[p2p-research] Fwd: High Wire: The Precarious Financial Lives of American Families

[Michel Bauwens]

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From: Valery GILBOS <revalery at gmail.com>
Date: Wed, Nov 12, 2008 at 12:34 AM
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To: Michel Bauwens <michelsub2004 at gmail.com>, Michel Bauwens
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 The New York Review of Books
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Volume 55, Number 18 · November 20, 2008
Trapped in the New 'You're on Your Own' World
By Robert M. Solow
High Wire: The Precarious Financial Lives of American Families
by Peter Gosselin

Basic Books, 374 pp., $26.95
1.

When the Bush-Cheney administration proposed to replace Social
Security with a system of individually accumulated, individually
owned, and individually invested accounts, my first thought was that
its goal was to take the Social out of Social Security. It took a few
minutes longer to realize that it also intended to take the Security
out of Social Security.

That attempt failed. In recent years, however, a mixture of public and
private policy decisions and impersonal market developments has had
the broad effect of shifting many financial risks from established
institutions, including even society at large, to individuals who are
unable to cope with them in an adequate way. Information may be
impossibly difficult for citizens to process; or else the basic
information may not be available to individuals or private groups.
Sometimes the scale of the possible bad outcomes may be overwhelming.
Sometimes the appropriate insurance market cannot function or just
does not exist. The result is that individuals and families can be the
casualties of situations that once would have been handled by a more
centralized and more bearable allocation of risks.

The current turmoil in credit markets and the recession that is sure
to follow are likely to drive this trend further. Banks, insurance
companies, and other financial institutions have seen too many risks
go sour. They will be more determined than ever to push further risks
onto those needy borrowers who are too weak and too ignorant to
bargain hard. Families, small businesses, and other borrowers of last
resort will be under great pressure.

Peter Gosselin's excellent and thoughtful book, High Wire: The
Precarious Financial Lives of American Families, is not the first to
explore this territory. Two others that come to mind are Louis
Uchitelle's The Disposable American[1] and Jacob Hacker's The Great
Risk Shift.[2] Gosselin is like Uchitelle in combining social
criticism with substantial stories of recognizable people who have
been trapped by bad luck or bad judgment in this new
you're-on-your-own world; he differs in covering a much broader
variety of risks and risk-bearers than Uchitelle's focus on workers
and job-related risks. Hacker's book also ranges over many issues, but
does not have Gosselin's expert journalistic use of recognizable
cases. (Professor Hacker is currently engaged in a Rockefeller
Foundation–sponsored effort to construct a general "Index of Economic
Security"—to show empirically how economic security varies over time
and across social groups.)

Gosselin, who works in the Washington bureau of the Los Angeles Times,
does a fine job of connecting the stories he tells to general ideas
and to economy- wide statistical markers, some developed for his
particular purpose. He has produced a readable and valuable book. In
this connection it cheers me up to see how he has profited from a stay
at the Urban Institute, a leading non- ideological research center in
Washington. (I am on the board of the Urban Institute, but our paths
never crossed there, though we are acquainted.)
2.

A grasp of the basic principles of insurance will provide
indispensable background for understanding both the scope of
Gosselin's argument and also the possible remedies for the failure of
social arrangements that he highlights. So I include a brief primer on
that subject, using the relatively straightforward example of fire
insurance.

Imagine a population of a million similar families, living in a
million more or less similar houses. From long experience it is known
that the chance that any given family will suffer a severe fire in any
given year is about one in ten thousand. In other words, we can expect
about a hundred fires per year. The same experience tells us that the
average amount of damage per fire is $200,000. So the total damage per
year is some $20 million. Serious house fires are rare, but when one
occurs it is devastating to the unlucky family.

The existence of fire insurance makes an enormous difference. If each
of the million families pays an insurance premium of $20 a year, all
damages can be reimbursed. Major house fires would still not be
welcome events; but they would not be financially catastrophic. The
small probability of a large loss is eliminated, and replaced by a
small but certain cost. Insurance companies would have to charge a bit
more than $20 per house, to cover administrative costs and profit.
Also companies would have to build up a reserve, to allow for the fact
that annual losses would surely fluctuate around the average of $20
million, with an occasional bad year. On the other side of the ledger,
investment of the reserves, presumably in reasonably safe and liquid
securities, would offset at least some of the costs of the system.

