hoover digest, 2013, no. 4, fall

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T H E H O O V E R I N S T I T U T I O N S T A N F O R D U N I V E R S I T Y

R E S E A R C H A N D O P I N I O N

O N P U B L I C P O L I C Y

2 0 1 3 N O 4 F A L L


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On the CoverSeaside villages like this one in an undatedSpanish travel poster suggest not just seasonspast but whole ways o lie changed. Theplacid towns and villages along Spains Pla-

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Hoover Digest N 2013 No. 4

ContentsHOOVER D IGEST 2013 NO . 4 FALL

THE ECONOmy

9 Failure Isan OptionA Very Good OneHow to let too big to ail banks close up shop, predictably and

airly. Bykenneth e. scott andjohn b. taylor.

14 Debt Is a MillstoneEconomists may make their errors, but theres no mistake about the

ederal debt. Its bad. Bymichael j. boskin.

19 Austerity Versus StimulusEither approach might work. The question is how the private sector

responds. Bycharles wolf jr.

22 Another Uncertainty PrincipleWhy cant economists gaze into the uture the way physicists gaze

into the atom? Because the science o economics is still emerging. By

russell roberts.

27 Bridges to NowhereWhen stimulus spending roars down the highway disguised as inra-

structure spending, its time to hit the brakes. Bypaul r. gregory.

TAxES

32 Many Happier ReturnsHow to mend the ederal tax code. Bygary s. becker.


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36 The Inequality DelusionWhy it isnt the governments job to equalize incomeor to try to

do so by manipulating taxes. Bydavid davenport.

I NTEll IGENCE

39 Lives in the BalanceThe NSAs data-mining eorts seem, in the end, to be a tradeo be-

tween national security and individual privacy thats worth making.

Byroger pilon and richard a. epstein.

42 Watching the DetectivesFree societies can indeed restrain their intelligence agencies, largely

by keeping them honest. Bymark harrison.

50 October SurprisesThe Cuban missile crisis represents an enduring tale o complacency,

ragmented data, and the rantic race to pick signal out o noise. Byamy b. zegart.

56 No Sae Havens?How Barack Obama learned to stop worrying and love the drone. By

kenneth anderson.


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64 A Beautiul FriendshipEuropeans have been claiming, to quote Captain Renault, to be

shocked, shocked about American spying. They should know bet-

ter. Byjosef joffe.

POl IT ICS

68 Another Bad BounceSigns that a political delusion may be about to die at last. By

thomas sowell.

HEAlTH CARE

71 The Coming Rate ShocksSleight o hand makes it appear that ObamaCare means cheaper pre-

miums. Look closer. The savings arent there. Bydaniel p. kessler.

74 No, He CantThe president has no constitutional authority to suspend theemployer mandateor, or that matter, any other law. By

michael w. mcconnell.

77 Medicare on Lie SupportHow desperate does Medicare have to become beore policy makers

act? Byscott w. atlas.

83 Delate the Disability BubbleInlated by broad eligibility and chronic unemployment, this trou-

bled program is due to pop. Bymichael j. boskin.


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SC IENCE

87 Against the GrainThe real mystery behind Oregons patch o mystery wheat is

why we let the USDA suppress biotech crops in the irst place. By

henry i. miller.

EDUCAT ION

93 Private Schools Let BehindCharter schools and online learning are making old-ashioned private

schools look . . . old-ashioned. Bychester e. finn jr.

ImmIGRAT ION

98 The Value o an ImmigrantUntil we clear up what we want rom immigrants, well never clear

up immigration policy. Byedward paul lazear.

I RAq

101 Kurdistan Seizes Its MomentIn the bustling, conident north, the pretense o one Iraq grows

weaker by the day. Byfouad ajami.


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EGyPT

106 Pendulum o PowerInstead o a new political system, Egyptians will get only a new

Nasser. Bysamuel tadros.

THE m IDDlE EAST

111 Taking on IranBetween empty ultimatums and threats o overwhelming orce lies a

diplomatic sweet spot. An interview withabraham d. sofaer.

119 Unholy AllianceAlas or Lebanon. Syria, Iran, and Hezbollah have turned the country

into an arena or their unending proxy wars. Bymarius deeb.

I NTERV IEw

124 We Are Going to Stand on PrincipleSenator Rand Paul on libertarianism and the GOP; the Senate; and

the Constitution. An interview with peter robinson.

VAlUES

134 Still the Essential NationAter a lietime o service to the nation, a relection on Americas role

in the world. Bygeorge p. shultz.

139 Who Speaks or Black Americans?When jurors rejected the racial narrative surrounding the Zimmer-

man trial, they also rejected certain present-day civil rights leaders.

Byshelby steele.


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H ISTORy AND CUlTURE

143 Shermans WayThe Civil War general was a prophet not o total war, as his critics

charge, but oconclusivewar. Byvictor davis hanson.

154 Declaration o DependenceTocqueville admired the independence o the Americans he met.

Their descendants now swaddle themselves in a regulatory state. By

niall ferguson.

HOOVER ARCH IVES

158Windows into HistoryIn seldom-seen treasures rom the Hoover Archives, stories o artists

and their times. Bynicholas siekierski.

168 On the Cover


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Hoover Digest N 2013 No. 4 9

THE ECONOMY

Failure Isan OptionA Very Good One

How to let too big to ail banks close up shop, predictably and

airly. ByKenneth E. Scott

and

John B. Taylor.

It is now three years since the Dodd-Frank Act was enacted to prevent the

possibility that taxpayers would have to bail out too big to ail banks.

Yet there is serious concern that the legislation has not solved the problem.

Many have called or new laws to limit the activities o very large banks or

even, as in the bill introduced last spring by Senators Sherrod Brown andDavid Vitter, to cause them to break up.

In our view, a straightorward reorm o the bankruptcy code would

acilitate the orderly bankruptcy o large ailing inancial institutions and

thereby deal with the bailout problem. The reorm should be enacted

now, whether or not urther actions are taken on big banks.

Under bankruptcy, a ailing irm can go into either liquidation, in

which it goes out o business and is dismantled into pieces that are soldo, or reorganization. In reorganization, assets are assigned a market

Kennethe. Scottis a senior research fellow at the Hoover Institution, a mem-

ber of Hoovers Working Group on Economic Policy, and the Ralph M. Par-

sons Professor of Law and Business (Emeritus) at Stanford University.JohnB.

tayloris the George P. Shultz Senior Fellow in Economics at the Hoover Institu-

tion, the chairman of Hoovers Working Group on Economic Policy and a memberof Hoovers Shultz-Stephenson Task Force on Energy Policy, and the Mary and Rob-

ert Raymond Professor of Economics at Stanford University. They are co-editors of

BankruptcyNotBailout: A Special Chapter 14 (Hoover Institution Press, 2012).


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value and losses are recognized. The interests o shareholders and

creditors are addressed in the order o priority stipulated by law,

which oten means stockholders are let with little or no own-

ership interest. Creditors, in order o contractual priority,have their debt claims written o, reduced in amount, or

converted into stock. In the end, the irm continues in

business, oten with new managers.

Title II o Dodd-Frank established a very di-

erent process, the Orderly Liquidation

Illustrationb

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TaylorJones

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Authority. The Federal Deposit Insurance Corporation has the authority to

resolve a large inancial irm when it ails. Consistent with the original ral-

lying cry or the legislation, it will wipe out shareholders. But the heart o

the new resolution process is reorganization, and that is where the problem is.The FDIC will transer a selected part o the irms assets and liabilities

to a new bridge institution, with more discretion and less transparency

and judicial oversight than in bankruptcy.

Some creditors claims can receive larger

payments than under a typical bank-

ruptcyeectively a bailoutin the

name o avoiding systemic conse-quences.

This violates the priority struc-

ture that underlies the entire credit

market. It also reduces the risk

incurred by large creditors expect-

ing to be so avored, and thus the

interest rate at which they arewilling to lend the bank money.

