Book Lovers Rejoice! Bookstores Will Survive!

The recent bankruptcy and closure of all the Borders bookstores is easily taken as a harbinger of the approaching demise of the bookstore and soon thereafter, the physical book itself. For those who grew up savoring trips to the bookstore hoping to find that unexpected gem, and for those who devoured and treasured those physical objects called books and fear that their end is imminent—keep the faith! 

The conventional wisdom is that Borders failed because it could not contend with on-line outlets like Amazon. The popularity of e-readers was supposedly the last straw. Ben Austen provides an article in Businessweek that lets us know that the situation is more complicated than that: The End of Borders Is Not the End of Books.

According to Austen’s tale, Borders was not done in due to competition, but rather to its own incompetence.

"When Borders declared bankruptcy in February, more than 200 of its 400 outlets were still ‘highly profitable,’ says its final chief executive officer, Mike Edwards. There’s no question that the book industry is in flux, with digital sales last year making up about $900 million of the $28 billion-a-year market and increasing fast. But a sizable portion of the book business is still taking place in actual stores. Barnes & Noble, the nation’s largest book retailer, hasn’t been forced to close its 700 locations. Thus, it wasn’t Amazon—or Amazon alone—that sank Borders."

Austen relates a sequence of unwise decisions made by Borders. Some of the blame could be attributed to the six CEOs it endured over the last twelve years.

"For the past decade and a half, Borders seems to have been in the business of making mistakes. Consider the company’s efforts to develop an online presence. Amazon was launched in 1995, and Barnes & Noble responded with its own website two years later. It took Borders another year to get started online, and the venture quickly lost tens of millions of dollars. In 2001, Borders made a deal with Amazon to run all of its online business—a partnership, in retrospect, that comes across as tragically shortsighted...Amazingly, Borders wouldn’t end the Amazon deal and launch its own website until 2008."

"Borders managed to be on the wrong end of several upheavals. It invested heavily in CDs and DVDs just as music and movies were going digital; in 2006, nearly a fifth of all Borders revenue came from music sales. And though this would be the company’s last year of profitability, it continued to expand, building huge stores of 25,000 and 30,000 square feet right into the Internet boom. Sales per square foot in its superstores plummeted from an average of $261 in 1997 to $173 by 2009. Borders even purchased a stationery company, Paperchase, in 2004, as handwritten correspondence withered. And then there’s the company’s entry into digital books: If you didn’t know Borders had an e-reader called Kobo, you’re not alone."

Perhaps the biggest error that Borders made was in expanding precipitously starting in the late 1990s. Just at the time when Amazon was becoming a force it established too many big stores in too many marginal locations. The well-placed stores generally were profitable, the poorly located ones faired less well.

Where does the book selling business reside post-Borders?

"Analysts predict that Barnes & Noble will have to shrink the number and size of its stores, and it hasn’t tried to gobble up many of the vacated Borders locations—70 percent of which, Barnes & Noble says, were within five miles of one of its outlets. (Barnes & Noble did purchase the remainder of Borders’s Web business.) But so far Barnes & Noble is holding on to its stores, focusing on e-books and filling its outlets with high-profit-margin nonbook items, such as educational toys and games."

Austen closes with some truly positive, and unexpected, insight.

"Small independents....may actually stand to gain the most from Borders’s passing. Plenty of shoppers don’t want to give a digital download to a niece for her birthday and often don’t think far enough ahead to order a book through Amazon for an upcoming trip. Many simply like the experience of going to a bookstore. Jeff Green, president of Jeff Green Partners, a retail-consulting firm based in Phoenix, believes bookstores of around 2,500 square feet offer a perfectly viable—if only modestly profitable—business model. John Rubin runs Above the Treeline, an Ann Arbor–based company that provides sales and inventory analytics as well as digital catalogs to booksellers. According to point-of-sale data he’s compiled, business at locally owned stores has, in fact, held steady in recent years. And while advances in technology have certainly made hardcover books a bit passé, they have also enabled small stores to operate far more efficiently. "It’s the only retail industry I can think of that will go full circle, back to the way it originally was," says Green. ‘From the small-village bookstore to the big-box retailer and then back again. That doesn’t ever happen in retail’."

Amazon is great for ordering a book you already know you want. It is not so good for browsing randomly. If you enjoy seeking out a few good titles out of a thousand options, rather than out of a hundred thousand, you may soon have more good browsing experiences. Those comfortable little bookstores may be coming back.

China, India, and Their Dangerous Border

About a year ago there were several articles discussing tensions between China and India. I summarized those in China and India: Is Conflict Inevitable? There are numerous sources of stress between the two countries. They both have huge populations in desperate need of access to resources and markets. The need to project influence and solidify relationships with neighboring countries inevitably leads the two elephants to step on each other’s toes. Both fear that the other is working to isolate them, both economically and militarily. 

President Obama’s recent trip to Asia, and his indication that the US will have a continuing economic and military presence in the area, has certainly stirred the pot and raised the level of concern in China at alliances between the US, India and others that are seen as a direct counter to China. Simon Denyer wrote an article in the Washington Post that summarized the political maneuverings between the two countries: China, India perform dangerous new dance of encircler, counter-encircler. Denyer’s piece reminds us of what have been issues for a long time.

When considering the question of the inevitability of conflict, the most disturbing of the scenarios was one provided by Jonathan Holslag in his book titled China and India: Prospects for Peace. Holslag saw the long border between the two countries as the location where trouble might start. Between the disputed territories and the unstable nations in the region, there would be numerous opportunities for escalation.

There is a detailed discussion of these border issues in an article in The Economist: India and China: A Himalayan rivalry. This source lists the size of the active Chinese forces at 2.3 million with 0.8 million reserves. India’s military is placed at 1.3 million active with 2.1 million reserves. In comparison, the US armed forces are stated to be 1.6 million active and 1.5 million reserves. It is expected that China would maintain such a large force, but India might provide a bit of a surprise. India has its disputes with Pakistan that would encourage the establishment of a significant military, but it is likely that India’s intentions and planning are currently dominated by the tensions on the 4000km border with China.

This map was provided by The Economist to illustrate the issues involved.

Hard feelings between the two countries go back to 1962 when China invaded territory claimed by India.

"In a weeklong assault the Chinese seized much of Arunachal, as well as a slab of Kashmir in the western Himalayas, and killed 3,000 Indian officers and men. Outside Tawang’s district headquarters a roadside memorial, built in the local Buddhist style, commemorates these dead. At a famous battle site, below the 14,000-foot pass that leads into Tawang, army convoys go slow, and salute their ghosts."

The Chinese withdrew, presumably because they had overextended their supply lines, but neither side has forgotten the incident, and each remain prepared for military action.

"Despite several threatened dust-ups—including one in 1986 that saw 200,000 Indian troops rushed to northern Tawang district—there has been no confirmed exchange of fire between Indian and Chinese troops since 1967."

The ongoing source of friction arises from the lack of a clear definition of where the border actually is, leading to disputed claims of ownership.

"The basic problem is twofold. In the undefined northern part of the frontier India claims an area the size of Switzerland, occupied by China, for its region of Ladakh. In the eastern part, China claims an Indian-occupied area three times bigger, including most of Arunachal. This 890km stretch of frontier was settled in 1914 by the governments of Britain and Tibet, which was then in effect independent, and named the McMahon Line after its creator, Sir Henry McMahon, foreign secretary of British-ruled India. For China—which was afforded mere observer status at the negotiations preceding the agreement—the McMahon Line represents a dire humiliation."

"Making matters worse, the McMahon Line was drawn with a fat nib, establishing a ten-kilometre margin for error, and it has never been demarcated. With more confusion in the central sector, bordering India’s northern state of Uttarakhand, there are in all a dozen stretches of frontier where neither side knows where even the disputed border should be. In these ‘pockets’, as they are called, Indian and Chinese border guards circle each other endlessly while littering the Himalayan hillsides—as dogs mark lampposts—to make their presence known. When China-India relations are strained, this gives rise to tit-for-tat and mostly bogus accusations of illegal border incursions—for which each side can offer the other’s empty cigarette and noodle packets as evidence. In official Indian parlance such proof is grimly referred to as "telltale signs". It is plainly garbage. Yet this is a carefully rehearsed and mutually comprehensible ritual for which both sides deserve credit, of a sort."

Tibet is another source of tension.

"The other great impediment to better relations is Tibet. Its fugitive Dalai Lama and his ‘government-in-exile’ have found refuge in India since 1959—and China blames him, and by extension his hosts, for the continued rebelliousness in his homeland."

Another area in which disputes will be inevitable involves the control of water emanating from the Himalayas. Both countries are in desperate need of this water. There is little reason to expect them to suddenly learn how to share.

When asked how a war between China and India might breakout, Holslag had this response.

"It wouldn't first be open war. China and India are building up their interests in conflict-prone and unstable states on their borders like Nepal and Burma — important sources of natural resources. If something goes wrong in these countries — if the politics implode — you could see the emergence of proxy wars in Asia. Distrust between India and China will grow and so too security concerns in a number of arenas. It's an important scenario that strategic planners in both Beijing and Delhi are looking at."

These border-related disputes appear as a thermostat for the overall relationship between China and India. When times are good, they discuss resolving issues; when times are bad they decry border "incursions" and threaten retaliation.

Stay tuned—there’s never a dull moment.

