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Today’s enactment of the First Step Act constitutes the most significant reform of the federal criminal justice system in a generation. The new law includes many laudable features, such as reducing mandatory minimum sentences for non-violent drug offenses, making retroactive the provisions of the Fair Sentencing Act of 2010 that reduced the crack-to-cocaine sentencing disparity, expanding the “safety valve” that allows certain non-violent drug offenders to avoid the harshness and rigidity of mandatory minimum prison sentences, and requiring the placement of prisoners near the families to whom they’ll one day return.

Policymakers, stakeholders, and activists have been pushing for many of these reforms for half a decade, and for those closest to the effort, the experience has been a roller coaster of advances and setbacks. Just weeks ago, despite growing support throughout much of the year, it seemed as though the door would close yet again on this bipartisan and cross-ideological effort. Then, in the immediate aftermath of a supportive tweet from President Trump, newfound support from Senator Ted Cruz, and needling from fellow Kentucky Senator Rand Paul, Senate Majority Leader Mitch McConnell reversed course and committed to bringing the First Step Act to the Senate floor for a vote. The bill passed the Senate on December 18, 2018, by a vote of 87-12, and then quickly moved to the House—which had passed a similar but less robust bill earlier this year—where it passed 358-36. The bill became law with the president’s signature earlier today.

In typical Washington fashion, the drama surrounding this effort has caused a flurry of media attention, perhaps leading some to the conclusion that this package of reforms will fix most, if not all, of what is wrong with our criminal justice system. But as even the staunchest advocates of the new law acknowledge, there is much more that needs to be done. As implied by the title of the bill—the First Step Act—there are additional reforms that must be instituted before Americans will have the criminal justice system they deserve and that justice demands.

Scholars with Cato’s Project on Criminal Justice have identified coercive plea bargaining as among the most perverse practices in America’s criminal justice system, both because it produces an alarming number of false convictions and because it has resulted in the near-elimination of the criminal jury trial. Today, more than 95 percent of convictions are obtained through plea bargains, rendering the constitutionally prescribed method for adjudicating criminal cases—the jury trial—practically extinct.

In its idealized form, plea bargaining is the process by which prosecutors and the criminal defendant negotiate a mutually acceptable resolution whereby the defendant avoids trial by pleading guilty to the alleged crime or crimes before a judge. The defendant typically gets the benefit of a modest reduction in prison time and/or financial penalties, while the prosecution gets to avoid the expense of a trial and the inevitable unpredictability of juries.

But the plea-bargaining process can easily become coercive when, for example, prosecutors stack charges in order to expose the defendant to greater prison time if they insist on going to trial, a well-documented phenomenon known as the trial penalty. Other coercive levers available to prosecutors include pretrial detention, the use of civil forfeiture that can deprive the accused of the resources needed to defend themselves, and threats to investigate friends and family members. The result is a system in which the government can convict and incarcerate people without the explicit approval of ordinary citizens, and without having to prove its case against the accused in a public and adversarial proceeding.

As part of its effort to raise public awareness of coercive plea bargaining and challenge its legitimacy, the Cato Institute’s Project on Criminal Justice hosted two events earlier this year—one in July titled Plea Bargaining: Good Policy or Good Riddance? and a second in October titled Coercive Plea Bargaining.

Cato has also begun a strategic amicus initiative designed to restore the Founding-era practice of ensuring that jurors have the information they need to perform not only their fact-finding function, but also their time-honored role of limiting government power by refusing to convict factually guilty defendants when it would be unjust to do so—a practice often referred to as “jury nullification,” but perhaps more accurately described as “conscientious acquittal.” To properly discharge the latter role of limiting government power, jurors should be advised of the likely consequences for the defendant if they are convicted, the substance of any plea offer(s) made to the defendant by the prosecution, and basic information about the history and importance of conscientious acquittal in the Anglo-American legal system.

And to set the stage for possible legislative responses to coercive plea bargaining, Cato will endeavor to educate policymakers in the coming months on the myriad problems associated with this unjust, unseemly, and extra-constitutional feature of our criminal justice system. If there is an appetite for a “Second Step Act” in 2019 or beyond, Congress would do well to include provisions that squarely confront the epidemic of coercive plea bargaining.

“This will be a wall with a big, very beautiful door because we want the legals to come back into the country.” -Donald J. Trump, August 23, 2015

“I want people to come into our country legally. I want to have a big, fat, beautiful open door.” -Donald J. Trump, September 3, 2015

“I want tremendous numbers of people to come in, and we are going to have that big beautiful door in the wall.” -Donald J. Trump, November 2, 2016

“We’re going to have a big, fat beautiful door right in the middle of the wall. We’re going to have people come in, but they’re coming in legally.” -Donald J. Trump, October 28, 2015

The House Freedom Caucus—a coalition of Republicans—were reportedly the “driving force” behind talking President Trump into a government shutdown over the border wall. Freedom Caucus leaders Jim Jordan (R-OH) and Mark Meadows (R-NC) “led a revolt” on the House floor against the bill that would have kept the government open without more money for Trump’s wall. Rep. Jordan justified their position this way:

Let’s do what we said. Let’s build the border security wall …It’s pretty simple. What did you tell the voters you were going to do? What did they elect you to do? Go do that.

That’s a fair point. Trump did center his campaign in 2016 around a border wall along the southern border. Of course, he also told voters repeatedly that Mexico—not U.S. taxpayers—would pay for it. But setting that issue aside, President Trump also vociferously promised that the border wall would contain a “big beautiful door” that would let in “tremendous numbers of people.” So why are Republicans not demanding a shutdown if the door isn’t built? Isn’t that what Americans were promised too?

Of course, they have no intention of keeping this promise. The Trump administration is closing down legal ports of entry for asylum seekers to prevent them from entering legally. It has championed bills to cut legal immigration by 50 percent, and its regulations are already making legal immigration much more difficult. Don’t expect any shutdowns for the “big beautiful door” any time soon.

The Census Bureau has released new data on state population growth between July 2017 and July 2018. Domestic migration between the states is one portion of annual population change. The Census data show that Americans are continuing to move from high-tax to low-tax states.

This Cato study examined interstate migration using IRS data for 2016. The new Census data confirms that people are moving from tax-punishing places such as California, Connecticut, Illinois, New York, and New Jersey to tax-friendly places such as Florida, Idaho, Nevada, Tennessee, and South Carolina.

In the chart, each blue dot is a state. The vertical axis shows the one-year Census net interstate migration figure as a percentage of 2017 state population. The horizontal axis shows state and local household taxes as a percentage of personal income in 2015. Household taxes include individual income, sales, and property taxes.

On the right, most of the high-tax states have net out-migration. The blue dot on the far right is New York with a tax burden of 13 percent and a net migration loss of nearly 1 percent (0.92) over the past year.

On the left, nearly all the net in-migration states have tax loads of less than 8.5 percent. The outlier on the bottom left is Alaska. If policymakers want their states to be people magnets, they should get their household tax burdens down to 8.5 percent of personal income or lower.

The red line is fitted from a simple regression that was highly statistically significant.

Earlier this year in Masterpiece Cakeshop, the Supreme Court contended with the issue of whether cake-baking is protected speech under the First Amendment, and thus whether a Christian baker could refuse to design a wedding cake for a same-sex ceremony. The Court ended up punting on the case’s major questions, but now the Arizona Supreme Court is facing a similar issue, this time with calligraphers instead of bakers.

Artists Joanna Duka and Breanna Koski are practicing Christians who own and operate Brush & Nib, an art studio in Phoenix, Arizona. In addition to designing wedding invitations using calligraphy, they produce recreations of wedding vows and other custom artistic works. Phoenix’s public accommodation law would require them to design invitations and vows for every ceremony—even those that conflict with their sincerely held faith. The city imposes draconian punishments for failing to comply with this law; Joanna and Breanna could face fines of $2,500 per day, or up to six months in jail. It seems that in Phoenix, Christian artists who oppose same-sex marriage must choose between practicing their faith and running a business if they want to avoid both bankruptcy and jail time.

Cato of course has a long history of supporting both gay rights and the First Amendment. We were the only organization in the entire country to have filed briefs supporting the petitioners in both Masterpiece Cakeshop and the marriage cases that ended in Obergefell v. Hodges (2015). Now, joined by professors Dale Carpenter and Eugene Volokh—who differed on Masterpiece Cakeshop because they consider cakemaking not sufficiently expressive for the First Amendment to apply—Cato has filed an amicus brief arguing that expressive small businesses (including calligraphers) are indeed protected from speech compulsions.

