By the time this edition of The Analyst is published, the U.S. presidential and congressional elections will be only ten weeks away. Hopes will be high that the world’s largest economy will be closer to breaking the stalemate in its trench warfare between the ideologues on the right and those on the left, who have been unable to agree with each other or reach a compromise in order to address the alarming fiscal, economic, and social challenges that the country has faced since the financial crisis of 2008. Sadly, it is possible that the election results will bring little change, and a dangerous journey to the fiscal brink may be required to frighten politicians into resolving their ideological impasse.

However, earlier this year, a book entitled American Gridlock by H. Woody Brock, founder and CEO of Strategic Economic Decisions Inc., won much praise from economists and business leaders for addressing the economic and social issues faced by the United States from new perspectives and for demonstrating that the choice is not only between free-market capitalism and a government-driven economy. Rather, Brock argues, the optimum solution lies in implementing constructive policies that allow “true capitalism” to flourish while incorporating social policies that help those who really need them. The book uses first principles and rigorous logic to develop compelling strategies for exiting the political quagmire. Brock’s key insights and proposals for replacing the “dialogue of the deaf” with pragmatic solutions can be summarized as follows.

Brock believes the United States is in danger of embarking upon a “lost decade,” and to avoid this he advocates for a domestic program akin to the Marshall Plan, the large-scale U.S. financial assistance program that helped European countries recover from World War Two (leaders of the stronger European Union countries today, eyeing the economic problems in the eurozone, might wish to take note!). The plan would include major investments in infrastructure and human capital, funded with government deficits if necessary, that have been independently judged to have a positive expected return, while raising taxes and cutting costs to reduce government deficits in other spending areas such as defence, transfer payments, and administration expenses. The accompanying shift in the composition of the government deficit towards projects that pay for themselves would tend to placate critics of deficit spending and excessive fiscal restraint as well as bond investors concerned about inflation and would lighten the debt-servicing burdens placed on future generations.

“The reasonable man adapts himself to the world; the unreasonable man persists in trying to adapt the world to himself; therefore all progress depends on the reasonable man.”
– George Bernard Shaw

To resolve the entitlements spending crisis, Brock advocates aggressively expanding the supply of health care services more rapidly than the demand for them is expected to grow in order to bring down prices. The flaw in Obamacare, he argues, is that it increases demand without adequately addressing supply and could lead to acute shortages in health care in the future. Supply can be increased by training more doctors and medical personnel and by increasing efficiency and productivity through sensible deregulation, eliminating archaic practices, and employing computer technology more extensively. The United States is a low-cost producer of many advanced goods and services yet stubbornly remains a high-cost supplier of health care services without achieving demonstrably better public health or longevity.

To prevent another perfect storm in the financial industry, Brock proposes the following remedies:

• improving the transparency of financial institutions’ financial statements and investment products and customers’ knowledge of investment products
• improving securitization by redressing moral hazard and requiring originators to retain a meaningful stake in their products
• reforming bankers’ compensation to reflect the long-term consequences of transactions and deals
• improving disclosures of the true extent of leverage behind securities and deals
• imposing new limits on the extent of leverage in the financial system
• imposing new Chinese walls between proprietary trading and other forms of banking
• reconceptualizing the entire field of risk management and acknowledging the limits inherent in risk assessment

The last of these reforms envisions retraining risk assessors, the basic premise being that both classical exogenous risk and endogenous risk (the latter not being amenable to assessment by traditional quantitative statistical analysis) must always be taken into account, even though they must be addressed differently. Trainees in the new program would learn that “fat-tailed” events are not simply random but are rather caused by factors that generate them (e.g., a financial crisis can be caused by excessive leverage, problematic hedging, incomplete markets, pricing model uncertainty, and correlated forecast mistakes). Brock pointedly calls for revisions to the CFA curriculum to address these issues.

To address persistent balance-of-trade problems, Brock argues for applying bargaining theory to trade relations with China. He states that the United States should forge a fair trade coalition with its Western allies, utilize this coalition’s power to force China to redress its unfair practices under penalty of large tariffs, and stop China from continuing its path of hyper-mercantilism, intellectual property theft, and currency manipulation. Brock notes that the preponderance of economic power would lie with such a coalition and that threats that are optimal and credible rarely ever get played. A cooperative agreement tends to be reached largely by the articulation of credible threats. Today’s mantra of being diplomatic and not rocking the boat may have it all backwards, he states. Brock also says that the United States should forge Free Passage coalitions with Vietnam, India, Brunei, Malaysia, Singapore, the Philippines, and other nations under threat from China in international waterways, especially the South China Sea and the Indian Ocean. He argues that the United States should guarantee free passage to any legitimate voyage to avoid the potential for worse confrontation later, as both history and game theory predict.

Finally, in the most profound part of his book, Brock reviews the concept of an idealized political economy and what people want from their resource allocation system—economic efficiency, stability, privacy, decentralization, freedom, and distributive justice. Brock argues that any satisfactory theory of distributive justice must include two distinct features—to each according to his need and to each according to his contribution. He argues that these two features are not incompatible and can be unified within a comprehensive theory. Brock’s book is addressed to all in government, business, and society who have been troubled by the seemingly intractable problems evident in the United States. His solutions are neither right wing nor left wing.

It is to be hoped that those in whom the electorate place their trust on November 7 will read the book, if they have not already done so. It may not be an exaggeration to say that the economic health of the United States and other Western developed countries, potentially, as well as the well-being of their citizens could depend on it.