Banks and Blood Money: Too Big to Fail, Too Big to Prosecute

Ed Vulliamy provides a detailed rendering of life along the US-Mexico border in his book Amexica: War along the Borderline. The central focus is, of course, on the drug cartels and their influence on events on both sides of the border. The magnitude and the extent of the cartels’ dealings are astonishing. Vulliamy’s book was originally issued in 2010. Throughout his writing one fact becomes obvious: there is so much activity and so much money involved that the cartels could not operate without the acquiescence of businesses on both sides of the border. By the time the paperback version came out Vulliamy had evidence of this collusion which he included in an afterword that he titled Blood Money.

An article by Michael Smith for Bloomberg provides details of how US banks aid the cartels in their business dealings. Money and drugs flow north across the border; money and guns return south across the border. One estimate quoted by Vulliamy puts the value of the drug trade at $323 billion per year. Smith provides the estimate that about $29 billion is transported by couriers to Mexico every year. To put this in perspective, he tells us that $29 billion in $100 bills would weigh 319 tons. Clearly, the bulk of the money must be moved electronically. Consequently, the inadvertent or complicit assistance of banks is required.

Smith provides this background.

"The 1970 Bank Secrecy Act requires banks to report all cash transactions above $10,000 to regulators and to tell the government about other suspected money-laundering activity. Big banks employ hundreds of investigators and spend millions of dollars on software programs to scour accounts."

The cartels attack the system by using legions of collaborators to make numerous small deposits or small transfers. Since the number of such transactions is so large, it produces a signature that banks are capable of detecting, perhaps not instantaneously, but inevitably. The observation of many deposits made in the same day by the same individual is a common indicator.

The Bloomberg article indicates, at best, spotty performance by the banks in detecting this money laundering. Some seem to back off as soon as laundering is detected, while others appear to continue involved at varying levels over long periods. There was one bank, Wachovia, with behavior so egregiously criminal that government prosecutors were forced to take action.

"Wachovia admitted it didn’t do enough to spot illicit funds in handling $378.4 billion for Mexican-currency-exchange houses from 2004 to 2007. That’s the largest violation of the Bank Secrecy Act, an anti-money-laundering law, in U.S. history -- a sum equal to one-third of Mexico’s current gross domestic product."

This was not a case of sloppy oversight. Wachovia knew exactly what it was doing.

"The U.S. Treasury has been warning banks about big Mexican-currency-exchange firms laundering drug money since 1996. By 2004, many U.S. banks had closed their accounts with these companies, which are known as casas de cambio."

"Wachovia ignored warnings by regulators and police, according to the deferred-prosecution agreement."

"'As early as 2004, Wachovia understood the risk,’ the bank admitted in court. ‘Despite these warnings, Wachovia remained in the business’."

Smith makes it clear that this is no mere "white collar financial crime."

"Twenty million people in the U.S. regularly use illegal drugs, spurring street crime and wrecking families. Narcotics cost the U.S. economy $215 billion a year -- enough to cover health care for 30.9 million Americans -- in overburdened courts, prisons and hospitals and lost productivity, the department says."

"’It’s the banks laundering money for the cartels that finances the tragedy,’ says Martin Woods, director of Wachovia’s anti-money-laundering unit in London from 2006 to 2009. Woods says he quit the bank in disgust after executives ignored his documentation that drug dealers were funneling money through Wachovia’s branch network."

"’If you don’t see the correlation between the money laundering by banks and the 22,000 people killed in Mexico, you’re missing the point,’ Woods says."

Given the magnitude of the crime, one would assume that prison sentences and mass terminations would ensue. What actually happened?—essentially nothing.

"Wells Fargo & Co., which bought Wachovia in 2008, has admitted in court that its unit failed to monitor and report suspected money laundering by narcotics traffickers...."

"Wells Fargo promised in a Miami federal courtroom to revamp its detection systems. Wachovia’s new owner paid $160 million in fines and penalties, less than 2 percent of its $12.3 billion profit in 2009."

"The bank declined to answer specific questions, including how much it made by handling $378.4 billion -- including $4 billion of cash-from Mexican exchange companies."

Why would those involved in such heinous crimes be issued a free pass and be set free to commit more crimes?

"No big U.S. bank -- Wells Fargo included -- has ever been indicted for violating the Bank Secrecy Act or any other federal law. Instead, the Justice Department settles criminal charges by using deferred-prosecution agreements, in which a bank pays a fine and promises not to break the law again."

Say what?!! Smith provides this explanation.

"Large banks are protected from indictments by a variant of the too-big-to-fail theory."

"Indicting a big bank could trigger a mad dash by investors to dump shares and cause panic in financial markets, says Jack Blum, a U.S. Senate investigator for 14 years and a consultant to international banks and brokerage firms on money laundering."

"The theory is like a get-out-of-jail-free card for big banks, Blum says."

"’There’s no capacity to regulate or punish them because they’re too big to be threatened with failure,’ Blum says. ‘They seem to be willing to do anything that improves their bottom line, until they’re caught’."

The Bloomberg article suggests that ongoing investigations of banks will be necessary and will continue.

Vulliamy adds to the story with this contribution.

"Antonio Maria Costa, executive director of the UN’s Office on Drugs and Crime from May 2002 to August 2010, charts the history of the contamination of the global banking industry by drug and criminal money since his first initiatives to try and curb it while at the European Commission during the 1990s. ‘The connection between organized crime and financial institutions started in the late 1970s and early 1980s,’ he says, ‘when the mafia became globalized with the economy’."

Costa says progress was made in combating the penetration of banks by criminal elements, but these efforts were overcome by events.

"Then two things happened: the financial crisis in Russia, after the emergence of the Russian mafia, and the crises of 2003 and 2007-2008....'With these crises,’ says Costa, ‘the banking sector was short of liquidity, so the banks exposed themselves to the criminal syndicates, who had cash in hand. It was pure quid pro quo: Banks needed cash, and criminal syndicates needed somewhere to put their cash. And we are talking about huge amounts of money.’ Criminal syndicates, he says, ‘will penetrate where there is least resistance, where the banks’ need is greatest. So it was Western Europe in 2003 and the USA and UK in 2007-2008’."

If you weren’t previously outraged at the behavior of our financial institutions—what’s holding you back now?

Good Laws Make Good People; Bad Laws Make Bad People

Kenneth Davidson provides a review of a book by Lynn Stout: Cultivating Conscience: How Good Laws Make Good People. The review appears in The American Interest.

Stout argues that people living in society tend to try to be good citizens and demonstrate respectable behavior under most circumstances.

"Backed by hundreds of studies by behavioral economists, as well as evolutionary theory, anthropological studies and neuroscience, she claims that people often really are motivated by conscience, generosity and even altruism."

The claim is made that a successful law will build on this tendency. If the law is deemed appropriate and fair, it will be obeyed. If one can assume that others are abiding by the law, the tendency will be to abide by it also.

"....A moral principle, fairness, comes into play for most people that trumps self-interest narrowly defined."

The problem is that these natural leanings toward decency can be easily undermined by social context and instructions by authority.

"Yet another set of behavioral studies that Stout describes adds to the insight that shared values and social context matter. One study, which has been replicated, concerns a common problem faced by day care centers. For various reasons, some parents tend to be late picking up their children and thereby inconvenience day care personnel, most of whom have after-work commitments. In the study, they worked with behavioral economists to impose a new rule that in effect fined parents who were late picking up their children on the grounds that it was unfair to expect the staff to stay late. To the surprise of some, the effect of the fine in this and succeeding studies was to increase the number of parents who were late in picking up their children. How to explain this?"

The explanation seems to be that the imposition of the monetary fine lessens the feeling of a commitment to accommodate the needs of the staff, and turns the situation into a financial issue that encourages people to focus on their self-interests. "Is the perturbation of my schedule needed to arrive on time worth more to me than the fine?" The analogy can be made to a law that is intended to discourage antisocial behavior with punishment, but only serves to disturb the normal impulses toward good citizenship.

"Laws that rely on punishment and deterrence, as most of ours still do, are necessary for a small category of people and certain types of actions, but they do not alone constitute a viable basis for regulating the vast range of human relationships. We can have a safer, more economically productive and more humane society if we jettison the antique view of human social nature that still informs our implicit assumptions about crime and punishment."

Laws and public policy should work together, not so much to punish misbehavior, but to encourage socially responsibility. The "broken windows" approach to decreasing crime in New York is an indicated approach that proved effective. If you create the impression that other citizens are behaving properly, individuals will be less likely to misbehave.

Good policies and bad policies can cause behavior to go spiraling off in good or bad directions.

"....behavior and how behavior is perceived form a recursive process, giving rise to self-fulfilling, or self-denying, prophecies. To the extent that we arrive at the conclusion that people are basically selfish and unreliable or that groups of people are not worthy of trust or respect, we undermine the possibility of civilized society. If, say, too many voices assert that taxes are government theft, then people are less likely to pay them. If we treat alien residents in the United States as if they are more likely to be criminals, the alien population is less likely to cooperate with law enforcement officials. And so on."

Stout believes that a number of false assumptions about human nature have influenced our policies in ways that have not been beneficial. Of particular interest is the targeting of the economists who indicate that humans are rational beings who will make decisions based on their self interest. This philosophy leads to the notion that a person’s self interest can be manipulated by applying incentives. The way to inhibit undesirable behavior is to issue punishments for such behavior.

"Stout rejects the proposition that law should be based on the assumption that we are in the main bad people who act solely on the basis of rational self-interest. She argues that this is a wildly incomplete description of human social life and blames it for creating generations of bad mental habits leading to misbegotten interactions of all kinds."