Nevertheless, fire insurance has its problems, two in particular.
Notice, first, that the existence of fire insurance does nothing to
diminish the number of fires. Insurance is a way of pooling or sharing
risks, not of eliminating them. In fact the opposite is true: the
existence of fire insurance probably increases the number of fires. In
the absence of insurance, one has to expect that home owners will be
very careful about loose matches, old soldering irons, and other such
dangers. The knowledge that they are fully covered may lead to some
carelessness, and to more fires. This sort of effect is called "moral
hazard." (It is why subsidized flood insurance encourages people to
live in flood plains.) Insurance companies have devices to discourage
moral hazard. Deductibles and co-payments are two such devices: no
fire is costless to the insuree. Required precautions are another
device; every insured home is supposed to have an approved
extinguisher and smoke alarms.

The second problem is different. All houses are not alike, after all.
Some are more fire-prone than others. To take an extreme case, suppose
that 90 percent of the million homes have, for various reasons,
essentially no risk of fire. The hundred fires per year all come from
the remaining 100,000, each with a probability of one in one thousand.
They are responsible for the annual damage cost of $20 million. The
900,000 fire-free home owners very likely know this. They are in
effect subsidizing the fire-prone houses, so they will choose not to
buy insurance. Only the fire-prone homes will be in the market.

This is called "adverse selection." To be viable, insurance companies
will have to charge a premium of $200 per year, and even some of the
fire-prone home owners may balk. You can easily imagine how the whole
insurance market might unravel if there are houses of many degrees of
fire-proneness: each time the rate rises, the least vulnerable, least
fire-prone customers may drop out, leading to a still higher rate and
still more dropouts. Insurance companies may respond by refusing
coverage altogether to very fire-prone houses (or refusing health
insurance to people who look as if they might actually become
seriously—or expensively—sick). Modern information technology and
data-mining techniques make it possible for insurance companies to
pinpoint the known risks associated with individual applicants and
quote "appropriate" rates.

Naturally, they do; but this only further undermines the insurance
principle. Unless something drastic is done about it, adverse
selection can lead to a situation in which precisely those who need
insurance most cannot get it, or cannot afford it. Keep in mind that
it is in the self-interest of the safe or healthy not to be in the
same insurance pool, paying the same rate, as the fire- or
sickness-prone, because they will be paying in more than the costs
they incur, so that others can pay in less. In such cases, if adequate
insurance is to be provided, there may have to be external regulation
or direct public provision.
3.

Gosselin interprets his theme broadly, and his book covers a lot of
ground. A sample of topics will convey the scope:

(1) A marked tendency for incomes to become more subject to large
fluctuations, especially recently, so that both poor and moderately
affluent people are increasingly exposed to the risk of a large—like
50 percent—drop in income from one year to the next.

(2) The growing unwillingness of employers to support defined-benefit
pension plans that impose on them the obligation to pay benefits based
on previous earnings to retired employees, and the replacement of such
plans by defined-contribution plans, 401(k) and others. These leave
the retirees facing the possibility that their own bad investment
choices or just the accident of retirement during a down period in the
securities markets will reduce eventual benefits below normal
expectations. This risk is on top of the well-known fact that many
employees, out of ignorance, inattention, or inertia, simply fail to
accept clearly favorable options when offered, and for the same
reasons, as well as bad luck, often invest predictably badly. It seems
inevitable that the recent volatility in equity markets will induce
even more employers to convert pension plans to forms that leave the
risks of stock market and bond market fluctuations squarely on the
employees.

(3) The erosion of employer-provided health insurance, and the
occasional tendency of insurance companies to welsh on expected
benefits, either by appealing to small print in the contract or simply
by stonewalling.

(4) The failure of the federal government to produce an organized plan
for the resettling of the victims of post-Katrina New Orleans, leaving
many former inhabitants with the Hobson's choice of either trying to
rebuild in the absence of any assurance that enough of their neighbors
will do the same, so as to render the old neighborhood livable, or
else abandoning their property and moving elsewhere.

That is quite an assortment of contingencies, and there are others.
What they have in common is that individuals have difficulty coping
with situations that combine high uncertainty and large potential
loss. Neither collective protection nor private insurance on
affordable terms is available to them. This striking variety of
circumstances adds interest and importance to High Wire, especially by
showing, with some drama, that the shifting of risks from institutions
to individuals occurs up and down the income scale, affecting the
apparently solid middle class as well as the poor.

This expository advantage comes at some cost, however. Different
circumstances implicate different aspects of the insurance principle.
Gosselin's agenda does not permit him to discuss them all in any
depth, or to show how they are related through the general properties
of insurance. I will try here to sketch a few of the complexities in
the hope of helping readers to see that the issues emphasized by
Gosselin's account are really quite central to major matters of social
policy.
4.

