Private Philanthropy has Many Lessons for Government
Joe|February 3, 2020
America’s nonprofit sector is booming. There are now over one and a half million nonprofits registered with the IRS, contributing nearly one trillion dollars to the economy. Private giving has risen to $430 billion, the highest level ever. Such private philanthropy often accomplishes things government services cannot. Private philanthropy allows for experimentation with a broader range of ideas, producing a greater variety of solutions and approaches to problem-solving in general. Philanthropic organizations often achieve considerably more success than government in addressing pressing issues. In 56 out of 71 studies that compared the efficiency of public agencies and philanthropic organizations that offer the same services, the private provider was more effective.
As Philanthropy magazine editor-in-chief Karl Zinsmeister recently wrote in the Wall Street Journal, private philanthropy’s comparative success has made it a target for politicians and editorialists who peddle bigger government and view philanthropy as its competitor. But government should not view philanthropy as a competitor. As Zinsmeister writes, “America’s highly decentralized philanthropy is one of its most pluralistic and democratic elements. Philanthropy disperses authority, gives individuals direct opportunities to change their communities, and lets nonmainstream alternatives have their day in the sun.” Politicians and officials should see philanthropic organizations as incubators of ideas that government can scale.
Since modern philanthropy emerged in the 19th Century, nonprofits have been quick to address societal ills when politicians hesitate. Historically, government has recognized the effectiveness of many philanthropic solutions, creating a long tradition of federal, state, and local governments adopting and expanding projects started by nonprofits.
One famous example is the establishment of Carnegie libraries. Andrew Carnegie built and donated over 1,500 public libraries across the United States to increase access to education for all Americans. Carnegie, an immigrant who had educated himself with the books he read while working from dawn to dusk starting at age thirteen, believed that public libraries would be especially beneficial for immigrants trying to assimilate and people who wanted to learn but were either too old for tax-payer funded high schools or could not afford to spend time in a formal classroom. Most significantly, Carnegie broke from earlier trends in library philanthropy that produced magnificent buildings that were too expensive for local taxes to support. The Carnegie libraries were efficient and functional, an architectural innovation adopted by local governments across the country seeking their own affordable public libraries.
The problems facing our growing world come at a pace too fast for the government to lumber in search of effective solutions. When governments see winning ideas that are better than their own, they should try to scale them. One form this can take is providing educators with tools that are experimentally proven to lead to more successful student outcomes. Math Shelf is a tablet-based app that has shown statistically significant improvements in mathematics performance among preschool students. The program has been expanded up to first grade, and studies have shown that students can learn more than a year and a half of additional mathematics with only twenty minutes of app use each day compared to students who did not use the app at all. Studies of Head Start, in comparison, show that the federally-run program has no discernible positive impact on participating students by the time they reach third grade. Head Start’s budget of $10 billion might not represent the best use of funds, whereas expanded access to tools like Math Shelf could help educators nationwide achieve better outcomes for their students.
But sometimes scaling fails. Policy makers should understand that what works to improve education outcomes for low-income students in inner-city Detroit might not work in Appalachia. In addition to adopting the winning solutions themselves, the government should incentivize local experimentation so that communities can tailor solutions to their unique situations.
In Chicago, local officials are doing exactly that. Violence plagues Chicago, and the city’s police have struggled to get homicides and shootings under control. 2016 was the most violent year in two decades for the city, with 780 murders and 4,300 shootings. In 2016, only 29% of murder investigations led to an arrest. Arnie Duncan, a Chicago native and former U.S. Secretary of Education under President Obama, realized that policing was not enough. He created a non-profit organization called Chicago CRED, which has sought a more effective approach to gun violence. Duncan and his team have worked with thoughtful and experienced philanthropists like Laurene Powell Jobs, local officials, like-minded organizations, and the communities most at risk of violent crime to experiment with street outreach, life coaching, counseling, and workforce development. With private funding, CRED could allocate resources more creatively. Chicago Mayor Lori Lightfoot is adopting a similarly holistic approach to public safety through targeted investment in the South and West side neighborhoods. The results are already staggering. Shooting dropped 8% in 2018 and 9.7% in 2019. There is more work to be done, but Chicago’s model of community-based solutions is a roaring success that other cities should emulate.
In general, government problem-solvers need to take chances on younger talent, higher-risk research, and a range of projects encouraged by private philanthropy in order to foster the development of the best ideas and solutions. They need to test unorthodox methods and move away from tired policies that don’t work.
This iterative approach could improve our country’s biomedical research system. The successes of privately funded biomedical research outpace those of the National Institute of Health (NIH) not because they have more resources but because they better allocate their resources. Nationally, total inputs for medical research is substantially increasing, but the results are not commensurate to this increase. At the same time, the number of scientists being trained has continued to rise, breeding hyper-competition for federal funds that researchers at the National Academy of Sciences believe “suppresses the creativity, cooperation, risk-taking, and original thinking required to make fundamental discoveries.”
Competition for NIH funding, in particular, has made the biomedical research system favor projects that have guaranteed results conducted by older, more established academics, rather than higher-risk, unconventional projects and younger researchers with new ideas. In 1980, NIH granted twelve times as much funding to researchers under 40 than over 50, but today five times as much funding goes to the older cohort. In the current system, younger academics feel immense pressure to conform to the tired formula of grant acquisition, producing stagnation where innovation should be encouraged. Many advocates of the NIH argue that the institution simply needs more resources, but additional funding alone will not correct the systemic problems hampering the NIH.
Damon Runyon Cancer Research Foundation has taken a different approach to funding research, and the results are impressive. Their award programs specifically target young cancer researchers early in their careers to do high-risk research that wouldn’t happen otherwise. Former grantees help determine which researchers have the most promise. Damon Runyon researchers have won twelve Nobel Prizes, and sixty-five of their scientists have been elected to the National Academy of Sciences. According to the nonprofit rating organization Charity Navigator, Damon Runyon’s results have “exceeded industry standards and outperformed most charities in its cause.”
For NIH and other funders to improve, they cannot just fund scientists who have proven their success or increase funding overall. In short, NIH should take inventory of its procedures and open itself to the better practices of other organizations, such as funding riskier research and younger researchers. NIH has a prominent role in our country’s scientific community, which makes it all the more important that it incorporates the promising approaches of private research funders.
It is no surprise that studies have found that 71% of American trust nonprofits over government to solve the most pressing issues of our time. Free and dynamic societies allow private individuals to experiment, innovate, and flourish. It is a perennial challenge for government to innovate and improve quickly, but there are many relevant lessons that public officials can learn from private citizens’ philanthropic ventures. Politicians and officials should work to fix the inefficiencies that plague public programs and use solutions from private philanthropy so that our government can more effectively achieve the results its citizens deserve.
Disclaimer: The chair of the Cicero Institute, Joe Lonsdale is a donor to UCSF, IGI, and Damon Runyon.
American capitalism is under siege. Nationalist-Right politicians defend reincarnations of 20th century industrial policy and blame weak wage growth on immigrants and foreign exporters. Meanwhile far-Left politicians including Bernie Sanders and Elizabeth Warren have popularized traditional Marxist critiques of the rich and want the federal government to nationalize banks, the healthcare system, and other sectors of the economy. Each rejects market competition in favor of expanded state involvement in the American economy. Each side has it wrong.
The problem with capitalism today is that market competition itself is in decline. The gravest threat to the American economy is “crony capitalism”, whereby special interests including industry groups and unions pervert the policy making process in order to restrict competition and line their own pockets. Market competition is precisely the feature of our economy that we must fight to preserve.
A competitive market is an evolutionary system in which every business must constantly test its worth against entrepreneurs with bold, new ideas. As Joseph Schumpeter noticed long ago, entrepreneurs create value for society by destroying outmoded, inefficient modes of business and replacing them with more productive models. Market competition naturally rewards creativity, innovation, and entrepreneurial genius, no matter how unexpected their origins. It ensures that the best ideas go viral, the worst ideas vanish into obscurity, and business leaders pay for their mistakes with lost market share.
