flows of income and services it yields will be attenuated by government action (read: the discretionary action of Big Players, among other things). As regime uncertainty is elevated, private investment is notched down from where it would have been. This can result in a business-cycle bust and even economic stagnation. For Higgs’ most recent book, which contains evidence on the negative effects of regime uncertainty, I recommend: Robert Higgs. Taking a Stand: Reflections on Life Liberty, and the Economy. Oakland, CA: The Independent Institute, 2015.

The real question is: are Big Players ascending or descending? In gathering data to answer this question, I have become convinced that the Big Players problem is big and getting bigger. Indeed, the problem has become much more pronounced since the onset of the great recession of 2008-2009.

Most central banks possess all the characteristics of Big Players in spades. Since the advent and implementation of quantitative easing (QE), they have become bigger players, with the state money they produce making up a much greater portion of broad money (state, plus bank money) than before 2009. Not only have their balance sheets exploded, but the composition of some of their balance sheets has changed in surprising ways. It used to be that central bank assets were solely comprised of domestic and foreign government bonds. Well, now you can find corporate bonds on some central bank balance sheets. And that’s not all. Central banks use their discretion to purchase equities, too. Just take a look at the Swiss National Bank (SNB), one of the alleged paragons of conservative central banking. By late last year (Q3), the total value of stocks held by the SNB had risen to $38.95 billion. That’s the size of some of the largest hedge funds in the world, and amounts to over 5 percent of Switzerland’s GDP.

The Bank of Japan (BoJ) is also openly a big buyer of stocks — namely, Japanese ETFs. The BoJ is authorized to purchase roughly $25 billion of ETFs per year, and the government leans on the BoJ to use its fire power — especially when the Japanese stock markets are “weak.”

Less surprising is the stock-buying propensity of the People’s Bank of China (PBoC). It has thrown hundreds of billions of yuan into purchasing publically listed Chinese shares in a bid to stave off multiple stock market crashes. And, when it comes to Chinese markets, the PBoC is not alone. When Beijing cracks the whip, the “national team” — a group of state-owned banks, brokers, pension funds, government agencies, and you name it — either buy or sell. Much of the same goes on in Russia and elsewhere, but in those places the scope and scale of the Big Player phenomenon is no match for that of the Middle Kingdom.

Right behind central banks are sovereign-wealth funds (SWFs). With over $7 trillion in assets, they are huge. But, transparency (read: disclosure rules) with regard to size, holdings and strategies is limited. About all we know is that when the SWFs’ political masters command, the SWF technocrats march.

Then there are traditional state-owned enterprises (SOEs). While the wave of privatizations that started in the late 1970s put a dent in the SOEs, they remain Big Players in many countries. And, when compared to similar private enterprises, their actions are more unpredictable and their performance is dismal. Sales per employee are lower for SOEs. Adjusted profits per employee are lower. Per dollar of sales, operating expenses plus wages are higher. Sales per dollar investment are lower. Profits per dollar of total assets are lower. Profits per dollar sales are lower. Sales per employee grow at a slower rate. And, with the exception of state-owned oil companies, who often have considerable monopoly power, most traditional SOEs generate accounting losses.

But, traditional SOEs are only the tip of the iceberg. State capitalism — a model in which governments pick winners and use capitalist tools such as listing SOEs on stock markets — is on the rise. With state capitalism, the visible hand of the State replaces Adam Smith’s invisible hand of the markets. State capitalism runs the gamut from public-private partnerships to SOEs, and highlights the relevance of the Big Player problem. For a review of State Capitalism, I recommend the special report on that topic, which was published in the 21 January 2012 issue of The Economist. A review of that edifying report will convince the reader that the Big Player problem lurks everywhere.

Going forward, we will clearly face headwinds created by Big Players and regime uncertainty.

Steve H. Hanke is a professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C. You can follow him on Twitter: @Steve_Hanke

Fed Dithering Will Destabilize Markets

Gerald P. O’Driscoll Jr.

As widely anticipated,the Fed on Wednesday decided not to raise its federal funds target rate. As it did so often in 2015, it put off a decision on a rate increase to the next meeting. The decision is unlikely to become easier as 2016 progresses. Investors beware.