The big banks, able to borrow at

a lower cost, are eectively getting

a subsidy$83 billion per year,


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according to widely cited Bloomberg estimates based on an International

Monetary Fund study.

The probability that some creditors will be bailed out has the perverse

eect o increasing the likelihood o a banks ailure. Normally the risksa inancial irm might choose to take are constrained by creditors as they

monitor and protect themselves rom losses by demanding collateral or

cutting their exposure. Bailouts give them less reason or concern and

action.

Shareholders in a ailing bank resolved under Dodd-Frank wont be

protected, but creditors said to be systemically important most likely

will be. Who and when? Thats up to political discretion. Hence there isuncertainty about how this process would operate, especially or com-

plex international irms. Some believe that earul policy makers would

ignore it in the heat o a crisis, resorting to taxpayer bailouts as in the

past. In short, too-big-to-ail and government bailouts remain possible

or even likely.

This approach would let a failing financial firm enter bankruptcy without

causing disruptive spillovers.

There is a better wayand it involves adding a chapter to the ed-

eral bankruptcy code speciically or large inancial institutions. A Chap-

ter 14 would apply to all inancial groups with assets over $100 billion.

A specialized panel o judges and court-appointed special masters with

inancial expertise would oversee the proceeding, which would includeall the parents subsidiaries, including insurance and brokerage. (Under

Dodd-Frank, insurance and brokerage services have to be handled sepa-

ratelywhich adds complexitywhile banks and other subsidiaries are

under FDIC jurisdiction.)

A bankruptcy petition could be iled by creditors, as now, but also by

the primary ederal supervisor o the irm or by a management that saw

insolvency looming. The procedure to determine asset values, liabilities,sales o some lines o business, write-downs o claims, and recapitaliza-

tion would take place according to the rule o law. There would be judi-

cial hearings and creditor participation, neither o which is a part o the


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Dodd-Frank resolution process. The strict priority rules o bankruptcy

would govern (with some modiications or holders o repurchase agree-

ments and swaps to limit their risks).

Chapter 14 would let a ailing inancial irm enter bankruptcy in a pre-dictable, rules-based manner without causing disruptive spillovers in the

economy. It would also permit people to continue to use the irms inan-

cial servicesjust as people lew on American or United planes when

those irms were in bankruptcy. The provisions also make it possible to

create in bankruptcy a newly capitalized entity that would credibly pro-

vide most o the inancial services the ailed irm was providing beore it

got into trouble.Customers would continue to do business with a inancial irm ater a

Chapter 14 iling i they were conident the irm could meet its current

obligations. That conidence would be achieved by giving post-petition

creditors a high priority. In all likelihood, this priority would enable the

irm to continue obtaining ample private inancingso-called debtor-in-

possession inancingto provide liquidity or normal operations.

The managements o the ive largest inancial irms in the UnitedStates control the investment o more than $8 trillion. A credible bank-

ruptcy procedure designed speciically or these and other large inancial

irms would substantially reduce the occasions to use the Dodd-Frank

resolution machinery and thus the concerns about its eects. It would

make creditors exposure much better deined and predictable, and

thereby reduce the likelihood o bailouts and the perverse, unair subsi-

dy they create.Reprinted by permission of the Wall Street Journal. 2013 Dow Jones & Co. All rights reserved.

Available from the Hoover Press is Bankruptcy, Not

Bailout: A Special Chapter 14, edited by Kenneth E. Scott

and John B. Taylor. To order, call 800.935.2882 or visit

www.hooverpress.org.


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THE ECONOMY

Debt Is a MillstoneEconomists may make their errors, but theres no mistake about the

ederal debt. Its bad. ByMichael J. Boskin.

The recent controversy over errors in a 2010 paper by the economists Car-

men Reinhart and Kenneth Rogo is a sad commentary on the demands

o the 24/7 news cycle and the politically toxic atmosphere surround-

ing iscal policy in the United States, Europe, and Japan. In their paper,

Growth in a Time o Debt, Reinhart and Rogo estimated large declines

in growth associated with public-debt/GDP ratios above 90 percent. But

it contained coding errors discovered by a University o Massachusettsgraduate student. When corrected, the eect is substantially smaller, but

nonetheless economically consequential.

The Reinhart/Rogo paper is just a small part o a voluminous aca-

demic literature that shows high debt levels to be economically risky. A

more undamental question is causality: the state o the economy certainly

aects the iscal position, just as taxation, spending, deicits, and debt may

aect economic growth.Research errors in economics are not uncommon, but they are usually

caught early, as happened once to me in a prepublication drat. Sometimes

errors are not discovered until later, when they are working papers, as with

Reinhart and Rogo, or ater publication, as with Nobel laureate Ken

Michael J. BoSKin is a senior fellow at the Hoover Institution, a member ofHoovers Shultz-Stephenson Task Force on Energy Policy and Working Group on

Economic Policy, and the T. M. Friedman Professor of Economics at Stanford

University.


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Arrow, who had to correct a mistake in the proo o his amous impos-

sibility theorem.

Economists use dierent methods to analyze iscal issues: stylized ana-

lytical models; macroeconometric models itted to aggregate data, such asthose used by the Federal Reserve, the European Central Bank, and the

U.S. Congressional Budget Oice (CBO); empirical estimation o key

parameters, such as spending multipliers; vector autoregressions; and his-

torical studies. Each o these approaches has its strengths and weaknesses,

and serious economists and policy makers do not rely on a single study;

rather, they base their judgments on complementary bodies o evidence.

Thus, there is no excuse or the outrage, the exaggerated claims or onepapers inluence, and the attempt to use the error to discredit legitimate

concerns over high levels o debt (let alone to viliy the authors).

T IMING IS IMPORTANT

While large deicits are usually undesirable, sometimes they can be benign

or even desirable, such as in recession, in wartime, or when used to inance

productive public investment. In normal times, deicits crowd out privateinvestment (and perhaps crowd in private saving and/or oreign capital)

and hence reduce uture growth. By contrast, in a deep, long-lasting reces-

sion, with the central banks policy rate at the zero lower bound (ZLB), a

well-timed, sensible iscal response can, in principle, be helpul.

Research errors in economics are not uncommon, but theyre usually

caught early.

But the political process may generate poorly timed or ineective

responsesocused on transers rather than purchases, inra-marginal

tax rebates, and spending that ails cost-beneit teststhat do little good

in the short run and cause substantial harm later. Americas 2008 stimu-

lus barely budged consumption upward, and the 2009 iscal stimulus

cost hundreds o thousands o dollars per job, many times higher thanmedian pay.

We should adopt policies that beneit the economy in the short run

at reasonable long-run cost, and reject those that do not. That sounds


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simple, but it is a much higher hurdle than politicians in Europe and the

United States have set or themselves in recent years.

I estimated the impact on GDP o Americas recent and projected debt

increase (in which the explosive growth o public spending on pensionsand health care looms largest) using our alternative estimates o the eect

o debt on growth: a smaller Reinhart/Rogo estimate rom a more recent

paper; a widely used International Monetary Fund study, which inds a

larger impact (and which deals with the potential reverse-causality prob-

lem); a related CBO study; and a simple production unction with govern-

ment debt crowding out tangible capital. The results were quite similar:

unless entitlement costsare brought under control, the resulting rise indebt will cut U.S. living standards by roughly 20 percent in a generation.

Corroborating statistical evidence shows that high deicits and debt

increase long-run interest rates. The eect is greater when modest deicit

and debt levels are exceeded and current-account deicits are large. The

Illustrationb

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TaylorJones

for

the

HooverDigest.


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increased interest rates are likely to retard private investment, which low-

ers uture growth in employment and wages.

Numerous studies show that government spending multipliers,

even when large at the ZLB, shrink rapidly, then turn negativeandmay even be negative during economic expansions and when house-

holds expect higher taxes beyond the ZLB period. Permanent tax cuts

and those on marginal rates have proved more likely to increase growth

than spending increases or temporary, inra-marginal tax rebates. Suc-

cessul iscal consolidations have emphasized spending cuts over tax

hikes by a ratio o ive or six to one, and spending cuts have been less

likely than tax increases to cause recessions in OECD countries.