When the best ideas win, we all benefit. In the past two centuries, entrepreneurs have developed fantastic innovations and streamlined modes of production, lifting our population from agrarian poverty to standards of living that would have astounded our ancestors. It’s no overstatement to say that the profit-motive — the right to keep one’s earned income — is the main explanation for this tectonic shift in human life. But if the profit-motive is the principal reagent in the grand experiment of economic progress, it is also dangerously volatile and corrosive.
In a state of nature, our acquisitive drives bend towards violent appropriation of the wealth of others. A legal framework that enshrines individual rights to person and property is the essential bulwark against this kind of brute force. But an expansive modern government presents private corporations with thousands of new opportunities to twist the coercive power of the state to favor their private interests. In medieval times cronyism was straightforward: the crown granted monopoly charters to favored guilds and corporations in exchange for bribes. Today’s crony capitalism replicates this old system of client politics in subtle, insidious ways.
The military-industrial complex is the granddaddy of all crony industries. The scholar Gordon Adams identified an “iron triangle” of special interest linking Congress, the military, and private contractors, such as Lockheed, Raytheon, and Northrup Grumman. The unholy union of pork-barrel politics, revolving door dynamics, and the plausible alibi of national security imperatives is the perfect cover for corruption and waste in the defense sector. One half of the Department of Defense budget is allocated to contractors every year and impartial decision making in military contracting alone could save our country at least $100 billion annually.  But the true magnitude of waste in the American defense industry is much higher.
Traditional economic laws just don’t seem to apply to the fantasyland of defense contracting. Unit economics are often mind boggling. Journalists were outraged to discover that during the Reagan administration our military spent $600 per aircraft toilet seat cover and $7,662 on a certain coffee machine. But today the toilet seat covers cost $10,000 apiece, and we’re spending $1,280 per mug on reheatable coffee cups!
A defense contractor such as Lockheed Martin will typically secure congressional “buy-in” to a contract at a low rate, and then ratchet up the price of the contract on the premise of sunk cost. Cost overruns on complex goods such as planes range as high as 3–4x the original estimates. Congress has financially bailed out private contractors, financed mergers between private contractors, issued no-bid deals to private contractors, and lent private contractors money for arms deals at egregiously low rates.
In return, defense contractors have metastasized and begun selling ludicrously overpriced, low-quality products to every government agency they can sink their fangs into. Consider that Lockheed Martin is the largest contractor not only for the Pentagon, but also for the Department of Energy and the Department of Transportation, the second largest contractor for the Department of State, and the third largest contractor for NASA. We spend over $300B a year in defense contracts with private contractors alone, but when you include non-defense expenditures the number is far higher.
Defense contractors typically locate production in as many congressional districts as possible so that Congress members will be able to claim they’ve “brought home jobs” to their districts when they award insane military contracts. Military executives are so completely aligned with private contractors that they often split up lobbying efforts for contracts. As Senator William Proxmire put it in 1969 “How hard a bargain will officers involved in procurement planning or specifications drive when they are one or two years from retirement and have the example to look at of over 2,000 fellow officers doing well on the outside after retirement?”
If the defense contractor industry’s death grip on government is a “military-industrial complex”, American banking may justly be described as a “Wall Street-treasury complex.” Revolving door hiring is rampant. During the writing of Dodd-Frank, 47 of 50 Goldman Sachs lobbyists, 42 of 46 JPMorgan Chase lobbyists, and 35 of 46 Citigroup lobbyists had held government positions. And the Treasury Department — led by former Goldman Sachs CEO Hank Paulson — was packed to the gills with former investment bankers.
It is an inescapable reality that the individuals with the expertise to regulate an industry are the same individuals who achieved positions of prominence within that industry, and finance is no exception. But it would be naïve to assume that former bankers launch new careers as financial regulators tabula rasa, with pure motives.
After the mortgage crisis and the savings and loan bailouts of the 1980s, which cost taxpayers over $200 billion, the government expanded Fannie Mae and Freddie Mac — two of the most offensive examples of crony capitalism in the country. Although technically private, the two mortgage lending giants had special access to U.S. Treasury loans, federal officials on their boards of directors, and an implicit guarantee from the government. Beginning in 1992, administrations from both political parties also expanded the low-income lending goals of these two giants, until over 50% of their loans went to low-income families. These questionable loans contributed to the giants’ collapse and bailout in 2008, which cost taxpayers over $180 billion.
Other banks also benefit from implicit government guarantees. Since the bailout of the Continental Illinois bank in 1984, large banks have assumed that the government will rescue them in a crisis. The too big to fail problem creates a “moral hazard”: banks take riskier bets with the understanding that the government will bail them out if those bets sour. As expected, the federal government’s Toxic Asset Relief Program (TARP) provided over $450 billion of bailout capital to banks during the 2008 crisis, at terms grossly favorable to the banks. To manage the vast portfolio of troubled assets the Federal Reserve acquired after the bailout, Treasury Secretary Tim Geithner gave three no-bid contracts to BlackRock, which spends tens of millions a year hiring former government employees and lobbying the federal government.
The Dodd-Frank Act reinforced the crony relationship between our government and financial industry. Today, a bank in trouble does not go through an ordinary bankruptcy. Instead, the “Orderly Liquidation Authority” gives special debtor financing and creditor support to a failing bank. In addition, Dodd-Frank and subsequent regulations made it harder for small and new banks to compete with large incumbents. Since Dodd-Frank, over 2,000 small banks have closed their doors. And while hundreds of new banks once opened every year, since 2009 the federal government has only approved about a dozen new banking applications.
A combination of anti-competitive regulation, and special government subsidies coddles America’s big banks more than virtually any businesses in the country. American taxpayers lost $200 billion in the Savings and Loan bailout, and our government is now on the hook for hundreds of billions more. America’s financial system is one of the biggest beneficiaries of crony capitalism today.
As we have discussed elsewhere, the American healthcare system spends twice the OECD average per patient, and wastes up to $1 trillion annually. American government is implicated in a web of financial relationships with thousands of private corporations in the healthcare industry, each of which is subject to perversion. But even more disturbing is the ease with which incumbent corporations lobby to manipulate healthcare laws and regulations in their favor.
A paradigmatic example of special interest capture in American healthcare is the hospital industry, represented by the American Hospital Association (AHA). Hospitals are often the largest employers in their congressional districts, and routinely mobilize local doctors to persuade congress members to enact laws increasing federal funding or kill unfavorable bills in committee hearings. Although hospitals drive 1/3rd of healthcare costs and are the worst special interest in the healthcare industry by far, they have successfully shifted politicians’ attention to the insurance industry.
Next, consider the case of Medicare, which insures elderly or disabled Americans. Medicare Part B sets rates for all services provided by physicians, on which the federal government spends over $300 billion annually. Prices for procedures are specified by the Specialty Society Relative Value Scale Update Committee, or “The RUC.” One could be forgiven for assuming that the RUC is comprised of government bureaucrats. In fact, it’s an offshoot of the American Medical Association — one of the most powerful trade groups in the entire healthcare industry. This cabal wields its influence to favor costly specialty care over primary care, and the prices of physician services skyrocket, year after year.,
Another way that doctors inflate their own salaries is by legally barring nurses, chiropractors, naturopathic doctors, and other health professionals from practicing at the full scope of their medical training. Although many states have taken measures to shift “scope of practice” laws, over 76% of non-physician health workers currently face restrictions — at the American consumer’s expense. For example, occupational licensure regulations that require nurse practitioners to be supervised by MDs when prescribing drugs increase physician wages by about 7%, with a corresponding increase in consumer costs.
Finally, consider the pharmaceutical industry. In what most regard as a Faustian bargain, the Obama administration secured the pharmaceutical industry’s support for the ACA by barring Medicare from negotiating the price of pharmaceutical drugs. Consequently, prices for physician-administered drugs grew at a compound annual rate of 10.1%, and prices for prescription drugs grew at a rate of 11.3% from 2013–2017. Drug manufacturers also engage in profiteering by gaming intellectual property law. The intended lifespan of a pharmaceutical patent is 20 years. But for the 12 best selling drugs in the United States, drug makers file hundreds of patent applications, extending their true patent exclusivity to 38 years! Prices have increased by 68% since 2012 for these blockbuster drugs.