The First Amendment, in stark contrast to Phoenix’s public accommodation law, protects people from government-compelled expression. The Supreme Court in Wooley v. Maynard (1977) established that even forcing a driver to display a license plate with the motto “Live Free or Die” violated that person’s “individual freedom of mind.” It would surely violate someone’s conscience far more to be forced to design art or otherwise convey messages for a ceremony with which they disagree.

Besides, the Arizona Supreme Court previously held that tattoo design is art, and that both the design and sale of such art is protected by the First Amendment. According to the Arizona Court of Appeals in this case, however, calligraphy—unlike tattoo design—is not “inherently expressive.”

The lower court ignored all historical evidence proving that calligraphy is art. Not only is calligraphy considered a fine art in Chinese tradition, but it also has had a profound effect on American history. After all, our own Declaration of Independence is a masterpiece of calligraphy, designed by Timothy Matlack. If Matlack were forced to design royal proclamations declaring the colonists traitors, his freedom of conscience would have been severely violated—and the same applies to the Brush & Nib artists.

Wooley also provides an important limiting principle for protecting individual freedom of mind: it does not apply to all conduct, only First Amendment-protected expression. Far from the blanket discrimination that hoteliers and restauranteurs often leveled at African-Americans in the Jim Crow era, refusing to create a wedding invitation is simply refusing to speak in a way that would betray one’s faith or compromise one’s conscience. Just as the government cannot force a patriot like Timothy Matlack to denounce his fellows, or an atheist to endorse Scientology, the government cannot force orthodox Christians, Jews, and Muslims to design art for same-sex weddings.

President Trump’s Syria announcement yesterday has sent the foreign policy community into orbit. The distress is mostly bipartisan, although the real vitriol seems to be coming more from Republicans than Democrats. See, for example, the stories of Vice President Pence’s meeting with GOP senators, and Rep. Adam Kinzinger’s meltdown on CNN.

A few, however, appreciated the president’s decision. See especially, Cato’s John Glaser (here and here), Defense Priorities’ Benjamin Friedman, Win without War’s Stephen Miles, and timely tweets from Democrat Ted Lieu and Republicans Rand Paul and Justin Amash.

Rather than simply rehash these statements, here are a few brief observations related to the president’s decision:

  • It should not be a surprise to anyone. Donald Trump has been railing against U.S. entanglement in Middle Eastern civil wars for years – as he noted this morning on Twitter. The only real surprise is that it took so long for him to overrule his foreign policy advisers who were dead set against withdrawal. (It does raise the question: Does he have the right foreign policy advisers?) As recently as this September, John Bolton explained publicly that U.S. forces would remain in Syria as long as Iranian forces were there – effectively signaling a willingness to leave U.S troops there forever. Wednesday’s announcement is merely the latest reminder that the president sets policy.
  • I’m particularly interested – and moderately concerned – by an apparent meeting of the minds (and possible quid pro quo?) between President Trump and Turkey’s President Recep Tayyip Erdogan. Aside from the troublesome atmospherics of the U.S. government drawing closer to an authoritarian thug, there are also grounds for asking what this means for the Kurds. Initial signs aren’t promising – Erdogan hinted that an offensive was imminent even before Trump’s announcement. If the decision to remove U.S. forces from Syria is part of a larger project that will tie the United States even more closely to the Turkish president, then President Trump almost certainly made the right decision for the wrong reason.
  • I have zero tolerance for those who bemoan the lack of congressional oversight of this decision, or who complain that the president opted for a troop withdrawal on his own, an apparent case of executive overreach. Where was this same outrage when a progression of U.S. presidents, up to and including Donald J. Trump, undertook military operations either without any congressional authorization, or only under the dubious cover of the 2001 and/or 2002 AUMFs? We should have had a proper debate over the post-9/11 AUMFs, and the appropriate recourse is to repeal rather than replace them. But those who didn’t want such a debate when U.S. forces were actively engaged in acts of war in multiple theaters, but who want one now that they’re leaving just one of those warzones, don’t have a leg to stand on.
  • The execution of this policy is almost certain to be chaotic. That is both unfortunate and unforgivable. The Pentagon, as it often does, will try to make it seem well-thought-out, but the mixed messages and general confusion emanating from the Trump administration over the last 24 hours are apparent to everyone. I understand that President Trump was new to the policymaking process when he was elected  – and, indeed, that likely worked in his favor electorally, as millions of Americans appeared to value his fresh perspective over Hillary Clinton’s experience. But his administration is now nearly two years old, and there simply is no excuse for a chaotic roll-out of an important foreign policy decision, one that certainly affects the lives of officially 2,000 American servicemen and women (the actual number could be twice that), plus potentially millions living in Syria. In my writing, I often stress how the impulse to do something (anything!) often ignores the unintended consequences of our actions. The other side is more concerned about sins of omission than sins of commission, claiming that these, too, have unintended consequences. Fair enough. In this instance, President Trump initiated a significant change in U.S. force posture in an active war zone, believing that the decision serves U.S. strategic interests. He has an obligation to take every possible step to ensure that it actually does advance our interests. An approach that amounts to “Tweet and hope for the best” doesn’t cut it.

Finally, the statements and tweets noted at the top reflect the major foreign policy debates going on within both parties. My colleagues Emma Ashford and Trevor Thrall broke this down in a recent piece for War on the Rocks, and in two episodes of the “Power Problems” podcast (with Bryan McGrath on the right and Jake Sullivan on the left). A key area of disagreement among foreign policy thinkers of all stripes revolves around the efficacy of military force, and the utility of other foreign policy tools, including diplomacy, economic carrots and sticks – and, yes, moral suasion. Leading by example, and calling on others to behave in ways that serve the cause of peace, was the touchstone of U.S. foreign policy for at least the first half of this country’s history. Some people have never forgotten that the nation’s Founders generally abhorred warfare, and were extremely reluctant to become embroiled in others’ disputes. It is significant, I think, that Rep. Ro Khanna frequently invokes John Quincy Adams in his speeches.

There is an alternative to the bipartisan foreign policy consensus that views the United States as the indispensable nation, and U.S. military power as the essential element of that indispensability. The responses to Trump’s Syria decision remind us that the particulars of that alternative will continue to be hammered out over at least the next two years.

President Trump recently backed off his demand for $5 billion in funding for his border wall, likely averting a government shutdown around Christmas.  However, the political debate over funding for border wall will merely reemerge in the New Year.  Besides new court decisions regarding DACA, there is little to break this deadlock.  Some of the suggestions below offer additional avenues on which to negotiate.  

One of President Trump’s persistent claims is that the wall will secure the border and he recently implied that Border Patrol agents are substitutes for such a barrier.  In that case, I have a suggestion for Congressional Democrats who will be negotiating with the President over the wall in the next several years:  If you must fund the wall in exchange for the DREAM Act or DACA, have Border Patrol pay for it.

This idea is simple in concept – just fire Border Patrol agents and use their saved salaries to fund the construction of the border wall.  As of the middle of 2018, the 19,338 Border Patrol agents had an average annual salary of $61,064.  Altogether, they were paid about $1.18 billion in 2018.  The savings from firing all of them in one year wouldn’t come close to funding the $25 billion or so to build the entire border wall and would only go a small portion of the way toward President Trump’s more modest $5 billion request, but it’s a start.

Of course, the government should not fire all the Border Patrol agents.  Some are necessary to patrol the border even if Congress liberalizes the immigration system.  But this is Washington, DC, and politics being what it is, we all must compromise.  If Congress instead fired half of all Border Patrol agents and instituted a policy of no new net hiring, that would free up $590.4 million per year for the construction of a border wall.  In 8 years and 5 months, about $5 billion in savings could be diverted to the wall.

Firing half of all Border Patrol agents might be too drastic for Congress, even though that would only reduce the number of agents down to about the level it was in 2000.  Another solution would be to cut Border Patrol pay by a quarter, cap their salaries, keep the same number of Border Patrol agents, and use the saved salaries to pay for the wall.  Enough money would be accumulated to pay for the $5 billion portion of the wall over the next 16 years and 11 months.     

