Nostradoofus

No comment on the President Bush “plan” of January 31, 2006, except to say that if you have any empathy at all, it’s hard to watch a man make a fool of himself on national TV.

The cheapest solution to the oil quandary requires understanding the problem very precisely. The problem is not oil supply — it is oil supply uncertainty. We do crazy things in the Mideast (e.g. cozying up to dictators, invading Iraq) because we fear the economic effect of unexpected disruptions in supply.

The solution is to build a gigantic strategic reserve, enough to cover all imports under normal demand conditions for 9 months. This would cost many billions, but is less expensive than the alternatives (war and economic shocks).

We need not be able to last forever without oil imports. We need only be able to outlast the exporters. Remember, they are much poorer than we are, and oil is essentially their sole source of income. None can survive six months without selling oil, and they cannot boycott just one country: since oil is a commodity, if they sell to ANY market economy, supply increases and price falls for everyone.

Imagine what would happen if Iran shut down exports under these conditions. The U.S. would experience minor hardship, but after six months, Iran’s economy would collapse. They only reason they wield power now is because our reserve is too small.

A giant reserve provides an economist’s form of independence: we still use oil, we still import, but we are no longer subject to pricing power by the seller. Best of all, this is something that requires no new technology. We could do it right now.

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I’m a lifelong, 5th-generation, pro-business Republican. But I’m the first to admit the party has lost its mind.

To see how far the GOP has strayed from its principles, imagine you live in 1965, under the Johnson administration, and are suddenly catapulted forward 40 years.

You arrive in 2005 to find that one party dominates politics. It engages in massive deficit spending. It attempts a guns-and-butter strategy of running a major overseas war while expanding social programs at home. It creates regulatory barriers to protect domestic industries from foreign competition. It expands regulation of financial markets, reducing the efficiency of the engines of American capitalism. It expands federal control over traditional states-rights issues. And its leadership values social engineering over economic advancement.

Now someone asks you: based on that information, which party is in power? You, freshly arrived from 1965, would naturally say Democrats. And you would be wrong.

Republicans are now demonstrably a bunch of regulation-happy, big-government spendthrifts. Where are the laissez-faire, get-out-of-my-face Republicans I thought I was voting for?

Who are these guys?

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If you reduce the supply of something, the price goes up. The more successfully the US destroys coca crops, the higher the price goes, and the greater the incentive for tropical farmers everywhere to simply grow more.

If you instead reduce demand, the price goes down. The more successfully the US reduces coca demand (whether by moral suasion, education, re-education, imprisonment, testing, etc), the lower the price goes, and the less the incentive to grow, refine and distribute it.

If you focus on demand reduction, you also:

1. Starve bad guys of profits.
2. Automatically reduce a variety of related domestic social problems.
3. Reduce the incentive for corruption of US officials.
4. Stabilize Mexico’s border regions, reducing violent crime in the US.
5. Become a model of self-restraint, worthy of self-respect and the respect of other nations.
6. Save money. Projecting military power is immensely expensive — much more than fixing domestic problems.

Supply reduction accomplishes none of these. Microeconomically, the 20-year “war on drugs” is not only a failure — it is a surprisingly dumb idea.

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The megastorms of recent weeks revealed that certain industrial resources of the U.S. are highly concentrated geographically. To choose just one example from dozens, the New Orleans flood inundated 25% of the world’s stockpile of zinc, sending commodities markets reeling (source: Financial Times).

More generally, it appears accurate to say that the forms of economic advancement of the past several decades bring lower resistance to infrastructure shocks. Intricate supply networks make us more dependent upon transport, communications and energy delivery systems. At the same time, scale economies and the benefits of industrial clustering both drive geographic concentration.

The result is that our economic status depends upon the joint probability that none of these myriad components will ever fail. That sounds pretty darn risky, over time.

The risk is much greater if we get into fights unnecessarily. Hawks take pride in past US military glory, but may forget it was facilitated by industrial invulnerability. Conditions are different today, and not just because the enemy can reach us more easily. The simple fact is that we can’t take a punch as well today as we could in 1950.

