Our Declaration of Dependence

As we get into the final stretch of the 2012 Presidential election, both parties are trying to convince the voters that this is the most important election of their lifetime and their choice will determine the course of the nation for the generations to come.   

If this is truly the most important election of our lifetime, it surely does not look like from the problems being discussed and the solutions being prescribed by  the two candidates.   One of the biggest problems the new administration will face will be the cost of our growing entitlements.  None of the candidates are providing any serious plans to address this problem.

In a fantastic essay written by Nicholas Eberstadt (A Nation of Takers: America’s Entitlement Epidemic), author makes the case that entitlement mentality is fundamentally changing the American character, which may be sacrificed long before the credibility of the US economy.   In this blog, I will try to summarize key points from this article.

Eberstadt suggests that while the American republic has endured for almost two and a quarter centuries, over the past fifty years, American government has become an entitlement machine which devotes more attention and resources to public transfer of money, goods and services to individual citizens than to any other objectives.

Eberstadt shares some breathtaking numbers.   In 1960, US government transfers to individuals totaled about $24 billion.  By 2010 that total was almost 100 times larger! It was around $2.2 trillion.   In 1960, entitlement related payments accounted for well under a third of the federal government’s total outlays.  By 2010, this share accounted for about two-third of all federal spending, with all other responsibilities of the federal government including defense making up barely one-third.  US government budget divides entitlement spending into six baskets: income maintenance, Medicaid, Medicare, Social Security, unemployment insurance and all the others.  Broadly speaking, the first two baskets attend to entitlements based on income status, the second two based upon old-age status and the next two based upon employment status. 

Income related entitlements including health-care services account for over $650 billion in2010.  For older Americans-Medicare, Social Security  and other pension related payments amounted to about $1.2 trillion in 2010.  To put things in perspective,  total revenue collected by the federal government in 2010 was around $2.2 trillion which is equal to the total entitlement spending that year.  It means every other function of the government including defense was funded thru deficit funding.  Budget deficit in 2010 was more than $1 trillion.

Eberstadt argues that there has been a steady shift towards entitlement lifestyle especially in the last couple of decades.  At the time of the founding of the country, there was an affinity for personal enterprise and industry and a contempt for anything that will smack of entitlements.  That resistance of government entitlement was ultimately overcome.  Today more than half of all American households receive transfer benefits from the government. 

Author argues that omnipresence of entitlements have already altered the American way of life.   With personal dependence on government handouts not only destigmatized but being enshrined as a right, mass behavior is changing in highly uncivil directions.  How many times have we seen elderly protesting “hands off my Medicare”, without realizing that their consumption will be at the expense of those born after them.   They rationalize this behavior with the notion that they have “already paid for” these benefits not knowing that on an average they will take out three times from the system more than what they put in.  The fact is that neither Social Security nor the Medicare trust funds can honor the future promises they have made today.   Unless we make significant changes in entitlement spending, we have decided to mortgage our future for a more comfortable retirement today.

Current fiscal trajectory is unsustainable.   The 2010 Bowles/Simpson commission report dealt with this problem squarely.  Their report was aptly called “The Moment of Truth”.   They provided a framework, which can provide solid underpinning of a legislation to address this problem. 

It is incumbent upon the Presidential candidates to share their plans for addressing this most “predictable crisis” facing us.  Until they clearly articulate their plans to implement recommendations of Bowles/Simpson commission report, they have not earned our vote.

Thinking Fast and Slow

Recently I read the book "Thinking, Fast and Slow" by Daniel Kahneman who received the 2002 Nobel Prize in Economics. It is a fascinating book. In this post, I will try to summarize my understanding of key concepts from the book.

Kahneman starts by introducing two systems, named rather inaptly, System 1 and System 2, that drive the way we think. System 1 is fast, intuitive and emotional which can be somewhat manipulated. System 2 is slower, deliberate and logical but also somewhat lazy. We would like to believe that we are deliberate, rational and logical and hence System 2 is at works but most of the time, System 1 is in charge and funny thing is, we can not do much about it.

A lot of things we do, like answer to 2+2=?, or drive a car on an empty road, detect hostility in a voice, orient to the source of a sudden sound, all happen without much effort or attention from our side. We do these and similar things, involuntarily and can not prevent ourselves from doing even if we want to. This is all System 1 at work.

Operations of System 2, however, require attention and are disrupted when attention is drawn away. Few examples would be to search memory to identify a surprising sound, count the occurrence of letter "a" in a page of text, compare two washing machines for overall value, fill out a tax form.

According to the author, System 1 and System 2 are both active whenever we are awake. System 1 runs automatically and System 2 is normally in a comfortable low-effort mode. System 1 continuously generates suggestions for System 2. When all goes smoothly, which is most of the time, System 2 adopts the suggestions from System 1 with little or no modification. We generally believe our impressions and act on our desires, and that is fine - usually.

When System 1 runs into difficulty, it calls on System 2 for support. For example, when we are surprised, or someone asks a questions for which we do not have a ready made answer, like 17X24=?, System 2 is activated.

The division of labor between System 1 and System 2 is highly efficient. Arrangement works well most of the time because System 1 is generally good at what it does. System 1 has biases, however, systematic errors that it is prone to make in specified circumstances. It sometimes answers easier questions than the one it was asked, and it has little understanding of logic and statistics. Here is a good example.

Let us take a simple puzzle. Do not try to solve it but listen to your intuition.

A bat and ball cost $1.10.
The bat costs one dollar more than the ball.
How much does the ball cost?

What number came to your mind? If you are like most people, your intuitive answer is 10 cents. Now actually do the math. Correct answer is 5 cents. It is safe to assume that intuitive answer also came to the mind of those who ended with the correct answer - they somehow managed to engage their System 2 and resist the suggestion of System 1.

Author also introduces the concept of WYSIATI (What You See Is All There Is). System 1 is radically insensitive to both the quality and quantity of the information that gives rise to impressions and intuitions. It leads us to jumping to conclusions on the basis of limited evidence.

There are other important concepts in the book, all of which can not be described here. Kahneman uses these concepts to conclude that humans need help to make more accurate and better decisions and in some cases policies and institutions can provide that help. Libertarian approach assumes that humans are perfectly rational (System 2 is at works all the time) and they will make the right decision every time so we should not interfere with the individual's right to choose, unless the choice harms others. Kahneman makes a case for "Nudge", based on the book of the same name, written by Richard Thaler and Cass Sunstein. They advocate a position of libertarian paternalism, in which state and other institutions are allowed to "nudge" people to make decisions that serve their own long-term interest. A good example of Nudge would be the designation of joining a pension plan as the default option. It is difficult to argue that anyone's freedom is diminished by being automatically enrolled in the plan, when they merely have to check a box to opt out. Humans need help to make good decisions and there are informed and unintrusive ways to provide that help.