There is yet another way to partially pay for the wall by shrinking Border Patrol.  Each mile of the wall will cost about $17,280,000 to construct according to recent DHS estimates and about $864,353 per mile in annual maintenance afterward.  At about 8.5 agents per mile along the Mexican border, on average, the salaries or wages of Border Patrol would have to be reduced by more than 100 percent to even maintain the new wall.  That’s obviously a non-starter … besides being impossible.  So how about Border Patrol pay for 1 percent of the construction costs and 10 percent of the annual maintenance costs by reducing their staff? 

Paying for 1 percent of the border wall construction by firing Border Patrol agents could be accomplished by reducing their numbers by 1,637 initially for only 3 years.  For the second and third years after the wall was constructed and maintenance costs were incurred, the Border Patrol would have about 3,954 fewer agents or be 20 percent smaller.  To fund maintenance after year threes, the permanent staff reduction would be about 2,317 Border Patrol agents or about 12 percent of their total current numbers.  If the cuts are entirely concentrated along the Mexican border, that would be a 14 percent cut in the numbers patrolling that border.    

If the above-proposed deals are still too complicated or extreme, here is my final compromise suggestion: Fire one Border Patrol agent for each mile of the wall that is built.  The $5 billion that Trump wanted for the wall would only pay for about 289 miles out of the current 1,637 unfenced border miles.  Firing 289 Border Patrol agents and preventing the hiring of replacements would only pay for about 0.4 percent of the cost of constructing the border wall and 7 percent of the annual maintenance afterward, but it’s a start.  It’s also easy to understand and explain.  Such a reduction might also motivate the administration and Border Patrol to only support building a wall in areas where they think it will most reduce unlawful crossings.    

President Trump has argued that the border wall will secure the border.  I doubt that is true, but I’m willing to take him at his word if he’s willing to shrink Border Patrol in exchange for funding the wall.  Since the wall will secure the border, that means we would need fewer Border Patrol agents.  Reducing the number of Border Patrol agents by one for each additional mile of the wall built would drop their numbers by about 1.5 percent and reduce the number of agents per mile along the Mexican border from about 8.5 today to 8.4 after the 289 miles are built. 

Throughout the entire Anglo-American legal tradition, the independence of citizen juries has been understood to be an indispensable structural check on executive and legislative power. This independence has traditionally implied that jurors would both understand the consequences of a conviction, and that they would possess the power of conscientious acquittal, or “jury nullification”—that is, the inherent prerogative to decline to convict a defendant, even if factual guilt is shown beyond a reasonable doubt, when convicting would work a manifest injustice. Nevertheless, modern courts generally do not protect a defendant’s right to make such arguments directly to a jury, nor even to inform a jury about the consequences of conviction. A fascinating case now pending before the Second Circuit illustrates the tensions in modern case law on the subject, and raises the crucial question of whether district courts may, at the very least, permit such arguments in appropriate cases.

Yehudi Manzano, a 31-year-old man, made the regrettable decision to get involved in a romantic relationship with a 15-year-old girl. While their sexual relationship was impermissible under Connecticut age-of-consent laws, there was no indication that any instance of sex was coerced. On one occasion, Mr. Manzano took a video on his cell phone of the two of them having sex, which he then deleted. But the video was uploaded to the cloud, federal prosecutors ultimately became aware of the recording, and they charged Mr. Manzano with both production and distribution of child pornography, which respectively carry mandatory minimum sentences of fifteen and five years.

Mr. Manzano exercised extraordinarily poor judgment, and he is independently facing state charges for second-degree sexual assault. But the federal charges against him — a threatened minimum of 15 years, all for taking and deleting a private video, in a non-coerced context, that no one but government investigators ever saw — are grossly disproportionate, and they exemplify the problems with mandatory minimum sentences in general. As such, Mr. Manzano’s attorney sought to introduce evidence of the mandatory minimum sentence and to argue for conscientious acquittal. The District Court judge did not conclusively resolve these motions, but it did indicate openness to letting Manzano’s counsel ask a government witness about the mandatory minimum, and said that if the evidence came in, he would allow argument on it. This is therefore the extraordinarily rare case where a district court showed even tentative willingness to permit arguments sounding in conscientious acquittal.

But even those conditional, preliminary rulings were too much for the prosecutor to accept. The government stayed the trial, and is now seeking the extraordinary remedy of a writ of mandamus from the Second Circuit, asking the appellate court to prohibit the District Court from permitting any evidence or argument about conscientious acquittal. In other words, according to the United States, keeping a jury in the dark about the actual consequences of conviction is so vital that it warrants stopping a trial and overriding the traditional discretion of district court judges to rule on evidentiary questions as they arise.

The Cato Institute, joined by FAMM and the NACDL, has therefore filed an amicus brief, urging the Second Circuit to deny the government’s petition. Not only is the District Court’s preliminary ruling well within its discretion, but the judge’s approach is also eminently reasonable, as it thoughtfully harmonizes many tensions in the modern case law of conscientious acquittal. Our brief argues that, throughout the Anglo-American legal tradition, pre-dating even Magna Carta, juries have always possessed the inherent authority to acquit defendants in the face of manifestly unjust prosecutions. This power was well-established in the Founding Era, in which juries were regularly aware of — and tailored their verdicts to — the consequences of conviction. And while modern cases (perhaps erroneously) do not generally afford defendants the right to argue for conscientious acquittal, no controlling cases preclude a district court from permitting such arguments.

Protecting the discretion of district court judges in this regard is all the more important today, in light of the vanishingly small role jury trials play in our criminal justice system. Today, jury trials have been all but replaced by plea bargaining as the baseline for criminal adjudication, and severe mandatory minimums, like the one at issue here, are a major driver of this trend. Preserving the possibility that juries may, in appropriate cases, be informed about the consequences of conviction is a small but vital safeguard against the wholesale erosion of the jury trial itself.

The U.S. House is expected to vote on the FIRST STEP Act today after the legislation passed the Senate late Tuesday.

For today’s Cato Daily Podcast, I spoke with Shon Hopwood of the Georgetown University Law Center about what the act does and why he views the legislation as both historic and modest reform.

 

Hopwood spoke at the Cato Institute’s Cato Club 200 event this year where he detailed his own experiences as a federal inmate and why sweeping criminal justice reform remains necessary.

This week marks the 40th anniversary of China’s opening to the outside world, announced at the Third Plenum of the Eleventh Party Congress in1978. After Mao Zedong’s disastrous Cultural Revolution and the failure of central planning, the nation was ready to embark on a new path of development. Individuals were to be given greater economic and political freedom under the leadership of Deng Xiaoping.   

How successful was that new path in the long run? Today, China’s paramount leader Xi Jinping expresses his desire for a “socialist rule of law” and supports the “principle of letting a hundred flowers bloom and a hundred schools of thought contend.” Yet what we see is increasing constraints on freedom of thought.

Xi and Deng had similar backgrounds, as both were at one point victimized and elevated by the Communist Party. During the Cultural Revolution, Deng was labelled a “capitalist roader” and his son was crippled by the Red Guards. Those events left an indelible mark and opened Deng’s mind to new thinking about how best to organize the economy and allow people to prosper. He thought that China’s leaders “ought to study the successful experiences of capitalist countries and bring them back to China.” That view contrasted sharply with Chairman Mao’s condemnation of private enterprise and his view of capitalists as criminals.

Deng announced a change of tone at the Third Plenum, two years after Mao’s death. Although he paid lip service to Mao, he rejected the idea of “class struggle” and made economic development the chief goal of the Chinese Communist Party (CCP).

In his speech, Deng argued that “the primary task is to emancipate our minds.”  He criticized the rigid thinking of many Party members, which he blamed on “historical conditions.” He was reluctant to openly blame Mao, so he pointed to Lin Biao, whom Mao had appointed vice chairman in 1966, and the Gang of Four, which included Mao’s wife Jiang Qing. Under the masquerade of “Party interests,” people were subject to Party control and oppressed. “Many important issues were often decided by one or two persons,” said Deng. Consequently, “there wasn’t much point in thinking things out for yourself.” He went on to say that “no clear distinction was made between right and wrong,” and that “people were naturally reluctant to use their brains.”  The simply adjusted “their words and actions according to whichever way the wind [was] blowing.”

In closing, Deng warned: “When everything has to be done by the book, when thinking turns rigid and blind faith is the fashion, it is impossible for a party or a nation to make progress. Its life will cease, and that party or nation will perish.” 