As consumers and taxpayers, Americans not only generate enormous piles of lucre for healthcare corporations but effectively subsidize healthcare costs for the rest of the world. Here, as in so many other industries, lobbyists use traditional financial contributions to open doors, and then manipulate politicians and regulators with a typhoon of misinformation and scare tactics. As Congress debated the Affordable Care Act in 2009, there were six registered healthcare lobbyists swarming Capitol Hill for every one member of Congress. Think-tanks and patient advocacy groups make some headway in reforming our healthcare system each year, but crony capitalists in American healthcare have an overwhelming advantage.
Tort litigation is lawsuits about harms that violate civil, not criminal law. The field emerged in the late 19th century and won a series of major victories in the 1960s and 1970s under the banner of Ralph Nader’s consumer protection movement. Today the trial lawyers’ lobby is closer to a cartel aimed at extorting businesses than a consumer advocacy lobby aimed at keeping Americans healthy and safe.
In the past decade, lawyers and law firms have spent $780 million on federal campaigns, and $725 million on state campaigns. The chief trial lawyer industry group is the American Association for Justice, which often funds million-dollar campaigns to defeat tort reforms and instead elect lawyer-friendly state judges to the bench. These judges then hand down verdicts which expand the grounds for new tort lawsuits. In addition, the AAJ lobbies for state legislation to expand definitions of consumer fraud, eliminate statutes of limitation on tort claims, outlaw arbitration clauses in employment contracts so they can force cases to trial, and facilitate “legal fishing” expeditions which allow tort lawyers subpoena documents on the shakiest of grounds.
The result of these crony lobbying efforts is an entire sub-industry of lawyers who bring tort lawsuits with little pretext save to enrich their own practices. The class-action settlement rate is an abysmal 33%, which is lower than tough federal cases, but lawyers persist in suing American companies in the wild hope that they’ll win and take a lucrative cut of the payout. For top personal injury lawyers and other varieties of tort litigators, payouts are lucrative indeed. By some reports a hundred or more trial lawyers are currently flying around the country on their own private jets.
The destructive effect of tort litigation is obvious when one considers the social cost of medical malpractice lawsuits. The annual administrative expenses associated with the medical liability system are $4 billion per year, and malpractice liability payments are $5.7 billion a year. Some of these cases are clearly warranted. But the true cost of medical malpractice suits is that doctors are incentivized to practice defensive medicine and order extraneous and unnecessary services in order to minimize their legal liabilities.
A recent study by Jonathan Gruber, one of the principal architects of the Affordable Care Act, investigated the Military Health System, where doctors are often immune from liability for medical malpractice. Gruber found that the intensity of inpatient care for active-duty patients (who may not sue their doctors) is approximately 5% lower than the intensity of care for non-active duty patients, or soldiers who receive care in private civilian facilities — with no difference in health outcomes. In particular, doctors exempt from liability tended not to prescribe useless, expensive diagnostic tests.
Broadening this result to the general economy suggests that medical malpractice suits alone are easily responsible for tens of billions if not over a hundred billion dollars in pointless damages and legal fees per year. Speculative tort lawsuits in other sectors account for tens of billions more in societal resources squandered on lawsuits rather than productive ventures. Despite the claims of tort reformers, when the country is subject to rule by trial lawyers, it is the American consumer who ultimately loses.
Public Sector Unions
Public sector unions may not qualify as capitalist, but they are certainly crony. Government employee unions have a zombie grip on our political apparatus. Groups such as prison guards, firemen, clerks, and teachers’ unions typically coerce government employees into paying union dues which are then used to elect union-friendly politicians and bully incumbent politicians into passing legislation that favors union interests. It’s political patronage, pure and simple.
The makeup of unionized workers in America is shifting. 2009 marked the first year that public sector union employees outnumbered private sector union employees, 7.9 million to 7.4 million. Between 1960 and 1980, the portion of full-time unionized public employees jumped from 10% to 36% of the public-sector work force. The American Federation of State, County, and Municipal Employees (AFSCME) grew from 99,000 members in 1955 to just under 1 million members and the American Federation of Teachers grew from 40,000 to more than half a million members.
Public sector unions are now wildly powerful players in American politics and have become extraordinarily successful at securing crony benefits for their members. In general, the salaries of public sector union members are anywhere from 17–37% higher than their private sector counterparts, and government employees make $14 more per hour in total compensation than private sector workers. Between 2000 and 2008, the price of state and local public services has increased by 41% nationally, compared with 27% for private services. But the larger problem is that government employees retire at early ages to receive taxpayer-funded pensions for the rest of their lives.
Consider the example of the California Correctional Peace Officers Association (CCPOA). The CCPOA has extensively lobbied the state government to build new prison facilities, increase the number of prison guards in the state’s employ, and give prison guards and parole agents cushy salaries, benefits, and pension plans. Between 1980 and 2000, California constructed 22 new prisons for adults, and by 2006 the average prison guard made over $100,000 annually with overtime. Corrections officers can retire at 50 and take 90% of their salaries for the rest of their lives. Today a full 11% of the state budget — more than the state spends on higher education — goes to the California penal system.
Public employee pensions are frighteningly underfunded. Unlike a traditional 401k, public employee pensions pay defined benefits to pensioners, regardless of how the market is performing. And public employee pensions typically use over-optimistic projected returns and discount rates, promise an unreasonably high level of benefits to pensioners, and then have to revise the expected rate of return downwards, increasing total liabilities drastically. For instance, the two largest public employee pensions in California — CalPERS and CalSTRS — initially projected returns of 7.5% but gradually revised that number to 7%, with the result that expected liabilities miraculously doubled. Actual returns are even lower.
Pension liabilities are stripping revenue away from our basic government programs, even after a decade of stock market growth. For example, Oakland schools recently cut their budget by $15 million after a 30% state tax increase. Pension costs have forced cities into insolvency in many states, and in a completely unprecedented development the entire state of Illinois may now go bankrupt, despite high tax rates., Estimates of total unfunded liabilities for state and local pensions range around $5 trillion. Unless we take immediate steps to rectify this problem, government employees are in for major benefit cuts over the next decade.
A final example of crony capitalism is the capture of local government by owners of urban real estate. Nowhere is the division between insiders and outsiders clearer or more literal than in housing. In many of America’s most dynamic cities, wealthy insiders have labored to prevent outsiders from moving into those cities. “NIMBY” (“Not in My Back Yard”) homeowners aim to create a false scarcity of land in order to retain the historic character of their neighborhoods and protect their home values against competition from new developments.
Although only 3% of America is urbanized, NIMBYs have used zoning and permitting requirements to make hundreds of millions of acres around cities effectively off-limits to new building. Some of these insiders have seen their properties appreciate by four or five times their original values, while outsiders must pay between four or five times the amount of rent or suffer torturous commutes to access opportunities in American cities.
It wasn’t always this way. For most of American history, a new home cost about three times the average family’s income. As incomes climbed, families bought bigger and better homes, but the proportion of their income going to housing stayed the same. Beginning in the 2000s, housing suddenly spiked to five times a family’s income. Many commentators described this phenomenon as a housing price bubble attributable to Americans gorging on cheap loans. Now we know the truth.
Most of American cities never saw a housing price “bubble,” because they never restricted new development. Today, just as before 2008, housing around Austin, Texas, or Columbus, Ohio, still costs about three times average income. Yet in a handful of cities, such as San Francisco, New York, or Boston, homes cost from five to nine times a families’ income! These cities’ prices have already surpassed their peak during the “bubble,” and will continue rising as long as these cities keep restricting new development.
While long-time residents of these cities have made millions off their appreciated housing, the rest of America remains locked out of these dynamic regions. One recent paper estimated that just removing housing restrictions in the Bay Area and New York would increase the average American family’s annual income by $2,000, due to increased competition for high-quality jobs. NIMBYs don’t just hurt local renters and would-be homeowners, they cripple the entire economy.
Too frequently our elected leaders describe American politics as a grand struggle between the forces of good and evil. This kind of mythological rhetoric obscures the true nature of the complex systems at work in our economy. The central problem facing our economy is the way in which private corporations and individuals interact with the different faces of our government.