The Fed has stated its intention to do a series of interest-rate increases over the next two years. Those statements have already moved markets. In particular, the dollar has strengthened against other currencies. A stronger dollar has ramifications both here and abroad. It makes U.S. exports more expensive on world markets. Purchasers in other countries must exchange more of their own currencies to purchase U.S. goods. That dampens demand, which impacts American producers and their suppliers. The stronger dollar also makes imports cheaper, and to some extent U.S. consumers and businesses will substitute imported goods for domestically produced ones. That slows U.S. economic growth.

The public justification for tighter monetary policy is weakening in the face of stubbornly low inflation rates.

The anticipation of a Fed tightening has already had some of the effects of an actual policy tightening. Markets are reacting in advance of further tightening. These market movements are expectations driven.

There are other effects of a stronger dollar.

1. Oil is priced globally in dollars. Dollar strengthening makes oil more expensive in local currencies, and that dampens demand for it. The collapse in oil prices was precipitated by the technological revolution in shale production. The decision of major producers, like Saudi Arabia, to keep pumping pushed prices down further. But the strong dollar has contributed. It is difficult to see oil prices rising significantly in the face of further dollar strengthening that would result from further hikes in interest rates.

2. There has been a great deal of borrowing in dollars in emerging markets by sovereigns and individuals. The servicing of those debts has become more expensive for those collecting taxes or earning income in depreciating local currencies. For the most heavily indebted borrowers, there is risk of default. For sovereign borrowers, default on foreign debt is as much a political decision as an economic one. Sovereign borrowers are more likely to default on debt held by foreigners than that held by their own citizens.

So, if the Fed adheres to its plan, 2016 will see turbulence in global credit markets and continued downward pressure on energy prices. With each postponement of a rate hike, however, the Fed will increase uncertainty in financial markets. Instead of being a stabilizing force in financial markets, Fed dithering will destabilize markets.

The Fed realizes that, by holding interest rates down for so long, it has distorted investment decisions and inflated asset bubbles. It needs to stick to its plan to raise short-term interest rates to more normal levels — 2 percent or higher. But the adverse reaction in global financial markets to its tentative first step pressures policy makers to hold off and postpone further rate hikes.

Fed officials have repeatedly justified a gradual increase in short-term interest rates by their anticipation of higher inflation rates as the economy strengthened and unemployment rates fell. Falling energy prices make higher inflation much less likely. The public justification for tighter monetary policy is weakening in the face of stubbornly low inflation rates.

The truth is the Fed kept interest rates too low for too long. It kept hoping that real economic growth would pick up. The effects of low interest rates channeled investment into financial speculation rather than real productive activity. Now that the Fed has decided to act, there will be major economic adjustments to be made. We have only begun to see some of these. Whether Fed officials can stay the course will be tested in 2016. It will likely be a turbulent year for investors.

Gerald O’Driscoll, a senior fellow at the Cato Institute. Formerly, he was vice president at Citigroup, and, before that, vice president at the Federal Reserve Bank of Dallas.

Socialism Means Coercion

Richard W. Rahn

Do you know what socialism is? Hillary Clinton struggled to find an answer when recently asked. Socialism is a system in which the government owns or controls the means of production, and allocates resources and rewards.

Sen. Bernie Sanders proudly proclaims himself a “democratic socialist,” and many in the Democratic Party seem to have no problem with it and, in fact, are embracing him and his ideas. Listening to all of this, one gets the feeling that for a significant portion of the population, history began in the year 2000. Where have been the great socialist success stories? Much of the world’s population greatly suffered under various forms of socialism in the 20th century. Not one of the various socialist models proved to be a success.

There was the communist variety of socialism in the former Soviet Union, Eastern Europe, China and Cambodia, which resulted in tens of millions of deaths from starvation and from the gulags. There was the national socialist (Nazi) model in Germany and Italy, which, like the communist version, resulted in tens of millions of deaths. Somewhat more benign, but still coercive, versions of socialism were prevalent in India, many places in Africa and South America, and all resulted in economic stagnation — because productive effort was separated from reward. The two most socialist countries today are North Korea and Cuba — both being very poor and repressive. The average Cuban government worker has a monthly wage which is less than what the average American worker makes in an hour.

Why does socialism always fail, and why will Bernie Sanders’ schemes and, to a lesser extent, Hillary’s Obamacare version, also fail?