After the Third Plenum, Deng advocated greater freedom of thought and supported the “Democracy (Xidan) Wall,” which served as a place to post criticism of Maoist thought, including the “Two Whatevers”: whatever Mao said should be taken as the truth, and whatever examples he set should be adhered to. Nevertheless, as China’s paramount leader, Deng was unwilling to accept large protests that could threaten the power of the CCP. The infamous Tiananmen Square incident occurred under his leadership.

Yet, despite the contradiction, Deng led China to a significantly freer path than the one Mao had set it upon. Can we say the same of Xi Jinping?

Since he came to power in 2013, Xi has cracked down on officials who deviate from CCP dogma, institutionalized “Xi Jinping Thought”— a 14-point manifesto to ensure CCP “leadership over all forms of work”—in the PRC Constitution, ended Deng’s collectivist governance by being “elected” president for life, launched a “social credit system” that could seriously erode personal freedom, and silenced leading liberal intellectuals such as Mao Yushi, whose Unirule Institute has seen its website shutdown and its office shuttered. Academic freedom suffers from the presence of propaganda departments at all universities, and there is a strong feeling that “the door to a free market in ideas is nearly shut.”

Although China has accomplished much in its 40 years of reform and opening to the outside world, it has a long way to go in terms of both economic and political freedom. At this point, it needs a Deng—someone who actually advances liberal ideas—rather than a Xi—someone who pays lip service, at best.

Most important, China needs a free market for ideas, as well as a free market for goods and services. Silencing the voices of Chinese liberals—and blocking the transmission of Western ideas of limited government, separation of powers, and freedom under a just rule of law—will not “emancipate the mind” or create a harmonious society.  

Among many other advantages it enjoys when it comes to influencing the course of monetary reform, the Fed has that of being able to shift the constraints that determine whether a proposed reform is or isn’t possible. If existing constraints don’t stand in the way of some reform Fed officials would rather not see happen, they can always put up a new one, tailor-made for the purpose.

The Fed seems prepared to do just that as part of its campaign to keep the “floor” system of monetary control it set-up in October 2008 around for good. Considering the floor system’s many disadvantages compared to a “corridor” system, should the plan work we may all live to regret it. Those disadvantages include:

  1. A considerable increase in the share of financial-institution intermediated credit that gets shunted into the Fed’s coffers;
  2. A moribund interbank fed-funds market, with correspondingly reduced incentives for interbank risk monitoring;
  3. A less-reliable monetary control mechanism, as evidenced by the failure of changes in the IOER rate to result in like changes in market-determined interest rates; and
  4. A Fed balance sheet made ripe for political abuse by the fact that it’s size is no longer a determinant of the stance of monetary policy.[1]

For the most part, Fed officials have tried to justify the floor operating system by ignoring its shortcomings whilst harping on its supposed advantages, including the fact that it enhances banks’ liquidity by encouraging them to stockpile reserves, and the fact that the new arrangement dispenses with the need for routine open-market operations.[2] Those officials are also inclined to avoid any public discussions of the topic, which, according to some press reports at least, is not to be among those addressed during the next summer’s Fed outreach program aimed at gaining public input concerning the “strategies, tools, and communication practices it uses to pursue its mandate of maximum employment and price stability.”[3]

But just in case these means for assuring the survival of the Fed’s floor system should prove inadequate, Fed officials have an ace up their sleeve: if hard-pressed on the matter, they can insist that switching from the current system to a corridor system is, not just undesirable, but impossible.

How so? The argument has to do with Basel’s LCR (Liquidity Coverage Ratio) requirements, first applied to U.S. banks in 2015. Those requirements call for banks to keep a substantial amount of  “High Quality Liquid Assets” (HQLAs) on hand at all times, with the precise proportion depending on the extent and volatility of banks’ nonoperating wholesale deposits.[4] Because excess reserves qualify as HQLAs, banks have been able to use them to meet the LCR requirements. In contrast, the floor system’s champions point out, switching to a corridor system would mean not having enough excess reserves in the system with which to meet those requirements.

The wrinkle is that, although excess reserves qualify as HQLAs, so do Treasury securities, Ginnie-Mae mortgage-backed securities, other non-MBS agency securities, and deposits at the Fed’s Term Deposit Facility. Because the same Fed asset sales that serve to reduce the stock of excess reserves increase the outstanding supply of Treasury securities by a like amount, even an unwind complete enough to force a switch to a corridor system would leave the banks with all the HQLAs they need to meet their LCR requirements. And though banks would rather meet their LCR requirements with excess reserves than with Treasuries so long as excess reserves earn higher returns, as they did until recently, under a corridor system excess reserves would yield less then even the shortest-term Treasuries, so that banks would prefer Treasuries. In short, contrary to what some experts have claimed, Basel’s LCR requirements don’t in themselves mean that we’re stuck with a floor system.

It’s here that the Fed’s special powers come into play. For although the published LCR requirements don’t themselves make it necessary for banks to stock-up on excess reserves, the Fed has been bending the rules to change that. In a Bank Policy Institute Research Note published in late November, BPIs Bill Nelson explains how:

In principle…banks could hold Treasury securities rather than excess reserves to satisfy their LCR. However, while the LCR regulation treats reserves and Treasury securities the same, Fed supervisors have reportedly instructed banks through the examination process that they must hold a certain, not publicly known, fraction of their HQLA as excess reserves. The Fed’s “LCR Reserve Requirement” creates an added function that only excess reserves will be able to satisfy.

Bill goes on to note how, when directly asked about this after a panel discussion at the Hoover Institution’s May 4th, 2018 Policy Conference on “Currencies, Capital, And Central Bank Balances,” Fed Vice Chair Randal Quarles “acknowledged that [Fed] supervisors have indicated to banks that there is an expectation that some HQLA be held in the form of excess reserves.”[5] And if you think there’s any difference between what Fed supervisors “expect” banks they supervise to do, and what those banks are bound to do to avoid getting in hot water, you don’t know how bank regulation really works in this country![6]

If the Fed’s extra-legal maneuvers somehow made either banks subjected to them or the general public better off, those maneuvers might perhaps be justifiable. But there’s no good reason to think so. On the contrary: the written rules are more than capable of keeping banks adequately stocked with reserves, and would remain just as capable were the Fed to switch to a corridor system. Indeed, the U.S. is now among a small minority of advanced economies that combine LCR requirements with minimum statutory reserve requirements particularly aimed at guarding against reserve shortages. Relatively modest IOER payments, such as would be consistent with a corridor system, would suffice to keep banks from using “sweep” accounts to evade those reserve requirements, as banks tended to do when reserves bore no interest at all. Also, in a corridor system a revived fed funds market would usually be a reliable source of extra reserves to any subset of sound banks that needed them. Finally, because Treasuries can serve as collateral for secured overnight and term borrowing, solvent banks that used them to meet their LCR requirements could also turn to secured lending markets, or to the Fed’s discount window, to make up for reserve deficiencies. In short, in treating Treasuries as equivalent to reserves for meeting banks’ liquidity needs, the Gnomes of Basel have (for once) gotten things right.

Make no mistake, if Fed supervisors are prepared to stick their thumbs on the HQLA scale to compel banks to meet some of their LCR requirements using reserves rather than Treasuries, it’s for one reason only: to allow Fed officials to claim, with implicit reference to their self-imposed constraint, that a floor system is the only monetary control game in town. Some people may call this clever strategizing. I call it abusing the Fed’s supervisory powers for the sake of thwarting worthwhile monetary reform.

___________________________

[1] For more on these and other disadvantages of the floor system see my recent Cato book, Floored!: How a Misguided Fed Experiment Deepened and Prolonged the Great Recession.

[2] While it’s pleasant for the New York Fed staff not to have to expend effort on managing routine open-market operations, whether the economies that this change is supposed to achieve will be realized through either a reduction in that staff or a corresponding increase in the quality or quantity of other Fed services remains to be seen. I, for one, am not holding my breath.

[3] According to a November 15th Bloomberg report, although “Virtually everything the Fed does in pursuit of its congressionally mandated goals will be on the table” during its summer policy review, which includes a June 2-4 “research” conference to be held at the Chicago Fed, “the review is not expected to include a look at how the Fed mechanically controls short-term interest rates, which is being discussed internally.”

[4] Nonoperating wholesale deposits include any such deposits apart from those held for clearing, custody, or cash management purposes.

[5] The published version of Quarles conference remarks is here. The full transcript, including the referred to question and answer, is, unfortunately, only available on the gated WSJ Pro site.