The problem is not that conservatives or progressives are evil but rather that our economic system and mode of government gravitate towards an equilibrium in which special interests have captured our political institutions. As the case of NIMBYism so clearly illustrates, the problem isn’t them, it’s you. We are too quick to demonize our fellow Americans and impatiently demand titanic policy reforms. Instead we need to make a conscious effort to identify when we or our employers are milking the political process at the expense of others.
We must work hard to ensure that every level of American government impartially serves the general public and resist the impulse to profit from illegitimate special relationships as a matter of conscience. Both Republicans and Democrats need to find the courage to stand up to special interests, especially the special interests on their own side. A breed of leaders who fight corruption even when it is politically inconvenient to do so could make our country grow and prosper at rates that we haven’t seen in many decades.
There are more instances of cronyism in the American economy than any essay could indict. The threat today is that our government is silently lapsing by degree into a feudal order in which special interest cartels dictate the economic life of our people. To achieve another century of economic progress and preserve the integrity of our republic, we must combat crony capitalism in every branch and jurisdiction of American government.
 In 2017, for example, the total DoD budget was $605.7 billion of which $320 billion went to private contractors. See: Schwartz et al. “Defense Acquisitions: How and Where DOD Spends Its Contracting Dollars.” Congressional Research Service, July 2, 2018.
 Hartung, William. “Prophets of War.” Nation Books, 2012. p.136
 Taibbi, Matt. “The Pentagon’s Bottomless Money Pit.” Rolling Stone, March 17, 2019.
 Cooper et al. “Politics, Hospital Behavior, and Health Care Spending.” Cowles Foundation, Yale University. August, 2017.
 For example, the RUC set the price of an arterial stent at $12,000, despite the fact that it’s a simple procedure that could be performed in a doctor’s office. The number of stent implants performed nationally increased by 70% in the next few years. See: Glock, Judge. “How Physicians Write Their Own Paycheck: The Relative Update Committee.” The Cicero Institute, April 28, 2019.
 Poses, Roy. 2011. “Conflicts of Interests Among the RUC’s Members,” Health Care Renewal.
 Kleiner et al. “Relaxing occupational licensing requirements: analyzing wages and prices for a medical service.” NBER, February 2014.
 Lieberman, Steven and Paul Ginsburg. “CMS’s International Pricing Model for Part B Drugs: Implementation Issues.” Health Affairs, July 9, 2019.
No matter who holds power, individuals and groups have the right to spend money to communicate their ideas.
Since the landmark political-speech case Citizens United v. FEC (2010), there has been broad public support for campaign-finance reform, fueled by a deep suspicion of both politicians and moneyed interests. According to a Gallup poll before the 2018 midterm election, more than half of Americans view members of Congress as corrupt and beholden to special interests rather than to their constituents. Nothing has exacerbated those concerns so much as the decision in Citizens United, which empowers corporations and unions to advocate for political candidates and positions, so long as their efforts are not coordinated with candidates.
Many Americans are legitimately worried about special interests and corporations using campaign spending as a quid pro quo to gain political access and influence. Elections do need appropriate oversight. But we must be careful that oversight does not come at the cost of our constitutional right to speak, or — what is a necessary corollary of that right — our ability to spend money to use or build media platforms that communicate our ideas.
The first oral arguments of Citizens United demonstrate the unanticipated perils of campaign-finance regulations for speech. In that case, Chief Justice Roberts asked the federal government’s solicitor general whether some books could be banned under the current law: “It’s a 500-page book, and at the end it says, and so vote for X! The government could ban that?” The solicitor general, to the shock of the Court, affirmed that, under the current law, such a book could be banned and the author imprisoned. This exchange explains why the unconstitutional restrictions on political speech were overturned.
Our Founders understood that free speech helps protect Americans no matter who holds power. The Citizens United decision is a natural extension of the rights of individuals to speak freely; anything less would have betrayed the very concept of the First Amendment. As law professor John McGinnis wrote in the Los Angeles Times in 2016: “If the 1st Amendment protects an individual’s right to speak, then why . . . shouldn’t a group of individuals, banded together in a partnership or other association, also enjoy that right? And if an association has that right, why would it lose it when it takes corporate form?” Lest we forget: In 1964 it was a corporation, the New York Times, that fought for its constitutional right to publicly criticize racist government officials with impunity, and it won that right in the famous Supreme Court case of New York Times Company v. Sullivan.
The freedoms afforded to the press and to corporations are intimately tied to the freedoms of citizens to speak without restriction. If money cannot be used to make political statements, then the government can regulate who can buy or start media companies, and it can censor what kinds of statements and endorsements media companies and their investors can make and when. This means that independent journalism requires the liberty to spend money freely. One need only look to our own history to understand that governments cannot be trusted to impartially regulate the press. After passage of the Alien and Sedition Acts of 1798, Federalist-party officials prosecuted Democratic-party journalists who opposed them. Imagine that your political adversary is in charge of the government agency regulating the media’s political activities. Do you trust the government to make decisions about which news is fit to print?
It can be tempting to restrict political spending in order to make American politics “more fair.” But the dangers of arbitrarily silencing people with political-speech laws are far greater than the risks associated with disproportionate influence. Giving everyone an “equal voice” without violating everyone’s fundamental rights is an impossible chimera. Wealthy people can afford to advertise their views, but they are not the only ones with outsized influence — others are able to shape perception through media or academic channels or to attract attention through their celebrity. The only way to equalize all speech would be to forbid all of it.
Contrary to the rhetoric of reformers, campaign-finance reforms often benefit the already powerful and well-connected elite. Special interests that have longstanding relationships wield a far more extensive arsenal of influence — political networking, nepotism, the revolving door, etc. — than simple campaign donations. In many cases, money is one of the few tools that grassroots advocacy groups and candidates have to employ in politics. The campaigns of independent and third-party candidates such as Ross Perot and Theodore Roosevelt (in 1912), who appealed to and performed strongly among voters from across the political spectrum, were possible only through substantial initial funding by private donors. If citizens were not permitted to use money to amplify their speech to take on the politically entrenched, the result would be disastrous for the American experiment in democracy: an ossified ruling class.
It is important to remember that ideas, not money, are the most powerful form of influence — and it shows in political-spending numbers. It might be surprising that heated elections such as those in 2016 elicited only about $6.5 billion in total campaign expenditures, which included spending by presidential candidates, Senate and House candidates, political parties, and independent interest groups. That is less than 0.2 percent of the federal government’s spending in just a single year. Given the stakes of control over the federal government, it is almost alarming that, as George Will has pointed out, U.S. presidential contests cost only about as much as Americans spend annually on Easter candy.
The reason there is so little money in politics is that in most races, cash is irrelevant to electoral results. As many as 80 to 90 percent of congressional races are “effectively predetermined” by factors such as the district’s partisan makeup and incumbency advantage — symptoms of gerrymandering, unlimited tenure, and other important, tangential issues. While advertising can help achieve basic name recognition early in campaigns, returns diminish quickly thereafter and rarely shift votes. In 1994, Stephen Levitt, the co-author of Freakonomics, did a famous study of congressional elections in which the same two candidates had faced each other more than once but who spent different amounts of money each time; Levitt found that a 50 percent increase in spending by one candidate caused only a 0.33 percent change in the vote. Moreover, political donations do not seem to sway legislators in favor of special interests. In a recent study, John Matsusaka of the University of Southern California found that at least 65 percent of the time, a legislator’s voting aligns with the wishes of the majority of constituents and that, in the remaining 35 percent of the time, voting most often aligns with the individual ideology of the politician rather than with the interests of their largest donors alone.
Rather than succumb to popular hysteria about money in politics, we ought to take a more philosophically rigorous view of the issue. Our Founding Fathers, while noting the potential danger of special interests, still believed that “factions” must play a role in democratic debate. James Madison and others understood that any attempt to abolish factionalism would limit freedom. In Federalist No. 10, Madison wrote that “liberty is to faction what air is to fire, an aliment without which it instantly expires. But it could not be less folly to abolish liberty, which is essential to political life, because it nourishes faction, than it would be to wish the annihilation of air . . . because it imparts to fire its destructive agency.”
The same must be said of speech.