It is true that every country has some socialist enterprises at the federal, state or local levels. For instance, the U.S. government owns Amtrak, and the city of Flint, Mich., owns its water department. Arguably, both would do much better in private hands. France has many more government-owned enterprises than neighboring Switzerland. Even France is still basically a capitalistic free-market economy — but with far less freedom and prosperity than Switzerland.

Why does socialism always fail, and why will Bernie Sanders‘ schemes and, to a lesser extent, Hillary’s Obamacare version, also fail? Under a capitalist free-market system, the business person seeks to produce goods and services that the consumer wants at the lowest possible cost — which includes having the smallest and most productive work force possible — in order to maximize profits. Under the socialist model, the political leaders decide what the consumers should have (which is often very different from what they want or need). Productivity and innovation are given short shift, needless workers are hired and few are fired. In almost all cases, costs soon outrun revenues, and the losses are made up by ever higher taxes or more debt — eventually causing an economic collapse. As economic stagnation increases, the citizens become more restless and either throw off the yoke of government through the ballot box, as was done in 1979 in the United Kingdom with the election of Margaret Thatcher, or the protesters are imprisoned until often a bloody revolt occurs.

Now back to Bernie Sanders who has proposed “Medicare for all” as one of his many schemes. Professor Gerald Friedman of the University of Massachusetts has examined the Sanders plan (and has no political ax to grind), and he estimates it would cost $40.9 trillion between 2017 and 2026. Hospitals and doctors would be forced to take huge cuts, driving many out of the medical profession, and reducing innovation and standards in health care. Patients would be forced to wait in long queues. It would be like the present failed Veterans Administration health system for all.

Back in 2002, Joshua Muravchik wrote a classic book on the history of socialism, “Heaven on Earth: The Rise and Fall of Socialism.” Perhaps it is time for the political class, including the commentators, to go back and read it and realize again that the next time the socialists will not get it right, because the model is fatally flawed.

What is most disturbing is the idea that America — and its unique success as a nation — was built around individual liberty and opportunity, not collective coercion. All too many no longer understand what the American Founders were trying to, and largely did, achieve. The young people who support Mr. Sanders, and even Hillary, seem to be generally ignorant of why America worked. Many do not want the government to restrict unfettered abortions or their right to smoke pot, but seem to be oblivious that socialism and big government makes everyone into an economic slave. Many workers in the Soviet Union, as is true of North Korea and Cuba today, could not even choose their own profession, or what town or apartment block they lived in. Such restrictions are the logical and necessary outcomes of socialism, unless it is thrown off before it reaches that stage.

Those in the news media who have an opportunity to quiz the presidential candidates would do the citizens a great favor if they could discern what the candidates really know about the Constitution and the arguments made in the Federalist Papers.

Richard W. Rahn is a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.

The Climate Snow Job

Patrick J. Michaels

An East Coast blizzard howling, global temperatures peaking, the desert Southwest flooding, drought-stricken California drying up—surely there’s a common thread tying together this “extreme” weather. There is. But it has little to do with what recent headlines have been saying about the hottest year ever. It is called business as usual.

Surface temperatures are indeed increasing slightly: They’ve been going up, in fits and starts, for more than 150 years, or since a miserably cold and pestilential period known as the Little Ice Age. Before carbon dioxide from economic activity could have warmed us up, temperatures rose three-quarters of a degree Fahrenheit between 1910 and World War II. They then cooled down a bit, only to warm again from the mid-1970s to the late ’90s, about the same amount as earlier in the century.

Whether temperatures have warmed much since then depends on what you look at. Until last June, most scientists acknowledged that warming reached a peak in the late 1990s, and since then had plateaued in a “hiatus.” There are about 60 different explanations for this in the refereed literature.

That changed last summer, when the National Oceanic and Atmospheric Administration (NOAA) decided to overhaul its data, throwing out satellite-sensed sea-surface temperatures since the late 1970s and instead relying on, among other sources, readings taken from the cooling-water-intake tubes of oceangoing vessels. The scientific literature is replete with articles about the large measurement errors that accrue in this data owing to the fact that a ship’s infrastructure conducts heat, absorbs a tremendous amount of the sun’s energy, and vessels’ intake tubes are at different ocean depths. See, for instance, John J. Kennedy’s “A review of uncertainty in in situ measurements and data sets of sea surface temperature,” published Jan. 24, 2014, by the journal Reviews of Geophysics.