If the port of Long Beach were destroyed in 1950, would the toy industry have collapsed? No. Today? Yes. 85% of toys come from China.

If Manhattan were destroyed in 1950, would the national home mortgage market have collapsed? No. Today? Yes. The entire mortgage business is built around securitization.

If the border with Mexico were closed in 1950, would the U.S. auto industry have collapsed? No. Today? Yes. Key components are built over the border.

The list of such dependencies is almost endless. We are exposed everywhere. As a result, globalization is simply inconsistent with the projection of military power against a determined opponent with little to lose.

Ironically, it’s the isolated economic also-rans that are least exposed, and hence the most dangerous to tangle with. Arab nations. Iran. North Korea. Cuba. Integrating these places into the global trading system would expose them to the same global dependencies that we face — and render it unprofitable for them to threaten anyone.

China, our supposed military rival, is perhaps the most exposed of any large nation. They would be crippled by global industrial network disruption. Thus it’s perhaps not sensible to worry about them from a military perspective — they simply have too much to lose.

Japan’s government may understand this better than ours or China’s. As the first practitioner of many of these modern industrial methods, they have decades more experience at such dependence, and presumably more willingness to prepare for shocks. Is their relative neutrality in world affairs one such preparation? Do they recognize, better than we do, that their way of life depends upon the function of those intricate networks?

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Biologists have come to recognize that the untrained human mind is not a reasoning machine, but simply a bunch of evolved heuristics that imitate reasoning. Good marketers already know this. Economists and politicians, take note.

Historically, the smartest politicians know that everyone loves the underdog. The smartest ones set policy to make themselves appear the underdog.

Recall Clinton’s self-anointment as the “Comeback Kid.” Why was that appealing? Fundamentally, and whether Clinton understood this or not, it was because human minds are predisposed to prefer the story in which a local boy overcomes the odds to win the title.

This applies in particular to war policy. If only Bush understood it. Unless given a good reason not to, people instinctively root for a plucky rebellion against imperial power. Smart policymakers try to position themselves as the underdog, the defender, or the offended party.

Abraham Lincoln understood this. In 1861, when he took office, much of the South had already seceded, and he had only tenuous support in the North to fight for the Union. A simple invasion would actually have galvanized opposition in both North and South, preventing him from being re-elected, and probably preventing the survival of the Union.

So what did he do? With much fanfare, he sent a supply convoy to the Union’s Fort Sumter in South Carolina, which had already seceded. But the ships did not land, and Lincoln did not attack. He simply waited offshore, looking threatening, until the South Carolina militia attacked the fort.

This was the pretense Lincoln needed. For the next 4 years, he managed to hang on to popular support for a bloody, divisive conflict, largely because he could argue the whole thing was defensive. The South had fired the first shot. They became Goliath, the Union David.

Fast forward to 2001. The United States invades Afghanistan, a sovereign nation, and no one complains. To the contrary, nations around the world are pouring their hearts out to support America. Why? Because there was a smoking-gun connection to the 9/11 attacks, so we could credibly claim that the invasion was actually defensive. The U.S. had managed to portray itself as the plucky defender against a global al Qaeda conspiracy.

Fast forward to 2003-5. Everyone suddenly hates American imperialism. Why? Because no credible case was made that an Iraq invasion was defensive. I’m not asserting that no credible case was made; I’m observing that no credible case must have been, given that most now perceive the U.S. as an aggressor. Iraq became David. America became Goliath.

The extent of America’s diplomatic foolishness here only comes into focus when you consider that this conflict’s David was one of the most reviled autocratic rulers on the planet. Yet we’re still the bad guy. There should be a signal here that we blew it in the PR department.

Note that nothing in this article argues against the invasion. It argues that the justification was amateurishly handled, given readily observable traits of human motivation.