Instead of eliminating the influences of special interests by restricting the liberties afforded to all citizens, in a large and diverse republic, Madison suggested, factions of citizens would compete to advance their ideological agendas. Adversaries such as the National Rifle Association and the Brady Center seek to organize like-minded citizens and rally political support through policy research, fundraising, advertising, and other means. Corporations and industry trade groups offer policy prescriptions that are then contested by non-governmental organizations and academics who rigorously analyze the policy prescriptions offered by those corporations.
Most political expenditures by interest groups aim to inform and excite the American public through legitimate avenues. Citizens who may oppose a competing interest should not silence that interest through legal restriction but rather signal their commitments by volunteering, contributing, and voting for their preferences. The importance of this approach is emphasized by the fact that some of the most effective special interests, such as the American Hospital Association, influence politicians primarily through slanted research, not financial contributions. Only about 2 percent of the AHA’s budget is spent on campaign contributions, but this understates its electoral activities, since AHA can mobilize hundreds of doctors for political efforts in a given congressional district without spending any money at all.
Even so, citizens should be vigilant and pay attention to the way that politicians interact with money, but the best way to moderate those interactions is to make them transparent. An example of this kind of reform is the un-adopted amendment that Representative Rodney Davis (R., Ill.) attached to to H.R.1 — the For the People Act of 2019, a campaign-finance-reform bill that the House passed this spring and that is unlikely to pass the Senate. Davis’s amendment would help voters know if their representatives’ campaigns are being financed largely by groups outside their district. Given access to information about campaign-finance expenditures, voters would be empowered to discern what constitutes unsavory politics and what does not. Imagine if all members of Congress wore NASCAR suits that labeled all of the major special interests that supported them — don’t you think lawmakers would start acting differently? As law professor Bradley Smith pointed out in 2010 in an essay in National Affairs, politicians are not obstinate: “Votes — not dollars — are what ultimately get put into ballot boxes. And it would make little sense to anger one’s constituents for a contribution that can only be used to try to win those constituents back.”
Madison believed that we should trust the ability of citizens to make political decisions to elect “fit characters” or to vote out unfit representatives. No amount of money can overcome the voter’s ultimate power. Fortunately, the Supreme Court in Citizens United maintained faith in the American citizen, declaring that “the right of citizens to inquire, to hear, to speak, and to use information to reach consensus is a precondition to enlightened self-government and a necessary means to protect it.”
Our citizens today are enfranchised irrespective of race, sex, and creed. We are, in this respect, more fit to make political decisions than any those in any previous political epoch. American citizens are afforded liberties by our forefathers, because the founders of our nation had confidence in their posterity to use and protect them wisely. The Founding Fathers did see the potential problems that liberties — those of citizens and of factions of citizens — could present a republic. Yet they knew that the freedom to speak was the foundation of any successful republic, and that any cure for the so-called problems of speech — as with other forms of liberty — would be worse than any of its associated illnesses.
Why the Public Should See PBM Prices
Joe|May 30, 2019
“What Congress should not do is heavily regulate the PBM industry by establishing hundreds of rules about how PBMs are allowed to profit from their business. This kind of Soviet, top-down approach is a terrible way to run an economy, and PBMs will inevitably find ways to game the system. Price transparency is a simpler, more American solution.”
Price-signaling is the backbone of a free market. Prices allow customers, businesses, and investors to decide when there is too much or too little of some good, and to bargain if a good is too expensive. At the bottom of what Adam Smith called the “invisible hand” and Hayek called “spontaneous order” are trillions of price signals from different actors, coordinating the ways that we work together and serve one another.
Piles of academic research have shown that transparent pricing makes goods cheaper for consumers and forces producers to be more efficient. For example, studies of advertising bans in areas from lawyers’ services to eyeglasses show that open price competition brings down costs for all. And a recent study of the relatively noncompetitive hospital market shows that price disclosure brought elective surgery prices down by 5%.
If prices are the code that runs our economic machine, we can fairly say that the Pharmacy Benefit Manager (PBM) industry is a system failure. Because America’s PBM industry is heavily concentrated — with three companies controlling 85% of the market — PBMs have been able to refuse to disclose prices to the insurers, manufacturers, pharmacies, and end consumers that they deal with. This corrupt arrangement is directly responsible for 10s of billions of dollars of waste every year. Here are a few ways that it happens:
PBMs supposedly negotiate on behalf of insurance companies with drug manufacturers to secure lower real prices on drugs. Rather than asking for a lower “list price” for a drug, the PBM accepts the manufacturer’s list price and then the manufacturer gives the PBM a rebate, some of which is passed on to the insurer, and some of which the PBM takes as a cut.
The issue is that rebate contracts between drug companies and PBMs are protected as “trade secrets.” PBM customers — including Medicare, private insurers, and even their auditors — typically can’t see the terms. Because insurance companies don’t know how much of a cut PBMs are taking, they can’t tell if the PBM “formularies” favor high cost or low-cost drugs or how much money PBMs are making on any particular drug. Right now, insurance companies can’t push back against abusive rent-seeking. If prices were transparent, they could.
When I go pick up a drug at a pharmacy, the pharmacy is reimbursed by a PBM. The PBM then charges the insurer for the drug. But PBMs routinely charge insurers and government payors way more than they reimburse pharmacies — a practice known as “spread pricing.” A small mark-up would be nothing out of the ordinary, but a recent Bloomberg report found that spreads are sometimes over 1,000%.
The problem is that because PBM-pharmacy contracts are opaque, insurers don’t know how badly they’re being fleeced. And it’s not just private insurance companies who are getting hosed, it’s federal tax payers. In a study of 90 drugs, (including 500 dosages and formulations), the same researchers found that PBMs and pharmacies siphoned off $1.3 billion of the $4.2 billion Medicaid insurers spent on the drugs in 2018. In a competitive market, this kind of egregious profiteering would not exist. Insurers would insist on paying the same price that PBMs reimburse pharmacies, maybe a small service fee attached.
3)The Maximum Allowable Cost List
Another way PBMs manipulate the pharmaceutical drug industry is by refusing to signal prices to pharmacies before the pharmacy sells someone a medicine. Instead, PBMs reimburse pharmacies after the pharmacy has sold a consumer a drug at a rate set on something called the “Maximum Allowable Cost” (MAC) list.
The MAC list is protected as a trade secret, so pharmacies never know what they’ll be reimbursed. Often PBMs reimburse pharmacies at well below the real cost of the drug, and the pharmacy will have to eat the loss — and as representative Doug Collins has argued, PBMs remorselessly use this technique to drive independent, mom-and-pop pharmacies out of business. If MAC pricing formulas were available in advance, pharmacies would be able to determine whether filling a particular prescription is profitable, could insist on the same prices that PBMs award other pharmacies, and could band together to negotiate with the Big 3 PBMs.
These examples illustrate how PBMs use trade secrets to play a shell game with insurers and pharmacies. To be clear, they aren’t the only ways PBMs exact their toll on the pharmaceutical industry — there are ex post facto “direct and indirect remuneration” (or “claw-back”) fees, “administrative fees”, favoring the pharmacies they own with exceptionally low prices, etc.
The problem is that the PBMs are so big and so powerful that they’ve been able to get away with obviously anti-competitive behavior. And the industry has only continued to consolidate, with major mergers between CVS and Aetna and between Express Scripts and Cigna announced last year. It would be no easy task for other industry players to hold PBMs to account in ordinary circumstances. Allowing PBMs to conceal prices in trade secret contracts fundamentally cripples the pharmaceutical drug market’s ability to hold PBMs accountable for their ill-gotten gains.
The Senate recently passed a bill that outlawed “gag orders” by which PBMs kept pharmacists from informing consumers if a cheaper option was available. Concealed prices are a gag order on the entire pharmaceutical industry and must be rejected on the same grounds.
Some organizations, such as ALEC, argue that a market is not truly “free” unless market actors such as PBMs can protect price information as a “trade secret.” We strongly disagree. The purpose of intellectual property law is to allow entrepreneurs to claim ownership over real innovations which improve the lives of human beings in new and beautiful ways, not to allow cartels to secretly price gouge their business partners.