DEBT IS A LONG-TERM DRAG

Some argue that iscal consolidation by gradual permanent reductions

in spending would be expansionary or high-debt countries, as occurred


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in some historical episodes. Others maintain that a temporary increase

in spending now would boost growth. Both could be expansionaryor

not, depending on details and circumstances. Because many countries

have been consolidating simultaneously, interest rates are already low;and, or the United States, which accounts or more than 20 percent o

the global economy and issues the global reserve currency, caution in

generalizing rom other iscal episodes is highly advisable.

Unless entitlement costs are brought under control, rising debt will cut

U.S. living standards by roughly 20 percent in a generation.

Nonetheless, the evidence clearly suggests that high debt/GDP ratios

eventually impede long-term growth; iscal consolidation should be

phased in gradually as economies recover; and the consolidation needs to

be primarily on the spending side o the budget. Finally, the notion that

we can wait ten to iteen years to start dealing with deicits and debt, as

economist Paul Krugman has suggested, is beyond irresponsible.

Reprinted by permission of Project Syndicate (www.project-syndicate.org). 2013 Project Syndicate Inc.All rights reserved.

Available from the Hoover Press is Entitlement Spending:

Our Coming Fiscal Tsunami, by David Koitz. To order, call

800.935.2882 or visit www.hooverpress.org.


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THE ECONOMY

Austerity VersusStimulusEither approach might work. The question is how the private sector

responds. ByCharles Wol Jr.

Why is it that in the United States the stimulus solution to the econ-

omys ills has perormed badly while in Europe the opposite approach,

austerity, has perormed even worse?

The answer is that austerity (deined as substantial reductions in debt-

inanced government spending) or stimulus (deined as high levels odebt-inanced government spending) will promote growth only in some

countries and in some circumstances.

Whether either policy will work depends critically on the responses o

the private sector. What is missing rom consideration today is whether the

private sectors reactions will enhance, retard, or reverse a policy o either

austerity or stimulus. In both the European Union and the United States,

policies would have been more eective i eorts had been made to antici-pate and mitigate the reasons or adverse responses o private businesses.

Four years since the great recession ended in mid2009, and not-

withstanding recent signs o modest improvements, the annual rate o

real U.S. GDP growth has averaged less than 2 percentwhich is 4 per-

centage points, or $600 billion, below the pace o recovery rom prior

deep recessions, such as in 198182. Recorded unemployment is 7.5

charleSWolfJr. is a senior research fellow at the Hoover Institution and a senior

economic adviser and corporate fellow in international economics at the Rand Cor-

poration. He is a professor of policy analysis at the Pardee Rand Graduate School.


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percent but is actually twice as high, allowing or involuntary temporary

and part-time employment, as well as discouraged workers who have

stopped looking or work.

The stimulus o 200912 averaged over 6 percent o GDP annuallybetween $1.2 trillion and $1.5 trillion. Yet it has been ineective.

Austerity in the EU has ared even worse. In the euro-currency area,

which includes seventeen o the EUs twenty-seven members, government

spending has been cut in hal, with dire consequences. GDP growth is at a

standstill, and recorded unemployment is 12 percent and rising.

Uncertainty is magnified when stimulus is accompanied by profuse,

costly, and ambiguous regulations.

Yet true believers in either policy, which include Nobel Prize winners

on both sides, discount the results. Stimulus adherents claim that the poor

record simply relects that the recession was so deep that the stimulus

should have been even bigger. Austerity adherents claim that its dismal

record simply relects that it was too severe and imposed too quickly.Both groups are overlooking the crucial role o the private sectors reac-

tions to austerity and stimulus.

In the United States, these reactions are crucial because the private sec-

tor is so largethe majority shareholder, so to speak. Its share o pur-

chased goods and services is approximately quadruple that o government.

Several actors are at work. One is what textbooks reer to as Ricardian

equivalencethat debt-inanced government spending in the presentmay require higher taxes in the uture, thereby motivating companies and

households to save rather than invest or spend.

An indicator o this is the ballooning o cash reserves on corporate bal-

ance sheets to over $2 trillion since 2009, thereby providing a major oset

to the stimulus goal o expanding aggregate demand. Other indicators are

increased household savings rates (by 3 to 4 percent annually) since 2009

and decreased household debt (by 8 percent), thus urther negating theincreased aggregate demand sought by stimulus.

Another impediment is the quandary created or business plans because

o uncertainty about where and how stimulus would aect each irms


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markets and those o its competitorsuncertainty that is magniied when

stimulus is accompanied by prouse, costly, and ambiguous regulations.

Finally, stimulus in the United States has been undercut by private-

investment decisions to invest abroad. Between the recessions turnaroundin mid2009 and the end o 2012, outward-bound U.S. private direct

investment rose steadily to $1.73 trillion annually rom $1.05 trillion.

This outward-bound investment currently exceeds (by $500 billion) the

outward low preceding the recession in 2007.

Private-sector reactions in Europe have also seriously aected austeritys

results. The EUs private sector is smaller relative to government than in

the United Statesabout three to two versus our to one. Moreover, thedirect involvement o government is more pervasive than in the United

States. For example, European governments are oten part-owners o pri-

vate corporations and sometimes sit on corporate boards.

Austerity in the EU has imposed simultaneous severe spending cuts on

both the government and the private economy, thereby reducing oppor-

tunities or either one to cushion the adverse impact o austerity on the

other. The EUs private businesses also seem less enabling o entrepreneur-ship and innovation that could acilitate adjustment to austerity.

Neither in the United States nor in the EU does the private sector speak

with one voice or necessarily react in a uniorm way. For example, some

venture-capital irms and other wealth-management companies in the Unit-

ed States have reacted less adversely to government policy than others. Still,

the experience to date strongly suggests that the reactions and behavior o

private investors and consumers to stimulus in the United States and auster-ity in the EU critically aected each policys tarnished record. Something or

policy makers to keep in mind when devising economic remedies.

Reprinted by permission of the Wall Street Journal. 2013 Dow Jones & Co. All rights reserved.

Available from the Hoover Press is Looking Backward

and Forward: Policy Issues in the Twenty-First Century,

by Charles Wolf Jr. To order, call 800.935.2882 or visit

www.hooverpress.org.


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THE ECONOMY

Another UncertaintyPrincipleWhy cant economists gaze into the uture the way physicists gaze

into the atom? Because the science o economics is still emerging.ByRussell Roberts.

When asked to prove the eectiveness o Keyness prescription o deicit

spending to cure an ailing economy, Keynesians usually point to World

War IIgovernment ran large deicits, GDP surged, and unemployment

disappeared. The economy certainly appeared to be healthy. The militaryindustrial sector grew larger and boosted measured GDP. Conscription

orced unemployment close to zero.

But did government spending on the military stimulate the economy

through the vaunted Keynesian multiplier? Government spending on the

military didnt stimulate private consumptionit crowded it out. Con-

sumers suered.

That doesnt disprove Keynesmaybe a smaller increase would havedone the trick o ixing the economy without reducing private consump-

tion. World War II doesnt prove Keynes was wrong, but it sure doesnt

prove him right either.

A better test came at the end o war. Paul Samuelson, a prominent

Keynesian who later won one o the irst Nobel Prizes, worried that i

the war ended suddenly and government spending contracted quickly, we

ruSSell roBertSis the John and Jean De Nault Research Fellow at the Hoover

Institution.


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would ace the greatest period o unemployment and industrial disloca-

tion which any economy has ever aced.

Federal spending ell by 40 percent in 1946 and ten million service

members were suddenly looking or work. Despite the warnings oSamuelson and others, nothing was done to cushion the expected blow

to the economy. But there was no recessionunemployment stayed

low.

World War II doesnt prove Keynes wrong, but it sure doesnt prove him

right either.

A year later, ederal spending was 60 percent below the 1945 level.