This interesting fact is presented.

"Beliefs about others’ behavior can also affect the expected fairness of their actions. For example, Stout notes that teachers of economics describe people as motivated primarily by self-interest, which may explain why ‘economics majors are famous for cooperating less in [behavioral studies] than non-economic students do’."

In other words, economists tend to be not only ill-informed—they are also ill-mannered and unpleasant to associate with.

Stouts presents a compelling argument that public policy can reinforce positive inclinations or diminish them. Her book may delve more into concrete examples, but this review is rather sparse in terms of applications. Clearly, an unwise law that is not supported by a majority of citizens, such as prohibition, generates contempt for the law and flagrant disobedience. In our current political situation there is a compulsion on the part of some to impose religious and social beliefs on all. Such maneuvers will not end well.

Taxes present the best example of a situation where the law, and implementation of the law, must be consistent with social expectations. If we do not believe taxes are fair, and if we do not believe that the majority of people are obeying the law, then the motivation to cheat will be obvious. Such a trend will put our society is in great danger and no amount of penalty will resolve the problem. Perhaps that is the difference between us and Greece.

Stout provides an insightful context within which policies and laws can be evaluated. One can only hope that her faith in human nature can be extended to include politicians and legislators.

Costs Are Being Saved in Medicare

We recently reported on a study of the myriad ways in which savings could be exacted from Medicare without affecting benefits. The conclusion was that there were many options that should be pursued before any drastic steps would be necessary. Maggie Maher had earlier reported on her blog Health Beat data that indicated the rate of growth in Medicare costs had greatly diminished. Maher has provided us with an update on the issue.

The data, from private sources, and confirmed by the Congressional budget Office, indicate that over the past year Medicare costs have grown at a rate of about 4%. In fact, the most recent data indicates growth at about 2.6%. This is to be compared with growth over the period 2000-2009 that averaged 9.7%. It was assumed that this was a result of a conscious effort on the part of the medical community to become more efficient in anticipation of full implementation of the healthcare reform legislation.

Maher reports that Peter Orszag is in agreement. Orszag also provides some insight into what is occurring. He is quoted as follows.

"We don’t yet have enough data to tell for sure what’s causing the recent deceleration in Medicare spending -- or whether it will last. But some evidence suggests it may be a shift toward value in the health-care sector. Various hospital executives have told me they have already begun to prepare for less generous reimbursement from Medicare as the new federal health-care-reform law takes effect and there is a greater focus on value. They are therefore trying to become more efficient now. That’s the discussion taking place in the strategic planning process at Mount Sinai Medical Center in New York, where I recently joined the board of directors."

"'The Mount Sinai experience may be instructive,’ he continued. ‘From September 2010 to May 2011, the hospital’s Medicare revenue rose only 2 percent over the previous year -- in part because the number of inpatient cases fell. Why was that? One important reason was that the number of patients readmitted to the hospital within 30 days of discharge was 5 percent less than what it had been the previous year’."

"'Reducing readmissions is one of the objectives of the federal health-care-reform law enacted last year. Historically, nearly 20 percent of Medicare patients have been readmitted to a hospital within 30 days of being discharged, in part because their doctors and other health-care providers have not managed patient handoffs very effectively’."

There are provisions in the new law to cut benefit payments to poorly performing hospitals and reward those providing cost-effective care by sharing the savings with them. The readmission rate of patients after a hospitalization is one of the prescribed metrics of effective care.

Orszag’s example is just one of many that illustrate the potential for cost savings. Hospitals incur about one-third of Medicare costs so lowering growth to 2% via relatively simple approaches is a big deal. Getting growth in expenses down to 2% puts the cost within the growth rate of the economy as a whole, and we can begin to consider the Medicare program as financially sustainable.

Maher reminds us that it is estimated that about 30% of current Medicare costs should be considered waste. There is a lot of room for improvement.

We can put this observed decrease in cost growth in context. At a 9.7% growth rate a $500B program becomes $1,048B over ten years and $2,646B over twenty years. At 4% growth it drops to $684B over ten years and $1,012 over twenty years. The 2% figure yields $586B over ten years and $714 over twenty. The savings are enormous. The lower growth rate saves almost $2T over twenty years. And remember we are just beginning to get serious about controlling costs.

Keep the faith! Keep the benefits!

Prison: Accountability Comes to the Medical Industry

One is occasionally encouraged to read of the healthcare industry making sincere efforts to produce more cost-effective and more efficient treatments for patients. However those initiatives are generally overwhelmed by accounts of physicians, drug companies, and medical device companies willing to break any moral or legal rule in order to maximize profit. This has been one of the dark days.

The Milwaukee Journal-Sentinel reports on the activities of the device maker Medtronic who produces a biological agent named Infuse that is used in spinal fusion surgery.

"Doctors who received millions of dollars from device maker Medtronic repeatedly failed to reveal serious complication linked to the company's lucrative back surgery product in 13 papers they co-authored for medical journals over the course of nearly a decade, according to a scathing new review."

"The review, published....in the Spine Journal, found complication rates that were 10 to 50 times greater than the estimated complication rates revealed in the papers co-authored by the doctors, who had financial ties to the company."

"The analysis is part of an unprecedented event in medicine: The entire issue of a medical journal devoted to a scientific and financial exposé of a product, the practices of the company that markets it and the financially conflicted doctors who tested and promoted it."

And what are the potential complications that the Medtronic-paid physicians neglected to mention or downplayed?

"It also found the studies co-authored by the Medtronic-associated doctors indicated there were no complications related to Infuse when they knew the product was linked to several serious side effects."

"Among those problems: Uncontrolled bone formation and the need for additional surgery; life-threatening inflammation; infections; implant movement; cancer risk; and effects on nerves leading to radiating leg pain, bladder retention and a complication that causes sterility in men."

The financial gain for many of the doctors living on the Medtronic tab amounted to millions of dollars.

How does one punish the guilty at Medtronic? How does one even identify the guilty?

A Reuters article came out today describing yet another case in which a drug company was fined for criminal behavior in marketing a medication for unapproved uses.

"Merck & Co will pay roughly $950 million to settle criminal and civil charges that it promoted the painkiller Vioxx for an unapproved use, the U.S. Justice Department said on Tuesday."

"The fine will conclude a long-running investigation into Merck's promotion of its one-time blockbuster drug, which was withdrawn from the market in September 2004 after being linked to heart risks."

"The Justice Department alleged that Merck promoted the drug for treating rheumatoid arthritis before it had been approved for that condition by the U.S. Food and Drug Administration."

There have been so many similar cases that paying fines has come to be considered a cost of doing business by the pharmaceutical business. If one sells $10B of a drug and pays a $1B fine, a healthy profit is made—particularly when the cost of the fine can be passed on to consumers.

Government agencies have grown frustrated with this process. Prosecution has been deemed not appropriate. Perhaps the relevant laws are too vague, or perhaps the possibility of convicting any one responsible individual is too small. The Office of Inspector General is contemplating the approach of holding the CEO of the company responsible. After Forest Laboratories pled guilty and was fined for improper marketing and for withholding data on side effects for the drug Celexa, the OIG let it be known that it was considering applying "exclusion" to the CEO. Exclusion is a way of prohibiting the excluded person from participating in government programs. If the CEO is excluded, then the company is also excluded. This is a way of assigning accountability to the leaders of the criminal corporations. This approach is not as efficacious as a prison sentence, but at least it is a step in the right direction.

A third case has appeared in the news. This one has behavior so egregious that people are actually going to go to prison. An Associated Press article provides the relevant information.

"The Synthes North America officials wanted to beat their competitors to market without going through the lengthy process of getting their products approved by the U.S. Food and Drug Administration, the judge found. So they plotted to train select surgeons in the off-label use of their bone cement and then have the doctors publish their findings, U.S. District Judge Legrome D. Davis said."

"The program continued even after a patient died in surgery in Texas in 2003 and another in California. The patients suffered a sharp drop in blood pressure after the bone-cement compound was injected into their spines. Synthes only halted the training after a third death in 2004."

"The pursuit of profits blinded medical company officials to the "the sanctity of human life," a federal judge said Monday in sentencing them [Synthes executives] to nine months in prison for unapproved testing of a bone-cement product that left three people dead."

There was little doubt that the actions of the then executives involved inappropriate and unacceptable risks.

"The bone cement, Norian XR, had been approved for surgical use in the arm, but not in the weight-bearing spine."

"Pilot studies had shown it could cause blood clots in humans, and pig research suggested the clots could move to the lungs, causing death within 30 seconds, government experts said. Synthes used the cement in about 200 spine patients."

The government was able to show that the company executives had direct responsibility for this effort.

"They became the rare corporate officials sent to prison after pleading guilty to a misdemeanor as ‘responsible corporate officers’ under the so-called Park Doctrine. The statute typically involves corporate leaders taking the fall for things that happened under their watch. In this case, Davis said they planned and executed the scheme, and sentenced them above the zero- to six-month guidelines."

These prison sentences form a wonderful precedent that will hopefully inhibit this sort of behavior in the future. It would have been even more effective if the precedent had involved merely criminal negligence on the part of the executives in overseeing company activities. That would have put the fear of God in many an executive.