Congress must demand that PBMs disclose rebates on a per-drug basis, administrative fees received from each client, pricing formulas for pharmacies, spread prices, and more. In short, Congress should insist that PBMs disclose every economic transaction they engage in, whether with insurers, manufacturers, pharmacies, wholesalers, or any other possible member of the pharmaceutical industry. The only way to subject PBMs to market discipline is to make every net price available to the public.
One of the few areas that the Trump administration, the Republican Senate, and the Democratic house agree on is the need for more price disclosure in the health care market — and with good reason. As Stanford’s Robin Feldman writes, “markets, like gardens, grow best in the sun. They wither without information.” Forcing sunlight into the dark recesses of the PBM market will empower consumers, health insurers, and others to negotiate better prices and check the power of this questionable oligopoly.
What Congress should not do is heavily regulate the PBM industry by establishing hundreds of rules about how PBMs are allowed to profit from their business. This kind of Soviet, top-down approach is a terrible way to run an economy, and PBMs will inevitably find ways to game the system. Price transparency is a simpler, more American solution.
Republicans should agree that market competition and an informed public are two of our greatest strengths as a civilization. We urge lawmakers to have the courage to insist on them in the areas of our economy where they are needed most.
 D. Andrew Austin and Jane Gravelle, “Does Price Transparency Improve Market Efficiency? Implications of Empirical Evidence in Other Markets for the Health Care Sector,” Congressional Research Service, Order Code RL34101, July 24, 2007, https://fas.org/sgp/crs/secrecy/RL34101.pdf
The Soviet Temptation: A Note to the Board of the AEI
Joe|April 15, 2019
…But ’tis a common proof,
That lowliness is young ambition’s ladder,
Whereto the climber-upward turns his face;
But when he once attains the upmost round.
He then unto the ladder turns his back,
Looks in the clouds, scorning the base degrees
By which he did ascend. So Caesar may.
Then, lest he may, prevent. And, since the quarrel
Will bear no colour for the thing he is,
Fashion it thus; that what he is, augmented,
Would run to these and these extremities:
And therefore think him as a serpent’s egg…
-Brutus, Act II Scene I, Julius Caesar
Our government is plagued by polarization, gridlock, and special interest capture which — combined with an overgrown administrative state and poor policy in many sectors — stall economic mobility and meaningful social progress. In this atmosphere, it’s intellectually tempting for policy thinkers to seize the reins of government and dictate technocratic solutions from the helm. Indeed, a virulent strain of top-down thinking has infected our nation’s capital. But the marketplace of ideas cannot function if constrained to legislators, regulators, and the small cluster of think tanks in their orbit.
It’s a tautology that any government action is top-down, but if it’s agreed that government is going to be involved in an industry, the highest and most effective role of government in a free society is to enable bottom-up, entrepreneurial innovation to solve the issues at hand. Rather than dictate how a sector should be run top-down, our policy goals should include creating frameworks that give entrepreneurs aligned incentives and maximal flexibility to experiment to achieve the agreed upon ends. Academics and policy makers do not have a monopoly on clever ideas and good judgment. They must abandon their hubris and instead champion policy frameworks that inspire and enable entrepreneurial individuals everywhere to improve education, healthcare, criminal justice, and other areas of society.
Although we support academic freedom, AEI’s role is to promote a certain set of values and we humbly suggest that it is the role of the board to remind its scholars of these values from time to time.
By way of example, a popular candidate for policy reform is America’s higher education system. Many colleges and universities are not preparing students for the workforce, as evidenced by the 2.5 million STEM jobs that will go unfilled in 2018.  400,000 Associates of Arts students a year graduate from arts and identity studies programs with minimal prospects for either a job or a bachelor’s degree. Other reports find that many employers are unable to fill jobs because students are being steered into bachelor’s degrees instead of trade schools. Meanwhile, 8 million Americans are currently in default on their student loans, and total student loan debt has reached a dizzying $1.4 trillion.
Untethered subsidies to higher education institutions ruled over by a large centralized bureaucracy are a failed experiment in Soviet-style economics. Regulatory restrictions on which programs qualify for accreditation chill experimentation with apprenticeships, competency-based education programs, and other kinds of skills-based pedagogies. Instead, approaches that take into account the values and lessons of free enterprise would tie funding to specific quantitative goals such as higher average salaries over the years after college or higher percent employment rates. These metrics would incentivize entrepreneurs to innovate, compete, and profit when they succeed, or lose when they fail. The greater the aligned profit opportunity, the greater our success will be at making students successful.
There are many areas for values-aligned scholars to disagree and innovate. If the Federal government is going to spend money on education, perhaps it should grant money to state governments to experiment with rewarding schools for pioneering new techniques that successfully prepare their students for the workforce. An intelligent policy that solders school revenues to real student outcomes would allow creative new ideas to filter into our education system, first through vocational schools and then through traditional forms of higher education.
For decades the American Enterprise Institute has proudly advanced the ideals of free enterprise and a “pluralistic, entrepreneurial culture.” At the heart of the AEI’s commitment to enterprise is the understanding that great ideas come from unexpected places. Enterprise thrives in a system where truly innovative products go viral, and visionary entrepreneurs are rewarded for their unique contributions to human life. Competitive markets are an effective sieve for groundbreaking insights because they are open to all comers and generate ideas from the bottom-up.
AEI is rightfully admired for drafting sound policy suggestions across most facets of American government — producing genuinely bottom-up reform proposals across various policy areas, not just in education but also in healthcare, where AEI scholars have expounded value-based, preventive models that would deliver cheaper, higher quality health services to Americans.Unfortunately, we are beginning to see symptoms of top-down thinking in AEI scholarship. This bias is most apparent in the AEI coverage of criminal justice reform, which seems to have fully surrendered to the Soviet mindset and makes technocratic judgments about which rehabilitation techniques to employ rather than advocating a systemic overhaul that aligns enterprise profits with developing creative solutions to recidivism from the bottom up. But AEI’s scholarship on higher education has also displayed an anti-market drift.
At their best, AEI’s papers on higher education recommend bottom-up innovation and competition by holding schools directly accountable for preparing students for the workforce. But in a recent series, several AEI scholars argue that the federal government should tie funding to student completion rates. This is a shortsighted, top-down strategy for mending our higher education system. Incentivizing colleges and universities to graduate as many students as possible turns schools into degree mills, corroding the value of the college degree as a signaling mechanism. As noted, degree completion often bears no relation to a student’s prospects for a successful career after graduation. This suggestion is not merely questionable policy; it goes entirely against the values and principles of AEI. The authors should be reminded to consider why liberty and free enterprise work and are a key part of our values.
These are minor examples, but working from the heart of DC, it’s very tempting to go along with the status quo and start prescribing top-down solutions. Emphasis on arbitrary intermediate metrics rather than ultimate social ends is characteristic of top-down policy thinking and inconsistent with the modest, democratic spirit of free enterprise. The leaders on the board of the American Enterprise Institute must take a stand for the values of enterprise and liberty and make sure that AEI scholars are advancing the Institute’s founding principles. Education in America will continue to be suboptimal until it embraces the principles of liberty and open innovation. The only major education reforms worth supporting are those that harness our shared values, such as frameworks that enable entrepreneurial teachers to compete, experiment, and innovate to better prepare students to succeed in the labor market — scaling the ideas that work and eliminating the schools that do not.
In translating these values into concrete policy, AEI researchers have much to explore and map out. Instead of a traditional income sharing agreement — which lends money to an individual student — the federal government could directly fund educational institutions themselves, for instance, and easily match existing IRS data on per-student educational program spending with the future salaries of students. Schools that produce high-earning graduates could then be allowed to take more students on government loans. There are many new ways for markets to work here.
Injecting entrepreneurial energy into a space is always superior to regulating it from above. While initial school credentialing is inescapable, it should be permissive. Educational institutions themselves should be the ultimate arbiters of which programs receive grant funding, not distant bureaucrats. Of course, colleges and universities will naturally be incentivized to cherry-pick the best students. Federal grants could adjust to reflect quantitative assessments of students’ parents’ salaries in order to create opportunity for the socio-economically challenged in a market-driven way. One course of study for AEI scholars is to consider how exactly to construct the rewards scale for different students. It may take several years to determine if a graduate will attain a high salary in the workforce, but as long as the reform doesn’t become a political football, the federal government and financial markets can disintermediate risks over medium timeframes.