[6] I refer here particularly to how regulation works for all save the big Wall Street banks. For them, the situation is often reversed, with the bankers intimidating their supervisors rather than the other way around.

[Cross-posted from Alt-M.org]

President Trump has ordered a withdrawal of U.S. troops from Syria. This is the right decision. The U.S. military presence in Syria has not been authorized by Congress, is illegal under international law, lacks a coherent strategy, and carries significant risks of entangling America in a broader quagmire in yet another Middle Eastern country.

As I wrote in Axios:

The Obama administration first deployed U.S. troops to Syria to complement its aerial bombing campaign against ISIS with special operations forces and coordinate with local anti-ISIS militias on the ground, gradually expanding from hundreds of troops to roughly 4,000.

The mission expanded, too, from merely defeating ISIS (substantially accomplished some time ago) to ushering Syrian President Bashar al-Assad out of power, expelling Iranian forces, and edging out Russia.

The bottom line: Absent achievable goals and a strong national security imperative backed up by congressional authorization, the U.S. presence in Syria is illegitimate and better off wound down.

One prominent criticism of Trump’s decision is that it lacks a clear public explanation and evades the carefully planned and coordinated inter-agency process that enables such a withdrawal to be executed safely and responsibly. This is a fair criticism. Indeed, Trump seems not to have consulted the Defense Department, State Department, or really any of the national security principles in his administration before making this announcement.

But the fault for evading process may lie more with the president’s hawkish advisors than with Trump himself. Trump has long expressed disapproval for the U.S. military presence in Syria, but his own officials – including National Security Advisor John Bolton, Secretary of State Mike Pompeo, Secretary of Defense James Mattis, and the current Special Representative for Syria Engagement James Jeffrey – either resisted or ignored the Commander in Chief’s clearly stated preferences on an ongoing military mission. That may have made the president feel he had no choice but to circumvent process and issue the order to withdraw on his own, via Twitter. 

That said, I do worry about an administration that is too deferential to Trump’s every whim. I was heartened, for example, that cabinet officials spent months pushing back on Trump’s call to withdraw from the Iran nuclear deal. Likewise with the president’s request for military options against North Korea, which the Pentagon reportedly slow-walked in the months before Trump shifted from maximum pressure to diplomatic negotiations with Kim Jong-un. And when Trump reportedly asked Mattis to assassinate Assad, it was probably a good thing that the Secretary of Defense chose not to take the suggestion seriously. 

That withdrawal is the right decision does not mean Syria will flourish in peace and security. Several undesirable contingencies may occur in the aftermath of our exit. The Turks may engage in operations against the Kurds in Syria’s northeast. ISIS may make some gains here and there. But if these things materialize, they should not be cited as proof that withdrawal was unwise. That’s exactly the flawed argument hawks employed to criticize the 2011 withdrawal from Iraq. Sure, it left a vacuum in which ISIS emerged. But ISIS itself is a product of the US invasion of Iraq. And our presence in Syria could very well be creating comparable unintended consequences, instead of preventing them.

It can’t be America’s purpose to indefinitely forestall every plausible misfortune that may or may not bedevil this troubled region. In the near term, we can engage in diplomacy to try to curb Turkish plans to target the Kurds. And with regard to ISIS, it’s not at all clear that their permanent defeat depends on maintaining a U.S. ground presence in Syria. The extremist group is already decimated, and even without an indefinite U.S. presence, it is surrounded by enemies to whom we can pass the buck (should resurgence even occur, which is not a given).

Anyone who favors a U.S. military presence in Syria should be calling for Congress to formally authorize it. That process will require making a strong public case that deployment is required to preempt an immediate threat to U.S. security and that the mission have coherent, achievable goals that clearly define what victory looks like. Otherwise, our presence in Syria is illegitimate.

A restriction of free speech by any other name is still unconstitutional. No matter how much the Missouri government wants to regulate alcohol it may not do so by restricting the freedom of speech. Cato joins the ACLU and the Freedom Center of Missouri on an amicus brief supporting a challenge to a Missouri law prohibiting alcohol producers from advertising alcohol prices unless the prices are displayed inside a retailer—and they may not advertise who their retail partners are unless they list more than one. This both limits and compels speech.

The government argues that advertising is “commercial speech” and therefore not afforded the same protections under the First Amendment as every other type of speech. The “commercial speech” doctrine traces back to Valentine v. Chrestensen, an infamous case from the 1940s in which the Court arbitrarily decided commercial advertising wasn’t constitutionally protected. The Court has slowly been hacking away at this arbitrary rule, eventually creating an intermediate protection for commercial speech in under the Central Hudson Gas & Electric Corp. v. Public Service Commission (1980), where courts must balance four factors before deciding whether to nullify a restriction on commercial speech.

The Central Hudson test requires courts to determine: (1) whether the speech is false or misleading, (2) whether the government has a “substantial interest” in regulating the speech at issue, (3) whether the censorship directly advances the government’s interest in regulating the desired object, and (4) whether the government’s speech-regulation is no more restrictive than necessary. As reasonable as the words may seem in the abstract, the test has sprouted a thicket of arbitrary rulings contrary to the original meaning of the First Amendment.

What exactly qualifies as a “substantial interest” for a government has never been particularly clear. Nor has the Court been able to demonstrate where in the First Amendment some types of speech are afforded greater protections than others. Justices from John Paul Stevens to Clarence Thomas have criticized the Central Hudson test for its arbitrary factors and lack of grounding in the text of the First Amendment.

Our brief argues that alcohol advertising is just as much a form of speech as literature and political speech, deserving of protection from arbitrary government restrictions. The Central Hudson test should be eliminated in favor of the standard First Amendment protection for any kind of speech—which of course isn’t absolute, but is also not subject to government whim.

Despite the “commercial speech” doctrine’s emergence seemingly over night, and that the Central Hudson test still stands after nearly 30 years, Cato once more opposes this impediment to both the freedom of speech and economic liberty in the hope that, as Shakespeare put it in Henry VI, Part III, “many strokes, though with a little ax, hew down and fell the hardest timbered oak.”

Last night, the Senate passed the Formerly Incarcerated Reenter Society Transformed Safely Transitioning Every Person (FIRST STEP) Act, a bill which could provide relief to thousands of federal inmates and an untold number of future defendants for federal drug crimes. The Senate was widely considered to be the biggest hurdle to the bill’s success, and so activists and other supporters are celebrating in a way seldom seen in Washington criminal justice circles. With the president’s vocal support of the bill, it is likely to pass the House and be signed into law.

Although most news stories about the bill feature the “unlikely allies” from across the political and ideological spectrum that supported this bill, such language downplays the many years of tireless effort organizations on the left and right have put into bipartisan reform. Previous efforts have come up short, in one instance painfully close to the finish line, so the relief and elation many advocates are expressing are well-earned. While Cato policy precludes its scholars endorsing legislation, my most sincere congratulations to the many organizations and individuals who fought so hard to make yesterday’s passage happen.

All that said, the FIRST STEP Act is aptly named because it only serves a small segment of the nation’s incarcerated population and thus cannot be the endpoint in the ongoing struggle for criminal justice reform. The United States holds over two million people in jails and prisons, mostly at the state and local levels. To the eligible prisoners who will be affected by FIRST STEP, the law may be a godsend, but for the vast majority of inmates, nothing will change when the president signs the bill into law. Taking nothing away from the achievements of FIRST STEP’s proponents, so much more needs to be done at every level of our criminal and carceral system.

Law enforcement officers continue to harass and over-police neighborhoods, bringing more people into the correctional system than need to be there in the first place. Prosecutors overcharge and over-sentence offenders, particularly those that exercise their constitutional rights to jury trials. Judges are still hamstrung by mandatory minimum sentencing laws that remove discretion and mercy in favor of punishment that may do more damage than good to the community.

Again, congratulations to our friends on the left, the right, and those in between who worked so hard to pass FIRST STEP. Cato is already working with some of these organizations on the next steps to making our criminal system fairer and less punitive.