NOAA’s alteration of its measurement standard and other changes produced a result that could have been predicted: a marginally significant warming trend in the data over the past several years, erasing the temperature plateau that vexed climate alarmists have found difficult to explain. Yet the increase remains far below what had been expected.

A blizzard! The hottest year ever! More signs that global warming and its extreme effects are beyond debate, right? Not even close.

It is nonetheless true that 2015 shows the highest average surface temperature in the 160-year global history since reliable records started being available, with or without the “hiatus.” But that is also not very surprising. Early in 2015, a massive El Niño broke out. These quasiperiodic reversals of Pacific trade winds and deep-ocean currents are well-documented but poorly understood. They suppress the normally massive upwelling of cold water off South America that spreads across the ocean (and is the reason that Lima may be the most pleasant equatorial city on the planet). The Pacific reversal releases massive amounts of heat, and therefore surface temperature spikes. El Niño years in a warm plateau usually set a global-temperature record. What happened this year also happened with the last big one, in 1998.

Global average surface temperature in 2015 popped up by a bit more than a quarter of a degree Fahrenheit compared with the previous year. In 1998 the temperature rose by slightly less than a quarter-degree from 1997.

When the Pacific circulation returns to its more customary mode, all that suppressed cold water will surge to the surface with a vengeance, and global temperatures will drop. Temperatures in 1999 were nearly three-tenths of a degree lower than in 1998, and a similar change should occur this time around, though it might not fit so neatly into a calendar year. Often the compensatory cooling, known as La Niña, is larger than the El Niño warming.

There are two real concerns about warming, neither of which has anything to do with the El Niño-enhanced recent peak. How much more is the world likely to warm as civilization continues to exhale carbon dioxide, and does warming make the weather more “extreme,” which means more costly?

Instead of relying on debatable surface-temperature information, consider instead readings in the free atmosphere (technically, the lower troposphere) taken by two independent sensors: satellite sounders and weather balloons. As has been shown repeatedly by University of Alabama climate scientist John Christy, since late 1978 (when the satellite record begins), the rate of warming in the satellite-sensed data is barely a third of what it was supposed to have been, according to the large family of global climate models now in existence. Balloon data, averaged over the four extant data sets, shows the same.

It is therefore probably prudent to cut by 50% the modeled temperature forecasts for the rest of this century. Doing so would mean that the world—without any political effort at all—won’t warm by the dreaded 3.6 degrees Fahrenheit by 2100 that the United Nations regards as the climate apocalypse.

The notion that world-wide weather is becoming more extreme is just that: a notion, or a testable hypothesis. As data from the world’s biggest reinsurer, Munich Re, and University of Colorado environmental-studies professor Roger Pielke Jr. have shown, weather-related losses haven’t increased at all over the past quarter-century. In fact, the trend, while not statistically significant, is downward. Last year showed the second-smallest weather-related loss of Global World Productivity, or GWP, in the entire record.

Without El Niño, temperatures in 2015 would have been typical of the post-1998 regime. And, even with El Niño, the effect those temperatures had on the global economy was de minimis.

Patrick J. Michaels, a climatologist, is the director of the Center for the Study of Science at the Cato Institute.

Conservatives against Trump

David Boaz

A lot of Americans think it would be better to have a businessman than a politician as president, and I sympathize with them. Alas, the only businessmen crazy enough to run for president seem to be, well, crazy. At least Ross Perot kept his craziness confined mostly to private matters, such as the looming disruption of his daughter’s wedding. Donald Trump puts it front and center.

From a libertarian point of view — and I think serious conservatives and liberals would share this view—Trump’s greatest offenses against American tradition and our founding principles are his nativism and his promise of one-man rule.

Trump’s greatest offenses against American tradition and our founding principles are his nativism and his promise of one-man rule.

Not since George Wallace has there been a presidential candidate who made racial and religious scapegoating so central to his campaign. Trump launched his campaign talking about Mexican rapists and has gone on to rant about mass deportation, bans on Muslim immigration, shutting down mosques, and building a wall around America. America is an exceptional nation in large part because we’ve aspired to rise above such prejudices and guarantee life, liberty, and the pursuit of happiness to everyone.