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U.S. industrial policy should aim to identify competitive dynamics and limits of offshoring, and feed this understanding back into the educational and research grant system.

Note I don’t say, “stop offshoring,” or “do more offshoring.” Offshoring is just a plaything of Adam Smith, like the electric motor. It happens, and you plan around it. All you can do is build a society that is competitive in the new circumstances.

For example, suppose — and this is just one possible direction — suppose that we’re on a trajectory in which 99% of software development ends up in well-educated developing countries. This might mitigate toward U.S. universities teaching abstract system design instead of implementation. It might imply creating new, extremely high leverage programming languages like Ruby. It might imply new modes of industrial organization such that a substantial part of the value chain is still captured here.

At minimum, the U.S. should be funding university research on this subject. While they still can. As the founder of India’s InfoSys told The World Is Flat author Thomas Friedman, “The global playing field has just been leveled, and you Americans are not ready.”

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This “is China the enemy?” stuff in the press is silly. China is not an enemy but a rival for geopolitical leadership. That’s an important distinction.

Does that matter? Yes. There is a game theory aspect to geopolitical ranking, such that we do enjoy benefits of leadership. We already speak the language of global commerce; we issue debt denominated in our own currency, at favorable prices; and we have outsize geopolitical influence.

China’s victory in this rivalry is almost inevitable: because of the huge population, they need attain only the GDP per capita of Mexico to take the global #1 position in aggregate GDP.

So what is an American geopolitical strategist to do? How could China dominance be delayed or prevented (if that were even desirable, which is a different question). Well, you could try to cause China to be broken up, to slow down its growth, or to speed up your own growth.

The first two require interfering with the rival’s internal politics, which would almost certainly turn rival into enemy. It’s a really bad idea to make an enemy of your biggest rival, as Japan and Germany learned in the 1940s.

So the only viable alternative is to improve yourself: increase your own growth and/or population to retain the lead as long as possible.

For example, note that China’s population growth rate is slowing, while America’s isn’t. With clever management, the U.S. may be able to increase GDP per cap by 4% between now and 2050, at which point we’ll have 600 million people. If China by then has a mature growth rate and population of only 900 million and falling, then U.S. dominance might be extended by 100 years or more.

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Lest we think all regulation is bad, look at unregulated Baja California.

Baja should be a tourist magnet: it has 2,000 miles of warm coastline, dry to subtropical weather, and rich and unusual flora, fauna and natural beauty. It is adjacent to California, one of the most prosperous places on the planet.

Yet outside of Tijuana and Cabo San Lucas, the whole peninsula sits impoverished and abandoned. Why? Too little regulation. Property rights are weak, so property doesn’t stay bought, leaving little incentive to develop. Government builds almost no infrastructure, so there’s little water (despite a huge, mostly untapped acquifer) or electricity. Bandits occasionally run amok for lack of adequate policing.

The environment is being trashed. Inside Baja’s national park, spraypaint graffiti covers boulders for mile after mile. Trash litters fields. Truckers perform roadside oil changes by simply draining engines directly onto the ground, leaving toxic black slicks at turnouts. Outside the national park, it’s worse.

Now imagine what would happen if the U.S. bought Baja, subdivided and resold it to developers, and used the proceeds to build infrastructure. A property gold rush, coincident with environmental cleanup. Why? Regulation — of property rights, civil order, environment, and much more.

Chew on this before you check “Libertarian” on your next voter registration card. A little bit of carefully designed, universally applied regulation is much better than none.

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To see the truth, ignore what people say, and examine their incentives and actions. Here’s a great example.

Iran enriches uranium for, they say, “peaceful purposes.” Now, why would the world’s 4th largest oil producer need nuclear power? They can extract oil practically free, and generate electricity from oil at less than a tenth the cost of nuclear.

What, then, could be their only remaining incentive for developing nuclear energy? Of course they are building a bomb.

The U.S. habit of shouting and beating drums is much less effective than simply pointing out the comical misalignment here between statements and incentives.

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