Output grew 7 percent and employment grew 4.8 percent, hitting record

levels. That extraordinary natural experiment could have ended the asci-

nation economists had with the work o Keynes. Instead, the Keynesians

recalibrated their models and looked to the uture.

WHERE D ID THE ST IMULUS GO?The ailure o the Obama stimulus package o 2009 to have the predicted

eects on the unemployment rate didnt change many minds either. In

January 2009, Alan Blinder o Princeton, a highly respected Keynesian,

argued that a $650 billion stimulus package would be big enough to ix

the economy. Instead we spent $820 billion; in return, we have the worst

recovery in modern American economic history.

O course, its possible that large natural experiments like these shouldntbe treated as decisive. The world is a complicated place. Lots o things

happen at once. Correlation is not causation. Maybe actors besides gov-

ernment spending account or the lethargy o the U.S. economy today or

the vitality o the U.S. economy in 1946.

Some economists argue that the stimulus should have been $2

trillion while others, equally illustrious, argue it should have been zero.

That is why I think it isnt just Keynesianism thats in trouble these

days but macroeconomics in general, at least the way journalists and


24/175


politicians expect us to practice it. When Nobel Prize winners argue that

the stimulus should have been $2 trillion while other equally illustrious

economists argue it should have been zeroand both have studies to

back up their claimsone has to wonder how much science there reallyis in economics.

Perhaps our proession should admit that some o the questions people

want us to answer simply cannot be answered.

One o those questions is whether or not $820 billion in additional

ederal spending, using borrowed money, is a good idea. I think its a bad

idea. But my reasons or thinking so are based on logic and philosophy,

not ancy statistical analysis.

Illustrationb

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TaylorJones

for

the

HooverDigest.


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But hasnt the nonpartisan Congressional Budget Oice (CBO) ound

that the stimulus created millions o jobs?

Sort o. At one point in 2011, the CBO estimated that the stimulus

had created between 400,000 and 2.4 million jobs. Not so precise. Worse,its not even an estimate: its simply the orecast the CBO did beore the

stimulus passed, recalculated using the actual amount o money that was

spent.

This is equivalent to sending a space probe to Mars but being unable

to veriy its location. When asked by the president where it is, the sci-

entists assure him that its on Mars. How do they know? Because their

models say so. In modern macroeconomics, we make predictions that


26/175


cannot be conirmed or veriied. I dont know what to call that, but it

isnt science.

STUBBORNLY COMPLEX

Some argue that we havent had enough serious recessions to model them

adequately. Give us twenty or thirty more, they say, and well have enough

data. Im more inclined to side with F. A. Hayek in his 1974 Nobel Prize

address, The Pretense o Knowledge. Hayek argued that the economy

was simply too complex to allow predictions o the precision we expect

rom, say, physics. So while a physicist can tell us where Mars will be on

January 1, 2035, and actually veriy the prediction when the time arrives,we economists will always struggle to identiy the path o the economy six

months rom now.

Economics isnt rocket science; its a lot harder. We should admit as

much and when asked to measure things we cannot measure, we should

admit our ignorance.

Reprinted by permission from the European(www.theeuropean-magazine.com). All rights reserved.

Available from the Hoover Press is Government Policies

and the Delayed Economic Recovery, edited by Lee E.

Ohanian, John B. Taylor, and Ian J. Wright. To order, call



27/175


THE ECONOMY

Bridges to NowhereWhen stimulus spending roars down the highway disguised as

inrastructure spending, its time to hit the brakes. ByPaul R. Gregory.

Big-government advocates seek to substitute inrastructure or the

S-word (stimulus). President Obamas State o the Union address called

or $40 billion to ix the nations roads and bridges and the establishment

o a ederal inrastructure bank. A ew weeks later, the president called or

an additional $4 billion in inrastructure spending. A billion here and a

billion there, and soon youre talking real money.

To persuade a wary public to spend more with trillion-dollar deicits,big-government advocates must gin up a national inrastructure emergen-

cy that threatens saety, jobs, and well-being. Public-spending lobbyists

are ready to oblige with D-plus report cards or aging and unreliable

roads, bridges, and ports. Big-government advocates substitute scare tac-

tics or the acts that our inrastructure is as good as Europes and that we

spend more than the European Union on public investment. I we spend

as much or more and have inerior inrastructure, that is a massive politi-cal ailure or which someone should pay.

Gone are grandiose plans or massive stimulus to boost output and

employment on Keynesian steroids. Instead the president is repackaging

stimulus as inrastructure spending. His Miami speech was timed to the

newly released American Society o Civil Engineers 2013 inrastructure

Paul r. GreGoryis a research fellow at the Hoover Institution. He is the Cullen

Distinguished Professor of Economics at the University of Houston and a research

professor at the German Institute for Economic Research in Berlin.


28/175


report card. Its D-plus rating rang the alarms that our roads, bridges, water

and waste treatment, rail, dams, and airports are crumbling and unsae.

At least the president reminded us in Miami that we have had the good

ortune o our years o enlightened stimulus spending under him:Now, over the last our years, weve done some good work. Construc-

tion crews have built or improved enough roads . . . to circle the globe

ourteen times and upgraded enough [rail] to go coast to coast and back.

Weve repaired or replaced more than twenty thousand bridges. Weve

helped get tens o thousands o construction workers back on the job.

I our roads circled the globe ity times, would we get a B-plus? Teach-ers reserve D-plus or students who make no eort other than to show up.

D-plus brings to mind backwater countries o Latin America and Asia.

Illustrationb

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TaylorJones

for

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HooverDigest.


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D-plus is a national disgrace or a once-great country! How could we have

let it get so bad?

The American Society o Civil Engineers Failure to Act study oers

a price tag or restoring a irst-world inrastructure. It would take $1.7 tril-lion to correct our current inrastructure deicit and an extra $160 billion a

yearor $1.1 trillion totalto meet our inrastructure needs through 2020.

Our civil engineers do not predict or us the eect o almost $3 trillion in

additional spending on the deicit. Ater all, what is it worth to be able to

drive across bridges without ear o plunging to certain death? (By my calcu-

lations, our bridge ailure rate is one in three hundred and ity thousand.)

Even though we do not have the $1.7 trillion or current needs andthe $1.1 trillion or later, we would be penny wise and pound oolish not

to borrow and


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spend, say the civil engineers. The $160 billion extra over each o the next

seven years would alone raise GDP by $3.1 trillion (a three to one return)

and add 3.5 million jobs, they say. What a bonanza!

We have not seen such optimistic numbers since the young Obamaadministration promised huge returns or the irst stimulus. Should we

again put caution aside? A word o warning: the website o the Ameri-

can Society o Civil Engineers shows it to be a lobbyist or inrastructure

spending. Asking the civil engineers how much inrastructure spending

we need is akin to asking deense contractors how much we should spend

to keep America sae. I doubt the big-government people would like that.

The United States ourteenth-place ranking in the World EconomicForums inrastructure index scarcely bespeaks a national scandal. Lux-

embourg and Canada rank just above the United States, and Austria and

Denmark rank just below. None o these countries is exactly a slouch

in the inrastructure category. Among the twenty largest countries, the

United States ranks second only to Canada. The World Economic Forum

index also shows that U.S. inrastructure beats the European Union aver-

age by a wide margin. How can that be, with the ast trains and the gleam-ing autobahns o the European Unionthe envy o our transportation

bureaucrats?

If we get less bang for our infrastructure buck than Europe does, the problem

would seem to be not too few dollars but too much waste and corruption.

Consider another inconvenient act. OECD inrastructure experts indthat Europe has too great a supply o roads and rail relative to demand. Yes,

there are trains departing every ew minutes, but they are hal empty. And

do Germans really need ive dierent autobahns to drive rom Munich to

Frankurt? The same OECD experts ind that the United States, Canada,

and Australia have built about the amount o inrastructure that its the

demand.