Start with the most general and most complex indicator of risk: the
year-to-year volatility of personal incomes. Gosselin's statistical
analysis confirms what others have found. Although precise results may
differ according to the source of the data, the time period, the
definition of income, and the population studied, the general
conclusion has to be that ordinary people are now more likely to
experience large fluctuations in earnings than they were three or four
decades ago. There is an element of paradox here: during the very same
period—from the mid-1990s to the present—year-to-year fluctuations in
national income have become noticeably milder, a fact that has come to
be called the Great Moderation. So the aggregate economy has become
more stable while individual fortunes have become less stable.

There is no arithmetic difficulty in this: your total calorie intake
per day could become more uniform even while the daily contributions
from meat, fish, fruits, and vegetables were coming to vary more
erratically. That would only require determination about your
consumption of calories. But it is natural to wonder why the economy
has evolved in this particular way. There are many possible
explanations, and many of them can be true. Rapid technological change
may be eliminating long-tenure jobs and the continuity of income that
they bring. The general shift in employment away from the production
of material goods and toward the production of services tends to
stabilize aggregate employment and income, because the demand for
services is less vulnerable to the business cycle than the demand for
goods; but job shifts and job destruction within the service sector
may have become more frequent. More broadly, as an economy gets
richer, and necessities form a smaller portion of expenditure, the
whims of fad, fashion, and minor changes in tastes can lead to erratic
fluctuations in the market value of particular skills and occupations,
and thus to volatility of individual earnings. Whatever the underlying
explanation, the fact remains.

Statistical volatility is an abstract fact. Gosselin humanizes it by
choosing as his basic indicator the chance that a person or family
will experience a year-to-year drop in income of more than 50 percent.
Sure enough, this probability almost doubled between the decades of
the 1970s and the 2000s, from one in twenty to about one in eleven.
(The probability of a 50+ percent rise in income also increased from
about one in nine to one in seven. Volatility works both ways, but it
is the bad surprises that hurt.)

Then Gosselin does an interesting thing. What sorts of contingencies
would lead to such a drastic and sudden reduction in a family's
income? The obvious suspects are major unemployment, illness,
retirement or disability, divorce or separation, death of a spouse,
even birth of a child leading to one parent's withdrawal from a job.
Adding all these together, Gosselin finds that their combined
incidence was somewhat lower in the decade between 1994 and 2003 than
it had been between 1974 and 1983. If one of them happens, however,
the chance that it leads to a 50 percent drop in income was much
higher in the later period than in the earlier one. So it is the
financial risk that has jumped, not the generic hard luck. This sounds
suspiciously like the tearing of a safety net. Welcome to the world of
Individual Responsibility—the approach to economic security that has
been advocated by government and the private sector in recent years.

There is a market-based way to deal with these bad episodes. Careful,
foresighted individuals and families can save some or all of their
favorable windfalls—those increases that are 50 percent, or greater or
smaller ones—and use them, and borrow if necessary, to smooth over the
bad patches. This hap-pens, to a statistically visible extent. Family
spending on consumption is in fact less volatile than family income.
So families do smooth the income peaks and valleys on their own. No
doubt the sequence of saving and borrowing is at work, but borrowing
is costly, and there may be other mechanisms operating, like
contributions from extended family or charities. All but the most
affluent families must pay a much higher interest rate when they
borrow than the interest they earn when they save, so income smoothing
is not as easy as it sounds, and is certainly expensive.

Now instead, imagine constructing a sort of income insurance policy.
We do have unemployment insurance, but it typically replaces only half
or less of wages and expires after twenty-six weeks. (Another thirteen
weeks have been tacked on temporarily as a response to the current
slowdown or recession.) At least in fantasy one can imagine a broader
policy to insure incomes that collects regular income- related
premiums from policyholders and promises in return to replace a
substantial part of any shortfall from some defined average income
that would have to be determined for each policyholder separately.

But it is hard to imagine a private insurance company offering such a
policy on anything like workable terms. The standard difficulties
besetting any insurance scheme would be much too acute. The moral
hazard problem—the danger that individuals would use the insurance as
a way to take frequent holidays from work—could perhaps be partially
controlled. For example, limiting insurance benefits to the
replacement of only a small fraction of the shortfall from "average"
income is analogous to a large co-payment or deductible; but if the
replacement fraction is very small, the risk reduction conferred by
insurance is also very small. Alternatively it might be possible for
the insurance company to require valid certification that the reported
income shortfall is not voluntary; the analogy is then to an outside
medical examination in disability insurance. Even so, moral hazard
surely does not disappear.