Women, Men, Marriage, and Society

Kate Bolick has written an interesting article for the Atlantic: All the Single Ladies. Bolick is a well-educated, professionally successful woman in her late thirties. She has chosen to remain single—thus far. In her article she examines the various pressures a woman in her position feels to marry, and examines the many reasons why she and other women have, in ever greater numbers, delayed marriage or bypassed it entirely. Her story is both very personal and representative of society in general. It makes an interesting read.

The story of women and marriage is tightly coupled to the story of men in society. The increase in college-educated women with robust careers has been coupled with the tendency for a large segment of the male population to be moving in the other direction, both academically and economically. It is clearly true that men have been hit harder by the changing economy over the past few decades, and that they have been slow in responding to these changes.

"A 2010 study of single, childless urban workers between the ages of 22 and 30 found that the women actually earned 8 percent more than the men. Women are also more likely than men to go to college: in 2010, 55 percent of all college graduates ages 25 to 29 were female."

"As of last year, women held 51.4 percent of all managerial and professional positions, up from 26 percent in 1980. Today women outnumber men not only in college but in graduate school; they earned 60 percent of all bachelor’s and master’s degrees awarded in 2010, and men are now more likely than women to hold only a high-school diploma."

Women have traditionally married upwards, looking for a mate who could provide economic security. What happens if this stock of economically-secure males is diminished?

"Recent years have seen an explosion of male joblessness and a steep decline in men’s life prospects that have disrupted the "romantic market" in ways that narrow a marriage-minded woman’s options: increasingly, her choice is between deadbeats (whose numbers are rising) and playboys (whose power is growing)."

On an individual level this situation is not necessarily dire, unless one clings to old notions about women’s role and place in society.

"But this strange state of affairs also presents an opportunity: as the economy evolves, it’s time to embrace new ideas about romance and family—and to acknowledge the end of "traditional" marriage as society’s highest ideal."

Much of Bolick’s article discusses these "new ideas about romance and family." What is of interest to us today is the implication for society as these trends continue.

Bolick suggests that to discover where we are headed we merely need to look to the demographics of the African American population.

"Given the crisis in gender it has suffered through for the past half century, the African American population might as well be a separate nation. An astonishing 70 percent of black women are unmarried, and they are more than twice as likely as white women to remain that way. Those black women who do marry are more likely than any other group of women to "marry down." This is often chalked up to high incarceration rates—in 2009, of the nearly 1.5 million men in prison, 39 percent were black—but it’s more than that. Across all income levels, black men have dropped far behind black women professionally and educationally; women with college degrees outnumber men 2-to-1. In August, the unemployment rate among black men age 20 or older exceeded 17 percent."

Bolick quotes a black law professor at Stanford, Ralph Richard Banks, who has written a book titled: Is Marriage for White People? He argues that the trends in the black community are a preview of what will occur in the white community.

There is a discussion of Banks and his book in The Economist that provides this chart.

The similarity in trend is obvious, with the major difference being the starting point. What does this portend?

"The collapse of marriage among blacks is well documented (see chart), but not the sexual, psychological, emotional and social toll this has taken on black women. Seven out of ten are single. Of the others, many are forced into ‘man-sharing’."

"Many black women respond by ‘marrying down, but not out,’ as Mr Banks puts it. But that makes bad marriages. Two out of every three black marriages fail, about twice the rate of white marriages."

The desirable black men seem to love this situation; having the pick of women does not encourage commitment to any one on them. Black women have the choice of marrying down or putting up with "players." If they do choose to marry it usually ends poorly.

Bolick states that these trends are becoming apparent in the white community where indicators of family and social stability are falling.

"Just as the decline of marriage in the black underclass augured the decline of marriage in the white underclass, the decline of marriage in the black middle class has prefigured the decline of marriage in the white middle class."

Why should we as a society be concerned about all this? Individual men and women will suffer their fates or find their ways through these issues. It is the residue of failed marriages and failed parents that we as a society will be responsible for. Failed marriages tend to produce troubled children. Men who fall out of the economy will continue to breed and become role models for their offspring.

The fear is that this situation could lead to a downward spiral with a permanent and growing underclass that is unable, or incapable, of competing economically.

Our Politics and Our "Ethnoregional Nations"

In reading Senator Jim Webb’s book, Born Fighting, about his Scots-Irish ancestors I was struck by the characteristics attributed to them: extreme individualism, distrust of authority, and strong evangelical Christian beliefs. The attempt was made to identify these people and their descendents with what has become known as the Tea Party: Born Fighting by Jim Webb. It seemed like such an obvious overlay of characteristics. Kevin Phillips, in his book American Theocracy, had already demonstrated that a map illustrating the location of the Scots-Irish and their immigration pattern out of the Appalachian regions overlaid nicely with the Republican, red-state voting pattern.

Alec MacGillis has an article in the Washington Post that discusses the book American Nations by Colin Woodard that lends further support to the association of Scots-Irish heritage and the current Republican Party. They will be referred to here also as "Borderlanders." The people known as the Scots-Irish originated in the borderlands between England and Scotland where they became devout Calvinists. They immigrated to Northern Ireland and became the cheap labor for the British plantations, and trusty Protestant allies against the indigenous Catholic Irish. It is from Ireland that hundreds of thousands then immigrated to the USA, thus picking up the label Scots-Irish. They ended up settling in the Appalachian areas because their culture and religion made them unwelcome in the coastal lowlands dominated by the better-educated Anglican English.

MacGillis begins with this anecdote:

"The day after the 2008 election, a remarkable map began making the rounds online. It showed the counties where John McCain had won more of the vote than George W. Bush had in his victory four years earlier. It was a nearly contiguous swath of the country, stretching from southwestern Pennsylvania through Appalachia, west across the upland South and into Oklahoma and north-central Texas."

"Presumably, something other than a singular affection for the latest Republican presidential candidate had allowed McCain to outperform Bush in this neck of the woods. But still, why this exact outline of the anti-Obama vote? What was behind it?"

Woodard’s book provides the necessary background.

"As Woodard sees it, the continent has long been divided into 11 rival regional "nations" determined by centuries-old settlement patterns. Yankeedom stretches from the Puritans’ New England to the land settled by their descendants in Upstate New York and the upper Midwest. New Netherland is Greater New York City, more interested in making money than in Yankee moralizing."

"The Midlands stretch from once-Quaker Philadelphia across the heart of the Midwest — German-dominated, open-minded and less inclined toward activist government than Yankeedom. Cavalier-founded Tidewater once ruled supreme but was hemmed in and saw its clout fade."

"The Deep South stretches to East Texas, long in tension but less so now with the Borderlanders, the feisty, individualistic Scots-Irish who scorned both the community-minded Yankees and the aristocrats of the Tidewater and the Deep South. The Borderlanders’ domain spans Appalachia, the southern Midwest and the upland South — the McCain stronghold described above."

Woodard takes the view that our history, past and present, is not easily understood unless one takes into consideration these regional differences.

"These nations looked different from the start: Where Yankeedom had countless towns, Tidewater had barely any — planters simply delivered supplies to their estates up the Chesapeake’s tributaries. The nations mistrusted each other deeply. And they often resorted to arms — the book reminds us of long-forgotten conflicts such as the Paxton Boys’ Borderlander assault on Midlander Philadelphia in 1764 and the Yankee-Pennamite wars in northern Pennsylvania in the late 18th century."

"In Woodard’s retelling, the country was unified in spite of itself. The Revolutionary War was a true insurgency only in Yankeedom; meanwhile, New Netherland became a Loyalist refuge, the pacifist-minded Midlanders lay low, the Deep Southern planters calculated how best to preserve (and expand) their slave economy, the Tidewater split into two camps, and the Borderlanders wrestled over whom they hated more — the British or the coastal elites oppressing them."

Woodard provides us with a concise summary of our recent political history.

"’Since 1877, the driving force in American politics hasn’t primarily been a class struggle or tension between agrarian and commercial interests, or even between competing partisan ideologies, although each has played a role,’ Woodard writes. ‘Ultimately, the determinative political struggle has been a clash between shifting coalitions of ethnoregional nations, one invariably headed by the Deep South, the other by Yankeedom’."

It would seem that culture is an enduring entity. Over two hundred years of living in the same country and initial characteristics persist. Thanks to Woodard and MacGillis for providing such illuminating information.

China Has a Health Crisis

China has been blessed by rapid economic growth for many years now. Many seem to believe that this growth can and will continue. In order to reach such elevated levels of economic activity, China has had to neglect other areas critical to its society. At some point it will have to pay the price for that neglect. We recently wrote of China’s Environmental Burden, which was based on the book The River Runs Black: The Environmental Challenge to China’s Future by Elizabeth C. Economy. China’s environmental issues are enormous and will be costly to remedy. They also constitute a major health problem. Yanzhong Huang provides an article in Foreign Affairs that addresses China’s health issues: The Sick Man of Asia: China’s Health Crisis. Huang issues a similar warning about China’s accumulating deficit in healthcare. Both issues will impact its economy and its society.

Huang provides this interesting insight: under Mao’s leadership the life expectancy increased from 35 years to 65 years, while under the current regime it increased only about five years between 1981 and 2009, a comparable period. To put this in context, Huang points out that other countries having similar life expectancies in 1981attained much better results with expectancy growth in the range 7-14 years. Countries in this category include Columbia, Malaysia, Mexico, and South Korea. Mao had set up a crude but functional process for training large numbers of people who could contribute to healthcare and wellness even in the most rural of regions. This system fell into decay when the new order took power and the focus changed towards economic growth.