Enabling entrepreneurial solutions instead of top-down techniques doesn’t mean that scholars can’t suggest ideas or give examples of what entrepreneurs might do — they just can’t prescribe exact implementation methods. In this new, competitive system, colleges and universities could try out various approaches such as:
Addressing quantified skills gaps by focusing on professions such as vocational nursing, K-12 education, and construction — and teaching work-ready skills.
Partnering with large corporations in need of new recruits; using industry certification programs to communicate with potential employers instead of traditional credentials; developing databases of regional businesses and their hiring needs.  Most mid-to-large companies would love dedicated recruiting programs, but do not currently have them.
Offering classes in the evenings when continuing-education students such as single moms and full time workers can actually attend them. Today, 30% of undergraduates in America are over the age of 25, and 25% of full-time college students are also working full-time.
Tinkering with the ratio of online educational material to focused physical classroom time or 1-on-1 mentorship sessions; conducting prior learning assessments; concentrating classes into 8-week vs. 16-week terms and seeing what gets results and is profitable for all involved.
Rather than deciding exactly how the industry is going to work, enlightened scholarship will instead recommend a framework that allows schools to independently test which of these strategies work for them, with competition in the marketplace determining what scales. The best solutions for particular student demographics and geographical regions will vary, and the blend of techniques employed by a school will have to fluctuate in real-time in response to changing labor market conditions. A bottom-up, experimental approach is the only way to calibrate curricula to regional idiosyncrasies.
We hope that in the coming years the American Enterprise Institute will maintain their tradition of excellence and generate many other bottom-up, market-driven proposals for reforming higher education and other policy areas. The question is how to set a simple long-term goal, such as student career growth as measured by salary, improved health outcomes, or lower recidivism rates, and unshackle entrepreneurs to compete and innovate towards better solutions. In all domains, leading policy advisors should pair bold systems-thinking with intellectual modesty, and craft policies which embrace unforeseen nuance and local wisdom.
When our scholars eschew enterprise-driven frameworks we should consider reminding them what AEI stands for, and why. When profit incentives are aligned towards appropriate goals, the innovative spirit of free enterprise will always be better at solving complex social problems than edicts from on high.
 Smith, Lamar. “To fill STEM jobs, federal programs need to focus on results.” Committee on Science, Space, & Technology. December 20, 2017.
 Schneider, Mark and Matthew Sigelman. “Saving the Associate of Arts Degree.” AEI,
 McCarthy, Pat. “Leading Practices for the State’s Secondary Career and Technical Education Programs.” Office of the Washington State Auditor. December 19, 2017.
 Levitz, Eric. “We Must Cancel Everyone’s Student Debt, for the Economy’s Sake.” New York Magazine, February 9, 2018.
 Capretta, James and Lanhee Chen. “Yes, there’s hope for health care reform.” AEI, August 31, 2018.
 Streeter, Ryan and Brent Orrell. “Time to Set Politics Aside to Move Ahead on Criminal Justice Reform.” AEI, June 6, 2018.
 Duwe, Grant. “The effectiveness of education and employment programming for prisoners.” AEI, May 2018.
 Robinson, Gerard and Elizabeth English. “Give Prisoners a Second Chance.” AEI, October 18, 2016.
 We were excited to see Naomi Schaefer Riley defend this position in an extremely recent piece, see: Riley, Naomi. “Time for Colleges to Get Some Skin in the Game.” City Journal, September 11, 2018.
 Schneider, Mark and Kim Clark. “Completion Reforms That Work.” AEI, May 2018.
 Turner, Sarah. “The Policy Imperative: Policy Tools Should Create Incentives for College Completion.” American Enterprise Institute, May 2018.
 AEI scholar Sarah Turner briefly contemplates tying federal dollars to default rates on student loans, but worries that default rates are a lagging indicator. In our view, default rates are clearly a superior metric to degree completion. However the best metric is future salary, which is the real, if implicit, outcome at which American higher education aims.
 Monroe Community College in Rochester, NY has begun using this database model. See: Alvarez, Joshua. “The Twelve Most Innovative Colleges for Adult Learners.” Washington Monthly, October 2017.
We have had the privilege of investing in dozens of great entrepreneurs, but we have passed on investments in thousands of others. Because we’re presented with so many investment opportunities, we tend to use heuristics as a first screen. Here are some major red flags that tell us a startup founder might not be somebody we’d want to back:
It’s possible for anyone with a little courage and resourcefulness to find a mutual contact who is willing to introduce them to an investor. If the founder can’t get a warm introduction and instead cold emails us, they don’t understand business development or how the world works.
The founder cites meaningless accolades prominently in their identity (deck, email signature, etc). Many individuals in our society have been programmed to seek badges of high grades and top universities and are stuck on a status-seeking treadmill. For those who crave approval, building a startup is often just another checkbox. Thousands of people win awards like Forbes 30 under 30 and speak on panels at tons of conferences so showing this off suggests both insecurity and questionable motives for a person’s work.
A great leader actively attempts to hire new executives who are clearly superior in key areas. We avoid founders who worry that a more talented hire would supplant them, or who may lack self-awareness about their own strengths and weaknesses and thus fail to understand how new exec hires could fill those gaps.
CEOs who don’t socialize with their teams and insist on rigid separation of “work” and “life” will never be able to build a band of creators who like each other and spend time together both inside the office and out. The best innovative companies consist of people who like each other and play together as well as work together.
Any successful entrepreneur will tell you that most value lies in the execution of any idea; CEOs who aren’t confident in their ability to execute more swiftly and accurately than the competition will not win. We pass on entrepreneurs who are overly worried that their idea will leak or someone will steal it, or spend a lot of time fretting about non-disclosure agreements and suspecting others of treason.
A competent founder will always have an opinion on why the industry they are trying to disrupt is broken. If the entrepreneur does not have a systematic vision of how to reform their industry or is unable to garner the support of successful industry insiders as key advisors for their project, they are unlikely to succeed.
Impressive founders show a track record of clearing their calendars to close key hires and persuading friends and colleagues from previous companies to join them in the future. We are unlikely to bet on an entrepreneur unless they are prepared to spend a huge amount of time recruiting and have attracted talented people from previous projects.
We are highly skeptical of an entrepreneur who has not mastered all the relevant numbers and statistics about his/her company’s performance, the industry, and the competition. Similarly, if a CEO gets defensive or upset when pressed about difficult topics around the business or a round of fundraising — and can’t admit when they have failed or made mistakes — they are unlikely to build a winning company.
Esper is the Future of Governance
Joe|January 16, 2019
8VC traditionally invests in companies that tackle industry-wide problems by reimagining traditional paradigms and helping modernize some of our oldest technological infrastructure. That’s why we invested in and launched Esper, a platform that helps modernize the regulatory process in our oldest and most important institution: government. Esper’s mission is to help government regulators make data-driven decisions.
We witness first-hand as many of our innovative companies struggle to navigate complex regulatory landscapes. Overlapping and sometimes conflicting federal and state regulations can be costly and confusing to even the most seasoned entrepreneurs. Startups, which rarely have a team of lawyers and compliance specialists, often live in a shadow of legal uncertainty and are afraid to ask questions for fear of heightened scrutiny.
Meanwhile, regulators struggle to balance critical administrative tasks with shifting political priorities and urgent health and safety concerns from their constituents. Both federal and state regulatory agencies confront a staggering volume of rules: The Federal Register contains over 100,000 final rules and 1.08 million individual restrictions, and the average state code contains between 100,000 and 200,000 individual restrictions. The sheer scale of work demanded of our agencies means that regulators seldom have time to properly evaluate and update policies with internal data and feedback from citizens, business owners, and other stakeholders.
At present, regulatory data such as cost-benefit analyses, lists of impacted industries, expiration dates, guidance documents, forms, and applications is scattered across the internet in turn-of-the-century websites like this one, or worse, in file cabinets. Regulators typically create a flurry of rules when a law is passed and revisit them only when a new law is enacted or they receive serious public complaints. There is no coordinated operating system to connect regulatory data points and flag which documents are affected by which legal events, so thousands of outdated, duplicative, and contradictory rules have accumulated at the federal and state levels.