Still, i all else ails, our big-government spenders at least can showthat we spend little on inrastructure relative to countries that have good

inrastructure. Get ready or a surprise. According to OECD statistics, the

United States spends 3.3 percent o its GDP (200611) on inrastruc-


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ture investment, versus the European Unions 3.1 percent. With roughly

equal GDP, the United States actually outspends the European Union,

our model o inrastructure perection.

I we spend as much as or more than the European Union on inra-structure, we should have better or equal results. In both the United States

and Europe, public investment and procurement are political processes

characterized by waste, politics, and corruption. I we get less bang or our

inrastructure buck than do our European colleagues, our problem would

be not too ew dollars but too much waste and corruption.

Asking civil engineers how much infrastructure spending we need is like

asking defense contractors how much to spend on weapons.

In his Miami pitch or more inrastructure spending, the president

stated: Weve got to do it in a way that makes sure taxpayer dollars are

spent wisely. Does he know something the people do not? Could it be

that taxpayer dollars have not been wisely spent? Could the unions, crony

capitalists, and lobbyists have proited at taxpayer expense?That would be as hard to believe as the police chie s surprise that there

was gambling in Casablanca.

Special to the Hoover Digest.

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32/175


TAXES

Many Happier ReturnsHow to mend the ederal tax code. ByGary S. Becker.

The ederal tax code is a messit is neither eicient, air, nor clear. A

complete set o suggestions to improve the tax system would take hun-dreds o pages, as did the excellent 2005 Report of the Presidents Advisory

Panel on Federal Tax Reform. I will concentrate on a ew o the changes

needed to stimulate a more eicient, aster-growing American economy.

A major priority is to eliminate taxes on savings and investments.

One reason is that they involve double taxation: personal and corporate

incomes are irst taxed, and then the returns on the savings and investment

out o these incomes are taxed again later. A second, even more important

problem with taxes on savings and investments is that in the long run they

are shited to labor because these taxes lower ater-tax returns, thereby

discouraging investment. A lower rate o investment slows down capital

accumulation, which leads to a lower ratio o capital to labor. Wages are

lower and pretax returns to capital are higher when the capital/labor ratio

is lower.

Moreover, the present system taxes dierent orms o saving and dier-

ent types o investment goods at dierent rates. This distorts the alloca-

tion o investments among investment categories. For example, deprecia-

tion tax rules allow durable capital to be depreciated more slowly than

E

PA/ShawnThew

GaryS. BecKeris the Rose-Marie and Jack R. Anderson Senior Fellow at the

Hoover Institution and a member of Hoovers Working Group on EconomicPolicy and Shultz-Stephenson Task Force on Energy Policy. He is also the Uni-

versity Professor of Economics and Sociology at the University of Chicago. He was

awarded the Nobel Memorial Prize in Economic Sciences in 1992.


33/175


less-durable capital, which lowers the relative tax rate on more-durablecapital. Similarly, savings that enter tax-ree IRA or Roth accounts are

taxed less heavily than other orms o savings.

One way to eliminate taxation o investments is to allow all investments

to be written o immediately as expenses instead o being depreciated over

time. Taxing only earnings would eliminate double taxation o savings.

Expensing investments and taxing earnings moves the income tax

code a long way in the direction o a tax on consumption rather than onincome. The basic eiciency advantage o consumption taxes is that they

do not distort the decision to consume now rather than consume later

since the returns on savings and investments are not taxed. By contrast,

Apple CEO Tim Cook testifies before Congress in May about the companys offshore account-

ing arrangements. We think we should do a comprehensive reform of the tax code, Cook

said in defense of Apples removing of billions of dollars from the IRSs oversight. For

multinationals the right approach would be simplicity. Just gut the code.


34/175


income taxes do distort this decision since they tax the incomes earned on

savings as well as the incomes that led to the savings.

Whether or not one moves to a consumption tax, taxes should be made

simpler and latter because that would reduce the large cost o tax com-pliance and encourage greater investment and work eort. A reasonable

proposal that would maintain progressivity yet have a much latter tax

structure would be to have only two or three tax rates, such as 20 percent,

25 percent, and 30 percent. The tax rate on low labor market earnings

would be even less than 20 percent i the earned-income tax credit on

low earnings were retained. This credit encourages poorer individuals to

enter the labor orce rather than staying out to become eligible or variouswelare beneits, such as ood stamps, unemployment compensation, and

housing subsidies.

Personal and corporate incomes are first taxed, and then the returns on

the savings and investments are taxed again.

The income tax base should be widened not only because that arrange-ment would be more eicient but because a wider base would help main-

tain tax revenue as rates are lattened and taxes on savings and investments

removed. As one step, the deductibility o mortgage interest should be

eliminated because that artiicially encourages investments in home own-

ership relative to investments in other orms o capital. This deduction

also avors higher-income amilies since they are more likely to itemize

deductions and have higher marginal tax rates. I it were too politicallydiicult to eliminate this deduction, a tax credit could be given to all

homeowners equal to a raction o their mortgage interest payments.

There would be an upper bound to the amount o interest payments that

could qualiy or the tax credit.

The exclusion o interest on state and local bonds rom income taxes

should be abolished because that artiicially encourages spending by

these governments relative to spending by households and businesses.Since higher-income individuals hold the vast majority o state and local

bonds, this tax exemption also avors higher-income people in an unde-

sirable way.


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The tax on business cash low (net o investment outlays) should be

aligned with the proposed latter personal income tax structure by lower-

ing corporate and partnership tax rates to the proposed maximum tax rate

on personal income, say 30 percent. Doing this, and taxing business cashlow net o investment deductions, would integrate the business tax into

an overall consumption tax.

Consumption taxes, unlike income taxes, do not distort the decision to

consume now rather than later.

These are the most needed reorms, although others are also desirable.Unortunately, major reorms have little chance o enactment in the pres-

ent political climate, but they are longer-run goals that should appeal to

both Democrats and Republicans.

Reprinted from the Becker-Posner Blog (www.becker-posner-blog.com).

New from the Hoover Press is Constitutional

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Moderation, by Peter Berkowitz. To order, call



36/175


TAXES

The InequalityDelusionWhy it isnt the governments job to equalize incomeor to try to do

so by manipulating taxes. ByDavid Davenport.

In his novel Gravitys Rainbow, Thomas Pynchon wrote: I they can

get you asking the wrong questions, they dont have to worry about the

answers. This describes to a T what President Obama has done in seek-

ing to make income inequality, as he put it in one o his speeches, the

deining issue o our time. I that is the question, then higher taxes on thewealthy, a large increase in the minimum wage, and other redistributionist

measures become the answer. But in act, the president is either mistaken

or misleading. Income inequality is not the right question to be asking.

When Obama and his supporters reer to income inequality, they are

taking a complex set o economic and social issues and boiling them down

to a single data point: the size o the dierence between the annual incomes

o top earners and those on the bottom o the income scale. While that is aninteresting issuethough there are problems with it, even as it ishaving it

stand alone as the driving orce or change is a gross oversimpliication that

will lead to bad outcomes. It would be as i we decided to judge baseball

pitchers by the number o walks they issue, not taking into account the vast

array o appropriate measures (wins and losses, earned run average, strike-

outs, hits given up, innings pitched, etc.) that combine to give a uller, more

accurate understanding o a pitchers eectiveness.

DaviD DavenPort is counselor to the director and a research fellow at the

Hoover Institution.


37/175


Asking about the gap between high and low earners is at best an incom-

plete question. It tells us nothing about why the gap may be growing or

shrinking. For example, it may be the case, as is shown in recent studies,

that incomes at both the top and bottom have grown, but incomes at thetop grew aster. But even that isnt enough to know, because you would

want to understand whythe top is growing aster. Is it at the expense o

those at the bottom? Actually no, since theirs is growing also, but it is due

to greater investment income at the top. Do we then want to penalize Bill

Gates and Steve Jobs or creating wildly successul companies, along with

the people who invested in them?

Pointing out the gap between high and low earners tells us nothing about

why the gap may be growing or shrinking.