What are the consequences of neglecting the health of its citizens?

"As a result, communicable diseases that had been all but eradicated during the Mao era reemerged and spread quickly in the 1980s."

"Like many less developed countries, China still battles a legion of microbial and viral threats, including HIV/AIDS, tuberculosis, viral hepatitis, and rabies. For instance, more than 130 million people in China have the hepatitis B virus -- accounting for about one-third of all HBV carriers in the world."

Perhaps more ominous is data that indicates the ills of a poor society are being compounded by the maladies of a rich society.

"A 2010 study by The New England Journal of Medicine suggests that China has the largest population of diabetics in the world and that the disease is spreading at a faster rate there than in Europe and the United States. Nearly ten percent of adults aged 20 or more in China now have diabetes -- close to the rate in the United States (11 percent) and far higher than those in Canada, Germany, and other Western countries. Noncommunicable diseases, including cardiovascular disease, chronic respiratory diseases, and cancer, account for 85 percent of total deaths in China today -- much higher than the average worldwide, which is 60 percent."

For some reason even mental health seems to be a problem.

"Data from the Ministry of Health suggest that the incidence of mental disorders climbed by more than 50 percent between 2003 and 2008. A major national survey conducted between 2001 and 2005 partly by the Beijing Suicide Research and Prevention Center at Beijing Huilongguan Hospital and based on interviews with 113 million Chinese throughout four provinces found that 17.5 percent of the population, or more than 227 million Chinese, suffered from some form of mental problem, such as mood and anxiety disorders. This is one of the highest such rates in the world. An estimated 287,000 people kill themselves in China each year; at 23 per 100,000, this, too, is one of the highest such rates worldwide and more than twice the suicide rate in the United States."

Huang also visits some of the environmental issues.

"According to a Ministry of Health report, the operations of 16 million companies and factories in China are poisonous or hazardous, and about 200 million workers are directly exposed to occupational hazards. Because of industrial pollution, especially water contamination in the countryside, China now counts 459 so-called cancer villages, villages with an unusually high number of cancer patients. Environmental pollution is also believed to have significantly increased the infertility rate for all couples of childbearing age, from three percent in 1990 to 12.5–15.0 percent today. According to a 2009 epidemiological study by the nongovernmental organizations China Women and Children Development Center and the Population Association of China, more than 40 million couples in mainland China may now be infertile."

Huang details how healthcare has been organized and then reorganized over the years. It makes interesting reading. Suffice it to say that the central government has recognized the problem and is trying to address it.

We tend to think of China as a strictly regulated country where a few decision makers formulate policy that is implemented nationwide according to their will. Both Huang on healthcare and Elizabeth Economy on the environment make the same point: the central government is unable to control what occurs in the provinces.

"....Chinese officials, especially local ones, have little interest in promoting health care. Their lack of action is reinforced by multiple interest groups. The tobacco industry is resisting stricter controls, for example, and health-care providers and government health departments have sometimes colluded to hijack the reform of public hospitals."

"Another problem is the lack of bureaucratic capacity when it comes to health policy. In addition to an ill-defined fiscal system, which has crippled the government’s ability to fund public services, policymakers in China cannot effectively monitor the behavior of policy implementers. In democracies, there are citizen groups to keep misbehavior by officials in check. But as long as China refuses to enfranchise the general public to monitor administrative measures, upper-level bureaucratic actors will continue to be foiled in their efforts by their subordinates."

Both Huang and Economy fear that this failure in governance could generate public unrest sufficient to threaten the legitimacy of the rulers. Consider this factoid from Huang:

"The high costs and inaccessibility of health care lead to frequent disputes between patients and health-care providers, and these could easily devolve into violence. More than 73 percent of China’s hospitals reported violent conflicts between patients and health-care workers in 2005, and close to 77 percent of them reported instances in which patients refused to be discharged after treatment or to pay hospital charges. In 2010, Shenyang, the capital city of Liaoning Province, in northeastern China, sought to hire police officers to handle conflicts between patients and health-care providers at the city’s 23 major hospitals."

Elizabeth Economy provides a more general assessment:

"In China, societal discontent is evident everywhere. It is expressed in forms as diverse as labor unrest, mounting peasant protest, and increased ethnic violence. As the government has diminished its role in guiding the economy, its role in managing society has decreased as well. For this reason, it retains few levers to shape public opinion and action, with the exception of suppression or media and internet censorship. It is this discontent, if mobilized throughout the country and more specifically directed at the Communist Party, that Chinese authorities fear."

If China hopes to continue to grow its economy it will need greater internal consumption to balance its export sector. This will be hampered if its people feel a lack of security and save their money in fear of expensive health problems. It must also improve its governance if it to develop thriving local economies.

"According to a series of public opinion surveys published in 2009, respondents ranked corruption, health-care reform, and food and drug safety as their top three concerns."

China watching continues to enthrall. Stay tuned—it will be fascinating.

Saving Costs in Medicare

Medicare is a constant target for any deficit reduction study. It is a large and growing program whose share in the federal budget seems destined to only grow larger. The simplest proposals suggest cutting benefits, but since this is one of the country’s most popular programs, one has to stop and ask whether this is really necessary. Given all the fraud and waste in our healthcare system, it could be possible to produce sufficient savings to protect the core benefits under the program. Paul Starr provides an excellent summary of Medicare’s history and enumerates a number of areas in which savings are possible—some of which may be unfamiliar to most. The article titled The Medicare Bind appears in The American Prospect.

Solving the problem by converting to a voucher system, as suggested by the Republicans, is easily dismissed. This proposal is merely a copout that tries to eliminate the problem rather than solve it. It merely transfers cost from the public to individuals and forces them to participate in a much more expensive healthcare arena. It would be a disaster for the individuals affected and it would require an even greater fraction of our economy be devoted to healthcare.

More moderate proposals include raising the eligibility age, and some forms of means testing. Raising the eligibility age actually increases the cost of healthcare in the country and would be devastating for many who had to spend an extra year or two searching for healthcare coverage at their advanced ages. Means testing could be part of general reform package, but, by itself, it is not likely to provide the needed savings.

A number of initiatives were included in the recent healthcare reform bill that aimed at reducing costs and making healthcare more effective. The net impact of these is yet to be known, but it is interesting to note that the rate of growth of Medicare costs has diminished considerably. It is as if the medical community has finally realized that something must be done and it has begun to act on its own before being required to. The encouragement to move to Accountable Care Organizations may not follow the government-encouraged path, but the efficiencies of integration into larger medical practice units is so obvious that it is happening already.

Starr reviews a number of proposals that have received considerable discussion such as negotiating drug prices and raising revenue by including a modest deductible or co-pay from Medicare participants. There is also the rise in Medicare tax that supports Part A that is programmed to occur.

"As of 2013, under the Affordable Care Act, there will be an additional Medicare tax of 0.9 percent on earned income over $200,000 for individuals and $250,000 for married couples. Furthermore, in a major shift, the full tax (3.8 percent) will also apply for the first time to interest, dividends, rents, and other unearned income over the $200,000 and $250,000 thresholds. These new revenues are a key element in the Affordable Care Act’s strengthening of Medicare’s finances...."

Starr’s greatest contribution to the subject is to point out a number of obscure, but expensive, aspects of Medicare’s implementation. Consider the funding of hospital construction.

"The decision in the 1980s to continue paying for capital costs was particularly important. Because Medicare beneficiaries represented roughly 40 percent of hospital revenue, Medicare defrayed 40 percent of the cost of any new hospital investment. The federal government did not cover 40 percent of a new school building that a local district wanted to build, but it paid for 40 percent of a new wing built by the local hospital, no questions asked. Although capital costs have now been folded into Medicare’s prospective rates, the long contrast in federal policy toward health care and education helps explain why so many communities in the United States have gleaming hospitals and run-down schools."

And then there is Medicare’s support for graduate medical education.

"Medicare payments to teaching hospitals include direct support, covering such things as residents’ salaries, and indirect support for expenses associated with teaching, such as extra tests residents may order. But, according to the congressionally established Medicare Payment Advisory Commission (MedPAC), the true indirect costs are substantially lower than what Medicare has been paying. Besides cutting back that excess, the report from the deficit commission chaired by Democrat Erskine Bowles and Republican Alan Simpson recommends limiting the top salaries paid to medical residents to 120 percent of the national average, for a total savings of $60 billion through 2020."

Medicare has congressionally imposed restrictions on what it can and cannot do in terms of determining which procedures and medications are reimbursable. This stymies attempts at cost effectiveness, but Starr suggests some modifications in reimbursement that he refers to as "reference pricing."

"Medicare should adopt "generic reference pricing": If a physician prescribes a brand-name drug when a generic equivalent is available, Medicare should pay only as much as the generic drug costs."

"The concept of "reference pricing" has wider relevance beyond pharmaceuticals: If one medical procedure is no more effective than another for a particular condition but the second is less expensive, Medicare should pay providers only the lesser amount. Reference pricing should receive a boost from one of the major initiatives in health-care reform—research on the comparative effectiveness of different treatments, which ought to begin providing better data on what works at what cost and what doesn’t work at all."

Starr also suggests that Medicare overpays specialists at the expense of primary care physicians, providing skewed incentives toward these two physician categories.