It’s a daunting task for policymakers to revise the regulatory corpus. It would literally take years for the average citizen or business owner to parse out which rules apply to them, and recent economic literature has confirmed that regulations slow economic growth by an average of 2% per year. Now more than ever, regulators face pressure by legislatures, governors’ offices, agency heads and others to conduct retrospective reviews and instill safeguards against excessive rulemaking. Many agencies have been ordered to review mountains of rules and conduct better cost-benefit assessments but aren’t sure how to begin.
Whatever one’s politics, making the administrative state more adaptive, intelligent, and transparent is vital for the American economy and for good governance. Indeed, modern software infrastructure with a coherent ontology for regulatory data is necessary to preserve our distinctly American tradition of checks and balances on government. Unless regulators can organize rules for themselves, legislators, and the public, our ship of state will be rudderless and adrift on a dark sea.
Esper is a software platform that allows administrative bureaucrats to run a fair, logical rulemaking process. Our company collates existing digital regulatory data to chart when a rule was last updated, when it will expire, and whether it contains a reference to a repealed law. This detailed analysis allows regulators to swiftly determine where to focus their attention and when they need to create, revise, or eliminate rules. In addition, Esper has built an algorithm that helps regulators compare their rules to similar rules in other jurisdictions (and was thrilled to find that regulators love being able to compete against their counterparts in other states!).
Esper’s product also equips regulators with a suite of tools to draft proposed rules, amend existing rules, and repeal outdated or costly rules. This workflow system is a significant departure from pen-and-paper or Microsoft Word-and-email exchanges. Regulators can now collaborate with each other, save amendments as drafts in a mutual library, and enter important information such as “how much will this rule cost?”, “who will this regulation impact?”, “how many businesses or individuals must comply?”, and “which special interest groups are lobbying to change this rule?”
We are making huge strides in capturing information on affected industries and persons and will ultimately be able to synchronize regulatory data with empirical data on the effects of rules. Esper also allows regulators to hold each other accountable to deadlines and specific goals, such as “update 50% of rules in Texas by the end of 2018.” The next evolution of the product will help agencies to synthesize public comments (e.g. number of complaints vs. encouragements) and enforcement data (e.g. number of penalties levied for non-compliance) to support data-driven policies.
Taken as a whole, Esper’s product features allow regulators to perform their jobs quickly, effectively, and verifiably. Deconstructing complex processes within government agencies allows governors’ offices, legislatures, and independent bodies to hold regulatory agencies to account, set new policy agendas informed by quantitative metrics, and track goals to completion. Government executives can now make more informed decisions about which sectors of an economy to monitor, how to allocate monetary resources and personnel, and when to reward or discipline appointed officials.
Technological infrastructure is transforming the ancient vocation of governance and rebuilding one of the largest, most broken industries in the world according to the principles of common sense. In the recent wave of blockchain enthusiasm we saw an obsession with new modes of governance and representation, from “liquid democracy” to “futarchy”, but we submit that the most important innovations in governance lie closer to home. Esper secured a contract with the state of Kentucky and a pilot in Arizona within a year of its inception, and several other states have expressed strong interest in the product. We’ve been very excited to see the rapid uptake of the product in line with our core investment thesis, but we’re not surprised. Esper’s technology completely revamps existing public policy infrastructure to enable real, living bureaucrats to govern in more thoughtful ways, and measure themselves more carefully against the will of the American people and their elected representatives.
Fix the International Price Index for Part B Drugs
Joe|January 9, 2019
The American federal government spends about $140B annually on prescription drugs. Medicare Part D, which reimburses drugs an American senior would pick up at the pharmacy, accounts for over $100B of this spending. Medicare Part B, which reimburses drugs administered in a clinical setting, accounts for another $28B in spending a year. The federal government relinquished all rights to negotiate the price of Part D drugs in the Medicare Modernization Act of 2003, but fortunately HHS can experiment with different negotiation strategies in Part B.
Medicare Part B covers drugs used to treat cancers, esoteric diseases, and other rare conditions. These drugs are often offered by only a single manufacturer and tend to be much more expensive than other drugs. For example, in 2016 Medicare Part B spent $2.2B dollars on prescriptions of Eylea (a macular degeneration treatment) and $1.6B on Rituxan (which is used to treat certain types of cancer and autoimmune diseases). Part B spending is growing at an alarming 11% annually, compared with 3.2% annually for Part D.
Part B reimbursement operates on a “fee-for-service” model. Manufacturers sell drugs to wholesalers and distributors, who then sell drugs to providers such as physicians and hospital networks. Providers purchase drugs, and then are reimbursed by the federal government through regional “Medicare Administrative Contractors” for the average sales price of the drug (ASP) plus an “add-on fee” worth 6% of the price of the prescribed drug. This “buy-and-bill” system rewards providers for prescribing the most expensive drugs possible, and manufacturers are only too happy to inflate the prices of drugs before selling them to providers. The American taxpayer suffers the costs of this perverse arrangement.
To solve the buy-and-bill problem and drive down the price of drugs, HHS recently proposed a rule that would reimburse vendors (not physicians) at a price determined by indexing reimbursement to the price of drugs in 16 other developed countries. In a price-per-gram comparison of 27 Part B drugs across these countries, HHS found that, on average, Medicare Part B pays 1.8x the average sales price of drugs in other countries. A true international price index could therefore be expected to drive down Medicare Part B expenditures about 45%. According to the proposed rule, the international price index will pilot in 25 states, and roughly $10.5B of annual Part B expenditures will fall within the scope of the program.
So far so good. A true price index would drive international markets for Part B drugs into new equilibria where the US saves billions of dollars a year and it would be more difficult for foreign governments to freeride on American R&D. However a crucial paragraph buried on page 40 of the proposed rule document reveals that HHS actually plans to impose a blunt 30% price control on selected Part B drugs rather than allow drug prices to dynamically respond to prices in the international marketplace. The paragraph reads:
CMS would also establish the model ‘Target Price’ for each drug by multiplying the IPI [International Price Index] by a factor that achieves the model goal of more closely aligning Medicare payment with international prices, which would be about a 30 percent reduction in Medicare spending for included Part B drugs over time, and then multiplying that revised index (IPI adjusted for spending reduction) by the international price for each included drug.
We reread the page a dozen times and were nonplussed when we realized that after defending the virtues of a price index, the authors of the rule actually just plan to multiply the price index by a coefficient to achieve a number that represents a 30% reduction in Medicare Part B payments. We hope that HHS has made a mistake and strongly suggest revising the document so that the price of any Part B drug is just directly pegged to the average of prices in the countries used to create the index. If the real aim of the document is to implement an arbitrary 30% price reduction over time, HHS should eliminate any references to price indices in this document.
A blunt price control defeats the entire spirit and purpose of an international price index, which is to allow prices of drugs to fluctuate naturally in response to aggregate demand and pricing strategies in foreign markets. Even if phased in gradually, a true price index would save taxpayers vastly more money (a ~45% price reduction would save 10–20 billion more than a 30% price index over the next decade). An adaptive index would also closely approximate an actual international market for drugs rather than the arbitrary rigidity of a Soviet price control.
This rule is currently in “advance notice for proposed rulemaking”, which means it must clear three more rounds of internal review and five rounds of external review before HHS can launch the pilot. There is plenty of time to correct this error and remove the paragraphs in question; we encourage HHS to do so.
The pharmaceutical industry is the largest lobby in the country by a huge margin, and PhRMA, the drug manufacturers trade organization, will certainly fight this proposal. In the past it has successfully quashed several promising Medicare Part B pilot studies, including a program that would have paid for cancer drugs at the price of the least costly equivalent (where multiple drugs offer similar efficacy). Nonetheless, we are optimistic that the Trump administration will be able to launch a pilot with a real price index, and are confident that a price index would save Americans billions on physician-administered drugs per year.
 The program will only operate in 25 states and will be restricted to (1) drugs incident to physician services, or 84% of Part B prescriptions and of this class, 2) only biologicals and single source drugs, or 90% of drugs in (1).