A urther problem is that most o the data collected on this phenom-

enon ocuses on pretax income, so it doesnt take into account the eects

o our progressive tax system. But that prompts an even deeper ques-

tion: is it the role o government, and its system o taxation, to equalizeincome among citizens? The United States already has one o the most

progressive tax systems in the world, so absent this red-herring question

about income inequality, taxing the wealthy would be an even tougher

case to make.

A more relevant question would be whether there is mobility among

the various income levels. In an equality-o-opportunity society such as

the United States, income inequality should be a problem only i an indi-viduals income is static. A Treasury Department study looked at income

mobility rom 1996 to 2005 and concluded that during the study period,

more than hal o taxpayers moved to a dierent income quintile. Approx-

imately hal o taxpayers in the bottom income quintile had moved to a

higher income group, and only 25 percent o those in the top quintile had

remained there. With people moving up and down the income distribu-

tion scale, there would appear to be equality o opportunity, i not equal-ity o outcome. And nearly everyone agrees that the impetus or more

mobility is education, not income redistribution. Education is where the

policy emphasis should be.


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Legendary ootball coach John Madden was asked to comment when a

team signing a notoriously laky quarterback announced that he was the

answer. Maddens response was, i he is the answer, I guess I dont know

what the question is. I income inequality is the answer, the question isnot how to have an equality-o-opportunity society. Instead, it is the much

more Machiavellian question o how to build a case or income redistribu-

tion, which is altogether the wrong question to be asking in a ree society.

A more relevant question: is there mobility among the various income

levels? It seems there is.

Unortunately, I conclude that President Obama wants to ask that very

questionhow we can redistribute income in a way that he thinks creates

greater equalitybut knowing how controversial that would be, he has

masked it in the cloak o income inequality. Lets hope Congress and the

American people see through his redistributionist cloak.

Special to the Hoover Digest.

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39/175


INTELLIGENCE

Lives in the BalanceThe NSAs data-mining eorts seem, in the end, to be a tradeo

between national security and individual privacy thats worth making.

ByRoger PilonandRichard A. Epstein.

Ater the news broke that the National Security Agency had been collect-

ing metadata about Americans phone calls and some oreign online com-

munications, President Obama was attacked or stating the obvious: no

amount o government ingenuity will guarantee the American people 100

percent security, 100 percent privacy, and zero inconvenience.

Legally, the president remains on secure ooting under the Patriot Act,which Congress passed shortly ater 9/11 and has since reauthorized by

large bipartisan majorities. As he stressed, the program has enjoyed the

continued support o all three branches o the ederal government. It has

been ree o political abuse since its inception. And, as he rightly added,

this nation has real problems i its people cant trust the combined actions

o the executive branch and Congress, backstopped by ederal judges

sworn to protect our individual liberties secured by the Bill o Rights.In asking or our trust, Obama would have been on stronger ground i

the NSA controversy had not ollowed hard on the heels o the Benghazi,

IRS, and AP/Fox News scandalsto say nothing o Attorney General

roGerPilonis vice president for legal affairs at the Cato Institute and director

of Catos Center for Constitutional Studies. richarD a. ePStein is the Peter

and Kirsten Bedford Senior Fellow at the Hoover Institution and a member ofHoovers John and Jean De Nault Task Force on Property Rights, Freedom, and

Prosperity. He is also the Laurence A. Tisch Professor of Law at New York Uni-

versity Law School and a senior lecturer at the University of Chicago.


40/175


Eric Holders problems. But give the president due credit: we can recall no

other instance in which he announced publicly that the responsibilities o

his oice had changed his mind. And or the betterheres why.

In domestic and oreign aairs, the basic unction o government isto protect our liberty, without unnecessarily violating that liberty in the

process. The text o the Fourth Amendment grasps that essential trade-

o by allowing searches, but not unreasonable ones. That instructive,

albeit vague, accommodation has led courts to crat legal rules that irst

deine what a search is and then indicate the circumstances under which

one is justiied. In the realm o oreign intelligence gathering, recogniz-

ing the need or secrecy and their own limitations, judges have shown anacute awareness o the strength o the public interest in national security.

They have rightly deerred to Congress and the executive branch, allow-

ing executive agencies to engage in the limited surveillance that lies at the

opposite pole rom ransacking a single persons sensitive papers or politi-

cal purposes.

That deerence is especially appropriate now that Congress, through

the Patriot Act, has set a delicate balance that enables the executive branchto carry out its basic duty to protect us rom another 9/11 while respect-

ing our privacy as much as possible. Obviously, reasonable people can

have reasonable dierences over how that balance is struck. But on this

question, political deliberation has done its job, because everyone on both

sides o the aisle is seeking the right constitutional balance.

This nation has real problems if its people cant trust the combined

actions of the executive branch and Congress, backstopped by federal

judges sworn to protect our individual liberties.

In 1979, in Smith v. Maryland, the U.S. Supreme Court addressed that

balance when it held that using a pen register to track telephone numbers

did not count as an invasion o privacy, even in ordinary criminal cases.Thats just what the government has done here on a grand scale. The

metadata it examines in its eort to uncover suspicious patterns enables it

to learn the numbers called, the locations o the parties, and the lengths


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o the calls. The government does not knowas some have charged

whether youve called your psychiatrist, lawyer, or lover. The names linked

to the phone numbers are not available to the government beore a court

grants a warrant on proo o probable cause, just as the Fourth Amend-ment requires. Indeed, once that warrant is granted to examine content,

the content can be used only or national security issues, not even ordi-

nary police work.

Political deliberation has done its job. Everyone on both sides of the aisle

is seeking the right constitutional balance.

As the president said, the process involves some necessary loss o pri-

vacy. But its trivial, certainly in comparison to the losses that would have

arisen i the government had ailed to discern the pattern that let it thwart

the 2009 New York subway bombing plot by Colorado airport shuttle

driver Najibullah Zazi, an Aghan-American, who was prosecuted and

ultimately pleaded guilty.

The critics miss the orest or the trees. Yes, government oicials mightconceivably misuse some o the trillions o bits o metadata they examine

using sophisticated algorithms. But one abuse is not a pattern o abuses.

And even one abuse is not likely to happen given the saeguards in place.

The cumulative weight o the evidence attests to the soundness o the

program. The critics would be more credible i they could identiy a pat-

tern o government abuses. But ater twelve years o continuous practice,

they cant cite even a single case. We should be thankul that here, at least,government has done its job and done it well.

Reprinted by permission of the Chicago Tribune. 2013 Chicago Tribune. All rights reserved.

Available from the Hoover Press is The Case Against the

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42/175


INTELLIGENCE

Watching theDetectivesFree societies can indeed restrain their intelligence agencies, largely

by keeping them honest. ByMark Harrison.

Natural questions arise rom news reports about mass surveillance in

Western societies. Are our liberties at risk, along with our privacy? Are we

moving in the wrong direction along the spectrum that runs rom a ree

and democratic society to a totalitarian police state?

To help answer such questions, it would seem only sensible to ask howsurveillance works in real totalitarian police states. The answer might give us a

reality check. Here I will point out some important similarities between what

the U.S. National Security Agency (and others) are up to and the unctions

o the secret police under communist rule. I also will show some dierences.

My conclusion? We are a long, long way rom mass surveillance in the

style o the Soviet KGB or Chinas Public Security Bureau. But that should

not be completely reassuring.Here are the similarities that seem important:

Mass surveillance. American counterintelligence is in the business o

mass surveillance. Theyre looking at everyone. Jeremy Bash, chie o sta

to ormer CIA director and deense secretary Leon Panetta, is quoted in

the New York Timesas saying:

MarK harriSonis a research fellow at the Hoover Institution, a professor of

economics at the University of Warwick, and an associate of Warwicks Centre

for Competitive Advantage in the Global Economy.


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I youre looking or a needle in the haystack, you need a haystack.

That haystack is the millions and billions o bits o our data that are

being gathered. Mass surveillance was also the business o the KGB, as

it is the business o the secret police under any dictator. In act, coun-terintelligence everywhere has an unquenchable thirst or personal acts.