Equally troubling is his idea of the presidency—his promise that he’s the guy, the man on a white horse, who can ride into Washington, fire the stupid people, hire the best people, and fix everything. He doesn’t talk about policy or working with Congress. He’s effectively vowing to be an American Mussolini, concentrating power in the Trump White House and governing by fiat. It’s a vision to make the last 16 years of executive abuse of power seem modest.

Without even getting into his past support for a massive wealth tax and single-payer health care, his know-nothing protectionism, or his passionate defense of eminent domain, I think we can say that this is a Republican campaign that would have appalled Buckley, Goldwater, and Reagan.

David Boaz is the executive vice president of the Cato Institute and the author of The Libertarian Mind.

Looking for Moderates in All the Wrong Places

A. Trevor Thrall

Doubling down on the same strategy that failed so miserably in Syria, the Pentagon is assessing various armed factions in in Libya an effort to find partners in the fight against ISIS. Given the recent history of U.S. intervention in the Middle East, it is hard to know what exactly the Obama administration is thinking.

They should know such proxy wars are a dead end. In fact, “an internal C.I.A. study,” the New York Times reported in October 2014, found that sending U.S. money and arms to local proxies in conflicts across the world, “rarely works.”

Whatever the administration is thinking, it is clear that they have failed to learn at least five important lessons from the experiences in Afghanistan, Iraq, and Syria.

Whatever the administration is thinking, it is clear that they have failed to learn at least five important lessons from the experiences in Afghanistan, Iraq, and Syria.

The first lesson is that armed groups in the middle of a civil war make lousy allies. None of the groups in Libya cares about what the United States wants; each is preoccupied with its own search for power and influence. True, some groups may agree to take U.S. support, but history reveals that they will do so in order to further their own causes, not to further the U.S. cause. Though none of the Libyan groups in question loves ISIS today, patterns of allegiance can shift quickly. Even if the United States enjoyed a deep knowledge of the Libyan political situation on the ground — which it does not — the United States has little ability to influence the behavior of proxies over the long term.

Second, providing weapons and money to existing conflicts only makes them bigger and more violent. Moreover, there is no promise that American weapons will wind up being used by groups allied with the United States or for purposes aligned with U.S. goals. U.S. experience in this regard is especially poignant. American funding to fight the Russians in the 1980s helped the Taliban rise to power in Afghanistan.  In Iraq, the Islamic State has captured thousands of U.S. Humvees, rifles, pistols, mortars, and other equipment originally given to the Iraqi army. 

And in Libya, U.S. weapons, including as many as 15,000 shoulder-to-air missiles, already fuel the conflict. In 2011, the United States blessed the transfer of arms from the United Arab Emirates and Qatar to rebels to fight Gadhafi, only to learn that some of the weapons were going to Islamist extremists that are now fighting for control in post-Gadhafi Libya.

Third, taking sides in other people’s wars creates new enemies. By supporting “moderates” in Libya the U.S. will inevitably add to the list of people and groups who are violently unhappy with the United States. By definition, since the U.S. will not support Islamist groups, its new enemies will be the most extreme groups and this, in turn, will increase the probability of future anti-American terrorism both in Libya and elsewhere.

Fourth, small conflicts have a way of turning into large conflicts. Once the United States engages in Libya, the president’s political fate becomes intertwined with Libya’s fate. At that point the president will face significant pressure to ensure victory even as setbacks or casualties mount. In Afghanistan and Iraq, presidents Bush and Obama both ordered massive military surges after failing to make progress in pacifying the chaos on the ground. In Syria the Obama administration followed the failed rebel training program by sending thousands more Special Forces troops. From there, the slope gets even more slippery. If ISIS scores a significant military victory against U.S. forces at this point, killing or wounding dozens of soldiers, it is difficult to see how the president could keep a lid on expanding U.S. intervention.

Finally, the United States has failed to learn that being a superpower does not imply the ability to remake the domestic politics of other nations. Despite almost fifteen years of military occupation, threats, bribes, economic development support, training and funding for military and police forces, the United States has made little headway in helping Afghanistan a stable nation or encouraging the Sunni and Shia in Iraq to get along within a system of shared governance. Instead, U.S. efforts have unleashed chaos and spawned the birth of ISIS.

The situation in Libya looks in many respects much like the one in Syria — a dizzying array of factions competing for influence in a society left angry and devastated by decades of oppression and conflict. And as with Syria, U.S. efforts to shape outcomes will be overwhelmed by the more powerful domestic political dynamics at work within Libya.