The adverse selection problem for private income insurance seems an
order of magnitude tougher. Most individuals know more about their own
income prospects than any insurance company could ever find out.
Inevitably the insurance rolls would be filled with potential losers
and risk-takers. Those with conservative temperaments and relatively
secure jobs and those who can pretty safely look forward to stable or
rising income with increasing experience and seniority would be
sensibly inclined to avoid the stiff insurance premium and protect
themselves against stepping on broken glass and other bad luck by
saving up for the rare and unpredictable rainy day. It is hard to see
how a universal private market for income insurance could survive.

But—and this is where the argument has really been leading—why does it
have to be private? Gosselin is aware, though many have forgotten,
that the idea of "social insurance" would once have seemed far more
natural than it does today. Think again about the contrast between
Roosevelt's Social Security and the Bush-Cheney "Ownership Society."
It is not just a matter of this or that piece of legislation. The
thought underlying social insurance is that life is a gamble,
especially economic life. There will be winners and serious losers.
The losers are singled out by bad luck, or occasional bad judgment, or
even the wrong personal idiosyncrasy at the wrong time. In any case,
we are in a sense all better off if we share the risk of losing and
convert the small risk of damaging loss into a small, universal, and
certain cost. This may have been a more natural frame of mind in the
Great Depression of the 1930s than during the Great Moderation, when
income growth was strong and inflation was relatively stable.

The irony is that the very fact of the Great Moderation makes social
insurance more easily practical. When the national income is stable
and secure, the allocation of a small fraction of it to the
stabilization or near stabilization of individual incomes is at worst
a minor burden and a widely shared burden. The otherwise difficult
problem of adverse selection is essentially nullified because the
insurance pool is not self-selected, but is by definition the whole
society; the social insurance premium takes the form of a tax. (It is
probably a good idea for benefits under an income insurance scheme to
be part of taxable income: the more "normal" the better.)

Moral hazard, however, is always with us. It is plausible that a
state-run universal social insurance system would be better able than
a private company to detect and prevent exploitation of the system by
malingerers. Maybe success would depend on the creation of a norm of
good citizenship; something like that underlies the establishment of
social insurance in the first place. It seems to work in the Nordic
countries—though not without strain—where the tradition of social
insurance is strongest. The US has a long way to go. Gosselin cleverly
cites the Mayflower Compact and its proposal to create such laws and
regulations "as shall be thought most meet and convenient for the
general good of the Colony, unto which we promise all due submission
and obedience." That is indeed a long way from where we are now.
Gosselin mentions that forty-one of fifty men on board signed.
5.

The other important institution that has been engaged in shifting risk
to individuals is the business firm as employer, especially the large
firm. The main risks to think about are those connected with nonwage
benefits like pensions and health care. (It is also important that the
average length of job tenure has been decreasing, but that has many
causes and is best dealt with as part of the general issue of income
volatility.) Health care is a specialized subject unto itself, and I
will not dwell on it. But there are some general principles underlying
this whole change in the landscape that are implicit in Gosselin's
excellent account, but need spelling out, so that we can understand
what is possible.

The first thing to understand is that changes in pension or other
benefit arrangements are not simply transfers between employer and
worker. Pretty clearly it is the total cost of an hour of labor that
matters to an employer, however it is divided between cash wages and
benefits. The preferences of workers are not so transparent; but
nonwage benefits are obviously very important, and it is a reasonable
first approximation that workers, like their employers, value a dollar
of wages about equally with a dollar of benefits. But then it is the
total cost of an hour of labor that the fundamental forces of the
labor market—whatever they are—must be determining. The allocation
between benefits and cash wages will depend on other factors, like tax
laws, the duration of contracts, transaction costs, and the like.

The point to remember is that one cannot really talk about benefits as
if they were independent of wages. Anything that happens to one of
them will affect the other. By the way, between December 1998 and
December 2007, according to the Department of Labor's Employment Cost
Index, wage and salary costs per hour in US private industry increased
by 32 percent and hourly benefit costs, including health benefits, by
50 percent (both uncorrected for inflation). That tells us something
about levels of spending, but does not speak to the question of
risk-bearing. One suspects that most businesses, as they shift from
defined-benefit to defined-contribution pension plans such as the
401(k), have also taken the opportunity to reduce their pension costs,
and thus their total labor costs, overall. It would be interesting to
have comprehensive data on that point, but I do not know of any.