President Trump has repeatedly cited drug smuggling as a reason to build a wall along the Southern border. But my new Cato policy analysis shows that, if stopping drug smuggling is the goal, a border wall is about the worst possible investment. Here are a few of the main findings:

  • Hundreds of miles of border fences built from 2003 to 2009 had no effect on marijuana smuggling.
  • Marijuana legalization starting in 2014 has cut marijuana smuggling between ports of entry (i.e. where a wall would go) 78 percent from 114 pounds per agent in 2013 to just 25 pounds per agent in 2018.  
  • Since marijuana is the primary drug smuggled between ports of entry, the total value of all drugs seized by the average Border Patrol agent fell 70 percent from 2013 to 2018.
  • As a result, the average inspector at ports of entry made drug seizures that were three times more valuable than those made by Border Patrol in 2018. In 2013—prior to legalization—the average Border Patrol agent made more valuable seizures.
  • By weight, the average port inspector seized 8 times more cocaine, 17 times more fentanyl, 23 times more methamphetamine, and 36 times more heroin than the average Border Patrol agent seized at the physical border in early 2018.

The best proxy measure for changes in drug smuggling is the amount of drugs seized by Border Patrol. To control for enforcement levels, the paper looks at seizures per agent. From 2003 to 2013, the rate of seizures per agent was virtually constant, even as the number of agents doubled and the government constructed hundreds of miles of border fences. But enforcement didn’t stop the flow—only when states, starting in 2014, started to fully legalize marijuana did marijuana smuggling decline (Figure 1).

Figure 1: Marijuana seizures and length of border fences

[HTML] Figure 2
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Because marijuana is primarily smuggled between ports of entry, the most valuable drug smuggling now occurs at ports of entry. As Figure 2 shows, Border Patrol was seizing more drugs—by value—in 2013, but by 2018, value of drugs seized at ports of entry was three times the value of drugs seized between ports of entry by Border Patrol. In other words, a border wall would not target the most valuable drugs crossing the border.

Figure 2: Value of drug seizures per agent by location of seizure [HTML] Figure 6
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All of this should inform policymakers on how to address illegal immigration as well. Policies that make legal immigration easier undermine the incentivizes for black market activity. As Figure 3 shows, when lesser-skilled guest worker admissions increase, the number of apprehensions per Border Patrol agent declines. Since 1949, a 10 percent increase in guest workers was associated with an 8.8 percent decrease in apprehensions per agent. The current H-2A and H-2B guest worker programs for seasonal workers are already helping the situation greatly, but they could be improved and expanded on to cut illegal entries further.

Figure 3: Lesser-skilled guest worker admissions and apprehensions per Border Patrol agent [HTML] Figure 8
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If Congress wants to address drug smuggling, it should legalize marijuana nationwide and invest in better ports of entry, not build a wall. The same lessons that drug smuggling have provided should apply to illegal immigration, cutting demand for illegal immigration by making more legal options available to immigrants.

This morning, Acting Attorney General Matthew Whitaker signed the Trump Administration’s new regulation banning bump stocks. The final rule is largely unchanged from the one put up for notice and comment several months ago, but contains over 100 pages of responses to the tens of thousands of comments submitted both in favor of and opposition to the rule (the majority of which opposed the rule, including a comment submitted by us and Josh Blackman).

The Administration’s main contention continues to be that language of the National Firearms Act and Gun Control Act—which has not needed clarification in some 80 years—is ambiguous in regards to bump firing, a contention we dispatched back in June. Yet the government is attempting to use this supposed ambiguity to shoehorn bump stocks into a statute that regulates possession of machine guns.

Regardless of what public opinion is at this moment, the law means what it says. The executive branch has the power to interpret existing law, not write new ones. The administration argues, essentially, that because the statute did not provide a separate definition of the terms “automatically” and “function,” that it gets to insert their own meaning. That simply isn’t the case. Administrative interpretations are supposed to do just that—interpret existing law—not give new meaning to an old one.

In this case, the existing law specifically defines “machine gun”; several administrations have reviewed bump stocks and repeatedly determined that they don’t fall in that category. It’s been clear for decades that Gatling guns and bump stocks were not machine guns. This regulation is not an attempt to clarify a vague law, but to seize political expediency to expand the power of the executive.

If the government really wants to regulate bump stocks, it needs to do so by passing a new law, not by assigning new meaning to an old one. The Founders weren’t short-sighted; there is a reason laws that affect the entire nation have to come through Congress, not reimagined by bureaucrats.

What’s worse is the fact that the administration’s attempt to skirt the Constitution is for something as inconsequential as bump stocks. We are talking about seriously damaging the integrity of our legal system over a novelty item. In a country as divided as ours, this seems like a squandering of political capital.

The powers of the federal government are few and defined, not open to unlimited interpretation by unelected bureaucrats. In light of this, our regulatory comment potentially gives Cato a right to intervene in the coming litigation. Stay tuned.

In a series of retrospectives on 1968, NPR reports on a sort of jury nullification that took place in Long Island and created a pre-Stonewall victory for gay rights and sexual freedom. In the summers, gay men would come out from New York City and elsewhere for sunbathing, house parties, and in some cases anonymous sex in a wooded area between the towns of Cherry Grove and Fire Island Pines. And some were arrested, fined, or even imprisoned. Then in 1968 some decided to fight back and hired a lawyer willing to fight for them:

In the autumn of 1968, close to two dozen gay men were acquitted of consensual sodomy charges in a series of criminal trials on Long Island. The trials and acquittals marked a pivotal moment in what eventually became the gay rights movement. They demonstrated to the larger gay community — then mainly closeted — that gay people could band together to resist police harassment….

In late August, 1968, police arrested 27 men in Cherry Grove. A few pleaded guilty to consensual sodomy and payed a fine of $250. But 22 men fought the charges in court.

Benedict Vuturo, a prominent Long Island criminal defense lawyer, was retained by the Mattachine Society. In the fall of 1968 Benny Vuturo, as he was known, demanded jury trials for all of the gay men he was defending.

“Benny said there’s terrible crimes on the mainland of Long Island, murders and rapes, and here the cops go and they beat the bushes and try to find these gay fellas who are not harming anyone,” said reporter Karl Grossman, who covered some of the trials for the Long Island Press.

“The juries, one after another, concurred, and they found the defendants not guilty, not guilty, not guilty. And that was the end of the police raids on Fire Island. To me, it really was a testament to the common sense of eastern Long Island residents who served on those juries, and to the jury system.”

Vuturo was hoping to lose one of the trials so he could challenge New York’s sodomy law but he won every case.

The state’s sodomy law was overturned in 1980, 12 years after the Fire Island trials. 

There wasn’t much doubt that the men had been doing what the law prohibited. Yet Long Island juries found them not guilty. That’s a phenomenon often called jury nullification, defined by the Legal Information Institute as “A jury’s knowing and deliberate rejection of the evidence or refusal to apply the law either because the jury wants to send a message about some social issue that is larger than the case itself, or because the result dictated by law is contrary to the jury’s sense of justice, morality, or fairness.” Read more about jury nullification in this Cato Institute book and in a Wall Street Journal article discussed here. It won’t surprise you to hear that judges and prosecutors don’t want juries to know their rights. I wrote about Stonewall here.

It turns out that NBC News covered the 1968 Fire Island story four months ago.

Senator Elizabeth Warren says yes, because patent protection gives drug companies monopoly power that they exploit. Her suggestion raises several issues.

First, Warren is right that while patents might incentivize innovation, they also keep prices elevated while new drugs are under patent, thereby reducing utilization. Patent policy should seek to balance these two effects, and current policy might not be the right balance.

Second, Warren’s suggested policy - more government, rather than reduction or elimination of existing patent protection - fits the standard progressive approach: assume the fix to imperfect government is more government, rather than less. 

Third, libertarians are divided over government patent protection. On the one hand, libertarians endorse a government role in defining and enforcing property rights generally, so why should intellectual property be any different? (And as a bonus, intellectual property protection is an enumerated power). Further, standard economics suggests that private investment in new ideas might be insufficient without patents.

On the other hand, the current patent system generates a non-trivial frictions: patent trolls try to “hold up” firms that might use patents for new products. This causes no ineffiiciency if Coasian bargaining costs are zero, but that seems unlikely. 

Existing research, moreover, provides little evidence that patent protection spurs innovation (although pharma may be an exception).

So, Warren raises a valid concern over patents. But rather than having government manufacture generic drugs (what could possibly go wrong?), why not just scale back existing patent protections?

By the end of 2019, Facebook promises to establish an independent body to handle appeals of its content moderation decisions. That intention follows an earlier suggestion by Mark Zuckerberg that Facebook might establish a “Supreme Court” of content moderation. Like the real Supreme Court, Facebook’s board will presumably review the meaning and application of its Community Standards, which might be considered the basic law of the platform.