A. Trevor Thrall is a senior fellow for the Cato Institute’s Defense and Foreign Policy Department. Thrall is an associate professor at George Mason University in the Department of Public & International Affairs.

El Chapo Shows the Folly of the War on Drugs

Jeffrey Miron

It might seem easy to dismiss the buzz over the recent capture of “El Chapo” Joaquín Guzmán and Sean Penn’s interview with him in Rolling Stone as obsession with the notorious drug kingpin or fascination with a Hollywood icon like Penn. Yet hype aside, El Chapo’s capture, Penn’s interview and the subsequent coverage draw crucial attention to the folly of the War on Drugs.

On the fundamental question of whether drug prohibition makes sense, El Chapo seems to understand the issue well. When Penn asks: “What is the relationship between production, sale and consumption?” Guzman answers: “If there was no consumption, there would be no sales. It is true that consumption, day after day, becomes bigger and bigger. So it sells and sells.”

Guzman has it exactly right: demand incentivizes supply. As long as consumers want drugs, markets will produce and sell them. If drugs were legal, this would occur as in other industries, but since drugs are outlawed, the market stays underground. Prohibition likely reduces drug use to some degree, but available evidence suggests a modest impact. The Netherlands and Portugal, for example, have far laxer drug laws than the U.S. but use rates that are similar or lower.

The U.S., now more than ever, must have a renewed conversation about the Drug War, and how to end it.

Regardless of any reduction in use, prohibition and the resultant black markets generate numerous adverse consequences. The incredible rates of violence and corruption in Mexico and other countries where drugs are sourced result directly from the attempt to suppress the drug trade, and much violence in the U.S. reflects disputes over drug territory or drug deals gone bad. Accidental overdoses from heroin and other drugs occur in large part because users in underground markets have poor information about the dosage they are consuming. Elevated law enforcement costs (roughly $50 billion per year in the U.S.), as well as policies like stop-and-frisk that inflame racial tensions and infringe on civil liberties, also flow directly from drug prohibition. Limitations on the use of marijuana as medicine are another troubling side effect of the drug war.

On the narrower question of whether targeting drug kingpins stems the flow of drugs, Penn’s question and Guzman’s response are revealing. Penn asks: “Do you think it is true you are responsible for the high level of drug addiction in the world?” Guzman says: “No, that is false, because the day I don’t exist, it’s not going to decrease in any way at all.”

Taking kingpins out of circulation will likely have no impact on the drug trade. When a kingpin is captured or killed, lieutenants step in, or the kingpin runs the operation from prison, or other suppliers make up for any disruption in the deposed kingpin’s operation. Pablo Escobar, who preceded El Chapo as the most notorious kingpin, died in 1993 with no visible impact on drug availability in the U.S. El Chapo himself was captured and imprisoned in 1993, but his brother ran the drug empire in his place. Throughout this period, drugs like cocaine and heroin became cheaper and cheaper.

In fact, targeting kingpins is one of the worst possible drug war strategies, since it appears to spur violence as lieutenants fight to secure the positions, territories and markets previously controlled by a killed or captured kingpin. In a recent research brief for the Cato Institute, Jason Lindo and María Padilla-Romo of Texas A&M University discuss their finding that the capture of a kingpin from a particular municipality causes that city’s homicide rate to increase by 80%. This escalation in violence persists for at least 12 months and even spreads to other cities served primarily by that drug organization. Independent research out of Stanford University finds a similar effect.

In Penn’s recent interview with Charlie Rose, Penn worries that his interaction with Guzman might fail to prompt discussion of the Drug War’s disastrous consequences, since public attention seems focused on the sensational and celebrity aspects of these events. That would be unfortunate: the U.S., now more than ever, must have a renewed conversation about the Drug War, and how to end it.

One approach to reform is state-by-state liberalization of drug laws, as has occurred increasingly in recent decades for marijuana. This constitutes genuine progress, but it runs into enormous conflict with federal prohibition. The ideal reform, therefore, would repeal federal prohibition while leaving states free to choose their own drug policies. This approach would de-escalate the drug war dramatically but allow for the differences in perspectives across states that is the core of our federalist system of government.

Jeffrey Miron is a professor of economics at Harvard University and director of economic studies at the Cato Institute.