The usual story is that US businesses have had to put heavier pressure
on labor costs as they faced intensified competition from imports
generally and especially those from emerging economies with low wages
and negligible benefits. It is also thought that technological changes
have had much the same effect: decreased demand and therefore downward
pressure on the wages and benefits of even moderately skilled labor.
There is certainly some truth in that kind of account.

The question, for Gosselin and his readers, is whether that is the
whole story, or whether there is another factor: a sea change in
public and private beliefs about the norms of the labor market, the
responsibilities of business firms, nonprofit organizations, and
governments toward the lot of their employees, clients, and citizens.
When Ronald Reagan fired the air traffic controllers in 1981, was he
just tending to the efficiency of the air transport system, or was he
also sending a message to the private economy that the implicit rules
of the game had changed and that unions could expect no protection,
much less sympathy? If the latter, it is a message that could also
extend to the behavior of insurance companies toward their
policyholders, and still elsewhere. Gosselin believes that the message
was intended and understood. If the government thinks that individuals
have no claim on society, but should stand or fall by their own
incapacities and mistakes, then business firms are surely not
responsible for picking up the pieces.
6.

Gosselin's last case study—the aftermath of Katrina in New Orleans—is
quite different from the others, but it has something in common with
them that is worth attention. He does not focus on the Lower Ninth
Ward; it is not news that poor black families do not attract the
attention or the assistance of our leaders. Instead he follows the
difficulties faced by a couple of reasonably well-off, rising,
property-owning families as they return to their devastated houses and
deserted neighborhoods, and try to decide what to do next.

When they think of rebuilding, they are handicapped by penny-pinching
authorities and incompetence. Clean-up lags, services are not
restored. Maybe worst of all, the Army Corps of Engineers cannot or
will not certify that the levees are sufficiently restored to protect
against the hundred-year flood; as a result, flood insurance is
unavailable, and lenders are unwilling to commit funds. That is
poignant but not unexpected. What connects all this to the rest of the
book is that the potential returnees are faced with a problem of
collective action. They could perhaps pull it off if they knew that
their neighbors were committed to the same effort, if there were good
reason to expect that a livable neighborhood would be recreated.

But that seems to be beyond reach. The neighbors are scattered and
uninformed. Many of them may be going through the same difficult
decision process and coming up against the same stumbling blocks.
There is no central agency or community organization offering
guidance, and no centralized source of funds to permit and reward
cooperation. The logical place to look was the federal government, but
the administration seemed to lack the will or the imagination or, more
likely, both. Gosselin makes a striking contrast with a nearby
community in which a long-standing Greek Orthodox religious group was
able to provide the needed organizational focus and access to
resources.

The analogy to social insurance is apparent. This is another case in
which individual action tends to unravel because the solution to the
problem has an all-or-nothing character—what economists call
increasing returns to scale—and because each individual's action
affects other individuals' decisions directly, and not through
prices—what economists call externalities. Individuals are asked to
take a chance that is just too risky for each of them alone.
Coordination at the center is required. A free-market economist would
see this. A free-market ideologue would not.
7.

The standard argument for leaving all the responsibility and decisions
to the individual in the free market is that, in appropriate
circumstances, that is the route, and maybe the only practical route,
to economic "efficiency." Any interference is a "distortion," and the
consequence of such distortion is that the economy produces less than
it could. (A more up-to-date version is that messing with the
atomistic market tends to cripple "innovation," but we actually know
little about how that works, in either direction.)

One standard counterargument is that the circumstances are not always
appropriate. The classic example is that private economic activity,
for instance, the burning of coal or oil in furnaces or cars, may
damage everyone's environment by emitting carbon dioxide and changing
the climate. In those cases, and there are many, market prices give
the wrong signals; regulation or taxation or subsidization is
justified precisely to restore efficiency. The New Orleans story is
another illustration of this point: perceptive government intervention
could have done much to assure the rebuilding of the city.

But efficiency is not the issue here, at least not the main issue. The
transfer of risk from social and private institutions to individuals
transfers a burden, mainly from the strong to the weak. That is
primarily an issue of equity. It will surely become more urgent in
current circumstances, perhaps urgent enough to be seen as a central
political issue. Suppose that the best way to relieve that burden is
by sharing the risk through universal social insurance. The premium
then has to be a tax, a tax on work or enterprise, or some productive
activity, and such a tax is a distortion, a source of inefficiency, a
true cost to society. What then? I know what Gosselin would say: a
society that won't pay a small cost to preserve equitable and fair
treatment of, among others, the sick, the old, the unemployed, and the
victims of natural disaster is not much of a society. Is that a
minority view?

—October 23, 2008

--
Rhe Gilbos
+856 (0)20 220 7600



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