Every secret policeman knows that the most dangerous enemy is the one

you dont have on ile. You can keep tabs on the ones already in the Rolo-

dexbut what about the sleepers, the new recruits, the ones that are out

there and completely invisible to you? Its what you dont know that can

kill you. So, in the interests o staying alive, you can never know enough.

Detection relies on big data. How do you ind the enemy you dont

know? By using data and looking or patterns in the data. This is what

the KGB did. It looked or several kinds o patterns. KGB agents were

pioneers o proiling, or example. They igured that many disloyal people

had markers in common, although exactly what mattered changed rom

one period to another. In one period it was your social origins: upper

class (which meant the regime had taken your property) or poor. In otherperiods it was whether you had amily members who had led abroad, or

you spoke a oreign language, or you had stayed behind when the war

came and tried to live quietly under German occupation. So the agency

looked or people with those markers. Another thing the KGB looked or

was who knew whom or was related to whom. When agents put a person

under surveillance, they obsessively tracked riends and amily members,

telephone callers, letter writers, and so on.A third thing was just to look or unusual patterns o activity in the street

and at work. To know what was unusual, agents had irst to know what

was usual, and this in itsel required data collection on a massive scale. The

abnormal would stand out only against the normal. Qualitatively, this isnt

dierent rom what the FBI or the NSA are doing. They too are mainly just

looking or anomalies, or patterns o interest in the data.

The goal is prevention. The ultimate goal o surveillance is preven-

tion. Exactly what is being prevented may vary. Most Western intelligence

agencies today are trying to prevent another 9/11 or its London equiva-


44/175


lent, another 7/7. They are also trying to prevent the public rom inding

out exactly how they are doing this, because that knowledge might help

their targets pass under the radar.

Chinas Public Security Bureau has a wider set o goals: to prevent publicdisorder, to prevent open criticism o Chinas leaders and political order,

and to prevent everyone rom getting the idea that open opposition could

ever be normal and go unpunished. The KGBs goals were pretty similar.

To do any o these things you have to be ready to react instantly to

signals that something is up. Sometimes you receive a signal, and you can

wait and see how it develops. Sometimes you have to react and nip it in

the bud even beore you know what it might be. To prevent the bad stuyou have to review all situations that look as i they have a potential or

going bad, and consider all people who look as i they have a potential to

become enemies. Identiying potential enemies is always and everywhere

a judgment call.

Risk of type I errors. So much o this work consists o judgment calls,

in act, that errors are inevitable. Some are what statisticians would calltype I errors and some are the opposite: type II. You make a type I error

when you see a pattern in randomness: or example, a person has a random

resemblance to a terrorist by having the wrong appearance and being in

the wrong place at the wrong time, and suddenly you have him on a plane

to Guantnamo Bay. To explain this another way, when youre looking

or a needle in a haystack, and its important to avoid missing it, its inevi-

table that you will turn up lots o things that might be needles becausethey look quite like needles and in act you might have even stuck one in

the pincushion beore you realized that its just a shiny thorn . . . and now

you cant be bothered to retrieve it. Yes, and that means that where there

is scope or error there is also scope or abuse, because secret policemen are

not all dedicated proessionals; among them will be those that are too lazy,

or too ambitious, or too much in love with power to correct a mistake.

A type II error is when you miss a pattern or overlook a real spy or ter-rorist. In most situations, Western societies show a preerence or type II

errors: wed rather leave a criminal at liberty than imprison an innocent

person. Thats not so hard when were talking about shopliting; its harder


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by orders o magnitude when the criminal at liberty has the potential to

behead a bystander or ly a passenger jet into a shopping mall.

Those are the ways in which Western counterintelligence looks very

much the same as counterintelligence under totalitarian rule. But there arealso some key dierences. Here they are:

Governed by law, and openly contested. Most obvious is the existence o

a legal ramework. It was not always like this but in both Britain and America

the intelligence services operate within the law, subject to both legislative and

judicial oversight. The law permits some things and not others. The NSA can

ind out that X sent e-mail to Y, but it cant read your e-mail without a courtorder that names you and convinces a judge o probable cause.

This ramework may well look unsatisactory, and may indeed be

unsatisactory; Im not a lawyer and dont pretend to know. At the same

time, we also have a ree press and intrepid journalists who have strong

incentives to ind scoops and dig out scandals. As a result, the scope o

secrecy and surveillance is law-governed (although imperectly), open to

ree discussion (to the extent that we know o it), and contested (vigor-ously and continually). I you dont like the law you can take the contest

to the polls and toss out the lawmakers. Or you can take a personal stand,

break the law, and answer or it in the courts.

The contrast with the situation in countries under communist rule

could not be more stark. There the KGB responded only to the instruc-

tions o the ruling party (and the same no doubt holds in China, Cuba,

North Korea, and Vietnam); there was and is no answerability to theparliament, the courts, or the press. What is more, the merest mention

o secrecy and surveillance was completely suppressed; the existence o

secrets was a well-policed secret.

A much bigger haystack. Americas haystack is o unimaginably vast

dimensions. Its so big that, according to Edward Luce in the Financial

Times, it employs a data-intelligence complex with a sta o nearly a mil-lion and a budget o $80 billion.

The KGBs haystack was pretty large in its time. It was put together rom

many individual straws: agent reports o gossip rom canteen queues and stu-


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dent dormitories, surveillance reports, inormation gathered rom micro-

phones, phone taps, opening the mail, and so orth. In orty years the archive

o KGB counterintelligence in Soviet Lithuania (a country o around 3

million people) accu-mulated at

Illustrationb

y

TaylorJones

for

the

HooverDigest.


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least a million pages o documents. On that basis, the total paperwork

o the entire Soviet KGB archive (or seventy years and a country o 200

million people and more) ought to exceed that o Soviet Lithuania by at

least two orders o magnitude. And this was in a society with one landlinesystem and one mail service, without networked computers or mobile

phones, where no one even had ree access to a photocopier. When even

intercity phone calls had to be booked through an operator in a city

exchange, it was relatively easy or the KGB to monitor anyones personal

network. So the size o Americas haystack must be thousands o times

larger than this, and probably tens or hundreds o times larger than even

Chinas haystack.This observation, at irst alarming, is testimony to the act that we

live in a ree society in which communication is unettered and o

negligible cost by historical standards. We, the citizens, are the ones

who make the haystack so large by our abundant use o the reedom

to communicate.


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Many fewer needles. The problem o inding needles in this vast hay-

stack is magniied by the act that Western societies do not appear system-

atically to produce needlescertainly not on the scale o more repressive

societies. As the sociologists Alex Inkeles and Raymond A. Bauer reported(in The Soviet Citizen, 1959) rom the irst wave o the Harvard Inter-

view Project, the Soviet system o repression was apparently based on the

assumption that everyone had a reason to hold a grudge against the com-

munist rulers somewhere in the past. A parent had lost property, a brother

had been arrested, a husband shot, a cousins amily resettled in the remote

interior. As time passed the salience o such historical events might recede,

yet or some reason each new generation o Soviet-educated citizens kepton throwing up new kinds o nonconormity and outright disloyalty that

had to be monitored and checked.

In contrast, Western societies are not governed by dictators who have

systematically expropriated property and penalized wide social classes and

ethnic groups; they also provide multiple channels or citizens to express

discontent and resentment and organize or social and political change.

Despite this, there are still needles: enemies o openness and tolerance.But they are ar ewer in number than the hostile orces that repressive

regimes cannot help but produce and reproduce continually.

More type I errors. Put a much bigger haystack together with ar ewer

needles and the implication is unmistakable. When the haystack is small

and needles are many, the chances o making type I errors are reduced.

Under communist rule, i it pricked like a needle and it looked like a

needle, there was at least a good chance that it was a needle. Any Westernintelligence agency trying to ind those ew needles in todays mega-hay-

stack has a greatly reduced chance o coming up with real needles com-

pared with its communist counterpart, and a correspondingly heightened

chance o alse positives.