"In determining physician payment levels, Medicare has for years relied on a private body with no accountability—the subspecialist-dominated Relative Value Scale Update Committee of the AMA, now being challenged by primary-care physicians because of a pattern of decision--making that has contributed to a wide disparity in incomes within the medical profession. Primary-care physicians earn median incomes that run $135,000 a year less than what subspecialists make, amounting to a gap of $3.5 million over the course of a career. That difference has contributed to the skewed incentives encouraging too few doctors to enter primary care."

Medicare also has the issue of regional variance in cost of treatment. A city in one location could be charging much more per Medicare participant than a similar city a hundred miles away. Often there is no other explanation for this than different medical treatment habits or fraud. The more expensive location does not provide better care.

"In the effort to achieve savings by reducing overtreatment, Medicare should focus on the regions with the highest costs per beneficiary. Led by John Wennberg, researchers at Dartmouth have highlighted the striking geographic differences in the use of medical services and pointed to local physician--practice patterns as a likely cause. Drawing on that research, a 2008 CBO report suggested that Medicare could cut its spending by 30 percent if high- and moderate-spending areas could cut their costs to those of the low-spending areas."

Surprisingly, Starr ignores fraud as an expense that can be reduced. The FBI estimates that 3-10% of healthcare costs are fraudulent. Medicare is probably a major target. If 5% of its costs could be eliminated by reducing fraud, that would add up to about $250B over a decade.

In sum, these proposals are capable of generating enormous savings over time. They are changes that protect the basic healthcare that seniors are now provided, and should be acceptable to both liberals and conservatives. Let us not make hasty decisions until we pursue these avenues.

Can—and Should—Bankers Be Prosecuted for Crimes?

The spate of books describing unethical, deceptive, and apparently illegal practices that led us into the housing bubble and the Great Recession have left many wondering why people have not been brought to trial for their actions. This lack of judicial action has generated frustration and the suspicion that bankers and financiers are less answerable to the law than other citizens. We have lived through the bailout, now where is the accountability? Jeff Madrick and Frank Partnoy address this issue in an article in The New York Review of Books: Should Some Bankers Be Prosecuted? Their answer is "yes."

The authors provide this summary of legal actions.

"In September 2011, the Securities and Exchange Commission asserted that overall it had charged seventy-three persons and entities with misconduct that led to or arose from the financial crisis, including misleading investors and concealing risks. But even the SEC’s highest- profile cases have let the defendants off lightly, and did not lead to criminal prosecutions. In 2010, Angelo Mozilo, the head of Countrywide Financial, the nation’s largest subprime mortgage underwriter, settled SEC charges that he misled mortgage buyers by paying a $22.5 million penalty and giving up $45 million of his gains. But Mozilo had made $129 million the year before the crisis began, and nearly another $300 million in the years before that. He did not have to admit to any guilt."

"The biggest SEC settlement thus far, alleging that Goldman Sachs misled investors about a complex mortgage product—telling investors to buy what had been conceived by some as a losing proposition—was for $550 million, a record of which the SEC boasted. But Goldman Sachs earned nearly $8.5 billion in 2010, the year of the settlement. No high-level executives at Goldman were sued or fined, and only one junior banker at Goldman was charged with fraud, in a civil case. A similar suit against JPMorgan resulted in a $153.6 million fine, but no criminal charges."

The Department of Justice has been provided documentation by various committees and agencies, but has yet to bring a case to trial. In fact, it has dropped a major investigation against Washington Mutual because the findings did not appear prosecutable under law.

The authors recognize that there are understandable reasons for such apparent timidity. Bringing down bankers would have economic consequences, and the financial lobby is very effective at influencing members of government. Bankers also try to protect themselves by making participants sign a statement saying that they are "sophisticated enough to understand the risks of the investment," a tactic that has worked in some cases.

However, the major reason for inaction probably lies within the financial laws themselves.

"To convict someone of criminal fraud under any of the [financial] laws we have mentioned, a prosecutor must prove both that the defendant misrepresented important facts to investors and also that he or she knew those facts were false. In other words, failure to disclose pertinent facts to investors out of sheer negligence can’t give rise to prosecutable fraud; there must be full knowledge that such essential information is not being disclosed."

While we can be charged with criminal negligence, bankers cannot. So bankers are held to a lower standard than normal citizens.

Proving criminal knowledge and intent is difficult, time and resource intensive, and it leads to uncertain results since jurors are easily confused about complex financial transactions. The result has been that government agencies usually settle for a fine rather than prosecute.

Madrick and Partnoy are sympathetic with the prosecutors over this dilemma. They assign fault to Congress for not strengthening these laws so that merely criminal negligence need be proven.

However, they argue that it is absolutely necessary for a legal precedent to be set. They compare the situation to the incidences of insider trading. In that case there is clear legal guidance and financial people have a definite indication of what is acceptable and what is prosecutable. Until a similar situation exists in banking, there is no motivation for financial people to resist pushing legal and ethical limits.

The authors indicate that the report by the Senate’s Permanent Subcommittee on Investigations (PSI), Wall Street and the Financial Crisis, contains a number of instances that could be prosecutable. They suggest one in particular where the evidence is particularly strong.

"The deal in question involves a $1.1 billion offering called Gemstone 7, assembled by the large German bank Deutsche Bank."

"The Gemstone 7 pool of mortgage bonds was particularly risky. Numerous e-mails uncovered by the PSI show that Deutsche Bank’s traders knew full well the risks of these securities. Almost a third of Gemstone 7’s securities were subprime mortgages issued by Long Beach, Fremont, and New Century, three notoriously low-quality lenders, according to PSI analyses. According to the Senate report, Deutsche Bank’s own employees used words like ‘crap’ and ‘pigs’ to describe these mortgages, and the bank’s traders even bet against some of these securities themselves."

Madrick and Partnoy believe it is critical that a prosecution be initiated in this or in a similar case.

"And if there were a guilty verdict, it would establish precedents that would make other prosecutions workable. Then—and perhaps only then—would a strong deterrence against such activities be created. If prosecutors are paralyzed by fear of losses and the complexity of these cases, justice may never be done."

And if this doesn’t work, then perhaps the solution is a full-fledged Occupy Congress movement to demand laws that allow financial criminals to be treated like criminals.

Is Big Oil Destined to Become Small Oil?

Following the notion that says all good things must come to an end, The Economist provides us with some data and a perhaps a new perspective on the future facing some of the least popular companies: Exxon, BP, Shell.... 

The surest way to make money in the oil business is to sell a lot of it at a very high price. The aforementioned companies are making huge profits right now by selling a lot of oil at a very high price. The Economist reminds us that to sell great quantities of oil, one has to possess great quantities of oil. This graph is provided to raise the question as to how long these outfits can continue to slurp from the trough.

Mighty Exxon doesn’t even make it into the top ten in terms of proven reserves. Shell and BP barely make it into the top twenty.

The past provided good times for the big international oil companies because even when they did not control the fields containing the oil, they controlled the technology required to extract it. That is no longer the case. Most oil is now controlled by national oil companies that have gradually been accumulating their own expertise.

"And the smart ones are arguably a bigger problem for the supermajors, since they are muscling onto their turf. They have pockets deeper than any well. And after years of working with the supermajors, their technical expertise is growing. Norway’s Statoil is a match for almost anyone. Brazil’s Petrobras is developing its own technologies to exploit ultra-deep water. Both are forming partnerships with other state-backed firms."

"And when it comes to discovering new barrels, the supermajors find that smaller and nimbler firms (such as Britain’s Tullow and Cairn and America’s Anadarko) are often better at it. In years gone by the supermajors would typically find four or five of the largest new oilfields every year, says David Branson of Booz and Company, a consultancy. Now they discover one or two."

The one area where the supermajors still have an advantage is in extracting oil from harsh environments. They also have an edge over smaller outfits where large amounts of capitalization are required.

Big oil exists on a slippery slope. When oil prices are high they extract large profits from their reserves and benefit from the rush to find newer more expensive sources. When oil prices fall, they suffer a double hit as the profits from their depleting reserves fall and interest in hard to extract oil dries up. There is also the long-term trend toward obsolescence as others continue to copy or exceed their technologies. Time is not on their side.

In pondering these uncertain future prospects, several thoughts come to mind:

"....creative destruction....survival of the fittest....couldn’t happen to nicer bunch of guys...."

Germany and the Minimum Wage

Given Germany’s tradition of healthy cooperation between employers and labor, it is surprising to learn that the country does not set a national minimum wage. A note in The Economist suggests that this is likely to change. Merkel’s party, the Christian Democratic Union (CDU), is likely to finally back a minimum wage that will be applied nationwide.
"Germany is one of the few European countries to lack a statutory minimum wage. Unions and employers negotiate wages sector by sector. In ten sectors agreed minimums apply to all. But jobs are growing in fragmented services not in manufacturing. Just over half of workers in western Germany are now covered by central agreements; in the east it is only a third. In 2007, 3.7m workers earned under €7 ($9) an hour and 1.2m under €5."

"The opposition Social Democrats and Greens have long backed a minimum wage. Now CDU leaders have endorsed a plan for a "binding lower limit for wages", set by an independent body representing unions and employers, similar to Britain’s Low Pay Commission. The expectation is that it will be close to the floor for temporary workers: €7.79 in the west and €6.89 in the east."

The author suggests that two factors played a role in the CDU’s change of heart. Interestingly enough, the world-wide concern over inequality, and the associated demonstrations, seem to have generated some concern on the part of the politicians. Even more interesting is the fact that the German legislators are beginning to realize that the conventional wisdom about setting a minimum is, in fact, false.

