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Book Review: The Great Risk Shift (part 1)

Yale political science professor Jacob S. Hacker's The Great Risk Shift describes the general decline in financial security over the past few decades and proposes programs to address it. I was not persuaded by this book, but as I hoped, I have learned things about the motivations of "well-intentioned" advocates of the welfare state. And as promised, I'll provide the individualist counterpoint to Hacker's major themes.

The book opens with the topic of increasing income volatility. It was apparent by the second page that this book would have significant gaps in balance, as Hacker focuses only on the down-side possibilities of volatility and omits the up-side. This prediction was accurate; a longer treatment of income volatility on pp30-34 only discussed drops in income, with no treatment of increases.

Contrary to Hacker's explanation on p30 that "we aren't confusing instability with income growth", I offer myself as an example. My income has been highly volatile, but not because I've lost my job or had my pay reduced. My income is volatile because a large part of my compensation is tied to the financial performance of my employer, in the form of bonuses that are high when the company is very profitable and low when the company is less profitable. I looked at all my tax returns since I started working for Intel and the year-over-year volatility is clear. Between my first and second internships my income increased +123%. Between my second internship and first full year of work my income increased +239%. My first three years of full-time work were stable (-1%, 0%, +1%) but followed by large increases (+15%, +21%) and I expect this year's income to be lower than last year's — due to a stock option exercise last year, not a pay reduction. I have been happy working under a variable-compensation pay structure emphasizing bonuses over salary and happy with the resulting high volatility in my income. My income has been volatile but rising. There are no anecdotes of people like me in the book.

Hacker's book is heavy on anecdotes intended to evoke an emotional reaction, as in the case of "middle-class but chronically ill parents [who] couldn't find a company that would even sell them a health care policy" (p3). While their plight may be tragic, the anecdote encourages confusing insurance with charity. The function of insurance is to pool resources against risks that are unpredictable individually, but predictable in the aggregate. Chronic conditions aren't covered by (new) insurance policies because they're no longer unpredictable risks — they're certainties. Real insurance is not widely-understood; what most people call health insurance today is closer to payment insulation than to risk protection. Real health insurance would pay no claims to most people but would cover the expected lifetime cost (not just the immediate treatments) of a major unpredictable illness.

The book also contains some cherry-picked data, such as the following alarming note:

Personal bankruptcy has gone from a rare occurrence to a routine one, with the number of households filing for bankruptcy rising from fewer than 290,000 in 1980 to more than two million in 2005. (p13)

A major change in bankruptcy law went into effect in 2005, causing a one-time spike in the number of filings — almost a half-million more in 2005 than in 2004. This change in the law was well-publicized and Hacker even mentions it later in the book (p37). It is poor scholarship to cite an exceptional year in support of a trend.

There's another numerical puzzle on pp23-24, in a discussion of how income swings have increased. Hacker cites the statistics that in the 1970s, Americans aged 25-61 had low income swings: over a 10-year period, the worst year would bring about 43% the income of the best year. In contrast, by the 1990s the worst year would have an income only about 25% of the best year. These numbers are clear by themselves, but Hacker gives an example of "an average Betty who had $60,000 in her best year" and contrasts her worst-year $15,000 in the '90s to her worst-year $30,000 in the '70s. (He interprets 43% as "just shy of 50 percent" and uses $30,000 — I would have used $25,000, also a nice round number, but closer to the truth.) The primary problem here is that while $60,000 may be a reasonable "best year" income in the '90s, it wouldn't be for the '70s. Even adjusted for inflation, the median income has risen about 15% from 1975 to 1995 (Census report, Apendix A, table A-1) so a reasonable "best year" in the '70s would be closer to $50,000, making the "worst year" in the '70s about $22,000 — not $30,000. The difference between the "worst years" of the '70s and the '90s is closer to $7,000 than to $15,000, cutting Hacker's fear-inspiring income drop comparison in half.

It was good of Hacker to mention that a two-worker household is more likely to experience an income shock than a single-earner household (although not until page 92) but unfortunately he does not explore how much of the increase in family income volatility is due to rising workforce participation of women.

Beyond quibbling over numbers, I have a larger point to make. I believe the increase in income volatility is a natural and even desirable feature of today's economy. It is a reflection of the economy's more rapid responses to changing conditions; evidence that the economy is healthier, not sicker. We should favor the volatility of today over the stability of the past because today's economy is more productive. Indeed, the volatility has contributed to productivity. As I discussed at length in my essay about globalization, it's not surprising that "the long-term unemployed are older, better educated, and more likely to be professionals than the unemployed as a whole" (p71) — this is expected in an advanced economy.

Hacker blames the "Personal Responsibility Crusade" for the erosion of traditional pensions and health insurance (p38):

The core assertion embodied in the Personal Responsibility Crusade is that Americans are best off dealing with economic risks on their own, without the overweening interference or expense of wider systems or risk sharing. Insurance, by protecting us from the full consequences of our choices, takes away our incentives to be economically productive and personally prudent.

I was originally uncertain whether Hacker misspoke in describing the Personal Responsibility Crusade as anti-insurance. But later statements convinced me that he believes this (p56, emphasis added):

By encouraging Americans to rely on themselves, tax-favored accounts would also make people more deeply invested in the market, more distrustful of direct government programs, more reluctant to join broader risk pools—and more likely to vote for conservative politicians.

Additionally (p57, emphasis added):

To pursue their attack on insurance, adherents of the Personal Responsibility Crusade have largely adopted strategies of stealth, seeking to transform existing arrangements beneath the radar screen of public awareness.

Most explicitly (p58):

In the ideology that guides the Personal Responsibility Crusade, the abandonment of insurance is liberating. Freed from the shackles of old-style risk protections, we can plan for our own future, make our own decisions about how much risk to bear in the market, and enjoy the financial rewards of our newfound freedom as we alone wish.

As a self-identified member and advocate of the Personal Responsibility Crusade, I declare this a straw man. We are not against insurance. In fact I think pooling is an excellent way to manage risk. However, I am hostile to welfare that masquerades as insurance. The two are very different, but equivocation on the meaning of "insurance" causes them to often be packaged together. Risk pooling is genuine insurance; but a program that is "generous" to low-income people is risk shifting, not risk pooling, and has more to do with political goals than with risk management. The irony of Hacker's title is that he's not at all opposed to shifting risk; he advocates shifting it to the wealthy.

(More to come…)

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