The act that so many people are looking or the ew needles, that the

number o big-data analysts must exceed the probable number o real ter-

rorists by a actor o one hundred or even ten thousand, just makes it

much, much worse. So you want to make a career as an analyst. How can

you distinguish yoursel i you never identiy a threat? How can you end


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o boredom i you never reach the point o saying this is someone we

should look at more closely? So you do it, and you make a mistake. Well,

you say, it was worth looking into.

And that is most unortunate, because as a society we want to live insaety but we also hate type I errors. We intensely dislike the idea that an

incidental bystander might get investigated, or even detained, because o

an intelligence error. So intelligence errors sow cynicism and mistrust.

NSA versus KGB: is there good or bad news in the comparison? To me

the news looks mostly good. Compared with the KGB, the NSA appears

quite benign. But there is also a warning, which lows rom the observa-

tion that there is no limit on what our guardians would like to knowabout us. The more they know, the better inormed they are. But the more

resources they have, the greater is the scope or overambition, the abuse o

power, and the alse positives that we rightly ear.

How much is enough? The purpose o national security is not to su-

ocate us with cotton wool. It is to enable us to be the people we would

like to be and to protect the rule o law that we would like to have. In a

ree, open society the limits o security are something we, the citizens,should always debate, contest, and, i necessary, push back.

Special to the Hoover Digest. Adapted from Mark Harrisons blog (https://blogs.warwick.ac.uk/markharrison).

Published by the Yale-Hoover Series on Stalin, Stalinism,

and the Cold War is Guns and Rubles: The Defense

Industry in the Stalinist State, edited by Mark Harrison.

To order, call 800.405.1619 or visit http://yalepress.yale.edu/yupbooks/order.asp.


50/175


INTELLIGENCE

October SurprisesThe Cuban missile crisis represents an enduring tale o complacency,

ragmented data, and the rantic race to pick signal out o noise. By

Amy B. Zegart.

In September 1962, CIA Director John McCone was honeymooning in

Europe but couldnt take his eyes o Cuba. Convinced the Soviets were

secretly deploying nuclear missiles ninety miles rom Florida, McCone

repeatedly cabled Washington with his concerns. Nobody believed him.

McCone was operating on a hunch, without solid evidence.

When the CIA issued a Special National Intelligence Estimateabout the Soviet arms buildup in Cuba on September 19, it disregard-

ed the directors views entirely. That estimate, like the previous three,

concluded the Soviets would not dare put nuclear missiles in Cuba.

A month later, U-2 spy planes snapped photographs that conirmed

McCones worst ears and ushered in the most dangerous thirteen days

in history.

The Cuban missile crisis o ity-one years ago stands as the most stud-ied event o the nuclear age. Academics have written so much about that

eyeball-to-eyeball moment that there are articles about why we should

stop writing articles about it. But there is at least one key lesson yet to be

learned. Generations o scholars and practitioners have insisted on calling

the crisis an intelligence successwhen there is much more to be learned by

calling it afailure.

aMy B. ZeGart is a senior fellow at the Hoover Institution and an affiliated

faculty member at the Center for International Security and Cooperation at Stan-

ford University.


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The success narrative says the CIA discovered Soviet missiles beore

they became operational, enabling President Kennedy to seize the initia-

tive and save the day. But the beginning o the story is just as impor-

tant and more oten orgotten: the CIA ailed to anticipatethe presenceo Soviet missiles despite widespread knowledge that Soviet arms ship-

ments were escalating dramatically that summer. All our intelligence

estimates on Cuba published in 1962 had a reassuring quality, highlight-

ing evidence that the Soviets sought to deend the island with conven-

tional arms, not deploy nuclear missiles there. Instead o inoculating the

Kennedy administration against the horrors o a possible Soviet missile

surprise, the intelligence estimates made the surprise even more suddenand shocking.

The bottom line: we got lucky.

It is comorting to think that we avoided nuclear Armageddon

through artul diplomacy, steely nerves, and timely intelligence. But

the truth is we got lucky. During the height o the crisis, a previouslyscheduled test simulating a missile attack rom Cuba was mistakenly

identiied as a real incoming strike, giving the North American Air

Deense Command just minutes to determine what to do. In a 2002

missile crisis anniversary conerence (yes, there are these things), schol-

ars learned or the irst time that one Soviet submarine captain actually

did order preparations to launch a nuclear-tipped torpedo o the U.S.

coast on October 27. Were it not or a man named Vasili Arkhipov,who persuaded the captain to wait or urther instructions rom Mos-

cow even as they were being bombarded by U.S. Navy depth charges

and running out o air, events could easily have taken a tragic turn.

Other terriying examples abound, showing just how close the edge o

disaster really was.

Calling something a success or ailure is not just an exercise in tweedy

semantics. It shits the ocus rom what went right to what went so wrong.And what went wrong ity-one years ago is still going wrong today: two

lingering questions rom 1962 suggest the deadly eects o organizational

pathologies in intelligence.


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MOMENT OF CRISIS: Five days after President Kennedy signed the Cuba

weapons embargo on October 23, 1962, Soviet leaders agreed to disman-

tle nuclear missiles there. Before the crisis, however, all four intelligence

estimates on Cuba published that year had reassured Washington that the

Soviets would defend the island with only conventional arms, not nuclear

missiles.


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1. Why did analysts miss the signals of Khrushchevs true intentions?

Sherman Kent, who led the CIAs estimating shop during the crisis,

argued that intelligence estimates missed the mark mostly because Khrush-

chev was nutty. There is no blinking the act that we came down on thewrong side, he admitted in 1964. But Kent added, no estimating pro-

cess can be expected to divine exactly when the enemy is about to make a

dramatically wrong decision. In other words, lets blame Khrushchev and

hope or more-predictable adversaries in the uture.

The more important and overlooked lesson here is that the struc-

ture o the U.S. intelligence system made a tough job nearly impossible.

Although the CIA was created in 1947 to prevent another Pearl Harbor,the agency has never really been central. Intelligence agencies in the

State, War, Navy, and Justice departments hobbled the CIA rom its

earliest days to protect their own tur. As a result, in 1962 intelligence

reporting and analysis about Cuba was handled by hal a dozen agencies

with dierent missions, specialties, incentives, security clearance levels,

access to inormation, and no common boss with the power to knock

bureaucratic heads together short o the president. In this bureaucraticjungle, signals o Khrushchevs true intentionsand there were sever-

algot dispersed and isolated instead o consolidated and ampliied to

sound the alarm.

Sound amiliar? Beore 9/11, this same ragmentation kept U.S. intelli-

gence agencies rom seizing twenty-three dierent opportunities to disrupt

the terrorist plot. In each instance, someone in an intelligence agency noticed

something important: a string o jihadist light school students in Arizona, asuspicious extremist at a Minnesota light school, two suspected Al-Qaeda

operatives with U.S. visas in their passports. These and other signals were not

drowned out by all the noise. They were ound, an incredible eat. And then,

just as incredibly, each signal got lost in the bureaucratic sprawl.

2. Why, despite new evidence of a dramatically escalating Soviet build-

up, did intelligence analysts continue to draw the same old conclusions?

In August and September 1962, intelligence showed a dramatic uptick

in Soviet personnel and weapons deployments to Cuba. Nevertheless, the

September 19 intelligence estimate concluded nothing had changed. The

Soviets were ramping up all right, but to deend Cuba.WhiteHouse


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Sherman Kent took a lot o heat or that estimate. Nearly all o it cen-

tered on mirror imaging, the tendency or analysts to assume an enemy

will behave as they would. For psychologists, cognitive limits in the Cuban

missile crisis have been the git that keeps on giving. But I am convinced

that organizational pressures were also at work.The thing to know about National Intelligence Estimates is that they

are collective products. No single person or agency writes them. Instead,

estimates require intense negotiation among many agencies to reach con-

THE DANGER PASSES: A U.S. surveillance aircraft (its shadow visible at lower right) flies

hoover digest, 2013, no. 4, fall

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