"A 2010 study said that a €7.50 minimum could eliminate 840,000 jobs at a cost of €4 billion a year."

As is often the case, economic projections are based on philosophy rather than data. What are the facts on the ground?

"Studies of eight sectors that have minimum wages commissioned by the labour ministry show little damage to employment. 'This contradicts all the fears of mainstream economists in Germany,' says Gerhard Bosch of the University of Duisburg-Essen."

All of you out there waving banners and camping out in the cold—keep the faith. You are likely accomplishing something even if you can’t recognize it yet.

"’This was a movement that came from the bottom up,’ says Karl-Josef Laumann, chief of the workers’ branch of the CDU. ‘If you work for eight hours you should be able to live from your wages’."

The concept of a "living wage" is an interesting one. Such thought are of little interest in the US because our politicians always think in terms of benefits to corporations. But, in effect, we do recognize the fact that a wage earner is not going to be allowed to die of hunger or exposure. Ultimately, the government provides sustenance in various subsidies: Food Stamps, Earned Income Tax Credit, Medicaid..... For some reason we seem to be more comfortable with the notion of support as a charitable act rather than as a right; we assemble a degrading and inefficient means of letting people know that they are failures.

We have the same arguments for why a higher minimum wage would be beneficial, but the conventional wisdom trumps all—no matter the data to the contrary. Perhaps if Germany provides us with one more data point, people will take notice.

Healthcare in China: Encouraging Children to Smoke

China watching is endlessly fascinating. One class of pundits views China’s ascendency as inevitable with its size and market prowess exerting great influence over all the nations of the world. Another views China and its economy as unconditionally unstable with a future of bursting economic bubbles, environmental Armageddon, or revolution—or all of the above. A third is convinced that China will be forced by social and economic forces to slow its growth and assume a development path similar to that of other BRIC-like countries.

A recent article by Yanzhong Huang in Foreign Affairs reminds us of social debts that China is accumulating in its frenzy to maximize economic growth—debts that are beginning to fall due. Huang’s focus is healthcare in China: The Sick Man of Asia: China’s Health Crisis. Much of China’s developing health problems will be derived from environmental issues that lead to birth defects, infertility, high cancer rates, lead poisoning, atmospheric pollution..... The list is quite extensive.

"A 2011 report by some of China’s leading economists and public health experts estimates that in 2005, disease cost more than five billion working days and 2.4 trillion yuan ($296 billion) in lost economic activity -- about 13 percent of China’s GDP."

"A 2004 survey conducted by the Development Research Center of the State Council found that disease and injury were the leading cause of poverty in rural areas: almost 41 percent of the farmers below the poverty line (defined by the government as annual earnings of 860 yuan, or $106 at the time) reported having fallen below it after they became sick or injured."

Huang’s article is long and detailed in providing a history of healthcare in China from Mao to the present day. More will come from that excellent article, but here the focus will be on one aspect of the issue: smoking.

A Businessweek article by Daryl Loo provides some insight into how China is dealing with the issue—or not dealing with it: For Chinese Students, Smoking Isn’t All Bad.

While China officially goes through the motions of discouraging the habit, what is actually occurring is something quite different. Some background statistics:

"China has more than 320 million smokers, a third of the world’s total, and 53 percent of men there smoke. About 1 million Chinese die from tobacco-related illnesses every year. The tobacco industry grew at an average annual rate of 19 percent from 2006 to 2010, according to State Tobacco. Last year, earnings rose 17 percent, to ¥605 billion ($95 billion), including ¥499 billion paid in taxes."

It is not surprising that smoking is common when the regulator happens to be the world’s biggest cigarette maker.

"Anti-tobacco groups say efforts in China to reduce sales, including a ban on smoking in public places introduced in May, have been hampered by light penalties, a lack of education about the dangers of smoking, and the fact that the regulator, the State Tobacco Monopoly Administration, also runs the world’s biggest cigarette maker."

What was so striking about this article was the photo lead-in, which showed two Chinese boys (probably under ten years old) puffing away. The tie-in was the fact that the tobacco industry builds schools around the country as a means of advertising their product, in hopes of getting the children to take up smoking.

"In dozens of rural villages in China’s western provinces, one of the first things primary school kids learn is what helps make their education possible: tobacco. The schools are sponsored by local units of China’s state-owned cigarette monopoly, China National Tobacco. ‘On the gates of these schools you’ll see slogans that say "Genius comes from hard work—tobacco helps you become talented,"’ says Xu Guihua, secretary general of the Chinese Association on Tobacco Control, a privately funded lobbying group. ‘They are pinning their hopes on young people taking up smoking’."

One of the most striking impressions of China is the extent to which greed will drive people to injure their neighbors: tainted milk, tainted toys, tainted food. Children always seem to be the most vulnerable. Somehow the notion of allowing the school system to become an enticement to take up smoking seems beyond the pale—even in China. Then again, perhaps the nasty habit is of less consequence than one might fear.

Elizabeth C. Economy, in her book The River Runs Black, brings us this perspective on what it means to inhale in China today.

"China’s poor air quality, too, has serious implications for public health. A joint study by the World Bank and SEPA in 2007 estimated that 650,000 and 700,000 people in China die prematurely from air pollution annually. In the country’s most polluted cities, when children breathe, it is the equivalent of smoking two packs of cigarettes per day."

Yes, there will be a big healthcare bill in the future.

Are Teachers Overpaid? It Depends on Your Political Party

Jordan Weissmann produced an article in the Atlantic that provides a perfect example of the adage that goes something like this: "There’s lies, there’s damned lies, and then there’s statistics." The subject is teachers’ salaries, and the issue is how their salaries compare with non-teacher peers. Not surprisingly, there is a lot of leeway in deciding what a "peer" is; equally non-surprisingly the results tend to follow the political biases of the people performing the analysis.

Teachers have become an integral part of our political scene. They enter this realm because they play such a large role in education—a contentious subject at all times. They also tend to be unionized and supporters of the Democratic Party, which automatically makes them targets of the Republican Party. In addition, as mostly public employees, they are categorized as lazy, overpaid, and coddled by a significant fraction of the populace.

Weismann provides us with the results of four attempts to address the pay issue: two from conservative organizations, one from a progressive-leaning outfit, and one, supposedly politically neutral, from an international study.

Let’s begin with the Economic Policy Institute (EPI) which tends to lean left on economic issues. It runs a continuing study which is periodically updated (2010).

"....there are two key stats--pay versus other college graduates and pay versus ‘comparable’ occupations. How do they pick ‘comparable’ fields? Using skill level data compiled by the BLS [Bureau of Labor Statistics], which rates jobs based on factors such as complexity and the knowledge base required to perform it. When they last ran the analysis in 2008, the researchers settled on 16 different other professions, including accountants, reporters, registered nurses, computer programmers, and clergy."

"Overall, the EPI finds that teachers make about 12% less than other similarly educated workers. The picture only changes a little when you factor in benefits. Extrapolating from trends they found in 2006 data, the researchers estimate that total compensation for public school teachers lags by 9%. Compared to professions requiring similar skill levels, the wage gap was 14.3%."

Weissmann suggests these results could be criticized on the basis of weighing formal educational attainment too heavily, because it does not necessarily translate into skill or productivity. That is a reasonable concern, but then he questions the validity of comparing educational attainment when it is known that the most intellectually promising students tend to enter fields other than teaching. That presumption implies that the higher a person scores on SAT tests, the better able they would be to teach addition to first graders. The skill set required for that task is much different than that required to design and build microchips for computers for example. Consequently, I would reject that as a concern unless there was some form of evidence that teachers were too cognitively impaired to perform their duties.

The Manhattan Institute for Policy Research, a conservative outfit, produced a study in 2007 that tried to look at hours worked as a means of comparing teachers with other occupations. They used BLS data for urban areas around the country to arrive at their conclusions.

"Public school teachers did pretty well by the hour. In 2005, they worked an average of 36.5 hours per week at an average wage of $34.06 an hour. That was better than 61% of the other occupations the researchers examined, including architects, psychologists, chemists, mechanical engineers, economists, and journalists (!)."

The criticisms of this approach tend to focus on the BLS data base itself. The fact that the analysis arrived at a 36.5 hour workweek should make one a bit suspicious. All the professions mentioned could also consist of a significant fraction of public service workers. While one might conjure up an image of a chemist who is developing anti-cancer drugs (and highly reimbursed for the deed), most chemists with a bachelors or masters degree are probably in public service in one way or another, and certainly making a lot less money.

The Heritage Foundation and the American Enterprise Institute came up with a recent study that claimed to correct flaws in other such studies. Their intent is to demonstrate that teachers should be compared to other professions on the basis of cognitive ability. In other words, the higher the IQ, the higher one deserves to be paid. Quit giggling—these guys are serious. This "enlightened" approach provides the result that:

"....public school teachers take home total compensation that's 52% higher than ‘fair market levels’ for professionals with similar cognitive abilities."

"When education is taken into account, teachers salaries are more than 12% lower than their peers. But when measured based on cognitive skills, the salary gap evaporates. Once you factor in benefits such as retiree healthcare and pensions, total teacher compensation starts to eclipse what others in their cohort make. To top it all off, teachers tend to take a pay cut when they move to other professions."

Anyone who spends a day listening to the discourse of our elected officials immediately realizes that cognitive abilities have no correlation with success—in fact one would be justified in assuming an inverse relationship. This study allows that teachers have above average scores when it comes to measurements of cognitive ability. That should be sufficient in a profession that is as much an art as a skill-driven occupation. To be a good teacher, is a high IQ of more value than attributes like patience and empathy? This whole approach is rather silly.