There are many questions about this new institution. This post looks at how its members might be selected.

To fix ideas, let’s begin with how members of the U.S. Supreme Court are selected. Appointments to the highest court are procedurally simple and normatively complex. Article II of the Constitution says the president “shall nominate, and by and with the Advice and Consent of the Senate, shall appoint…Judges of the Supreme Court…” Advice and Consent can mean a simple majority or a supermajority of senators. Whatever the rule, senators vote only once on a nominee. Thereafter justices “hold their Offices during good Behavior.” (Article III) In practice that means justices continue serving however unpopular their decisions. Of course, justices may be impeached and removed from the Supreme Court. However, Congress has not removed justices or judges because of their decisions. It really does require bad behavior.

Clearly the framers of the U.S. Constitution valued judicial independence, especially a certain distance from the unfiltered will of the majority. A candidate for the presidency may promise voters to nominate a favored judge to the Court; he lacks power to seat anyone. Candidates for the Senate may promise to support or oppose a nominee to the Court, but no senator or group of senators can decide whom to nominate. Once seated, the “good Behavior” standard means a justice serves until retirement, death, or impeachment and removal. The first two are by far the most likely means of departing the Court. The justices need not fear their peers in the executive or the legislative branches or indeed, the people themselves, since they may not be recalled by an angry electorate.

But justices are not free to exercise the judicial power of the United States as they wish. Presumably they are obligated to interpret and apply the words of the Constitution which both empowers and limits the government. The courts are not independent of “We, the People” understood over time as the will of majorities and supermajorities expressed as the text of and amendments to the Constitution. The presidents and senators who nominate and appoint justices also depend directly or indirectly on voters. In these ways, the selection of Supreme Court justices balances independence and representation, thereby fostering the legitimacy of the Court and its decisions.

Following legal and constitutional values might enhance the legitimacy of Facebook’s “appeals court.” Facebook clearly values independence in this new review board: Zuckerberg describes the board as “an independent body, whose decisions would be transparent and binding.” But he also says, the board would “uphold the principle of giving people a voice.”

You might think Facebook’s Community Standards cannot support its review board the way the Constitution supports the Supreme Court. The Constitution gained consent through a deliberative process that led to approval of the document eventually in all states. Nothing like that happened at Facebook. Yet every user consents to abide by Facebook’s Community Standards when joining the platform. We might question the quality of that consent, but it seems similar to the consent given to the Constitution by those of us who joined the “platform” after 1789.

What about applying the Community Standards? Zuckerberg says the board should be independent of Facebook for three reasons:

First, it will prevent the concentration of too much decision-making within our teams. Second, it will create accountability and oversight. Third, it will provide assurance that these decisions are made in the best interests of our community and not for commercial reasons.

Members of the board might serve during “good behavior” like justices. This would create space for its members to interpret and apply Facebook’s Community Standards as they saw fit.  Perhaps extended terms for members of the board could attain the same end. But remember: even Supreme Court justices can be removed for bad behavior.

Facebook’s board also needs to be independent in the sense of being free of both politics and commerce. Many people fear that Facebook’s content governance reflects the political commitments of its managers and employees. The interpretation of Facebook’s Community Standards also could become the plaything national political forces.  In both instances, concerns about independence reflect worries about misrepresentation. What should be for all turns out to reflect the will of a few. How might the selection of review board members better represent Facebook’s users?

Let’s begin with a straightforward idea of representation. Imagine Mark Zuckerberg appoints the members of the board. Zuckerberg is accountable to Facebook’s users because they can exit the platform and thereby harm or destroy his business. That constraint would mean his appointments represent the concerns of users, along with other matters important to the business. Zuckerberg is a faithful agent of his customers not because he wishes to be so but because he must be.

Facebook wants its content moderation to be accepted as legitimate by its users (and by others). Would users accept this market theory of representation for the board? Many people doubt that markets constrain business managers. Others will think of representation as direct voting rather than indirect responses to consumer desires. Partial acceptance of the market theory may not be adequate to legitimize the new body.

So instead of one person, maybe every adult should elect the members of the board. But direct election seems impossible. The institutions to make that happen do not exist and would take a long time to create. If created, the elections would likely have low turnout with dire implications for the legitimacy of the board.

Any decisionmaker faced with a similar situation tends to act on what might be called the stakeholder theory of representation. Facebook could determine which groups have a strong interest in content moderation by the company. They could then consult with these organized interests about who should serve on the board and then appoint them. The stakeholders would nominate while Facebook managers appoint the “justices” of the review board. Facebook might well see these appointments as representative of its users. The appointees would not work for Facebook and hence be independent in a sense. More realistically, if these selections were done correctly, Facebook would give its critics (and supporters) a seat at the appeals court.  Its critics might become more constructive or even supporters of Facebook’s content moderation.

But who would these appointed stakeholders represent? They would be suggested by groups with intense interests in Facebook’s content moderation. For them, the benefits of organizing to influence content moderation would outweigh its costs as noted in a famous book.  For most Facebook users, the opposite would be true; the costs of organizing would outweigh its benefits. As a result, the appointees would likely have atypical views about the meaning and application of Facebook’s Community Standards. In other words, representatives of stakeholders are unlikely to be representative of Facebook’s users.

Turning to stakeholders to help with a political challenge is natural. Above all, they are there, and you know them. Stakeholders do indeed offer a measure of representation, and perhaps also some independence from forces outside any organization. Indeed conflict among stakeholding members might enhance the board’s independence.  But the representation they offer is flawed. And perhaps, at this stage of institutional design, Facebook might look for alternatives that offer more in the way of both independence and representation.

Return Mail, Inc. is a small technological company that developed a and patented a system for processing returned mail after a failed delivery attempt, using optical scanners, computer databases, and other mechanisms. When it sought to enforce its patent against the United States Post Service (USPS), it knew that in the wake of the 2011 America Invents Act (AIA), the U.S. Patent and Trademark Office (PTO) could change its mind and conclude that the patent was granted in error and should have no further force. It also knew, however—or so it thought—that once the government made a decision regarding a patent, the government would be expected to speak with one voice. Instead, two different governmental agencies came to different conclusions and attempted to argue amongst themselves over Return Mail’s rights.

Article II of the Constitution vests the executive power in the president alone because the president is uniquely accountable to the entire American public.  Yet the USPS, although part of the government, operates independently of direct presidential control and is able to take legal positions that conflict with presidential directives and priorities. The Supreme Court has permitted the creation of such agencies, but it has never sanctioned these agencies to directly contradict presidential decisions and to seek the resolution of such disputes in the judiciary branch.

Such a system creates significant problems for the public in general, because it can never know who is actually speaking for the government and which directives it must comply with. It’s particularly problematic in the world of patents—which Congress from very early on determined must have uniform application throughout the country and charging a single agency with reviewing applications and a single court with hearing all appeals. Allowing myriad government agencies to reach their own conclusions on the meaning and scope of patents would undermine the system that Congress has taken pains to construct over more than 200 years (regardless of the proper scope of patents and other legislative reforms that may be worth pursuing).

Further, allowing the government to disperse the executive power between the president and independent agencies has a risk of undermining the due process protections that must be afforded to patentees before their patent rights are taken away. The Supreme Court has always maintained that patentees’ rights are protected by the essential guarantees of the Due Process Clause. Under the current system for administrative patent cancellation proceedings, the director of the PTO (who is responsible to the president and terminable at will) has the power to select administrative patent judges and assign them to particular cases. In cases where an executive agency seeks review of a patent issued by the PTO, the government—through that agency—has an interest in the outcome of the proceedings, but it is also the one sitting in judgment of the case. Our system of government has rejected procedures where one can be a judge in his own case. Allowing one government agency to challenge a patent while another government agency sits in judgment of that challenge would undermine more than 400 years of Anglo-American jurisprudence.

The Cato Institute, joined by Professor Gregory Dolin of the University of Baltimore, have filed an amicus brief urging the Supreme Court to hold that fidelity to our constitutional structure requires construing the AIA to apply solely to the resolution of disputes between private parties where the PTO remains a neutral and disinterested adjudicator and where politically accountable branches remain responsible to the citizens for the decisions that they have reached.

The case of Return Mail, Inc. v. U.S. Postal Service will be argued at the Supreme Court in the new year.

This blog post is part of a larger series on stock-market “short-termism”. See also my entries on share buybacks and progressive corporate governance reforms.

I. Introduction

To recapitulate the “myopia thesis”: managers of publicly traded firms are hostage to diversified shareholders who forego careful study of the firm’s fundamentals and instead respond to the latest, easily digestible quarterly earnings report. Rather than undertaking investments that might have a substantial return down the road, managers mimic the priorities of transient shareholders uninterested in a firm’s long-term strategy. Future-oriented firms that resist this temptation will find it more difficult to raise capital. This will then jeopardize their ability to survive long enough to reap the returns from long-term investments. 

The myopia hypothesis predicts that: 1) stock markets undervalue firms that sacrifice short-term profitability for longer-term growth 2) firms will therefore rationally forego long-term investments such as research and development (R&D) and capital expenditures (CAPEX). In this post, I will critically examine the evidence for such claims.

II. Profits, P/E Ratios and IPOs

Several economic indicators challenge the first pillar of short-termism thesis. In a recent NBER working paper, Steve Kaplan contrasts the early predictions of the myopia theorists in the 1980s with subsequent trends in corporate profits. If the short-termists of yesterday had been correct, the earnings posted by publicly held firms throughout the 80s and 90s would have evaporated over the medium-to-long term. Instead, we’ve since witnessed a steady upward march of corporate profits into now unprecedented territory.[1]

Moreover, while earnings have been on the rise over the past several decades, the price-to-earnings ratio (P/E) of the median firm listed on the S&P has risen even faster, currently at 25 compared to a historical median of 15.[2] A higher P/E ratio indicates that shareholders are valuing future earnings very highly. The very names that come to mind when one thinks of dynamic, future-oriented firms: Google, Apple, Amazon, Microsoft, Facebook all have exceptionally P/E ratios (~35), in many cases despite long periods of losses (Amazon netted more income in the final quarter of 2017 than in all 54 post-IPO quarters cumulatively). Investors act as if today’s unexceptional profits are going to grow substantially over the coming years and are pricing this optimism into current share prices. For these five firms, total profits of $101 billion in 2017 translated into a valuation worth 15% of the entire S&P 500.[3] The latest “Special Report” of the Economist magazine, while describing the potential monopoly threat that these tech giants pose, nonetheless concedes that their currently stratospheric valuations are in anticipation of future profits:

To justify its valuation, Facebook’s rate of “monetisation” will have to surge, suggesting that it extracts a bigger fee from other firms who want to reach consumers. To justify its $820bn market value, Amazon will have to increase its share of American retail to 12% (Walmart’s share today is 7%). Likewise Netflix will have to roughly double its nominal fee per user over the next ten years. Though tech firms’ profits as a share of gdp today are not extraordinarily large, Wall Street is predicting they will be in a decade’s time, with the median ratio for the five firms rising to 0.28%. That is above the 0.24% median level of Standard Oil, us Steel, at&t and ibm when they were each clobbered by antitrust regulators. The tech firms are expected to have higher returns on capital than the oligopolies of old, suggesting that they are better at extracting income per dollar of assets.

The Economist goes on to elaborate the ways in which prominent firms are leaving money on the table in the short-term to build future marketshare:

For Amazon and Netflix the rents flow in the other direction because their prices are low today: in total they subsidise their combined 240m paying subscribers to the tune of about $50 per person per year, based on the amount of additional free cashflow they would have needed to cover their cost of capital in 2017

Further corroboration can be found in the timing of IPOs. Notable examples such as Uber notwithstanding, the overall trend in IPOs has been toward more and more “premature” births of firms into public markets. The average profitability of a firm at the date of its IPO has been declining over the past several decades, as investors are willing to purchase shares in firms earlier in their life cycle.[4] Kaplan, citing IPO statistics by Jay Ritter, notes that just 4% of biotech firms that had an IPO between 2013-2016 were posting profits at the time. If publicly traded companies were indeed hobbled by myopic shareholders, this would present a massive arbitrage opportunity for investment vehicles operating on a longer time horizon. Venture capital and private equity funds are equipped for this purpose yet have not seen the abnormal profits or increased marketshare that one would expect if publicly traded firms were consistently failing to anticipate trillion dollar bills a few steps ahead on the sidewalk.[5]

III. R&D Up, Not Down, In Public Firms

The second key piece of evidence militating against the myopia thesis is that publicly traded U.S. firms, particularly those with the bubbliest valuations, are conducting more R&D than ever before, not less. Let’s begin by noting the strong upward trend in the overall private sector’s spending on R&D, which I’ve divided by total GDP (known as “R&D Intensity”):

Next, let’s look at R&D spending by the five aforementioned firms that shareholders are tripping over themselves to invest in:

The only way to reconcile the myopia hypothesis with the foregoing data is to maintain that these firms’ valuations would be even higher if they were spending less on R&D. For some reason, that counterfactual rings false. Post-recessionary declines in capital expenditures, on the other hand, seem superficially sympatico with short-termism, but can be adequately explained by reference to lower capacity utilization, and is in fact a worldwide phenomenon not restricted to the “overly financialized” Anglosphere.[6]

Let’s recall the mechanism by which short-termism is said to operate: diversified, rationally ignorant shareholders with short time-horizons turnover at high rates and punish future-oriented investments that incur immediate costs, such as R&D. We would expect, therefore, that publicly traded firms, whose shareholder profiles check those boxes, would suffer more acutely from myopia than privately held firms. Indeed, studies have found that publicly traded companies that go private register more patents post-transition, and, conversely, that privately held firms suffer a decline in patent quality after an IPO.[7][8] More directly to the point, a 2015 paper found that compared to privately held firms matched on a battery of relevant characteristics, public corporations engage in less net investment, and are less likely to capitalize on new investment opportunities as they emerge.[9]

A 2018 Federal Reserve Board working paper that uses corporate tax return data, comes to the opposite conclusion. Because private and public firms are subject to the same IRS filing requirements, the researchers were able to use the exact same measure of R&D investment when comparing the two groups, where previous studies had to impute measures of R&D for private firms. Moreover, whereas the Asker et al paper only had access to an unrepresentative sample of private firms and had to combine their measurement of capital expenditures with merger and acquisition activity as a rough proxy for net investment, the FRB study’s IRS data allows it to directly measure long-term investment, and to divide this measure into its physical and intangible (R&D) components. Beyond being far more granular, this dataset also captures the full universe of private U.S. corporations, allowing the researchers to compare a representative sample of private firms against their publicly traded counterparts, mitigating the selection effect that has plagued past comparisons. Not only do the Fed researchers find statistically significant differences between private and public firms, the magnitude of these effects is substantial:

…public firms invest…46.1 percentage points more in long-term assets than their private firm counterparts. It is not simply that public firms invest more relative to their asset base and thus out-invest private firms, they also direct a greater share of their investment portfolios to long-term assets. Public firms allocate 9 percentage points more of their total investment dollars to long-term assets than comparable private firms. The long-term investment advantage of pubic firms over private firms largely stems from their outsized investments in R&D. Public firms invest 39.2 percentage points more in R&D expenditures relative to physical assets, and dedicate 11 percentage points more of their investment budgets towards R&D than private firms[10].

Moreover, the researchers directly attribute this result to the difference in the shareholder profiles facing private vs. public firms:

The access to capital investment and the ability to spread risks among many small shareholders appears to facilitate heavier investments in R&D, arguably the riskiest of asset classes.

This result does not appear to stem from an omitted variable confounding the comparison between private and public firms. By exploiting the variation in R&D spending pre and post-IPO within the same firm, the researchers similarly note:

We find that public firms do not alter their short-term investment relative to physical assets following an IPO. These firms do, however, increase their long-term investments, and particularly investments in R&D: firms increase their R&D-to-physical asset ratios by 34.5 percentage points, and their R&D-to-total investment shares by 17.1 percentage points. Using an event study framework, we show that this increase in R&D expenditures occurs immediately upon IPO and persists for at least 10 years. We also examine changes in investment behavior following stock market delistings: results are less precise, but generally point to a reduction in R&D investments upon going private.

[1] Kaplan (2017)

[2] ibid

[3] Roe (2018)

[4] Fama and French, 2004; Ritter, 2016; cited in Kaplan, 2017

[5] Supra note 4

[6] Supra note 4

[7] Lerner, Sorensen and Stromberg (2011)

[8] Bernstein (2015)

[9] Asker, Ferre-Mensa, and Ljungqvist (2015)

[10] Feldman et al 2018

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