Finally, Weissmann provides us with some data from the OECD that attempts to compare salaries for teachers in different countries. The OECD’s approach was again to try and compare the salaries of educational peers.

This study probably tells us something about the prestige associated with teaching in the various countries. On that basis the US falls in the bottom quartile—not a surprising result. Weissmann is justifiably concerned that the absolute value of the results might be inaccurate given the exceptionally low implied compensation rates. If the OECD’s intention was to exhort nations to spend more on education, this data would be supportive.

The studies also seem to imply that all occupations are created equal. Is it true that a teacher has the same value to society as a computer programmer or an accountant? I suspect the answer to that question will also depend on political orientation.

This discussion indicates that one can manipulate data in many ways to arrive at the result one desires. What is the casual reader to assume when the headline reads "Teachers are overpaid by 52%"? What is more frightening is that the media controls which of these studies one gets to hear about.

Russia and Its People: A Death Spiral?

Russia presents the bizarre image of a modern, supposedly well-educated society that is regressing in terms of health and social development. Its demographics have been discussed previously here. Nicholas Eberstadt summarizes the demographic issues and discusses some rather critical implications, both for Russia and for the rest of the world, in an article in Foreign Affairs: The Dying Bear.

There are a number of countries whose populations are close to, or are beginning to decrease. These include Germany, Italy and Japan. These nations face declining birth rates, but an ever healthier society. Russia is different in that its population decline comes from a declining birth rate and, uniquely for a modern nation, increased mortality rates.

"Since 1992, according to Rosstat, Russia's federal statistics agency....about 12.5 million more Russians have been buried than born -- or nearly three funerals for every two live deliveries for the past 20 years. Globally, in the years since World War II, there has been only one more horrific surfeit of deaths over births: in China in 1959-61, as a result of Mao Zedong's catastrophic Great Leap Forward."

In Russia, life expectancies have been falling for decades.

"According to estimates from the Human Mortality Database, a research consortium, overall life expectancy at birth in Russia was slightly lower in 2009 (the latest year for which figures are available) than in 1961, almost half a century earlier. The situation is even worse for Russia's adult population: in 2009, life expectancy at age 15 for all Russian adults was more than two years below its level in 1959; life expectancy for young men sank by almost four years over those two generations."

"By various measures, Russia's demographic indicators resemble those in many of the world's poorest and least developed societies. In 2009, overall life expectancy at age 15 was estimated to be lower in Russia than in Bangladesh, East Timor, Eritrea, Madagascar, Niger, and Yemen; even worse, Russia's adult male life expectancy was estimated to be lower than Sudan's, Rwanda's, and even AIDS-ravaged Botswana's. Although Russian women fare relatively better than Russian men, the mortality rate for Russian women of working age in 2009 was slightly higher than for working-age women in Bolivia, South America's poorest country; 20 years earlier, Russia's death rate for working-age women was 45 percent lower than Bolivia's."

Although Russians are among the heaviest smokers and are famous for their love of vodka, Eberstadt claims the explanation is more complex than that. For those interested in healthcare in Russia, a more detailed explanation can be found here. It seems that there may be nothing more mysterious going on than the combination of a people with atrocious personal habits residing in a country with an atrocious public health system.

Eberstadt’s concern in this article is focused on the consequences for Russia and the world of this state of affairs.

"There is also little evidence that Russia's political leadership has been able to enact policies that have any long-term hope of correcting this slide. This peacetime population crisis threatens Russia's economic outlook, its ambitions to modernize and develop, and quite possibly its security. In other words, Russia's demographic travails have terrible and outsized implications, both for those inside the country's borders and for those beyond. The humanitarian toll has already been immense, and the continuing economic cost threatens to be huge; no less important, Russia's demographic decline portends ominously for the external behavior of the Kremlin, which will have to confront a far less favorable power balance than it had been banking on."

Russia appears, on the surface, to be economically healthy. It has vast amounts of energy for sale to a needy world, but it has been unable to compete economically in other areas. As Eberstadt points out: even with all its wealth in natural resources Russia’s exports are on about the same level as that of tiny Belgium.

One is accustomed to think of Russia as a highly educated society with a long history of accomplishments in the arts and sciences. The actual situation is quite the contrary. One can go here to discover that Russian students on a whole have a reading proficiency that is equivalent to the US’s lowest performing region—Washington DC. On the international scale that puts Russia just behind Turkey and just ahead of Bulgaria.

The university system also has a superficial sheen of health with the fraction of its adult population with a postsecondary education "30 percentage points higher than the OECD average." However, there is little observable result from all that education. Eberstadt suggests that numbers of patent applications and numbers of scientific publications are indicators of a healthy economy. In these the education system is failing and the country is falling far behind its BRIC cohort of Brazil, India and China.

"In effect, Russia stands as a new and disturbing wonder in today's globalized world: a society characterized by high levels of schooling but low levels of health, knowledge, and education."

Measures of family life in Russia are equally ominous. The divorce rate in the soviet era was bad—since it has become even worse. While divorce rates seem to be growing everywhere in the developed world, Russia is again unique in that it provides little means of support for struggling single parents.

"Unlike Europeans or Americans, they can count on little support from social welfare programs. Although Western economic theory would suggest that having fewer children means that parents can invest more in each child, the opposite seems to be happening in Russia: despite its steep drop in births, the country has seen small but ominous decreases in primary school enrollment ratios and alarming increases in child abandonment. According to official statistics, more than 400,000 Russian children below 18 years of age lived in residential care as of 2004, meaning that almost one child in 70 was in a children's home, an orphanage, or a state-run boarding school. Russia is also home to a large and growing contingent of homeless children, which, according to some nongovernmental and charitable organizations, could very well exceed the number of youth under institutional care."

Added to dysfunction in the economy and in society, Russia is also an aging nation.

"The Census Bureau also anticipates that Russians 65 and older, a cohort that now makes up 13 percent of the country's population, will compose almost 19 percent in 2025. As a result of aging alone, per capita mortality in Russia would rise by more than 20 percent if nothing else changed. And given the immense negative momentum in public health among the Russian population today, attaining any long-term improvements in life expectancy promises to be a formidable task."

Russian population numbers have been propped up by immigration of millions of workers from former Soviet Union countries. There may be trouble growing on that front also.

"But the outlook for future immigration to Russia is clouded: changes in education policy throughout the former Soviet Union mean that today's immigrants from the Caucasus and Central Asia speak less Russian than their parents and thus have more difficultly integrating into Russian society. Meanwhile, the Russian public's attitude toward newcomers from those regions has grown less welcoming."

Eberstadt has concerns Russia will not be in a position to maintain its current status among nations. It has many issues to deal with, but a declining means with which to address them. Consider its Far East region on the other side of the Urals.

"....a region of over two million square miles and barely six million inhabitants. One-sixth of the population of this harsh and forbidding territory has moved out since 1989, and the exodus continues. Many Russian analysts and policymakers are worried about what will become of this resource-rich area that adjoins a rising and densely populated China."

This could be viewed as an opportunity for close economic integration with China and other neighbors, but it could also merely mean that Russia will at some point lose the force or will to retain this as a sovereign region—with unknowable international consequences.

Russia’s inability to develop an innovative economy that can complement its natural resource-based activities, also has implications for its military, where its defense capabilities seem to be living off of Soviet-era developments. It may even have trouble maintaining a military force of the requisite size.

"Maintaining the country's current force structure -- a military of more than a million soldiers, mainly comprising conscripts obliged to serve one-year terms of service -- will not be feasible in the years immediately ahead. Despite plans to transform Russia's armed forces into an all-volunteer service, the Russian military continues to be manned mainly by 18-year-old men. In 1990, slightly more than one million boys were born in Russia; by 1999, however, this number had dropped by 39 percent, to 626,000. Roughly speaking, this means that Russia's pool of prospective recruits is set to fall by almost two-fifths between 2008 and 2017. If Moscow is to prevent this dramatic drop-off in military manpower, it has only two choices: induct fewer qualified conscripts or extend the term of service under the draft beyond the current 12 months. The former is unpalatable because of the need for healthy and educated troops for modern militaries; the latter is politically impossible because of the immense unpopularity of the draft and the penurious wages paid to Russian soldiers."

Besides an inevitable need to come to terms with China in the Far East, Russia finds itself surrounded by countries with uncertain intentions and uncertain futures.

"Russia is surrounded by countries whose stability and comity in the decades ahead are anything but given: for example, Afghanistan, Iran, North Korea, Pakistan, and the Central Asian republics. If Russia's periphery becomes more unstable and threatening at the same time that Russia's rulers realize their relative power is waning, the Kremlin's behavior may well become less confident -- and more risky."

Eberstadt’s greatest fear seems to be an emerging Russia that is increasingly dysfunctional, but still striving to maintain past glories. No longer having the conventional military might to ensure its dominance, it will still have a vast arsenal of nuclear weapons at its disposal.

"Indeed, once the Kremlin finally confronts the true depths of the country's ugly demographic truths, Russia's political leaders could very well become more alarmist, mercurial, and confrontational in their international posture. And in the process, Moscow might become more prone to miscalculation when it comes to relations with both allies and rivals."

As a country, Russia has one of the more intriguing stories to tell. Stay tuned—it will be interesting!